[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 2006 Edition]
[From the U.S. Government Printing Office]



[[Page i]]



          26


          Part 1 (Sec. Sec.  1.61 to 1.169)

                         Revised as of April 1, 2006


          Internal Revenue
          
          


________________________

          Containing a codification of documents of general 
          applicability and future effect

          As of April 1, 2006
          With Ancillaries
                    Published by
                    Office of the Federal Register
                    National Archives and Records
                    Administration
                    A Special Edition of the Federal Register

[[Page ii]]

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[[Page iii]]




                            Table of Contents



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

  Title 26:
          Chapter I--Internal Revenue Service, Department of 
          the Treasury (Continued)                                   3
  Findings Aids:
      Table of CFR Titles and Chapters........................    1145
      Alphabetical List of Agencies Appearing in the CFR......    1163
      Table of OMB Control Numbers............................    1173
      List of CFR Sections Affected...........................    1191

[[Page iv]]





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

                     Cite this Code: CFR
                     To cite the regulations in 
                       this volume use title, 
                       part and section number. 
                       Thus,  26 CFR 1.61-1 
                       refers to title 26, part 
                       1, section 61-1.

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

[[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

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    To determine whether a Code volume has been amended since its 
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Register page number of the latest amendment of any given rule.

EFFECTIVE AND EXPIRATION DATES

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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 
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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 
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CFR INDEXES AND TABULAR GUIDES

    A subject index to the Code of Federal Regulations is contained in a 
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the revision dates of the 50 CFR titles.

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appearing in the Code of Federal Regulations.

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[[Page vii]]

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register. The NARA site also contains links to GPO Access.

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

April 1, 2006.

[[Page ix]]



                               THIS TITLE

    Title 26--Internal Revenue is composed of twenty volumes. The 
contents of these volumes represent all current regulations issued by 
the Internal Revenue Service, Department of the Treasury, as of April 1, 
2006. The first thirteen volumes comprise part 1 (Subchapter A--Income 
Tax) and are arranged by sections as follows: Sec. Sec.  1.0-1.60; 
Sec. Sec.  1.61-1.169; Sec. Sec.  1.170-1.300; Sec. Sec.  1.301-1.400; 
Sec. Sec.  1.401-1.440; Sec. Sec.  1.441-1.500; Sec. Sec.  1.501-1.640; 
Sec. Sec.  1.641-1.850; Sec. Sec.  1.851-1.907; Sec. Sec.  1.908-1.1000; 
Sec. Sec.  1.1001-1.1400; Sec. Sec.  1.1401-1.1550; and Sec.  1.1551 to 
end. The fourteenth 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 1]]



                       TITLE 26--INTERNAL REVENUE




          (This book contains part 1, Sec. Sec. 1.61 to 1.169)

  --------------------------------------------------------------------
                                                                    Part

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

[[Page 3]]



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




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


  Editorial Note: 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.

                  SUBCHAPTER A--INCOME TAX (CONTINUED)
Part                                                                Page
1               Income taxes................................           5

Supplementary Publications: Internal Revenue Service Looseleaf 
  Regulations System, Alcohol and Tobacco Tax Regulations, and 
  Regulations Under Tax Conventions.
  Editorial Note: Treasury Decision 6091, 19 FR 5167, Aug. 17, 1954, 
provides in part as follows:
  Paragraph 1. All regulations (including all Treasury decisions) 
prescribed by, or under authority duly delegated by, the Secretary of 
the Treasury, or jointly by the Secretary and the Commissioner of 
Internal Revenue, or by the Commissioner of Internal Revenue with the 
approval of the Secretary of the Treasury, or jointly by the 
Commissioner of Internal Revenue and the Commissioner of Customs or the 
Commissioner of Narcotics with the approval of the Secretary of the 
Treasury, applicable under any provision of law in effect on the date of 
enactment of the Code, to the extent such provision of law is repealed 
by the Code, are hereby prescribed under and made applicable to the 
provisions of the Code corresponding to the provision of law so repealed 
insofar as any such regulation is not inconsistent with the Code. Such 
regulations shall become effective as regulations under the various 
provisions of the Code as of the dates the corresponding provisions of 
law are repealed by the Code, until superseded by regulations issued 
under the Code.
  Par. 2. With respect to any provision of the Code which depends for 
its application upon the promulgation of regulations or which is to be 
applied in such manner as may be prescribed by regulations, all 
instructions or rules in effect immediately prior to the enactment of 
the Code, to the extent such instructions or rules could be prescribed 
as regulations under authority of such provision of the Code, shall be 
applied as regulations under such provision insofar as such instructions 
or rules are not inconsistent with the Code. Such instructions or rules 
shall be applied as regulations under the applicable provision of the 
Code as of the date such provision takes effect.
  Par. 3. If any election made or other act done pursuant to any 
provision of the Internal Revenue Code of 1939 or prior internal revenue 
laws would (except for the enactment of the Code) be effective for any 
period subsequent to such enactment, and if corresponding provisions are 
contained in the Code, such election or other act shall be given the 
same effect under the corresponding provisions of the Code to the extent 
not inconsistent therewith. The term ``act'' includes, but is not 
limited to, an allocation, identification, declaration, agreement, 
option, waiver, relinquishment, or renunciation.
  Par. 4. The limits of the various internal revenue districts have not 
been changed by the enactment of the Code. Furthermore, delegations of 
authority made pursuant to the provisions of Reorganization Plan No. 26 
of 1950 and Reorganization Plan No. 1 of 1952 (as well as redelegations 
thereunder), including those governing the authority of the Commissioner 
of Internal Revenue, the Regional Commissioners of Internal Revenue, or 
the District Directors of Internal Revenue, are applicable to the 
provisions of the Code to the extent consistent therewith.

[[Page 5]]



                   SUBCHAPTER A_INCOME TAX (CONTINUED)





PART 1_INCOME TAXES--Table of Contents




                      COMPUTATION OF TAXABLE INCOME

  Definition of Gross Income, Adjusted Gross Income, and Taxable Income

Sec.
1.61-1 Gross income.
1.61-2 Compensation for services, including fees, commissions, and 
          similar items.
1.61-2T Taxation of fringe benefits--1985 through 1988 (temporary).
1.61-3 Gross income derived from business.
1.61-4 Gross income of farmers.
1.61-5 Allocations by cooperative associations; per-unit retain 
          certificates--tax treatment as to cooperatives and patrons.
1.61-6 Gains derived from dealings in property.
1.61-7 Interest.
1.61-8 Rents and royalties.
1.61-9 Dividends.
1.61-10 Alimony and separate maintenance payments; annuities; income 
          from life insurance and endowment contracts.
1.61-11 Pensions.
1.61-12 Income from discharge of indebtedness.
1.61-13 Distributive share of partnership gross income; income in 
          respect of a decedent; income from an interest in an estate or 
          trust.
1.61-14 Miscellaneous items of gross income.
1.61-15 Options received as payment of income.
1.61-21 Taxation of fringe benefits.
1.61-22 Taxation of split-dollar life insurance arrangements.
1.62-1 Adjusted gross income.
1.62-1T Adjusted gross income (temporary).
1.62-2 Reimbursements and other expense allowance arrangements.
1.63-1 Change of treatment with respect to the zero bracket amount and 
          itemized deductions.
1.63-2 Cross reference.
1.66-1 Treatment of community income.
1.66-2 Treatment of community income where spouses live apart.
1.66-3 Denial of the Federal income tax benefits resulting from the 
          operation of community property law where spouse not notified.
1.66-4 Request for relief from the Federal income tax liability 
          resulting from the operation of community property law.
1.66-5 Effective date.
1.67-1T 2-percent floor on miscellaneous itemized deductions 
          (temporary).
1.67-2T Treatment of pass-through entities (temporary).
1.67-3 Allocation of expenses by real estate mortgage investment 
          conduits.
1.67-3T Allocation of expenses by real estate mortgage investment 
          conduits (temporary).
1.67-4T Allocation of expenses by nongrantor trusts and estates 
          (temporary). [Reserved]

               Items Specifically Included in Gross Income

1.71-1 Alimony and separate maintenance payments; income to wife or 
          former wife.
1.71-1T Alimony and separate maintenance payments (temporary).
1.71-2 Effective date; taxable years ending after March 31, 1954, 
          subject to the Internal Revenue Code of 1939.
1.72-1 Introduction.
1.72-2 Applicability of section.
1.72-3 Excludable amounts not income.
1.72-4 Exclusion ratio.
1.72-5 Expected return.
1.72-6 Investment in the contract.
1.72-7 Adjustment in investment where a contract contains a refund 
          feature.
1.72-8 Effect of certain employer contributions with respect to premiums 
          or other consideration paid or contributed by an employee.
1.72-9 Tables.
1.72-10 Effect of transfer of contracts on investment in the contract.
1.72-11 Amounts not received as annuity payments.
1.72-12 Effect of taking an annuity in lieu of a lump sum upon the 
          maturity of a contract.
1.72-13 Special rule for employee contributions recoverable in three 
          years.
1.72-14 Exceptions from application of principles of section 72.
1.72-15 Applicability of section 72 to accident or health plans.
1.72-16 Life insurance contracts purchased under qualified employee 
          plans.
1.72-17 Special rules applicable to owner-employees.
1.72-17A Special rules applicable to employee annuities and 
          distributions under deferred compensation plans to self-
          employed individuals and owner-employees.
1.72-18 Treatment of certain total distributions with respect to self-
          employed individuals.
1.72(e)-1T Treatment of distributions where substantially all 
          contributions are employee contributions (temporary).
1.72(p)-1 Loans treated as distributions.
1.73-1 Services of child.
1.74-1 Prizes and awards.
1.75-1 Treatment of bond premiums in case of dealers in tax-exempt 
          securities.

[[Page 6]]

1.77-1 Election to consider Commodity Credit Corporation loans as 
          income.
1.77-2 Effect of election to consider commodity credit loans as income.
1.78-1 Dividends received from certain foreign corporations by certain 
          domestic corporations choosing the foreign tax credit.
1.79-0 Group-term life insurance--definitions of certain terms.
1.79-1 Group-term life insurance--general rules.
1.79-2 Exceptions to the rule of inclusion.
1.79-3 Determination of amount equal to cost of group-term life 
          insurance.
1.79-4T Questions and answers relating to the nondiscrimination 
          requirements for group-term life insurance (temporary).
1.82-1 Payments for or reimbursements of expenses of moving from one 
          residence to another residence attributable to employment or 
          self-employment.
1.83-1 Property transferred in connection with the performance of 
          services.
1.83-2 Election to include in gross income in year of transfer.
1.83-3 Meaning and use of certain terms.
1.83-4 Special rules.
1.83-5 Restrictions that will never lapse.
1.83-6 Deduction by employer.
1.83-7 Taxation of nonqualified stock options.
1.83-8 Applicability of section and transitional rules.
1.84-1 Transfer of appreciated property to political organizations.
1.85-1 Unemployment compensation.
1.88-1 Nuclear decommissioning costs.

              Items Specifically Excluded From Gross Income

1.101-1 Exclusion from gross income of proceeds of life insurance 
          contracts payable by reason of death.
1.101-2 Employees' death benefits.
1.101-3 Interest payments.
1.101-4 Payment of life insurance proceeds at a date later than death.
1.101-5 Alimony, etc., payments.
1.101-6 Effective date.
1.101-7 Mortality table used to determine exclusion for deferred 
          payments of life insurance proceeds.
1.102-1 Gifts and inheritances.
1.103-1 Interest upon obligations of a State, territory, etc.
1.103-2 Dividends from shares and stock of Federal agencies or 
          instrumentalities.
1.103-3 Interest upon notes secured by mortgages executed to Federal 
          agencies or instrumentalities.
1.103-4 Interest upon United States obligations.
1.103-5 Treasury bond exemption in the case of trusts or partnerships.
1.103-6 Interest upon United States obligations in the case of 
          nonresident aliens and foreign corporations, not engaged in 
          business in the United States.
1.103-7 Industrial development bonds.
1.103-8 Interest on bonds to finance certain exempt facilities.
1.103-9 Interest on bonds to finance industrial parks.
1.103-10 Exemption for certain small issues of industrial development 
          bonds.
1.103-11 Bonds held by substantial users.
1.103-16 Obligations of certain volunteer fire departments.
1.103(n)-1T Limitation on aggregate amount of private activity bonds 
          (temporary).
1.103(n)-2T Private activity bond defined (temporary).
1.103(n)-3T Private activity bond limit (temporary).
1.103(n)-4T Elective carryforward of unused private activity bond limit 
          (temporary).
1.103(n)-5T Certification of no consideration for allocation 
          (temporary).
1.103(n)-6T Determinations of population (temporary).
1.103(n)-7T Election to allocate State ceiling to certain facilities for 
          local furnishing of electricity (temporary).
1.103A-2 Qualified mortgage bond.
1.104-1 Compensation for injuries or sickness.
1.105-1 Amounts attributable to employer contributions.
1.105-2 Amounts expended for medical care.
1.105-3 Payments unrelated to absence from work.
1.105-4 Wage continuation plans.
1.105-5 Accident and health plans.
1.105-6 Special rules for employees retired before January 27, 1975.
1.105-11 Self-insured medical reimbursement plan.
1.106-1 Contributions by employer to accident and health plans.
1.107-1 Rental value of parsonages.
1.108-1 Stock-for-debt exception not to apply in de minimis cases.
1.108-2 Acquisition of indebtedness by a person related to the debtor.
1.108-3 Intercompany losses and deductions.
1.108-4 Election to reduce basis of depreciable property under section 
          108(b)(5) of the Internal Revenue Code .
1.108-5 Time and manner for making election under the Omnibus Budget 
          Reconciliation Act of 1993.
1.108-6 Limitations on the exclusion of income from the discharge of 
          qualified real property business indebtedness.
1.108-7 Reduction of attributes.
1.108(c)-1T [Reserved]
1.109-1 Exclusion from gross income of lessor of real property of value 
          of improvements erected by lessee.
1.110-1 Qualified lessee construction allowances.
1.111-1 Recovery of certain items previously deducted or credited.

[[Page 7]]

1.112-1 Combat zone compensation of members of the Armed Forces.
1.113-1 Mustering-out payments for members of the Armed Forces.
1.117-1 Exclusion of amounts received as a scholarship or fellowship 
          grant.
1.117-2 Limitations.
1.117-3 Definitions.
1.117-4 Items not considered as scholarships or fellowship grants.
1.117-5 Federal grants requiring future service as a Federal employee.
1.118-1 Contributions to the capital of a corporation.
1.118-2 Contribution in aid of construction.
1.119-1 Meals and lodging furnished for the convenience of the employer.
1.120-1 Statutory subsistence allowance received by police.
1.120-3 Notice of application for recognition of status of qualified 
          group legal services plan.
1.121-1 Exclusion of gain from sale or exchange of a principal 
          residence.
1.121-2 Limitations.
1.121-3 Reduced maximum exclusion for taxpayers failing to meet certain 
          requirements.
1.121-4 Special rules.
1.121-5 Suspension of 5-year period for certain members of the uniformed 
          services and Foreign Service.
1.122-1 Applicable rules relating to certain reduced uniformed services 
          retirement pay.
1.123-1 Exclusion of insurance proceeds for reimbursement of certain 
          living expenses.
1.125-2T Question and answer relating to the benefits that may be 
          offered under a cafeteria plan (temporary).
1.125-3 Effect of the Family and Medical Leave Act (FMLA) on the 
          operation of cafeteria plans.
1.125-4 Permitted election changes.
1.127-1 Amounts received under a qualified educational assistance 
          program.
1.127-2 Qualified educational assistance program.
1.132-0 Outline of regulations under section 132.
1.132-1 Exclusion from gross income for certain fringe benefits.
1.132-1T Exclusion from gross income of certain fringe benefits--1985 
          through 1988 (temporary).
1.132-2 No-additional-cost services.
1.132-2T No-additional-cost service--1985 through 1988 (temporary).
1.132-3 Qualified employee discounts.
1.132-3T Qualified employee discount--1985 through 1988 (temporary).
1.132-4 Line of business limitation.
1.132-4T Line of business limitation--1985 through 1988 (temporary).
1.132-5 Working condition fringes.
1.132-5T Working condition fringe--1985 through 1988 (temporary).
1.132-6 De minimis fringes.
1.132-6T De minimis fringe--1985 through 1988 (temporary).
1.132-7 Employer-operated eating facilities.
1.132-7T Treatment of employer-operated eating facilities--1985 through 
          1988 (temporary).
1.132-8 Fringe benefit nondiscrimination rules.
1.132-8T Nondiscrimination rules--1985 through 1988 (temporary).
1.133-1T Questions and answers relating to interest on certain loans 
          used to acquire employer securities (temporary).
1.141-0 Table of contents.

          Tax Exemption Requirements for State and Local Bonds

1.141-1 Definitions and rules of general application.
1.141-2 Private activity bond tests.
1.141-3 Definition of private business use.
1.141-4 Private security or payment test.
1.141-5 Private loan financing test.
1.141-6 Allocation and accounting rules.
1.141-7 Special rules for output facilities.
1.141-8 $15 million limitation for output facilities.
1.141-9 Unrelated or disproportionate use test.
1.141-10 Coordination with volume cap. [Reserved]
1.141-11 Acquisition of nongovernmental output property. [Reserved]
1.141-12 Remedial actions.
1.141-13 Refunding issues.
1.141-14 Anti-abuse rules.
1.141-15 Effective dates.
1.141-16 Effective dates for qualified private activity bond provisions.
1.142-0 Table of contents.
1.142-1 Exempt facility bonds.
1.142-2 Remedial actions.
1.142-3 Refunding issues. [Reserved]
1.142-4 Use of proceeds to provide a facility.
1.142(a)(5)-1 Exempt facility bonds: Sewage facilities.
1.142(f)(4)-1 Manner of making election to terminate tax-exempt bond 
          financing.
1.143(g)-1 Requirements related to arbitrage.
1.144-0 Table of contents.
1.144-1 Qualified small issue bonds, qualified student loan bonds, and 
          qualified redevelopment bonds.
1.144-2 Remedial actions.
1.144-3 Standard deduction for individuals choosing income averaging. 
          [Reserved]
1.145-0 Table of contents.
1.145-1 Qualified 501(c)(3) bonds.
1.145-2 Application of private activity bond regulations.
1.147-0 Table of contents.
1.147-1 Other requirements applicable to certain private activity bonds.

[[Page 8]]

1.147-2 Remedial actions.
1.147(b)-1 Bond maturity limitation--treatment of working capital.
1.148-0 Scope and table of contents.
1.148-1 Definitions and elections.
1.148-2 General arbitrage yield restriction rules.
1.148-3 General arbitrage rebate rules.
1.148-4 Yield on an issue of bonds.
1.148-5 Yield and valuation of investments.
1.148-6 General allocation and accounting rules.
1.148-7 Spending exceptions to the rebate requirement.
1.148-8 Small issuer exception to rebate requirement.
1.148-9 Arbitrage rules for refunding issues.
1.148-10 Anti-abuse rules and authority of Commissioner.
1.148-11 Effective dates.
1.149(b)-1 Federally guaranteed bonds.
1.149(d)-1 Limitations on advance refundings.
1.149(e)-1 Information reporting requirements for tax-exempt bonds.
1.149(g)-1 Hedge bonds.
1.150-1 Definitions.
1.150-2 Proceeds of bonds used for reimbursement.
1.150-4 Change in use of facilities financed with tax-exempt private 
          activity bonds.
1.150-5 Filing notices and elections.

   Regulations Applicable to Certain Bonds Sold Prior to July 8, 1997

1.148-1A Definitions and elections.
1.148-2A General arbitrage yield restriction rules.
1.148-3A General arbitrage rebate rules.
1.148-4A Yield on an issue of bonds.
1.148-5A Yield and valuation of investments.
1.148-6A General allocation and accounting rules.
1.148-9A Arbitrage rules for refunding issues.
1.148-10A Anti-abuse rules and authority of Commissioner.
1.148-11A Effective dates.
1.149(d)-1A Limitations on advance refundings.
1.150-1A Definitions.

                   Deductions for Personal Exemptions

1.151-1 Deductions for personal exemptions.
1.151-2 Additional exemptions for dependents.
1.151-3 Definitions.
1.151-4 Amount of deduction for each exemption under section 151.
1.152-1 General definition of a dependent.
1.152-2 Rules relating to general definition of dependent.
1.152-3 Multiple support agreements.
1.152-4 Support test in case of child of divorced or separated parents.
1.152.4T Dependency exemption in the case of a child of divorced 
          parents, etc. (temporary).
1.153-1 Determination of marital status.
1.154 Statutory provisions; cross references.

          Itemized Deductions for Individuals and Corporations

1.161-1 Allowance of deductions.
1.162-1 Business expenses.
1.162-2 Traveling expenses.
1.162-3 Cost of materials.
1.162-4 Repairs.
1.162-5 Expenses for education.
1.162-6 Professional expenses.
1.162-7 Compensation for personal services.
1.162-8 Treatment of excessive compensation.
1.162-9 Bonuses to employees.
1.162-10 Certain employee benefits.
1.162-10T Questions and answers relating to the deduction of employee 
          benefits under the Tax Reform Act of 1984; certain limits on 
          amounts deductible (temporary).
1.162-11 Rentals.
1.162-12 Expenses of farmers.
1.162-13 Depositors' guaranty fund.
1.162-14 Expenditures for advertising or promotion of good will.
1.162-15 Contributions, dues, etc.
1.162-16 Cross reference.
1.162-17 Reporting and substantiation of certain business expenses of 
          employees.
1.162-18 Illegal bribes and kickbacks.
1.162-19 Capital contributions to Federal National Mortgage Association.
1.162-20 Expenditures attributable to lobbying, political campaigns, 
          attempts to influence legislation, etc., and certain 
          advertising.
1.162-21 Fines and penalties.
1.162-22 Treble damage payments under the antitrust laws.
1.162-25 Deductions with respect to noncash fringe benefits.
1.162-25T Deductions with respect to noncash fringe benefits 
          (temporary).
1.162-27 Certain employee remuneration in excess of $1,000,000.
1.162-28 Allocation of costs to lobbying activities.
1.162-29 Influencing legislation.
1.163-1 Interest deduction in general.
1.163-2 Installment purchases where interest charge is not separately 
          stated.
1.163-3 Deduction for discount on bond issued on or before May 27, 1969.
1.163-4 Deduction for original issue discount on certain obligations 
          issued after May 27, 1969.
1.163-5 Denial of interest deduction on certain obligations issued after 
          December 31, 1982, unless issued in registered form.
1.163-5T Denial of interest deduction on certain obligations issued 
          after December 31, 1982, unless issued in registered form 
          (temporary).

[[Page 9]]

1.163-6T Reduction of deduction where section 25 credit taken 
          (temporary).
1.163-7 Deduction for OID on certain debt instruments.
1.163-8T Allocation of interest expense among expenditures (temporary).
1.163-9T Personal interest (temporary).
1.163-10T Qualified residence interest (temporary).
1.163-12 Deduction of original issue discount on instrument held by 
          related foreign person.
1.163-13 Treatment of bond issuance premium.
1.163(d)-1 Time and manner for making elections under the Omnibus Budget 
          Reconciliation Act of 1993 and the Jobs and Growth Tax Relief 
          Reconciliation Act of 2003.
1.164-1 Deduction for taxes.
1.164-2 Deduction denied in case of certain taxes.
1.164-3 Definitions and special rules.
1.164-4 Taxes for local benefits.
1.164-5 Certain retail sales taxes and gasoline taxes.
1.164-6 Apportionment of taxes on real property between seller and 
          purchaser.
1.164-7 Taxes of shareholder paid by corporation.
1.164-8 Payments for municipal services in atomic energy communities.
1.165-1 Losses.
1.165-2 Obsolescence of nondepreciable property.
1.165-3 Demolition of buildings.
1.165-4 Decline in value of stock.
1.165-5 Worthless securities.
1.165-6 Farming losses.
1.165-7 Casualty losses.
1.165-8 Theft losses.
1.165-9 Sale of residential property.
1.165-10 Wagering losses.
1.165-11 Election in respect of losses attributable to a disaster.
1.165-12 Denial of deduction for losses on registration-required 
          obligations not in registered form.
1.165-13T Questions and answers relating to the treatment of losses on 
          certain straddle transactions entered into before the 
          effective date of the Economic Recovery Tax Act of 1981, under 
          section 108 of the Tax Reform Act of 1984 (temporary).
1.166-1 Bad debts.
1.166-2 Evidence of worthlessness.
1.166-3 Partial or total worthlessness.
1.166-4 Reserve for bad debts.
1.166-5 Nonbusiness debts.
1.166-6 Sale of mortgaged or pledged property.
1.166-7 Worthless bonds issued by an individual.
1.166-8 Losses of guarantors, endorsers, and indemnitors incurred on 
          agreements made before January 1, 1976.
1.166-9 Losses of guarantors, endorsers, and indemnitors incurred, on 
          agreements made after December 31, 1975, in taxable years 
          beginning after such date.
1.166-10 Reserve for guaranteed debt obligations.
1.167(a)-1 Depreciation in general.
1.167(a)-2 Tangible property.
1.167(a)-3 Intangibles.
1.167(a)-4 Leased property.
1.167(a)-5 Apportionment of basis.
1.167(a)-5T Application of section 1060 to section 167 (temporary).
1.167(a)-6 Depreciation in special cases.
1.167(a)-7 Accounting for depreciable property.
1.167(a)-8 Retirements.
1.167(a)-9 Obsolescence.
1.167(a)-10 When depreciation deduction is allowable.
1.167(a)-11 Depreciation based on class lives and asset depreciation 
          ranges for property placed in service after December 31, 1970.
1.167(a)-12 Depreciation based on class lives for property first placed 
          in service before January 1, 1971.
1.167(a)-13T Certain elections for intangible property (temporary).
1.167(a)-14 Treatment of certain intangible property excluded from 
          section 197.
1.167(a)-14T Treatment of certain intangible property excluded from 
          section 197 (temporary).
1.167(b)-0 Methods of computing depreciation.
1.167(b)-1 Straight line method.
1.167(b)-2 Declining balance method.
1.167(b)-3 Sum of the years-digits method.
1.167(b)-4 Other methods.
1.167(c)-1 Limitations on methods of computing depreciation under 
          section 167(b) (2), (3), and (4).
1.167(d)-1 Agreement as to useful life and rates of depreciation.
1.167(e)-1 Change in method.
1.167(e)-1T Change in method (temporary).
1.167(f)-1 Reduction of salvage value taken into account for certain 
          personal property.
1.167(g)-1 Basis for depreciation.
1.167(h)-1 Life tenants and beneficiaries of trusts and estates.
1.167(i)-1 Depreciation of improvements in the case of mines, etc.
1.167(l)-1 Limitations on reasonable allowance in case of property of 
          certain public utilities.
1.167(l)-2 Public utility property; election as to post-1969 property 
          representing growth in capacity.
1.167(l)-3 Multiple regulation, asset acquisitions, reorganizations, 
          etc.
1.167(l)-4 Public utility property; election to use asset depreciation 
          range system.
1.167(m)-1 Class lives.
1.168-5 Special rules.

[[Page 10]]

1.168(a)-1T Modified accelerated cost recovery system (temporary).
1.168(b)-1T Definitions (temporary).
1.168(d)-0 Table of contents for the applicable convention rules.
1.168(d)-1 Applicable convention--Half-year and mid-quarter conventions.
1.168(d)-1T Applicable conventions--Half-year and mid-quarter 
          conventions (temporary).
1.168(f)(8)-1T Safe-harbor lease information returns concerning 
          qualified mass commuting vehicles (temporary).
1.168(h)-1 Like-kind exchanges involving tax-exempt use property.
1.168(i)-0 Table of contents for the general asset account rules.
1.168(i)-0T Table of contents for the general asset account rules 
          (temporary).
1.168(i)-1 General asset accounts.
1.168(i)-1T General asset accounts (temporary).
1.168(i)-2 Lease term.
1.168(i)-4 Changes in use.
1.168(i)-5T Table of contents (temporary).
1.168(i)-6T Like-kind exchanges and involuntary conversions (temporary).
1.168(j)-1T Questions and answers concerning tax-exempt entity leasing 
          rules (temporary).
1.168(k)-0T Table of contents (temporary).
1.168(k)-1T Additional first year depreciation deduction (temporary).
1.168A-1 Amortization of emergency facilities; general rule.
1.168A-2 Election of amortization.
1.168A-3 Election to discontinue amortization.
1.168A-4 Definitions.
1.168A-5 Adjusted basis of emergency facility.
1.168A-6 Depreciation of portion of emergency facility not subject to 
          amortization.
1.168A-7 Payment by United States of unamortized cost of facility.
1.169-1 Amortization of pollution control facilities.
1.169-2 Definitions.
1.169-3 Amortizable basis.
1.169-3T Amortizable basis (temporary).
1.169-4 Time and manner of making elections

    Authority: 26 U.S.C. 7805, unless otherwise noted.
    Section 1.61-2T also issued under 26 U.S.C. 61.
    Section 1.61-21 also issued under 26 U.S.C. 61.
    Sections 1.62-1T and 1.62-2 also issued under 26 U.S.C. 62.
    Section 1.66-4 also issued under 26 U.S.C. 66(c);
    Sections 1.67-2T and 1.67-3T also issued under 26 U.S.C. 67(c).
    Section 1.67-3 also issued under 26 U.S.C. 67(c).
    Sections 1.72-4, 1.72-5, 1.72-6, 1.72-7, 1.72-8, and 1.72-11 also 
issued under 26 U.S.C. 72(c).
    Section 1.101-7 also issued under 26 U.S.C. 101(d)(2)(B)(ii).
    Section 1.103-10 also issued under 26 U.S.C. 103(b)(6).
    Section 1.103A-2 also issued under 26 U.S.C. 103A(j).
    Section 1.108-1 also issued under 26 U.S.C. 108(e)(8) and 
108(e)(10(B).
    Section 1.108-2 also issued under 26 U.S.C. 108.
    Section 1.108-3 also issued under 26 U.S.C. 108, 267, and 1502.
    Section 1.108-4 also issued under 26 U.S.C. 108.
    Section 1.108-5 also issued under 26 U.S.C. 108.
    Section 1.108(c)-1 also issued under the authority of 26 U.S.C. 
108(d)(9).
    Section 1.110-1 also issued under 26 U.S.C. 110(d).
    Sections 1.132-0 through 1.132-8T also issued under 26 U.S.C. 132.
    Sections 1.148-0 through 1.148-11 also issued under 26 U.S.C. 148 
(f), (g), and (i).
    Sections 1.148-6 also issued under 26 U.S.C. 148 (f), (g), and (i).
    Section 1.149(b)-1 also issued under 26 U.S.C. 149(b)(3)(B) (v).
    Section 1.149(d)-1 also issued under 26 U.S.C. 149(d)(7).
    Section 1.149(e)-1 also issued under 26 U.S.C. 149(e).
    Section 1.149(g)-1 also issued under 26 U.S.C. 149(g)(5).
    Sections 1.150-4 also issued under 26 U.S.C. 150 (c)(5).
    Section 1.163-8T also issued under 26 U.S.C. 469(k)(4).
    Section 1.163-9T also issued under 26 U.S.C. 163(h)(3)(D).
    Section 1.163-11T is also issued under 26 U.S.C. 163(h).
    Section 1.165-12 also issued under 26 U.S.C. 165(j)(3).
    Section 1.166-10 also issued under 26 U.S.C. 166(f).
    Section 1.168(d)-1 also issued under 26 U.S.C. 168(d)(3).
    Section 1.168(f)(8)-1T also added under sec. 112(c), Black Lung 
Benefits Revenue Act of 1981 (Pub. L. 97-119).
    Section 1.168(h)-1 also issued under 26 U.S.C. 168.
    Section 1.168(i)-1 also issued under 26 U.S.C. 168(i)(4).
    Section 1.168(i)-2 also issued under 26 U.S.C. 168.
    Section 1.168(i)-4 also issued under 26 U.S.C. 168(i)(5).
    Section 1.168(j)-1T also added under 26 U.S.C. 168(j)(10).

    Source: T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 
1960, unless otherwise noted.

[[Page 11]]

                      COMPUTATION OF TAXABLE INCOME

  Definition of Gross Income, Adjusted Gross Income, and Taxable Income



Sec. 1.61-1  Gross income.

    (a) General definition. Gross income means all income from whatever 
source derived, unless excluded by law. Gross income includes income 
realized in any form, whether in money, property, or services. Income 
may be realized, therefore, in the form of services, meals, 
accommodations, stock, or other property, as well as in cash. Section 61 
lists the more common items of gross income for purposes of 
illustration. For purposes of further illustration, Sec. 1.61-14 
mentions several miscellaneous items of gross income not listed 
specifically in section 61. Gross income, however, is not limited to the 
items so enumerated.
    (b) Cross references. Cross references to other provisions of the 
Code are to be found throughout the regulations under section 61. The 
purpose of these cross references is to direct attention to the more 
common items which are included in or excluded from gross income 
entirely, or treated in some special manner. To the extent that another 
section of the Code or of the regulations thereunder, provides specific 
treatment for any item of income, such other provision shall apply 
notwithstanding section 61 and the regulations thereunder. The cross 
references do not cover all possible items.
    (1) For examples of items specifically included in gross income, see 
Part II (section 71 and following), Subchapter B, Chapter 1 of the Code.
    (2) For examples of items specifically excluded from gross income, 
see part III (section 101 and following), Subchapter B, Chapter 1 of the 
Code.
    (3) For general rules as to the taxable year for which an item is to 
be included in gross income, see section 451 and the regulations 
thereunder.



Sec. 1.61-2  Compensation for services, including fees, commissions, 
and similar items.

    (a) In general. (1) Wages, salaries, commissions paid salesmen, 
compensation for services on the basis of a percentage of profits, 
commissions on insurance premiums, tips, bonuses (including Christmas 
bonuses), termination or severance pay, rewards, jury fees, marriage 
fees and other contributions received by a clergyman for services, pay 
of persons in the military or naval forces of the United States, retired 
pay of employees, pensions, and retirement allowances are income to the 
recipients unless excluded by law. Several special rules apply to 
members of the Armed Forces, National Oceanic and Atmospheric 
Administration, and Public Health Service of the United States; see 
paragraph (b) of this section.
    (2) The Code provides special rules including the following items in 
gross income:
    (i) Distributions from employees' trusts, see sections 72, 402, and 
403, and the regulations thereunder;
    (ii) Compensation for child's services (in child's gross income), 
see section 73 and the regulations thereunder;
    (iii) Prizes and awards, see section 74 and the regulations 
thereunder.
    (3) Similarly, the Code provides special rules excluding the 
following items from gross income in whole or in part:
    (i) Gifts, see section 102 and the regulations thereunder;
    (ii) Compensation for injuries or sickness, see section 104 and the 
regulations thereunder;
    (iii) Amounts received under accident and health plans, see section 
105 and the regulations thereunder;
    (iv) Scholarship and fellowship grants, see section 117 and the 
regulations thereunder;
    (v) Miscellaneous items, see section 122.
    (b) Members of the Armed Forces, National Oceanic and Atmospheric 
Administration, and Public Health Service. (1) Subsistence and uniform 
allowances granted commissioned officers, chief warrant officers, 
warrant officers, and enlisted personnel of the Armed Forces, National 
Oceanic and Atmospheric Administration, and Public Health Service of the 
United States, and amounts received by them as commutation of quarters, 
are excluded from gross income. Similarly, the

[[Page 12]]

value of quarters or subsistence furnished to such persons is excluded 
from gross income.
    (2) For purposes of this section, quarters or subsistence includes 
the following allowances for expenses incurred after December 31, 1993, 
by members of the Armed Forces, members of the commissioned corps of the 
National Oceanic and Atmospheric Administration, and members of the 
commissioned corps of the Public Health Service, to the extent that the 
allowances are not otherwise excluded from gross income under another 
provision of the Internal Revenue Code: a dislocation allowance, 
authorized by 37 U.S.C. 407; a temporary lodging allowance, authorized 
by 37 U.S.C. 405; a temporary lodging expense, authorized by 37 U.S.C. 
404a; and a move-in housing allowance, authorized by 37 U.S.C. 405. No 
deduction is allowed under this chapter for any expenses reimbursed by 
such excluded allowances. For the exclusion from gross income of--
    (i) Disability pensions, see section 104(a)(4) and the regulations 
thereunder;
    (ii) Miscellaneous items, see section 122.
    (3) The per diem or actual expense allowance, the monetary allowance 
in lieu of transportation, and the mileage allowance received by members 
of the Armed Forces, National Oceanic and Atmospheric Administration, 
and the Public Health Service, while in a travel status or on temporary 
duty away from their permanent stations, are included in their gross 
income except to the extent excluded under the accountable plan 
provisions of Sec. 1.62-2.
    (c) Payment to charitable, etc., organization on behalf of person 
rendering services. The value of services is not includible in gross 
income when such services are rendered directly and gratuitously to an 
organization described in section 170(c). Where, however, pursuant to an 
agreement or understanding, services are rendered to a person for the 
benefit of an organization described in section 170(c) and an amount for 
such services is paid to such organization by the person to whom the 
services are rendered, the amount so paid constitutes income to the 
person performing the services.
    (d) Compensation paid other than in cash--(1) In general. Except as 
otherwise provided in paragraph (d)(6)(i) of this section (relating to 
certain property transferred after June 30, 1969), if services are paid 
for in property, the fair market value of the property taken in payment 
must be included in income as compensation. If services are paid for in 
exchange for other services, the fair market value of such other 
services taken in payment must be included in income as compensation. If 
the services are rendered at a stipulated price, such price will be 
presumed to be the fair market value of the compensation received in the 
absence of evidence to the contrary. For special rules relating to 
certain options received as compensation, see Sec. Sec. 1.61-15, 1.83-
7, and section 421 and the regulations thereunder. For special rules 
relating to premiums paid by an employer for an annuity contract which 
is not subject to section 403(a), see section 403(c) and the regulations 
thereunder and Sec. 1.83-8(a). For special rules relating to 
contributions made to an employees' trust which is not exempt under 
section 501, see section 402(b) and the regulations thereunder and Sec. 
1.83-8(a).
    (2) Property transferred to employee or independent contractor. (i) 
Except as otherwise provided in section 421 and the regulations 
thereunder and Sec. 1.61-15 (relating to stock options), and paragraph 
(d)(6)(i) of this section, if property is transferred by an employer to 
an employee or if property is transferred to an independent contractor, 
as compensation for services, for an amount less than its fair market 
value, then regardless of whether the transfer is in the form of a sale 
or exchange, the difference between the amount paid for the property and 
the amount of its fair market value at the time of the transfer is 
compensation and shall be included in the gross income of the employee 
or independent contractor. In computing the gain or loss from the 
subsequent sale of such property, its basis shall be the amount paid for 
the property increased by the amount of such difference included in 
gross income

[[Page 13]]

    (ii)(A) Cost of life insurance on the life of the employee. 
Generally, life insurance premiums paid by an employer on the life of 
his employee where the proceeds of such insurance are payable to the 
beneficiary of such employee are part of the gross income of the 
employee. However, the amount includible in the employee's gross income 
is determined with regard to the provisions of section 403 and the 
regulations thereunder in the case of an individual contract issued 
after December 31, 1962, or a group contract, which provides incidental 
life insurance protection and which satisfies the requirements of 
section 401(g) and Sec. 1.401-9, relating to the nontransferability of 
annuity contracts. For example, if an employee or independent contractor 
is the owner (as defined in Sec. 1.61-22(c)(1)) of a life insurance 
contract and the payments with regard to such contract are not split-
dollar loans under Sec. 1.7872-15(b)(1), the employee or independent 
contractor must include in income the amount of any such payments by the 
employer or service recipient with respect to such contract during any 
year to the extent that the employee's or independent contractor's 
rights to the life insurance contract are substantially vested (within 
the meaning of Sec. 1.83-3(b)). This result is the same regardless of 
whether the employee or independent contractor has at all times been the 
owner of the life insurance contract or the contract previously has been 
owned by the employer or service recipient as part of a split-dollar 
life insurance arrangement (as defined in Sec. 1.61-22(b)(1) or (2)) 
and was transferred by the employer or service recipient to the employee 
or independent contractor under Sec. 1.61-22(g). For the special rules 
relating to the includibility in an employee's gross income of an amount 
equal to the cost of certain group term life insurance on the employee's 
life which is carried directly or indirectly by his employer, see 
section 79 and the regulations thereunder. For special rules relating to 
the exclusion of contributions by an employer to accident and health 
plans for the employee, see section 106 and the regulations thereunder.
    (B) Cost of group-term life insurance on the life of an individual 
other than an employee. The cost (determined under paragraph (d)(2) of 
Sec. 1.79-3) of group-term life insurance on the life of an individual 
other than an employee (such as the spouse or dependent of the employee) 
provided in connection with the performance of services by the employee 
is includible in the gross income of the employee.
    (3) Meals and living quarters. The value of living quarters or meals 
which an employee receives in addition to his salary constitutes gross 
income unless they are furnished for the convenience of the employer and 
meet the conditions specified in section 119 and the regulations 
thereunder. For the treatment of rental value of parsonages or rental 
allowance paid to ministers, see section 107 and the regulations 
thereunder; for the treatment of statutory subsistence allowances 
received by police, see section 120 and the regulations thereunder.
    (4) Stock and notes transferred to employee or independent 
contractor. Except as otherwise provided by section 421 and the 
regulations thereunder and Sec. 1.61-15 (relating to stock options), 
and paragraph (d)(6)(i) of this section, if a corporation transfers its 
own stock to an employee or independent contractor as compensation for 
services, the fair market value of the stock at the time of transfer 
shall be included in the gross income of the employee or independent 
contractor. Notes or other evidences of indebtedness received in payment 
for services constitute income in the amount of their fair market value 
at the time of the transfer. A taxpayer receiving as compensation a note 
regarded as good for its face value at maturity, but not bearing 
interest, shall treat as income as of the time of receipt its fair 
discounted value computed at the prevailing rate. As payments are 
received on such a note, there shall be included in income that portion 
of each payment which represents the proportionate part of the discount 
originally taken on the entire note.
    (5) Property transferred on or before June 30, 1969, subject to 
restrictions. Notwithstanding paragraph (d) (1), (2), or (4) of this 
section, if any property is transferred after September 24, 1959, by

[[Page 14]]

an employer to an employee or independent contractor as compensation for 
services, and such property is subject to a restriction which has a 
significant effect on its value at the time of transfer, the rules of 
Sec. 1.421-6(d)(2) shall apply in determining the time and the amount 
of compensation to be included in the gross income of the employee or 
independent contractor. This (5) is also applicable to transfers subject 
to a restriction which has a significant effect on its value at the time 
of transfer and to which Sec. 1.83-8(b) (relating to transitional rules 
with respect to transfers of restricted property) applies. For special 
rules relating to options to purchase stock or other property which are 
issued as compensation for services, see Sec. 1.61-15 and section 421 
and the regulations thereunder.
    (6) Certain property transferred, premiums paid, and contributions 
made in connection with the performance of services after June 30, 
1969--(i) Exception. Paragraph (d) (1), (2), (4), and (5) of this 
section and Sec. 1.61-15 do not apply to the transfer of property (as 
defined in Sec. 1.83-3(e)) after June 30, 1969, unless Sec. 1.83-8 
(relating to the applicability of section 83 and transitional rules) 
applies. If section 83 applies to a transfer of property, and the 
property is not subject to a restriction that has a significant effect 
on the fair market value of such property, then the rules contained in 
paragraph (d) (1), (2), and (4) of this section and Sec. 1.61-15 shall 
also apply to such transfer to the extent such rules are not 
inconsistent with section 83.
    (ii) Cross references. For rules relating to premiums paid by an 
employer for an annuity contract which is not subject to section 403(a), 
see section 403(c) and the regulations thereunder. For rules relating to 
contributions made to an employees' trust which is not exempt under 
section 501(a), see section 402(b) and the regulations thereunder.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6696, 28 FR 
13450, Dec. 12, 1963; T.D. 6856, 30 FR 13316, Oct. 20, 1965; T.D. 7544, 
43 FR 31913, July 24, 1978; T.D. 7623, 44 FR 28800, May 17, 1979; T.D. 
8256, 54 FR 28582, July 6, 1989; T.D. 8607, 60 FR 40076, Aug. 7, 1995; 
T.D. 9092, 68 FR 54344, Sept. 17, 2003]



Sec. 1.61-2T  Taxation of fringe benefits--1985 through 1988 (temporary).

    (a) Fringe benefits--(1) In general. Section 61(a)(1) provides that, 
except as otherwise provided in subtitle A, gross income includes 
compensation for services, including fees, commissions, fringe benefits, 
and similar items. Examples of fringe benefits include: an employer-
provided automobile, a flight on an employer-provided aircraft, an 
employer-provided free or discounted commercial airline flight, an 
employer-provided vacation, and employer-provided discount on property 
or services, and emkployer-provided membership in a country club or 
other social club, and an employer-provided ticket to an entertainment 
or sporting event.
    (2) Fringe benefits excluded from income. To the extent that a 
particular fringe benefit is specifically excluded from gross income 
pursuant to another section of subtitle A, that section shall govern the 
treatment of the fringe benefit. Thus, if the requirements of the 
governing section are satisfied, the fringe benefits may be excludable 
from gross income. Examples of excludable fringe benefits are qualified 
tuition reductions provided to an employee (section 177(d)); meals and 
lodging furnished to an employee for the convenience of the employer 
(section 119); and benefits provided under a dependent care assistance 
program (section 129). Similarly, the value of the use by an employee of 
an employer-provided vehicle or a flight provided to an employee on an 
employer-provided aircraft may be excludable from income under section 
105 (because, for example, the trnsportation is provided for medical 
reasons) if and to the extent that the requirements of that section are 
satisfied. Section 61 and the regulations thereunder shall apply, 
however, to the extent that they are not inconsistent with such other 
section. For example, many fringe benefits specifically addressed in 
other sections of subtitle A are excluded from gross income only to the 
extent that they do not exceed specific dollar or percentage limits, or 
only if certain other requirements are met. If the limits are exceeded 
or the requirements are not met, some or all of the fringe benefit may 
be

[[Page 15]]

includible in gross income. See paragraph (b)(3) of this section.
    (3) Compensation for services. A fringe benefit provided in 
connection with the performance of services shall be considered to have 
been provided as compensation for servcies. Refraining from the 
performance of services (such as pursuant to a covenant not to compete) 
is deemed to be the performance of services for purposes of this 
section.
    (4) Recipient of a fringe benefit--(i) Definition. A fringe benefit 
is included in the income of the ``recipient'' of the fringe benefit. 
The recipient of a fringe benefit is the person performing the services 
in connection with which the fringe benefit is provided. Thus, a person 
may be considered to be a recipient, even though that person did not 
actually receive the fringe benefit. For example, a fringe benefit 
provided to any person is connection with the performance of services by 
another person is considered to have been provided to the person who 
performs the services and not the person who receives the fringe 
benefit. In addition, if a fringe benefit is provided to a person, but 
taxable to a second person as the recipient, such benefit is referred to 
as provided to the second person and use by the first person is 
considered use by the second person. For example, provision of an 
automobile to an employee's spouse by the employer is taxable to the 
employee as the recipient. The automobile is referred to as available to 
the employee and use by the employee's spouse is considered use by the 
employee.
    (ii) Recipient may be other than an employee. The recipient of a 
fringe benefit need not be an employee of the provider of the fringe 
benefit, but may be a partner, director, or an independent contractor. 
For convenience, the term ``employee'' includes a reference to any 
recipient of a fringe benefit, unless otherwise specifically provided in 
this section.
    (5) Provider of a fringe benefit. The ``provider'' of a fringe 
benefit is that person for whom the services are performed, regardless 
of whether that person actually provides the fringe benefit to the 
recipient. The provider of a fringe benefit need not be the employer of 
the recipient of the fringe benefit, but may be, for example, a client 
or customer of an independent contractor. For convenience, the term 
``employer'' includes a reference to any provider of a fringe benefit, 
unless otherwise specifically provided in this section.
    (6) Effective date. This section is effective from January 1, 1985, 
to December 31, 1988, with respect to fringe benefits furnished before 
January 1, 1989. No inference may be drawn from the promulgation or 
terms of this section concerning the application of law in effect prior 
to January 1, 1985.
    (b) Valuation of fringe benefits--(1) In general. An employee must 
include in gross income the amount by which the fair market value of the 
fringe benefit exceeds the sum of (i) the amount, if any, paid for the 
benefit, and (ii) the amount, if any, specifically excluded from gross 
income by some other section of subtitle A. Therefore, for example, if 
the employee pays fair market value for what is received, no amount is 
includible in the gross income of the employee.
    (2) Fair market value. In general, fair market value is determined 
on the basis of all the facts and circumstances. Specifically, the fair 
market value of a fringe benefit is that amount a (hypothetical person 
would have to pay a hypothetical third party to obtain (i.e., purchase 
or lease) the particular fringe benefit. Thus, for example, the effect 
of any special relationship that may exist between the employer and the 
employee must be disregarded. This also means that an employee's 
subjective perception of the value of a fringe benefit is not relevant 
to the determination of a fringe benefit's fair market value. In 
addition, the cost incurred by the employer is not determinative of the 
fair market value of the fringe benefit. For special rules relating to 
the valuation of certain fringe benefits, see paragraph (c) of this 
section.
    (3) Exclusion from income based on cost. If a statutory exclusion 
phrased in terms of cost applies to the provision of a fringe benefit, 
section 61 does not require the inclusion in the recipient's gross 
income of the difference between

[[Page 16]]

the fair market value and the excludable cost of that fringe benefit. 
For example, section 129 provides an exclusion from an employee's gross 
income for amounts paid or incurred by an employer to provide dependent 
care assistance to employees. Even if the fair market value of the 
dependent care assistance exceeds the employer's cost, the excess is not 
subject to inclusion under section 61 and this section. If the statutory 
cost exclusion is a limited amount, however, then the fair market value 
of the fringe benefit attributable to any excess cost is subject to 
inclusion.
    (4) Fair market value of the availability of an employer-provided 
vehicle. If the vehicle special valuation rules of paragraph (d), (e), 
or (f) of this section are not used by a taxpayer entitled to use such 
rules, the value of the availability of an employer-provided vehicle is 
determined under the general valuation principles set forth in this 
section. In general, such valuation must be determined by reference to 
the cost to a hypothetical person of leasing from a hypothetical third 
party the same or comparable vehicle on the same or comparable terms in 
the geographic area in which the vehicle is available for use. Unless 
the employee can substantiate that the same or comparable vehicle could 
have been leased on a cents-per-mile basis, the value of the 
availability of the vehicle cannot be determined by reference to a 
cents-per-mile rate applied to the number of miles the vehicle is 
driven. An example of a comparable lease term is the amount of time that 
the vehicle is available to the employee for use, e.g., a one-year 
period.
    (5) Fair market value of a flight on an employer-provided aircraft. 
If the non-commercial flight special valuation rule of paragraph (g) of 
this section is not used (or is not properly used) by a taxpayer 
entitled to use such rule, the value of a flight on an employer-provided 
aircraft is determined under the general valuation principles set forth 
in this section. An example of how the general valuation principles 
would apply is that if an employee whose flight is primarily personal 
controls the use of an aircraft with respect to such flight, such flight 
is valued by reference to how much it would cost a hypothetical person 
to charter the same or comparable aircraft for the same or comparable 
flight. The cost to charter the aircraft must be allocated among all 
employees on board the aircraft based on all the facts and 
circumstances, including which employees controlled the use of the 
aircraft. Notwithstanding the allocation required by the preceding 
sentence, no additional amount shall be included in the income of any 
employee whose flight is properly valued under the special valuation 
rule of paragraph (g) of this section.
    (c) Special valuation rules--(1) In general. Paragraphs (d) through 
(j) of this section provide special valuation rules that may be used 
under certain circumstances for certain commonly provided fringe 
benefits. Paragraph (d) provides a lease valuation rule relating to 
employer-provided automobiles. Paragraph (e) provides a cents-per-mile 
valuation rule relating to employer-provided vehicles. Paragraph (f) 
provides a commuting valuation rule relating to employer-provided 
vehicles. Paragraph (g) provides a flight valuation rule relating to 
flights on employer-provided aircraft. Paragraph (h) provides a flight 
valuation rule relating to flights on commercial airlines. Paragraph(i) 
is reserved. Paragraph (j) provides a meal valuation rule relating to 
employer-operated eating facilities for employees. For general rules 
relating to the valuation of fringe benefits not eligible for valuation 
under the special valuation rules, see paragraph (d) of this section.
    (2) Use of the special valuation rules--(i) In general. The Special 
valuation rules may be used for income, employment tax, and reporting 
purposes. Use of any of the special valuation rules is optional. An 
employer need not use the same vehicle special valuation rule for all 
vehicles provided to all employees. For example, an employer may use the 
automobile lease valuation rule for automobiles provided to some 
employees, and the commuting and vehicle cents-per-mile valuation rules 
for automobiles provided to other employees. Except as otherwise 
provided, however, if either the commercial flight valuation rule or the 
noncommercial flight

[[Page 17]]

valuation rule is used, such rule must be used by an employer to value 
all flights taken by employees in a calendar year. Effective January 1, 
1986, if an employer uses one of the special rules to value the benefit 
provided to an employee, the employee may not use another special rule 
to value that benefit. The employee may, however, use general valuation 
rules based on facts and circumstances (see paragraph (b) of this 
section). Effective January 1, 1986, an employee may only use a special 
valuation rule if the employer uses the rule. If a special rule is used, 
it must be used for all purposes. If an employer properly uses a special 
rule and the employee uses the special rule, the employee must include 
in gross income the amount determined by the employer under the special 
rule less any amount reimbursed by the employee to the employer. The 
employer and the employee may use the special rules to determine the 
amount of the reimbursement due the employer by the employee. If an 
employer properly uses a special rule and properly determines the amount 
of an employee's working condition fringe under section 132 and Sec. 
1.132-1T (under the general rule or under a special rule), and the 
employee uses the special valuation rule, the employee must include in 
gross income the amount determined by the employer less any amount 
reimbursed by the employee to the employer.
    (ii) Transitional rules--(A) Use of vehicle special valuation rules 
for 1985 and 1986. For purposes of valuing the use or availability of a 
vehicle, the consistency rules provided in paragraphs (d)(6) and (e)(5) 
of this section (relating to the automobile lease valuation rule and the 
vehicle cents-per-mile valuation rule, respectively) apply for 1987 and 
thereafter. Therefore, for 1985 and 1986 an employer (and employee, 
subject to paragraph (c)(2)(i) of this section) may use any applicable 
special valuation rule (or no special valuation rule) to value the use 
or availability of a vehicle, subject to paragraph (c)(2)(ii)(B) of this 
section.
    (B) Consistency Rules for 1985 and 1986. If an employer uses the 
automobile lease valuation rule of paragraph (d) of this section in 1985 
or 1986 with respect to an automobile, such rule must be used for the 
entire calendar year with respect to the automobile except for any 
period during which the commuting valuation rule of paragraph (f) of 
this section is properly used. If an employer uses the vehicle cents-
per-mile valuation rule of pararaph (e) of this section in 1985 or 1986 
with respect to a vehicle, such rule must be used for the entire 
calendar year with respect to the vehicle except for any period during 
which the commuting valuation rule of paragraph (f) of this section is 
properly used. The rules of this paragraph (c)(2)(ii)(B) also apply to 
employees using the special valuation rules of paragraphs (d) or (e) of 
this section.
    (C) Employee's use of special valuation rules for 1985. An employee 
may use a special valuation rule (other than the rule in paragraph (e) 
of this section relating to the vehicle cents-per-mile valuation rule) 
during 1985 even if the employer does not use the same special valuation 
rule during 1985. An employee's use of a special valuation rule in 1986 
and thereafter must be consistent with his employer's use of the rule as 
required under paragraph (c)(2)(i) of this section.
    (D) Examples. The following examples illustrate the rules of 
paragraph (c)(2)(ii) of this section:

    Example (1). Assume that an employer properly uses the automobile 
lease valuation rule in 1985. The employer may use the vehicle cents-
per-mile valuation rule in 1986 if the requirements of the vehicle 
cents-per-mile valuation rule are satisfied.
    Example (2). Assume that an employer does not use a special 
valuation rule to value the availability of an automobile in 1985. The 
employer may use any of the special valuation rules in 1986 if the 
requirements of the rule chosen are satisfied. The same applies for 
1987.
    Example (3). Assume that an employer properly uses the vehicle 
cents-per-mile valuation rule in 1985. The employer may continue to use 
to the rule or use any of the other special valuation rules to value the 
benefit provided in 1986 if the requirements of the rule chosen are 
satisfied. Alternatively, the employer may use none of the special 
valuation rules in 1986 but use any of the rules in 1987 if the 
requirements of the rule chosen are satisfied.
    Example (4). Assume that an employee properly uses the automobile 
lease valuation rule in 1985. In 1986 and thereafter the employee may 
use a special valuation rule only if the employee's employer uses the 
same

[[Page 18]]

special valuation rule. The employee may use general valuation 
principles to value the benefit provided in 1986 and thereafter.

    (3) Election to use the special valuation rules--A particular 
special valuation rule is deemed to have been elected by the employer 
(and, if applicable, by the employee), if the employer (and, if 
applicable, the employee) determines the value of the fringe benefit 
provided by applying the special valuation rule and treats such value as 
the fair market value of the fringe benefit for income, employment tax, 
and reporting purposes. Neither the employer nor the employee is 
required to notify the Internal Revenue Service of the election.
    (4) Application of section 414 to employers. For purposes of 
paragraphs (c) through (j) of this section, except as otherwise provided 
therein, the term ``employer'' includes all entities required to be 
treated as a single employer under section 414 (b), (c), or (m).
    (5) Valuation formulas contained in the special valuation rules. The 
valuation formulas contained in the special valuation rules are provided 
only for use in connection with such rules. Thus, when a special 
valuation rule is properly applied to a fringe benefit, the Commissioner 
will accept the value calculated pursuant to the rule as the fair market 
value of that fringe benefit. However, when a special valuation rule is 
not properly applied to a fringe benefit (see, for example, paragraph 
(g)(11) of this section), or when a special valuation rule is not used 
to value a fringe benefit by a taxpayer entitled to use the rule, the 
fair market value of that fringe benefit may not be determined by 
reference to any value calculated under any special valuation rule. 
Under the circumstances described in the preceding sentence, the fair 
market value of the fringe benefit must be determined pursuant to 
paragraph (b) of this section.
    (6) Modification of the special valuation rules. The Commissioner 
may, if he deems it necessary, add, delete, or modify the special 
valuation rules, including the valuation formulas contained herein, on a 
prospective basis.
    (7) Special Accounting Period. If the employer is using the special 
accounting rule provided in Announcement 85-113 (1985-31 I.R.B., August 
5, 1985) (relating to the reporting of and withholding on the value of 
noncash fringe benefits), benefits which are deemed provided in a 
subsequent calendar year pursuant to such rule are considered as 
provided in such subsequent calendar year for purposes of the special 
valuation rules. Thus, if a particular special valuation rule is in 
effect for a calendar year, it applies to benefits deemed provided 
during such calendar year under the special accounting rule.
    (d) Automobile lease valuation rule--(1) In general--(i) Annual 
Lease Value. Under the special valuation rule of this paragraph (d), if 
an employer provides an employee with an automobile that is available to 
the employee for an entire calendar year, the value of the benefit 
provided in the Annual Lease Value (determined under paragraph (d)(2) of 
this section) of that automobile. Except as otherwise provided, for an 
automobile that is available to an employee for less than an entire 
calendar year, the value of the benefit provided is either a pro-rated 
Annual Lease Value or the Daily Lease Value (as defined in paragraph 
(d)(4) of this section), whichever is applicable. Absent any statutory 
exclusion relating to the employer-provided automobile (see, for 
example, section 132(a)(3) and Sec. 1.132-5T(b)), the amount of the 
Annual Lease Value (or a pro-rated Annual Lease Value or the Daily Lease 
Value, as applicable) is included in the gross income of the employee.
    (ii) Definition of automobile. For purposes of this paragraph (d), 
the term ``automobile'' means any four-wheeled vehicle manufactured 
primarily for use on public streets, roads, and highways.
    (2) Calculation of Annual Lease Value--(i) In general. The Annual 
Lease Value of a particular automobile is calculated as follows:
    (A) Determine the fair market value of the automobile as of the 
first date on which the automobile is made available to any employee of 
the employer for personal use. For an automobile first made available to 
any employee for personal use prior to January 1, 1985, determine the 
fair market value as of January 1, 1985. For rules relating to 
determination of the fair market value of an automobile for purposes of

[[Page 19]]

this paragraph (d), see paragraph (d)(5) of this section.
    (B) Select the dollar range in column 1 of the Annual Lease Value 
Table, set forth in paragraph (d)(2)(iii) of this section, corresponding 
to the fair market value of the automobile. Except as otherwise provided 
in paragraphs (d)(2) (iv) and (v) of this section, the Annual Lease 
Value for each year of availability of the automobile is the 
corresponding amount in column 2 of the Table.
    (ii) Use by employee only in 1985. If the employee, but not the 
employer, is using the special rule of this paragraph (d), the employee 
may calculate the Annual Lease Value in the same manner as described in 
paragraph (d)(2)(i)(A) of this section, except that the fair market 
value of the automobile is determined as of the first date on which the 
automobile is made available to the employee for personal use or, for an 
automobile made available to the employee for personal use prior to 
January 1, 1985, by determining the fair market value as of January 1, 
1985. If the employer is also using the special rule of this paragraph 
(d), however, then the employee to whom the automobile is made available 
must use the special rule, if at all, by using the Annual Lease Value 
calculated by the employer. The rules of this paragraph (d)(2)(ii) apply 
only for 1985.
    (iii) Annual Lease Value Table.

------------------------------------------------------------------------
                                                                 Annual
                 Automobile fair market value                    lease
                                                                 value
(1)                                                                  (2)
------------------------------------------------------------------------
$0 to $999...................................................       $600
$1,000 to $1,999.............................................        850
$2,000 to $2,999.............................................      1,100
$3,000 to $3,999.............................................      1,350
$4,000 to $4,999.............................................      1,600
$5,000 to $5,999.............................................      1,850
$6,000 to $6,999.............................................      2,100
$7,000 to $7,999.............................................      2,350
$8,000 to $8,999.............................................      2,600
$9,000 to $9,999.............................................      2,850
$10,000 to $10,999...........................................      3,100
$11,000 to $11,999...........................................      3,350
$12,000 to $12,999...........................................      3,600
$13,000 to $13,999...........................................      3,850
$14,000 to $14,999...........................................      4,100
$15,000 to $15,999...........................................      4,350
$16,000 to $16,999...........................................      4,600
$17,000 to $17,999...........................................      4,850
$18,000 to $18,999...........................................      5,100
$19,000 to $19,999...........................................      5,350
$20,000 to $20,999...........................................      5,600
$21,000 to $21,999...........................................      5,580
$22,000 to $22,999...........................................      6,100
$23,000 to $23,999...........................................      6,350
$24,000 to $24,999...........................................      6,600
$25,000 to $25,999...........................................      6,850
$26,000 to $27,999...........................................      7,250
$28,000 to $29,999...........................................      7,750
$30,000 to $31,999...........................................      8,250
$32,000 to $33,999...........................................      8,750
$34,000 to $35,999...........................................      9,250
$36,000 to $37,999...........................................      9,750
$38,000 to $39,999...........................................     10,250
$40,000 to $41,999...........................................     10,750
$42,000 to $43,999...........................................     11,250
$44,000 to $45,999...........................................     11,750
$46,000 to $47,999...........................................     12,250
$48,000 to $49,999...........................................     12,750
$50,000 to $51,999...........................................     13,250
$52,000 to $53,999...........................................     13,750
$54,000 to $55,999...........................................     14,250
$56,000 to $57,999...........................................     14,750
$58,000 to $59,999...........................................     15,250
------------------------------------------------------------------------


For vehicles having a fair market value in excess of $59,999, the Annual 
Lease Value is equal to: (.25 x the fair market value of the automobile) 
+ $500.
    (iv) Recalculation of annual lease value. The Annual Lease Values 
determined under the rules of this paragraph (d) are based on a four-
year lease term. Therefore, except as otherwise provided in paragraph 
(d)(2)(v) of this section, the Annual Lease Value calculated by applying 
paragraph (d)(2) (i) or (ii) of this section shall remain in effect for 
the period that begins with the first date the special valuation rule of 
paragraph (d) of this section is applied by the employer to the 
automobile and ends on December 31 of the fourth full calendar year 
following that date. The Annual Lease Value for each subsequent four-
year period is calculated by determining the fair market value of the 
automobile as of the January 1 following the period described in the 
previous sentence and selecting the amount in column 2 of the Annual 
Lease Value Table corresponding to the appropriate dollar range in 
column 1 of the Table. If, however, the employer is using the special 
accounting rule provided in Announcement 85-113 (1985-31 I.R.B., August 
5, 1985) (relating to the reporting of and withholding on the value of 
noncash fringe benefits), the employer may calculate the Annual Lease 
Value for each subsequent four-

[[Page 20]]

year period as of the beginning of the special accounting period that 
begins immediately prior to the January 1 described in the previous 
sentence. For example, assume that pursuant to Announcement 85-113, an 
employer uses the special accounting rule. Assume further that beginning 
on November 1, 1985, the special accounting period is November 1 to 
October 31 and that the employer elects to use the special valuation 
rule of this paragraph (d) as of January 1, 1985. The employer may 
recalculate the Annual Lease Value as of November 1, 1988, rather than 
as of January 1, 1989.
    (v) Transfer of the automobile to another employee. Unless the 
primary purpose of the transfer is to reduce Federal taxes, if an 
employer transfers an automobile from one employee to another employee, 
the employer may recalculate the Annual Lease Value based on the fair 
market value of the automobile as of January 1 of the year of transfer. 
If, however, the employer is using the special accounting rule provided 
in Announcement 85-113 (1985-31 I.R.B., August 5, 1985) (relating to the 
reporting of and withholding on the value of noncash fringe benefits), 
the employer may recalculate the Annual Lease Value based on the fair 
market value of the automobile as of the beginning of the special 
accounting period in which the transfer occurs. If the employer does not 
recalculate the Annual Lease Value, and the employee to whom the 
automobile is transferred uses the special valuation rule, the employee 
may not recalculate the Annual Lease Value.
    (3) Services included in, or excluded from, the Annual Lease Value 
Table--(i) Maintenance and insurance included. The Annual Lease Values 
contained in the Annual Lease Value Table include the fair market value 
of maintenance of, and insurance for, the automobile. Neither an 
employer nor an employee may reduce the Annual Lease Value by the fair 
market value of any service included in the Annual Lease Value that is 
not provided by the employer, such as reducing the Annual Lease Value by 
the fair market value of a maintenance service contract or insurance. An 
employer or employee may take into account the services actually 
provided with respect to the automobile by valuing the availability of 
the automobile under the general valuation rules of paragraph (b) of 
this section.
    (ii) Fuel excluded--(A) In general. The Annual Lease Values do not 
include the fair market value of fuel provided by the employer, 
regardless of whether fuel is provided in kind or its cost is reimbursed 
by or charged to the employer.
    (B) Valuation of fuel provided in kind. The provision of fuel in 
kind may be valued at fair market value based on all the facts and 
circumstances or, in the alternative, it may be valued at 5.5 cents per 
mile for all miles driven by the employee. However, the provision of 
fuel in kind may not be valued at 5.5 cents per mile for miles driven 
outside the United States, Canada, and Mexico. For purposes of this 
section, the United States includes the United States and its 
territories.
    (C) Valuation of fuel where cost reimbursed by or charged to 
employer. The fair market value of fuel, the cost of which is reimbursed 
by or charged to an employer, is generally the amount of the actual 
reimbursement or the amount charged, provided the purchase of the fuel 
is at arm's length. If an employer with a fleet of at least 20 
automobiles that meet the requirements of paragraph (d)(5)(v)(C) of this 
section reimburses employees for the cost of fuel or allows employees to 
charge the employer for the cost of the fuel, however, the fair market 
value of fuel provided to those automobiles may be determined by 
reference to the employer's fleet-average cents-per-mile fuel cost. The 
fleet-average cents-per-mile fuel cost in equal to the fleet-average 
per-gallon fuel cost divided by the fleet-average miles-per-gallon rate. 
The averages described in the preceding sentence must be determined by 
averaging the per-gallon fuel costs and miles-per-gallon rates of a 
representative sample of the automobiles in the fleet equal to the 
greater of ten percent of the automobiles in the fleet or 20 automobiles 
for a representative period, such as a two month period.
    (iii) All other services excluded. The fair market value of any 
service not specifically identified in paragraph (d)(3)(i) of this 
section that is provided

[[Page 21]]

by the employer with respect to an automobile (such as the services of a 
chauffeur) must be added to the Annual Lease Value of the automobile in 
determining the fair market value of the benefit provided.
    (4) Availability of an automobile for less than an entire calendar 
year--(i) Pro-rated Annual Lease Value used for continuous availability 
of 30 or more days. Except as otherwise provided in paragraph (d)(4)(iv) 
of this section, for periods of continuous availability of 30 or more 
days, but less than an entire calendar year, the value of the 
availability of the employer-provided automobile is the pro-rated Annual 
Lease Value. The pro-rated Annual Lease Value is calculated by 
multiplying the applicable Annual Lease Value by a fraction, the 
numerator of which is the number of days of availability and the 
denominator of which is 365.
    (ii) Daily Lease Value used for continuous availability of less than 
30 days. Except as otherwise provided in paragraph (d)(4)(iii) of this 
section, for periods of continuous availability of one or more but less 
than 30 days, the value of the availability of the employer-provided 
automobile is the Daily Lease Value. The Daily Lease Value is calculated 
by multiplying the applicable Annual Lease Value by a fraction, the 
numerator of which is four times the number of days of availability and 
the denominator of which is 365.
    (iii) Election to treat all periods as periods of at least 30 days. 
A pro-rated Annual Lease Value may be applied with respect to a period 
of continuous availability of less than 30 days, by treating the 
automobile as if it had been available for 30 days, if to do so would 
result in a lower valuation than applying the Daily Lease Value to the 
shorter period of actual availability.
    (iv) Periods of unavailability--(A) General rule. In general, a pro-
rated Annual Lease Value (as provided in paragraph (d)(4)(i) of this 
section) is used to value the availability of an employer-provided 
automobile when the automobile is available to an employee for a period 
of continuous availability of at least 30 days but less than the entire 
calendar year. Neither an employer nor an employee may use a pro-rated 
Annual Lease Value when the reduction of Federal taxes is the primary 
reason the automobile is unavailable to an employee during the calendar 
year.
    (B) Unavailability for personal reasons of the employee. If an 
automobile is unavailable to an employee because of personal reasons of 
the employee, such as while the employee is on vacation, a pro-rated 
Annual Lease Value may not be used. For example, assume an automobile is 
available to an employee during the first five months of the year and 
during the last five months of the year. Assume further that the period 
of unavailability occurs because the employee is on vacation. The Annual 
Lease Value, if it is applied, must be applied with respect to the 
entire 12 month period. The Annual Lease Value may not be pro-rated to 
take into account the two-month period of unavailability.
    (5) Fair market value--(i) In general. For purposes of determining 
the Annual Lease Value of an automobile under the Annual Lease Value 
Table, the fair market value of an automobile is that amount a 
hypothetical person would have to pay a hypothetical third party to 
purchase the particular automobile provided. Thus, for example, any 
special relationship that may exist between the employee and the 
employer must be disregarded. Also, the employee's subjective perception 
of the value of the automobile is not relevant to the determination of 
the automobile's fair market value. In addition, except as provided in 
paragraph (d)(5) (ii) of this section, the cost incurred by the employer 
of either purchasing of leasing the automobile is not determinative of 
the fair market value of the automobile.
    (ii) Safe-harbor valuation rule. For purposes of calculating the 
Annual Lease Value of an automobile under this paragraph (d), the safe-
harbor value of the automobile may be used as the fair market value of 
the automobile For an automobile owned by the employer, the safe-harbor 
value of the automobile is the employer's cost of purchasing the 
automobile, provided the purchase is made at arm's length. For an 
automobile leased by the employer, the safe-harbor value of the 
automobile is the value determined

[[Page 22]]

under paragraph (d)(5)(iii) of this section.
    (iii) Use of nationally recognized pricing guides. The fair market 
value of an automobile that is (A) provided to an employee prior to 
January 1, 1985, (B) being revalued pursuant to paragraphs (d)(2) (iv) 
or (v) of this section, or (C) is a leased automobile being valued 
pursuant to paragraph (d)(5)(ii) of this section, may be determined by 
using the retail value of such automobile as reported in a nationally 
recognized publication that regularly reports new or used automobile 
retail values, whichever is applicable. The values contained in (and 
obtained from) the publication must be reasonable with respect to the 
automobile being valued.
    (iv) Fair market value of special equipment--(A) Certain equipment 
excluded. The fair market value of an automobile does not include the 
fair market value of any telephone or any specialized equipment that is 
added to or carried in the automobile if the presence of such equipment 
is necessitated by, and attributable to, the business needs of the 
employer.
    (B) Use of specialized equipment outside of employer's business. The 
value of specialized equipment must be included, however, if the 
employee to whom the automobile is available uses the specialized 
equipment in a trade of business of the employee other than the 
employee's trade or business of being an employee of the employer.
    (C) Equipment susceptible to personal use. The exclusion rule 
provided in this paragraph (d)(5)(iv) does not apply to specialized 
equipment susceptible to personal use.
    (v) Fleet-average valuation rule--(A) In general. An employer with a 
fleet of 20 or more automobiles may use a fleet-average value for 
purposes of calculating the Annual Lease Values of the automobiles in 
the fleet. The fleet-average value is the average of the fair market 
values of each automobile in the fleet. The fair market value of each 
automobile in the fleet shall be determined, pursuant to the rules of 
paragraphs (d)(5) (i) through (iv) of this section, as of the later of 
January 1, 1985, or the first date on which the automobile is made 
available to any employee of the employer for personal use.
    (B) Period for use of rule. The fleet-average valuation rule of this 
paragraph (d)(5)(v) may be used by an employer as of January 1 of any 
calendar year following the calendar year in which the employer acquires 
a fleet of 20 or more automobiles. The Annual Lease Value calculated for 
the automobiles in the fleet, based on the fleet-average value, shall 
remain in effect for the period that begins with the first January 1 the 
fleet-average valuation rule of this paragraph (d)(5)(v) is applied by 
the employer to the automobiles in the fleet and ends on December 31 of 
the subsequent calendar year. The Annual Lease Value for each subsequent 
two year period is calculated by determining the fleet-average value of 
the automobiles in the fleet as of the first January 1 of such period. 
An employer may cease using the fleet-average valuation rule as of any 
January 1. The fleet-average valuation rule does not apply as of January 
1 of the year in which the number of automobiles in the employer's fleet 
declines to fewer than 20. If, however, the employer is using the 
special accounting rule provided in Announcement 85-113 (I.R.B. No. 31, 
August 5, 1985), the employer may apply the rules of this paragraph 
(d)(5)(v)(B) on the basis of the special accounting period rather than 
the calendar year. (This is accomplished by substituting (1) the 
beginning of the special accounting period that begins immediately prior 
to the January 1 described in this paragraph (d)(5)(v)(B) for January 1 
wherever it appears in this paragraph (d)(5)(v)(B) and (2) the end of 
such accounting period for December 31.) The revaluation rules of 
paragraph (d)(2) (iv) and (v) of this section do not apply to 
automobiles valued under this paragraph (d)(5)(v).
    (C) Limitations on use of fleet-average rule. The rule provided in 
this paragraph (d)(5)(v) may not be used for any automobile whose fair 
market value (determined pursuant to paragraphs (d)(5) (i) through (iv) 
of this section as of either the first date on which the automobile is 
made available to any employee of the employer for personal use or, if 
later, January 1, 1985) exceeds $16,500. In addition, the rule provided 
in

[[Page 23]]

this paragraph (d)(5)(v) may only be used for automobiles that the 
employer reasonably expects will regularly be used in the employer's 
trade or business. Infrequent use of the vehicle, such as for trips to 
the airport or between the employer's multiple business premises, does 
not constitute regular use of the vehicle in the employer's trade or 
business.
    (D) Additional automobiles added to the fleet. If the rule provided 
in this paragraph (d)(5)(v) is used by an employer, it must be used for 
every automobile included in or added to the fleet that meets the 
requirements of paragraph (d)(5)(v)(C) of this section. The fleet-
average value in effect at the time an automobile is added to the fleet 
is treated as the fair market value of the automobile for purposes of 
determining the Annual Lease Value of the automobile until the fleet-
average value changes pursuant to paragraph (d)(5)(v)(B) of this 
section.
    (E) Use of the fleet-average rule by employees. An employee can only 
use the fleet-average value if it is used by the employer. If an 
employer uses the fleet-average value, and the employee uses the special 
valuation rule of paragraph (d) of this section, the employee must use 
the fleet-average value.
    (6) Consistency rules--(i) Use of the automobile lease valuation 
rule by an employer. Except as provided in paragraph (d)(5) (v)(B) of 
this section, an employer may adopt the automobile lease valuation rule 
of this paragraph (d) for an automobile only if the rule is adopted with 
respect to the later of the period that begins on January 1, 1987, or 
the first period in which the automobile is made available to an 
employee of the employer for personal use or, if the commuting valuation 
rule of paragraph (f) of this section is used when the automobile is 
first made available to an employee of the employer for personal use, 
the first period in which the commuting valuation rule is not used.
    (ii) An employer must use the automobile lease valuation rule for 
all subsequent periods. Once the automobile lease valuation rule has 
been adopted for an automobile by an employer, the rule must be used by 
the employer for all subsequent periods in which the employer makes the 
automobile available to any employee, except that the employer may, for 
any period during which use of the automobile qualifies for the 
commuting valuation rule of paragraph (f) of this section, use the 
commuting valuation rule with respect to the automobile.
    (iii) Use of the automobile lease valuation rule by an employee. 
Except as provided in paragraph (c)(2)(ii)(C) of this section, an 
employee may adopt the automobile lease valuation rule for an automobile 
only if the rule is adopted (A) by the employer and (B) with respect to 
the first period in which the automobile for which the employer 
(consistent with paragraph (d)(6)(i) of this section) adopted the rule 
is made available to that employee for personal use, or, if the 
commuting valuation rule of paragraph (f) of this section is used when 
the automobile is first made available to that employee for personal 
use, the first period in which the commuting valuation rule is not used.
    (iv) An employee must use the automobile lease valuation rule for 
all subsequent periods. Once the automobile lease valuation rule has 
been adopted for an automobile by an employee, the rule must be used by 
the employee for all subsequent periods in which the automobile for 
which the rule is used is available to the employee, except that the 
employee may, for any period during which use of the automobile 
qualifies for use of the commuting valuation rule of paragraph (f) of 
this section and for which the employer uses the rule, use the commuting 
valuation rule with respect to the automobile.
    (v) Replacement automobiles. Notwithstanding anything in this 
paragraph (D)(6) to the contrary, if the automobile lease valuation rule 
is used by an employer, or by an employer and an employee, with respect 
to a particular automobile, and a replacement automobile is provided to 
the employee for the primary purpose of reducing Federal taxes, then the 
employer, or the employer and the employee, using the rule must continue 
to use the rule with respect to the replacement automobile.
    (e) Vehicle cents-per-mile valuation rule--(1) In general--(i) 
General rule. Under the vehicle cents-per-mile valuation rule of this 
paragraph (e), if an

[[Page 24]]

employer provides an employee with the use of a vehicle that (A) the 
employer reasonably expects will be regularly used in the employer's 
trade or business throughout the calendar year (or such shorter period 
as the vehicle may be owned or leased by the employer) or (B) satisfies 
the requirements of paragraph (e)(1)(ii) of this section, the value of 
the benefit provided in the calendar year is the standard mileage rate 
provided in the applicable Revenue Ruling or Revenue Procedure (``cents-
per-mile rate'') multiplied by the total number of miles the vehicle is 
driven by the employee for personal purposes. For 1985, the standard 
mileage rate is 21 cents per mile for the first 15,000 miles and 11 
cents per mile for all miles over 15,000. See Rev. Proc. 85-49. The 
standard mileage rate must be applied to personal miles independent of 
business miles. Thus, for example, if an employee drives 20,000 personal 
miles and 35,000 business miles in 1985, the value of the personal use 
of the vehicle is $3,700 (15,000x$.21+5,000x$.11). For purposes of this 
section, the use of a vehicle for personal purposes is any use of the 
vehicle other than use in the employee's trade or business of being an 
employee of the employer. Infrequent use of the vehicle, such as for 
trips to the airport or between the employer's multiple business 
premises, does not constitute regular use of the vehicle in the 
employer's trade or business.
    (ii) Mileage rule. A vehicle satisfies the requirements of this 
paragraph (e)(1)(ii) in a calendar year if (A) it is actually driven at 
least 10,000 miles in the year, and (B) use of the vehicle during the 
year is primarily by employees. For example, if a vehicle is used by 
only one employee during the year and that employee drives a vehicle at 
least 10,000 miles in a calendar year, such vehicle satisfies the 
requirements of this paragraph (e)(1)(ii) even if all miles driven by 
the employee are personal. The requirements of this paragraph 
(e)(1)(ii), however, will not be satisfied if during the year the 
vehicle is transferred among employees in such a way which enables an 
employee whose use was at a rate significantly less that 10,000 miles 
per year to meet the 10,000 mile threshold. Assume that an employee uses 
a vehicle for the first six months of the year and drives 2,000 miles, 
and that vehicle is then used by other employees who drive the vehicle 
8,000 miles in the last six months of the year. Because the rate at 
which miles were driven in the first six months of the year would result 
in only 4,000 miles being driven in the year, and because the first 
employee did not use the vehicle during the last six months of the year, 
the requirements of this paragraph (e)(1)(ii) are not satisfied. The 
requirement of paragraph (e)(1)(ii)(B) of this section is deemed 
satisfied if employees use the vehicle on a consistent basis for 
commuting. If the employer does not own or lease the vehicle during a 
portion of the year, the 10,000 mile threshold is to be reduced 
proportionately to reflect the periods when the employer owned or leased 
the vehicle. For purposes of this paragraph (e)(1)(ii), use of the 
vehicle by an individual (other than the employee) whose use would be 
taxed to the employee is not considered use by the employee.
    (iii) Limitation on use of the vehicle cents-per-mile valuation 
rule. The value of the use of an automobile (as defined in paragraph 
(d)(1)(ii) of this section) may not be determined under the vehicle 
cents-per-mile valuation rule of this paragraph (e) if the fair market 
value of the automobile (determined pursuant to paragraphs (d)(5) (i) 
through (iv) of this section as of the later of January 1, 1985, or the 
first date on which the automobile is made available to any employee of 
the employer for personal use) exceeds $12,800. No inference may be 
drawn from the promulgation or terms of this section concerning the 
application of law in effect prior to January 1, 1985.
    (2) Definition of vehicle. For purposes of this paragraph (e), the 
term ``vehicle'' means any motorized wheeled vehicle manufactured 
primarily for use on public streets, roads, and highways. The term 
``vehicle'' includes an automobile as defined in paragraph (d)(1)(ii) of 
this section.
    (3) Services included in, or excluded from, the cents-per-mile 
rate--(i) Maintenance and insurance included. The cents-per-mile rate 
includes the fair market value of maintenance of, and

[[Page 25]]

insurance for, the vehicle. An employer may not reduce the cents-per-
mile rate by the fair market value of any service included in the cents-
per-mile rate but not provided by the employer. An employer or employee 
may take into account the services provided with respect to the 
automobile by valuing the availability of the automobile under the 
general valuation rules of paragraph (b) of this section.
    (ii) Fuel provided by the employer--(A) Miles driven in the United 
States, Canada, and Mexico. With respect to miles driven in the United 
States, Canada, and Mexico, the cents-per-mile rate includes the fair 
market value of fuel provided by the employer. If fuel is not provided 
by the employer, the cents-per-mile rate may be reduced by no more than 
5.5 cents or the amount specified in any applicable Revenue Ruling or 
Revenue Procedure. For purposes of this section, the United States 
includes the United States and its territories.
    (B) Miles driven outside the United States, Canada, and Mexico. With 
respect to miles driven outside the United States, Canada, and Mexico, 
the fair market value of fuel provided by the employer is not reflected 
in the cents-per-mile rate. Accordingly, the cents-per-mile rate may be 
reduced but by no more than 5.5 cents or the amount specified in any 
applicable Revenue Ruling or Revenue Procedure. If the employer provides 
the fuel in kind, it must be valued based on all the facts and 
circumstances. If the employer reimburses the employee for the cost of 
fuel or allows the employee to charge the employer for the cost of fuel, 
the fair market value of the fuel is generally the amount of the actual 
reimbursement or the amount charged, provided the purchase of fuel is at 
arm's length.
    (4) Valuation of personal use only. The vehicle cents-per-mile 
valuation rule of this paragraph (e) may only be used to value the miles 
driven for personal purposes. Thus, the employer must include an amount 
in an employee's income with respect to the use of a vehicle that is 
equal to the product of the number of personal miles driven by the 
employee and the appropriate cents-per-mile rate. The employer may not 
include in income a greater or lesser amount; for example, the employer 
may not include in income 100 percent (all business and personal miles) 
of the value of the use of the vehicle. The term ``personal miles'' 
means all miles driven by the employee except miles driven by the 
employee is the employee's trade or business of being an employee of the 
employer.
    (5) Consistency rules--(i) Use of the vehicle cents-per-mile 
valuation rule by an employer. An employer must adopt the vehicle cents-
per-mile valuation rule of this paragraph (e) for a vehicle by the later 
of the period that begins on January 1, 1987, or the first period in 
which the vehicle is used by an employee of the employer for personal 
use or, if the commuting valuation rule of paragraph (f) of this section 
is used when the vehicle is first used by an employee of the employer 
for personal use, the first period in which the commuting valuation rule 
is not used.
    (ii) An employer must use the vehicle cents-per-mile valuation rule 
for all subsequent periods. Once the vehicle cents-per-mile valuation 
rule has been adopted for a vehicle by an employer, the rule must be 
used by the employer for all subsequent periods in which the vehicle 
qualifies for use of the rule, except that (A) the employer may, for any 
period during which use of the vehicle qualifies for the commuting 
valuation rule of paragraph (f) of this section, use the commuting 
valuation rule with respect to the vehicle, and (B) if the employer 
elects to use the automobile lease valuation rule of paragraph (d) of 
this section for a period in which the vehicle does not qualify for use 
of the vehicle cents-per-mile valuation rule, then the employer must 
comply with the requirements of paragraph (d)(6) of this section. If the 
vehicle fails to qualify for use of the vehicle cents-per-mile valuation 
rule during a subsequent period, the employer may adopt for such 
subsequent period and thereafter any other special valuation rule for 
which the vehicle then qualifies. For purposes of paragraph (d)(6) of 
this section, the first day on which an automobile with respect to which 
the vehicle cents-per-mile rule had been used fails to qualify for use 
of the vehicle cents-per-mile valuation

[[Page 26]]

rule may be deemed to be the first day on which the automobile is 
available to an employee of the employer for personal use.
    (iii) Use of the vehicle cents-per-mile valuation rule by an 
employee. An employee may adopt the vehicle cents-per-mile valuation 
rule for a vehicle only if the rule is adopted (A) by the employer and 
(B) with respect to the first period in which the vehicle for which the 
employer (consistent with paragraph (e)(5)(i) of this section) adopted 
the rule is available to that employee for personal use or, if the 
commuting valuation rule of paragraph (f) of this section is used by 
both the employer and the employee when the vehicle is first used by an 
employee for personal use, the first period in which the commuting 
valuation rule is not used.
    (iv) An employee must use the vehicle cents-per-mile valuation rule 
for all subsequent periods. Once the vehicle cents-per-mile valuation 
rule has been adopted for a vehicle by an employee, the rule must be 
used by the employee for all subsequent periods of personal use of the 
vehicle by the employee for which the rule is used by the employer, 
except that the employee may, for any period during which use of the 
vehicle qualifies for use of the commuting valuation rule of paragraph 
(f) of this section and for which such rule is used by the employer, use 
the commuting valuation rule with respect to the vehicle.
    (v) Replacement vehicles. Notwithstanding anything in this paragraph 
(e)(5) to the contrary, if the vehicle cents-per-mile valuation rule is 
used by an employer, or by an employer and an employee, with respect to 
a particular vehicle, and a replacement vehicle is provided to the 
employee for the primary purpose of reducing Federal taxes, then the 
employer, or the employer and the employee, using the rule must continue 
to use the rule with respect to the replacement vehicle if the 
replacement vehicle qualifies for use of the rule.
    (f) Commuting valuation rule--(1) In general. Under the commuting 
valuation rule of this paragraph (f), the value of the commuting use of 
an employer-provided vehicle may be determined pursuant to paragraph 
(f)(3) of this section if the following criteria are met by the employer 
and employees with respect to the vehicle:
    (i) The vehicle is owned or leased by the employer and is provided 
to one or more employees for use in connection with the employer's trade 
or business and is used in the employer's trade or business;
    (ii) For bona fide noncompensatory business reasons, the employer 
requires the employee to commute to and/or from work in the vehicle;
    (iii) The employer has established a written policy under which the 
employee may not use the vehicle for personal purposes, other than for 
commuting or de minimis personal use (such as a stop for a personal 
errand on the way between a business delivery and the employee's home);
    (iv) Except for de minimis personal use, the employee does not use 
the vehicle for any personal purpose other than commuting; and
    (v) The employee required to use the vehicle for commuting is not a 
control employee of the employer (as defined in paragraphs (f) (5) and 
(6) of this section).

If the vehicle is a chauffeur-driven vehicle, the commuting valuation 
rule of this paragraph (f) may not be used to value the commuting use of 
any passenger who commutes in the vehicle. The rule may be used, 
however, to value the commuting use of the chauffeur. Personal use of a 
vehicle is all use of the vehicle by the employee that is not used in 
the employee's trade or business of being an employee of the employer.
    (2) Special rules. Notwithstanding anything in paragraph (f)(1) of 
this section to the contrary, the following special rules apply--
    (i) Written policy not required in 1985. The policy described in 
paragraph (f)(1)(iii) of this section prohibiting personal use need not 
be written with respect to the commuting use which occurs prior to 
January 1, 1986;
    (ii) Commuting use during 1985. For commuting use that occurs after 
December 31, 1984, but before January 1, 1986, the restrictions of 
paragraph (f)(1)(v) of this section shall be applied by substituting 
``an employee who is

[[Page 27]]

an officer or a five-percent owner of the employer'' in lieu of ``a 
control employee''. For purposes of determining who is a five-percent 
owner, any individual who owns (or is considered as owning) five or more 
percent of the fair market value of an entity (the ``owned entity'') is 
considered a five-percent owner of all entities that would be aggregated 
with the owned entity under the rules of section 414 (b), (c), or (m). 
An employee who is an officer of an employer shall be treated as an 
officer of all entities treated as a single employer pursuant to section 
414 (b), (c), or (m). The definitions provided in paragraphs (f)(5)(i) 
and (f)(6) of this section may be used to define an officer; and
    (iii) Control employee exception. If the vehicle in which the 
employee is required to commute is not an automobile as defined in 
paragraph (d)(1)(ii) of this section, the restrictions of paragraph 
(f)(1)(v) of this section do not apply.
    (3) Commuting value--(i) $1.50 per one-way commute. If the 
requirements of this paragraph (f) are satisfied, the value of the 
commuting use of an employer-provided vehicle is $1.50 per one-way 
commute (e.g., from home to work or from work to home).
    (ii) Value per employee. If there is more than one employee who 
commutes in the vehicle, such as in the case of an employer-sponsored 
car pool, the amount includible in the income of each employee is $1.50 
per one-way commute. Thus, the amount includible for each round-trip 
commute is $3.00 per employee.
    (4) Definition of vehicle. For purposes of this paragraph (f), the 
term ``vehicle'' means any motorized wheeled vehicle manufactured 
primarily for use on public streets, roads, and highways. The term 
``vehicle'' includes an automobile as defined in paragraph (d)(1)(ii) of 
this section.
    (5) Control employee defined--Non-government employer. For purposes 
of this paragraph (f), a control employee of a non-government employer 
is any employee--
    (i) Who is a Board- or shareholder-appointed, confirmed, or elected 
officer of the employer,
    (ii) Who is a director of the employer, or
    (iii) Who owns a one-percent or greater equity, capital, or profits 
interest in the employer.

For purposes of determining who is a one-percent owner under paragraph 
(f)(5)(iii) of this section, any individual who owns (or is considered 
as owning under section 318(a) or principles similar to section 318(a) 
for entities other than corporations) one percent or more of the fair 
market value of an entity (the ``owned entity'') is considered a one-
percent owner of all entities which would be aggregated with the owned 
entity under the rules of section 414 (b), (c), or (m). An employee who 
is an officer of an employer shall be treated as an officer of all 
entities treated as a single employer pursuant to section 414 (b), (c) 
or (m).
    (6) Control employee defined--Government employer. For purposes of 
this paragraph (f), a control employee of a government employer if any--
    (i) Elected official,
    (ii) Federal employee who is appointed by the President and 
confirmed by the Senate. In the case of commissioned officers of the 
United States Armed Forces, an officer is any individual with the rank 
of brigadier general or above or the rank of rear admiral (lower half) 
or above; or
    (iii) State or local executive officer comparable to the individuals 
described in paragraph (f)(6) (i) and (ii) of this section.

For purposes of this paragraph (f), the term ``government'' includes any 
Federal, state, or local governmental unit, and any agency or 
instrumentality thereof.
    (g) Non-commercial flight valuation rule--(1) In general. Under the 
non-commercial flight valuation rule of this paragraph (g), if an 
employee is provided with a flight on an employer-provided aircraft, the 
value of the flight is calculated using the aircraft valuation formula 
provided in paragraph (g)(5) of this section. Except as otherwise 
provided, for purposes of this paragraph (g), a flight provided to a 
person whose flight would be taxable to an employee as the recipient is 
referred to as provided to the employee, and a flight

[[Page 28]]

taken by such person is considered a flight taken by the employee.
    (2) Eligible flights and eligible aircraft. The valuation rule of 
this paragraph (g) may be used to value flights on all employer-provided 
aircraft, including helicopters. The valuation rule of this paragraph 
(g) may be used to value international as well as domestic flights. The 
valuation rule of this paragraph (g) may not be used to value a flight 
on any commercial aircraft on which air transportation is sold to the 
public on a per-seat basis. For a special valuation rule relating to 
certain flights on commercial aircraft, see paragraph (h) of this 
section.
    (3) Definition of a flight--(i) General rule. Except as otherwise 
provided in paragraph (g)(3)(iii) of this section (relating to 
intermediate stops), for purposes of this paragraph (g), an individual's 
flight is the distance (in statute miles) between the place at which the 
individual boards the aircraft and the place at which the individual 
deplanes.
    (ii) Valuation of each flight. Under the valuation rule of this 
paragraph (g), value is determined separately for each flight. Thus, a 
round-trip is comprised of at least two flights. For example, an 
employee who takes a personal trip on an employer-provided aircraft from 
New York, New York to Denver, Colorado, Denver to Los Angeles, 
California, and Los Angeles to New York has taken three flights and must 
apply the aircraft valuation formula separately to each flight. The 
value of a flight must be determined on a passenger-by-passenger basis. 
For example, if an individual accompanies an employee and the flight 
taken by the individual would be taxed to the employee, the employee 
would be taxed on the special rule value of the flight by the employee 
and by the individual.
    (iii) Intermediate stop. If the primary purpose of a landing is 
necessitated by weather conditions, by an emergency, for purposes of 
refueling or obtaining other services relating to the aircraft, or for 
purposes of the employer's business unrelated to the employee whose 
flight is being valued (``an intermediate stop''), the distance between 
the place at which the trip originates and the place at which the 
intermediate stop occurs is not considered a flight. For example, assume 
that an employee's trip originates in St. Louis, Missouri, on route to 
Seattle, Washington, but, because of weather conditions, the aircraft 
lands in Denver, Colorado, and the employee stays in Denver overnight. 
Assume further that the next day the aircraft flies to Seattle where the 
employee deplanes. The employee's flight is the distance between the 
airport in St. Louis and the airport in Seattle. Assume that a trip 
originates in New York, New York, with five passengers and makes an 
intermediate stop in Chicago, Illinois, before going on to Los Angeles, 
California. If one of the five passengers deplanes in Chicago, the 
distance of that passenger's flight would be the distance between the 
airport in New York and the airport in Chicago. The intermediate stop is 
disregarded when measuring the flights taken by each of the other 
passengers. Their flights would be the distance between the airport in 
New York and the airport in Los Angeles.
    (4) Personal and non-personal flights--(i) In general. The valuation 
rule of this paragraph (g) applies to personal flights on employer-
provided aircraft. A personal flight is one the value of which is not 
excludable under another section of subtitle A, such as under section 
132(d) (relating to a working condition fringe). However, solely for 
purposes of paragraphs (g)(4)(ii) and (g)(4)(iii) of this section, 
references to personal flights do not include flights a portion of which 
would not be excludable by reason of section 274.(c).
    (ii) Trip primarily for employer's business. If an employee 
combines, in one trip, personal and business flights on an employer-
provided aircraft and the employee's trip is primarily for the 
employer's business (see Sec. 1.162-2(b)(2)), the employee must include 
in income the excess of the value of all the flights that comprise the 
trip over the value of the flights that would have been taken had there 
been no personal flights but only business flights. For example, assume 
that an employee flies on an employer-provided aircraft from Chicago, 
Illinois to Miami, Florida, for the employer's business and that from 
Miami the employee flies on the employer-provided aircraft to Orlando, 
Florida,

[[Page 29]]

for personal purposes and then flies back to Chicago. Assume further 
that the primary purpose of the trip is for the employer's business. The 
amount includible in income is the excess of the value of the three 
flights (Chicago to Miami, Miami to Orlando, and Orlando to Chicago), 
over the value of the flights that would have been taken had there been 
no personal flights but only business flights (Chicago to Miami and 
Miami to Chicago).
    (iii) Primarily personal trip. In an employee combines, in one trip, 
personal and business flights on an employer-provided aircraft and the 
aircraft's trip is primarily personal (see Sec. 1.162-2(b)(2)), the 
amount includible in the employee's income is the value of the personal 
flights that would have been taken had there been no business flights 
but only personal flights. For example, assume that an employee flies on 
an employer-provided aircraft from San Francisco, California, to Los 
Angeles, California, for the employer's business and that from Los 
Angeles the employee flies on an employer-provided aircraft to Palm 
Springs, California, primarily for personal reasons and then flies back 
to San Francisco. Assume further that the primary purpose of the trip is 
personal. The amount includible in the employee's income is the value of 
personal flights that would have been taken had there been no business 
flights but only personal flights (San Francisco to Palm Springs and 
Palm Springs to San Francisco).
    (iv) Application of section 274(c). The value of employer-provided 
travel outside the United States away from home may not be excluded from 
the employee's gross income as a working condition fringe, by either the 
employer or the employee, to the extent not deductible by reason of 
section 274(c). The valuation rule of this paragraph (g) applies to that 
portion of the value of any flight not excludable by reason of section 
274(c). Such value must be included in income in addition to the amounts 
determined under paragraphs (g)(4)(ii) and (g)(4)(iii) of this section.
    (v) Flight by individuals who are not personal guests. If an 
individual who is not an employee of the employer providing the aircraft 
is on a flight, and the individual is not the personal guest of any 
employee, the flight by the individual is not taxable to any employee of 
the employer providing the aircraft. The rule in the preceding sentence 
applies where the individual is provided the flight by the employer for 
noncompensatory business reasons of the employer. For example, assume 
that G, and employee of company Y, accompanies A, an employee of company 
X, on company X's aircraft for the purpose of inspecting land under 
consideration for purchase by company X from company Y. The flight by G 
is not taxable to A.
    (5) Aircraft valuation formula. Under the valuation rule of this 
paragraph (g), the value of a flight is determined by multiplying the 
base aircraft valuation formula for the period during which the flight 
was taken by the appropriate aircraft multiple (as provided in paragraph 
(g)(7) of this section) and then adding the applicable terminal charge. 
The base aircraft valuation formula (also known as the Standard Industry 
Fare Level formula or SIFL) in effect on June 30, 1985, is as follows: 
($.1402 per mile for the first 500 miles, $.1069 per mile for miles 
between 501 and 1500, and $.1028 per mile for miles over 1500). The 
terminal charge in effect on June 30, 1985, is $25.62. The SIFL cents-
per-mile rates in the formula and the terminal charge are calculated by 
the Department of Transportation and are revised semi-annually.
    (6) SIFL formula in effect for a particular flight. For purposes of 
this paragraph (g), in determining the value of a particular flight 
during the first six months of a calendar year, the SIFL formula (and 
terminal charge) in effect on December 31 of the preceding year applies, 
and in determining the value of a particular flight during the last six 
months of a calendar year, the SIFL formula (and terminal charge) in 
effect on June 30 of that year applies. The following is the SIFL 
formula in effect on December 31, 1984: ($.1480 per mile for the first 
500 miles, $.1128 per mile for miles between 501 and 1500, and $.1085 
per mile for miles over 1500). The terminal charge in effect on December 
31, 1984, is $27.05.
    (7) Aircraft multiples--(i) In general. The aircraft multiples are 
based on the maximum certified takeoff weight of

[[Page 30]]

the aircraft. For purposes of applying the aircraft valuation formula 
described in paragraph (g)(5) of this section, the aircraft multiples 
are as follows:

                              [In percent]
------------------------------------------------------------------------
                                                      Aircraft multiple
                                                           for a--
                                                   ---------------------
 Maximum certified takeoff weight of the aircraft                 Non-
                                                     Control    control
                                                     employee   employee
------------------------------------------------------------------------
6,000 lbs. or less................................       62.5       15.6
6,001 to 10,000 lbs...............................      125.0       23.4
10,001 to 25,000 lbs..............................      300.0       31.3
25,001 lbs. or more...............................      400.0       31.3
------------------------------------------------------------------------

    (ii) Flights treated as provided a to control employee. Except as 
provided in paragraph (g)(10) of this section, any flight provided to an 
individual whose flight would be taxable to a control employee (as 
defined in paragraph (g)(8) and (9) of this section) as the recipient 
shall be valued as if such flight has been provided to that control 
employee. For example, assume that the chief executive officer of an 
employer, his spouse, and his two children fly on an employer-provided 
aircraft for personal purposes. Assume further that the maximum 
certified takeoff weight of the aircraft is 12,000 lbs. The amount 
includible in the employee's income is 4 x ((300 percent x base aircraft 
valuation formula) plus the applicable terminal charge).
    (8) Control employee defined--Nongovernment employer. For purposes 
of this paragraph (g), a control employee of a non-government employer 
is any employee--
    (i) Who is a Board- or shareholder- appointed, confirmed, or elected 
officer of the employer, limited to the lesser of (A) one-percent of all 
employees (increased to the next highest integer, if not an integer) or 
(B) ten employees;
    (ii) Whose compensation equals or exceeds the compensation of the 
top one percent most highly-paid employees of the employer (increased to 
the next highest integer, if not an integer) limited to a maximum of 25 
employees;
    (iii) Who owns a ten-percent or greater equity, capital or profits 
interest in the employer; or
    (iv) Who is a director of the employer.

For purposes of this paragraph (g), any employee who is a family member 
(within the meaning of section 267(c)(4)) of a control employee is also 
a control employee. Pursuant to this paragraph (g)(8), an employee may 
be a control employee under more than one of the requirements listed in 
paragraphs (g)(8) (i) through (iv) of this section. For example, an 
employee may be both an officer under paragraph (g)(8)(i) of this 
section and a highly-paid employee under paragraph (g)(8)(ii) of this 
section. In this case, for purposes of the officer limitation rule of 
paragraph (g)(8)(i) of this section and the highly-paid employee 
limitation rule of paragraph (g)(8)(ii) of this section, the employee 
would be counted as reducing both such limitation rules. In no event 
shall an employee whose compensation is less than $50,000 be a control 
employee under paragraph (g)(8)(ii) of this section. For purposes of 
determining who is a ten-percent owner under paragraph (g)(8)(iii) of 
this section, any individual who owns (or is considered as owning under 
section 318(a) or principles similar to section 318(a) for entities 
other than corporations) ten percent or more of the fair market value of 
an entity (the ``owned entity'') is considered a ten-percent owner of 
all entities which would be aggregated with the owned entity under the 
rules of section 414 (b), (c), or (m). For purposes of determining who 
is an officer under paragraph (g)(8)(i) of this section, notwithstanding 
anything in this section to the contrary, if the employer would be 
aggregated with other employers under the rules of section 414 (b), (c), 
or (m), the officer definition and the limitations are applied to each 
separate employer rather than to the aggregated employer. If applicable, 
the officer limitation rule of paragraph (g)(8)(i) of this section is 
applied to employees in descending order of their compensation. Thus, if 
an employer has 11 board-appointed officers, the employee with the least 
compensation of those officers would not be an officer under paragraph 
(g)(8)(i) of this section. For purposes of this paragraph (g), the term 
``compensation'' means the amount reported on a Form W-2 as income for 
the prior calendar year. Compensation

[[Page 31]]

includes all amounts received from all entities treated as a single 
employer under section 414 (b), (c), or (m).
    (9) Control employee defined--Government. For purposes of this 
paragraph (g), a control employee of a government employer is any--
    (i) Elected officials;
    (ii) Federal employee who is appointed by the President and 
confirmed by the Senate. In the case of commissioned officers of the 
United States Armed Forces, an officer is any individual with the rank 
or brigadier general or above or the rank of rear admiral (lower half) 
or above; or
    (iii) State or local executive officer comparable to the individuals 
in paragraph (g)(9)(i) and (ii) of this section.

For purposes of this paragraph (g), the term ``government'' includes any 
Federal, state, or local government unit, and any agency or 
instrumentality thereof.
    (10) Seating capacity rule--(i) In general. Where 50 percent of more 
of the regular passenger seating capacity of an aircraft (as used by the 
employer) is occupied by individuals whose flights are primarily for the 
employer's business (and whose flights are excludable from income under 
section 132(d)), the value of a flight on that aircraft by any employee 
who is not flying primarily for the employer's business (or who is 
flying primarily for the employer's business but the value of whose 
flight is not excludable under section 132(d) by reason of section 
274(c)) is deemed to be zero. See Sec. 1.132-5T which limits the 
exclusion under section 132(d) to situations where the employee receives 
the flight in connection with the performance of services for the 
employer providing the aircraft. For purposes of this paragraph (g)(10), 
the term ``employee'' includes only employees and partners of the 
employer providing the aircraft and does not include independent 
contractors and directors of the employer.

For purposes of this paragraph (g)(10), the second sentence of paragraph 
(g)(1) of this section will not apply. Instead, a flight taken by an 
individual who is either treated as an employee pursuant to section 
132(f)(1) or whose flight is treated as a flight taken by an employee 
pursuant to section 132(f)(2) is considered a flight taken by an 
employee. If (A) a flight is considered taken by an individual other 
than an employee (as defined in this paragraph (g)(10)), (B) the value 
of that individual's flight is not excludable under section 132(d), and 
(C) the seating capacity rule of this paragraph (g)(10) otherwise 
applies, then the value of the flight provided to such an individual is 
the value of a flight provided to a non-control employee (even if the 
individual who would be taxed on the value of such individual's flight 
is a control employee).
    (ii) Application of 50-percent test to multiple flights. The seating 
capacity rule of this paragraph (g)(10) must be met both at the time the 
individual whose flight is being valued boards the aircraft and at the 
time the individual deplanes. For example, assume that employee A boards 
an employer-provided aircraft for personal purposes in New York, New 
York, and that at that time 80 percent of the regular passenger seating 
capacity of the aircraft is occupied by individuals whose flights are 
primarily for the employer's business (and whose flights are excludable 
from income under section 132(d)) (``the business passengers''). If the 
aircraft flies directly to Hartford, Connecticut where all of the 
passengers, including A, deplane, the requirements of the seating 
capacity rule of this paragraph (g)(10) have been satisfied. If instead, 
some of the passengers, including A, remain on the aircraft in Hartford 
and the aircraft continues on to Boston, Massachusetts, where they all 
deplane, the requirements of the seating capacity rule of this paragraph 
(g)(10) will not be satisfied unless at least 50 percent of the seats 
comprising the aircraft's regular passenger seating capacity were 
occupied by the business passengers at the time A deplanes in Boston.
    (iii) Regular passenger seating capacity. The regular passenger 
seating capacity of an aircraft is the maximum number of seats that have 
at any time been on the aircraft (while owned or leased by the 
employer). Except to the extent excluded pursuant to paragraph 
(g)(10)(v) of this section, regular seating capacity includes all seats 
which may be occupied by members of the

[[Page 32]]

flight crew. It is irrelevant that on a particular flight, less than the 
maximum number of seats are available for use, because, for example, 
some of the seats are removed. When determining the maximum number of 
seats, those seats that cannot at any time be legally used during 
takeoff and are not any time used during takeoff are not counted.
    (iv) Examples. The rules of paragraph (g)(10)(iii) of this section 
are illustrated by the following examples:

    Example (1). Employer A and employer B order the same aircraft, 
except that A orders it with 10 seats and B orders it with eight seats. 
A always uses its aircraft as a 10-seat aircraft; B always uses its 
aircraft as an eight-seat aircraft. The regular passenger seating 
capacity of A's aircraft is 10 and of B's aircraft is eight.
    Example (2). Assume the same facts as in example (1), except that 
whenever A's chief executive officer and spouse use the aircraft eight 
seats are removed. Even if substantially all of the use of the aircraft 
is by the chief executive officer and spouse the regular passenger 
seating capacity of the aircraft is 10.
    Example (3). Assume the same facts as in example (1), except that 
whenever more than eight people want to fly in B's aircraft, two extra 
seats are added. Even if substantially all of the use of the aircraft 
occurs with eight seats, the regular passenger seating capacity of the 
aircraft is 10.

    (v) Seats occupied by flight crew. When determining the regular 
passenger seating capacity of an aircraft, any seat occupied by a member 
of the flight crew (whether or not such individual is an employee of the 
employer providing the aircraft) shall not be counted, unless the 
purpose of the flight by such individual is not primarily to serve as a 
member of the flight crew. If the seat occupied by a member of the 
flight crew is not counted as a passenger seat pursuant to the previous 
sentence, such member of the flight crew is disregarded in applying the 
50 percent test described in the first sentence of paragraph (g)(10)(i) 
of this section. For example, assume that, prior to the application of 
this paragraph (g)(10)(v), the regular passenger seating capacity of an 
aircraft is two seats.


Assume further that an employee pilots the aircraft and that the 
employee's flight is not primarily for the employer's business. If the 
employee's spouse occupies the other seat for personal purposes, the 
seating capacity rule is not met and the value of both flights must be 
included in the employee's income. If, however, the employee's flight 
were primarily for the employer's business (unrelated to serving as a 
member of the flight crew), then the seating capacity rule is met and 
the value of the flight for the employee's spouse is deemed to be zero. 
If the employee's flight were primarily to serve as a member of the 
flight crew, then the seating capacity rule is not met and the value of 
a flight by any passenger for primarily personal reasons is not deemed 
to be zero.
    (11) Erroneous use of the non-commercial flight valuation rule--(i) 
In general. If the non-commercial flight valuation rule of this 
paragraph (g) is used by an employer or a control employee, as the case 
may be, on a return as originally filed, on the grounds that either the 
control employee is not in fact a control employee, or that the aircraft 
is within a specific weight classification, and either position is 
subsequently determined to be erroneous, the valuation rule of this 
paragraph (g) (including paragraph (g)(13) of this section) is not 
available to value the flight taken by that control employee by the 
person or persons taking the erroneous position. With respect to the 
weight classifications, the previous sentence does not apply if the 
position taken is that the weight of the aircraft is greater than it is 
subsequently determined to be. If, with respect to a flight by a control 
employee, the seating capacity rule of paragraph (g)(10) of this section 
is used by an employer or the control employee, as the case may be, on a 
return as originally filed, and it is subsequently determined that the 
requirements of paragraph (g)(10) of this section were not met, the 
valuation rule of this paragraph (g) (including paragraph (g)(13) of 
this section) is not available to value the flight taken by that control 
employee by the person or persons taking the erroneous position.
    (ii) Value of flight excluded as a working condition fringe. If 
either an employer or an employee, on a return as originally filed, 
excludes from the employee's income or wages the value of a

[[Page 33]]

flight on the grounds that the flight was excludable as a working 
condition fringe under section 132, and that position is subsequently 
determined to be erroneous, the valuation rule of this paragraph (g) 
(including paragraph (g)(13) of this section) is not available to value 
the flight taken by that employee by the person or persons taking the 
erroneous position.
    (12) Consistency rules--(i) Use by the employer. Except as otherwise 
provided in paragraphs (g)(11) and (g)(13)(iv) of this section, if the 
non-commercial flight valuation rule of this paragraph (g) is used by an 
employer to value flights provided in a calendar year, the rule must be 
used to value all flights provided in the calendar year.
    (ii) Use by the employee. Except as otherwise provided in paragraphs 
(g)(11) and (g)(13)(iv) of this section, if the non-commercial flight 
valuation rule of this paragraph (g) is used by an employee to value a 
flight taken in a calendar year, the rule must be used to value all 
flights taken in the calendar year.
    (13) Transitional valuation rule--(i) In general. If the value of a 
flight determined under this paragraph (g)(13) is lower than the value 
of the flight otherwise determined under paragraph (g) of this section, 
the value of the flight is the lower amount. The transitional valuation 
rule of this paragraph (g)(13) is available only for flights provided 
after December 31, 1984, and before January 1, 1986.
    (ii) Transitional valuation rule aircraft multiples. The appropriate 
aircraft multiples under the transitional valuation rule are as follows:
    (A) 125 percent of the base aircraft valuation formula, plus the 
applicable terminal charge, for any flight by any employee who is not a 
key employee (as defined in paragraph (g)(13)(iii) of this section.)
    (B) 125 percent of the base aircraft valuation formula, plus the 
applicable terminal charge, for a flight by a key employee if there is a 
primary business purpose of the trip by the aircraft. For purposes of 
this paragraph (g)(13)(ii) (B), entertaining an employee or other 
individual is not a business purpose.
    (C) 600 percent of the base aircraft valuation formula, plus the 
applicable terminal charge, for a flight by a key employee if there is 
not primary business for the trip by the aircraft.


Where there is no business purpose for the trip by the aircraft, the 
alternative valuation rule may not be used to value a flight by a key 
employee. For purposes of this section, compensating an employee is not 
a business purpose.
    (iii) Key employee defined. A ``key employee'' is any employee who 
is a five-percent owner or an officer of the employer, or who, with 
respect to a particular trip by the aircraft, controls the use of the 
aircraft. For purposes of determining who is a five-percent owner, any 
individual who owns (or is considered as owning) five or more percent of 
the fair market value of an entity (the ``owned entity'') is considered 
a five-percent owner of all entities that would be aggregated with the 
owned entity under the rules of section 414(b), (c), or (m).
    (iv) Erroneous use of transitional valuation rule. If the 
transitional valuation rule is used by an employer or a key employee, as 
the case may be, on a return as originally filed, on the grounds that--
    (A) The key employee is not in fact a key employee,
    (B) An aircraft trip had a primary business purpose, or
    (C) An aircraft trip had some business purpose,

and such position is subsequently determined to be erroneous, neither 
the transitional valuation rule nor the non-commercial flight valuation 
rule of this paragraph (g) is available to value such flight taken by 
that key employee by the person or persons taking the erroneous 
position.
    (h) Commercial flight valuation rule--(1) In general. Under the 
commercial flight valuation rule of this paragraph (h), the value of a 
space-available flight (as defined in paragraph (h)(2) of this section) 
on a commercial aircraft is 25 percent of the actual carrier's highest 
unrestricted coach fare in effect for the particular flight taken.
    (2) Space-available flight. The commercial flight valuation rule of 
this paragraph (h) is available to value a space-available flight. The 
term ``space-available flight'' means a flight on a commercial aircraft 
(i) for which

[[Page 34]]

the airline (the acutal carrier) incurs no substantial additional cost 
(including forgone revenue) determined without regard to any amount paid 
for the flight and (ii) which is subject to the same types of 
restrictions customarily associated with flying on an employee 
``standby'' or ``space-available'' basis. A flight may be a space-
available flight even if the airline that is the actual carrier is not 
the employer of the employee.
    (3) Commercial aircraft. If the actual carrier does not offer, in 
the ordinary course of its business, air transportation to customers on 
a per-seat basis, the commercial flight valuation rule of this paragraph 
(h) is not available. Thus, if, in the ordinary course of its line of 
business, the employer only offers air transportation to customers on a 
charter basis, the commerical flight valuation rule of this paragraph 
(h) may not be used to value a space-available flight on the employer's 
aircraft. Similarly, if, in the ordinary course of its line of business, 
an employer only offers air transportation to customers for the 
transport of cargo, the commercial flight valuation rule of this 
paragraph (h) may not be used to value a space-available flight on the 
employer's aircraft.
    (4) Timing of inclusion. The date that the flight is taken is the 
relevant date for purposes of applying section 61(a)(1) and this section 
to a space-available flight on a commercial aircraft. The date of 
purchase or issuance of a pass or ticket is not relevant. Thus, this 
section applies to a flight taken on or after January 1, 1985, 
regardless of the date on which the pass or ticket for the flight was 
purchased or issued.
    (5) Consistency rules--(i) Use by employer. If the commercial flight 
valuation rule of this paragraph (h) is used by an employer to value 
flights provided in a calendar year, the rule must be used to value all 
flights provided in the calendar year.
    (ii) Use by employee. If the commercial flight valuation rule of 
this paragraph (h) is used by an employee to value a flight taken in a 
calendar year, the rule must be used to value all flights taken by such 
employee in the calendar year.
    (i) [Reserved]
    (j) Valuation of meals provided at an employer-operated eating 
facility for employees--(1) In general. The valuation rule of this 
paragraph (j) may be used to value a meal provided at an employer-
operated eating facility for employees (as defined in Sec. 1.132-7T). 
For rules relating to an exclusion for the value of meals provided at an 
employer-operated eating facility for employees, see Sec. 1.132-7T.
    (2) Valuation formula--(i) In general. The value of all meals 
provided at an employer-operated eating facility for employees during a 
calendar year is 150 percent of the direct operaitng costs of the eating 
facility (``total meal value''). For purposes of this paragraph (j), the 
definition of direct operating costs provided in Sec. 1.132-7T applies. 
The taxable value of meals provided at an eating facility may be 
determined in two ways. The ``individual meal subsidy'' may be treated 
as the taxable value of a meal provided at the eating facility (see 
paragraph (j)(2)(ii) of this section). Alternatively, the employer may 
allocate the ``total meal subsidy'' among employees (see paragraph 
(j)(2)(iii) of this section).
    (ii) ``Individual meal subsidy'' defined. The ``individual meal 
subsidy'' is determined by multiplying the price charged for a 
particular meal by a fraction, the numerator of which is the total meal 
value and the denominator of which is the gross receipts of the eating 
facility, and then subtracting the amount paid for the meal. The taxable 
value of meals provided to a particular employee during a calendar year, 
therefore, is the sum of the individual meal subsidies provided to the 
employee during the calendar year.
    (iii) Allocation of ``total meal subsidy.'' Instead of using the 
individual meal value method, the employer may allocate the ``total meal 
subsidy'' (total meal value less the gross receipts of the facility) 
among employees in any manner reasonable under the circumstances.

[T.D. 8063, 50 FR 52285, Dec. 23, 1985, as amended by T.D. 8256, 54 FR 
28582, July 6, 1989; T.D. 8457, 57 FR 62195, Dec. 30, 1992]

[[Page 35]]



Sec. 1.61-3  Gross income derived from business.

    (a) In general. In a manufacturing, merchandising, or mining 
business, ``gross income'' means the total sales, less the cost of goods 
sold, plus any income from investments and from incidental or outside 
operations or sources. Gross income is determined without subtraction of 
depletion allowances based on a percentage of income to the extent that 
it exceeds cost depletion which may be required to be included in the 
amount of inventoriable costs as provided in Sec. 1.471-11 and without 
subtraction of selling expenses, losses or other items not ordinarily 
used in computing costs of goods sold or amounts which are of a type for 
which a deduction would be disallowed under section 162 (c), (f), or (g) 
in the case of a business expense. The cost of goods sold should be 
determined in accordance with the method of accounting consistently used 
by the taxpayer. Thus, for example, an amount cannot be taken into 
account in the computation of cost of goods sold any earlier than the 
taxable year in which economic performance occurs with respect to the 
amount (see Sec. 1.446-1(c)(1)(ii)).
    (b) State contracts. The profit from a contract with a State or 
political subdivision thereof must be included in gross income. If 
warrants are issued by a city, town, or other political subdivision of a 
State, and are accepted by the contractor in payment for public work 
done, the fair market value of such warrants should be returned as 
income. If, upon conversion of the warrants into cash, the contractor 
does not receive and cannot recover the full value of the warrants so 
returned, he may deduct any loss sustained from his gross income for the 
year in which the warrants are so converted. If, however, he realizes 
more than the value of the warrants so returned, he must include the 
excess in his gross income for the year in which realized.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7207, 37 FR 20767, Oct. 5, 1972; T.D. 7285, 38 FR 26184, 
Sept. 19, 1973; T.D. 8408, 57 FR 12419, Apr. 10, 1992]



Sec. 1.61-4  Gross income of farmers.

    (a) Farmers using the cash method of accounting. A farmer using the 
cash receipts and disbursements method of accounting shall include in 
his gross income for the taxable year--
    (1) The amount of cash and the value of merchandise or other 
property received during the taxable year from the sale of livestock and 
produce which he raised,
    (2) The profits from the sale of any livestock or other items which 
were purchased,
    (3) All amounts received from breeding fees, fees from rent of 
teams, machinery, or land, and other incidental farm income,
    (4) All subsidy and conservation payments received which must be 
considered as income, and
    (5) Gross income from all other sources.

The profit from the sale of livestock or other items which were 
purchased is to be ascertained by deducting the cost from the sales 
price in the year in which the sale occurs, except that in the case of 
the sale of purchased animals held for draft, breeding, or dairy 
purposes, the profits shall be the amount of any excess of the sales 
price over the amount representing the difference between the cost and 
the depreciation allowed or allowable (determined in accordance with the 
rules applicable under section 1016(a) and the regulations thereunder). 
However, see section 162 and the regulations thereunder with respect to 
the computation of taxable income on other than the crop method where 
the cost of seeds or young plants purchased for further development and 
cultivation prior to sale is involved. Crop shares (whether or not 
considered rent under State law) shall be included in gross income as of 
the year in which the crop shares are reduced to money or the equivalent 
of money. See section 263A for rules regarding costs that are required 
to be capitalized.
    (b) Farmers using an accrual method of accounting. A farmer using an 
accrual method of accounting must use inventories to determine his gross 
income. His gross income on an accrual method is determined by adding 
the total of the items described in subparagraphs

[[Page 36]]

(1) through (5) of this paragraph and subtracting therefrom the total of 
the items described in subparagraphs (6) and (7) of this paragraph. 
These items are as follows:
    (1) The sales price of all livestock and other products held for 
sale and sold during the year;
    (2) The inventory value of livestock and products on hand and not 
sold at the end of the year;
    (3) All miscellaneous items of income, such as breeding fees, fees 
from the rent of teams, machinery, or land, or other incidental farm 
income;
    (4) Any subsidy or conservation payments which must be considered as 
income;
    (5) Gross income from all other sources;
    (6) The inventory value of the livestock and products on hand and 
not sold at the beginning of the year; and
    (7) The cost of any livestock or products purchased during the year 
(except livestock held for draft, dairy, or breeding purposes, unless 
included in inventory).

All livestock raised or purchased for sale shall be added in the 
inventory at their proper valuation determined in accordance with the 
method authorized and adopted for the purpose. Livestock acquired for 
draft, breeding, or dairy purposes and not for sale may be included in 
the inventory (see subparagraphs (2), (6), and (7) of this paragraph) 
instead of being treated as capital assets subject to depreciation, 
provided such practice is followed consistently from year to year by the 
taxpayer. When any livestock included in an inventory are sold, their 
cost must not be taken as an additional deduction in computing taxable 
income, because such deduction is reflected in the inventory. See the 
regulations under section 471. See section 263A for rules regarding 
costs that are required to be capitalized. Crop shares (whether or not 
considered rent under State law) shall be included in gross income as of 
the year in which the crop shares are reduced to money or the equivalent 
of money.
    (c) Special rules for certain receipts. In the case of the sale of 
machinery, farm equipment, or any other property (except stock in trade 
of the taxpayer, or property of a kind which would properly be included 
in the inventory of the taxpayer if on hand at the close of the taxable 
year, or property held by the taxpayer primarily for sale to customers 
in the ordinary course of his trade or business), any excess of the 
proceeds of the sale over the adjusted basis of such property shall be 
included in the taxpayer's gross income for the taxable year in which 
such sale is made. See, however, section 453 and the regulations 
thereunder for special rules relating to certain installment sales. If 
farm produce is exchanged for merchandise, groceries, or the like, the 
market value of the article received in exchange is to be included in 
gross income. Proceeds of insurance, such as hail or fire insurance on 
growing crops, should be included in gross income to the extent of the 
amount received in cash or its equivalent for the crop injured or 
destroyed. See section 451(d) for special rule relating to election to 
include crop insurance proceeds in income for taxable year following 
taxable year of destruction. For taxable years beginning after July 12, 
1972, where a farmer is engaged in producing crops and the process of 
gathering and disposing of such crops is not completed within the 
taxable year in which such crops are planted, the income therefrom may, 
with the consent of the Commissioner (see section 446 and the 
regulations thereunder), be computed upon the crop method. For taxable 
years beginning on or before July 12, 1972, where a farmer is engaged in 
producing crops which take more than a year from the time of planting to 
the time of gathering and disposing, the income therefrom may, with the 
consent of the Commissioner (see section 446 and the regulations 
thereunder), be computed upon the crop method. In any case in which the 
crop method is used, the entire cost of producing the crop must be taken 
as a deduction for the year in which the gross income from the crop is 
realized, and not earlier.
    (d) Definition of ``farm''. As used in this section, the term 
``farm'' embraces the farm in the ordinarily accepted sense, and 
includes stock, dairy, poultry, fruit, and truck farms; also 
plantations, ranches, and all land used for

[[Page 37]]

farming operations. All individuals, partnerships, or corporations that 
cultivate, operate, or manage farms for gain or profit, either as owners 
or tenants, are designated as farmers. For more detailed rules with 
respect to the determination of whether or not an individual is engaged 
in farming, see Sec. 1.175-3. For rules applicable to persons 
cultivating or operating a farm for recreation or pleasure, see sections 
162 and 165, and the regulations thereunder.
    (e) Cross references. (1) For election to include Commodity Credit 
Corporation loans as income, see section 77 and regulations thereunder.
    (2) For definition of gross income derived from farming for purposes 
of limiting deductibility of soil and water conservation expenditures, 
see section 175 and regulations thereunder.
    (3) For definition of gross income from farming in connection with 
declarations of estimated income tax, see section 6073 and regulations 
thereunder.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7198, 37 FR 13679, July 13, 1972; T.D. 8729, 62 FR 
44546, Aug. 22, 1997]



Sec. 1.61-5  Allocations by cooperative associations; per-unit retain 
certificates--tax treatment as to cooperatives and patrons.

    (a) In general. Amounts allocated on the basis of the business done 
with or for a patron by a cooperative association, whether or not 
entitled to tax treatment under section 522, in cash, merchandise, 
capital stock, revolving fund certificates, retain certificates, 
certificates of indebtedness, letters of advice or in some other manner 
disclosing to the patron the dollar amount allocated, shall be included 
in the computation of the gross income of such patron for the taxable 
year in which received to the extent prescribed in paragraph (b) of this 
section, regardless of whether the allocation is deemed, for the purpose 
of section 522, to be made at the close of a preceding taxable year of 
the cooperative association. The determination of the extent of 
taxability of such amounts is in no way dependent upon the method of 
accounting employed by the patron or upon the method, cash, accrual, or 
otherwise, upon which the taxable income of such patron is computed.
    (b) Extent of taxability. (1) Amounts allocated to a patron on a 
patronage basis by a cooperative association with respect to products 
marketed for such patron, or with respect to supplies, equipment, or 
services, the cost of which was deductible by the patron under section 
162 or section 212, shall be included in the computation of the gross 
income of such patron, as ordinary income, to the following extent:
    (i) If the allocation is in cash, the amount of cash received.
    (ii) If the allocation is in merchandise, the amount of the fair 
market value of such merchandise at the time of receipt by the patron.
    (iii) If the allocation is in the form of revolving fund 
certificates, retain certificates, certificates of indebtedness, letters 
of advice, or similar documents, the amount of the fair market value of 
such document at the time of its receipt by the patron. For purposes of 
this subdivision, any document containing an unconditional promise to 
pay a fixed sum of money on demand or at a fixed or determinable time 
shall be considered to have a fair market value at the time of its 
receipt by the patron, unless it is clearly established to the contrary. 
However, for purposes of this subdivision, any document which is payable 
only in the discretion of the cooperative association, or which is 
otherwise subject to conditions beyond the control of the patron, shall 
be considered not to have any fair market value at the time of its 
receipt by the patron, unless it is clearly established to the contrary.
    (iv) If the allocation is in the form of capital stock, the amount 
of the fair market value, if any, of such capital stock at the time of 
its receipt by the patron.
    (2) If any allocation to which subparagraph (1) of this paragraph 
applies is received in the form of a document of the type described in 
subparagraph (1) (iii) or (iv) of this paragraph and is redeemed in full 
or in part or is otherwise disposed of, there shall be included in the 
computation of the gross income of the patron, as ordinary income, in 
the year of redemption or

[[Page 38]]

other disposition, the excess of the amount realized on the redemption 
or other disposition over the amount previously included in the 
computation of gross income under such subparagraph.
    (3)(i) Amounts which are allocated on a patronage basis by a 
cooperative association with respect to supplies, equipment, or 
services, the cost of which was not deductible by the patron under 
section 162 or section 212, are not includible in the computation of the 
gross income of such patron. However, in the case of such amounts which 
are allocated with respect to capital assets (as defined in section 
1221) or property used in the trade or business within the meaning of 
section 1231, such amounts shall, to the extent set forth in 
subparagraph (1) of this paragraph, be taken into account by such patron 
in determining the cost of the property to which the allocation relates. 
Notwithstanding the preceding sentence, to the extent that such amounts 
are in excess of the unrecovered cost of such property, and to the 
extent that such amounts relate to such property which the patron no 
longer owns, they shall be included in the computation of the gross 
income of such patron.
    (ii) If any patronage dividend is allocated to the patron in the 
form of a document of the type described in subparagraph (1) (iii) or 
(iv) of this paragraph, and if such allocation is with respect to 
capital assets (as defined in section 1221) or property used in the 
trade or business within the meaning of section 1231, any amount 
realized on the redemption or other disposition of such document which 
is in excess of the amount which was taken into account upon the receipt 
of the document by the patron shall be taken into account by such patron 
in the year of redemption or other disposition as an adjustment to basis 
or as an inclusion in the computation of gross income, as the case may 
be.
    (iii) Any adjustment to basis in respect of an amount to which 
subdivision (i) or (ii) of this subparagraph applies shall be made as of 
the first day of the taxable year in which such amount is received.
    (iv) The application of the provisions of this subparagraph may be 
illustrated by the following examples:

    Example (1). On July 1, 1959, P, a patron of a cooperative 
association, purchases a tractor for use in his farming business from 
such association for $2,200. The tractor has an estimated useful life of 
five years and an estimated salvage value of $200. P files his income 
tax returns on a calendar year basis and claims depreciation on the 
tractor for the year 1959 of $200 pursuant to his use of the straight-
line method at the rate of $400 per year. On July 1, 1960, the 
cooperative association allocates to P with respect to his purchase of 
the tractor a dividend of $300 in cash. P will reduce his depreciation 
allowance with respect to the tractor for 1960 (and subsequent taxable 
years) to $333.33, determined as follows:

Cost of tractor, July 1, 1959..................................   $2,200
  Less:
    Depreciation for 1959 (6 mos.)....................     $200
    Adjustment as of Jan. 1, 1960, for cash patronage       300
     dividend.........................................
    Salvage value.....................................      200
                                                       ----------
                                                            700
                                                                --------
      Basis for depreciation for the remaining 4\1/2\ years of     1,500
       estimated life..........................................
Basis for depreciation divided by the 4\1/2\ years of remaining   333.33
 life..........................................................
 

    Example (2). Assume the same facts as in example (1), except that on 
July 1, 1960, the cooperative association allocates a dividend to P with 
respect to his purchase of the tractor in the form of a revolving fund 
certificate having a face amount of $300. The certificate is redeemable 
in cash at the discretion of the directors of the association and is 
subject to diminution by any future losses of the association, and has 
no fair market value when received by P. Since the certificate had no 
fair market value when received by P, no amount with respect to such 
certificate was taken into account by him in the year 1960. In 1965, P 
receives $300 cash from the association in full redemption of the 
certificate. Prior to 1965, he had recovered through depreciation $2,000 
of the cost of the tractor, leaving an unrecovered cost of $200 (the 
salvage value). For the year 1965, the redemption proceeds of $300 are 
applied against the unrecovered cost of $200, reducing the basis to 
zero, and the balance of the redemption proceeds, $100, is includible in 
the computation of P's gross income.
    Example (3). Assume the same facts as in example (2), except that 
the certificate is redeemed in full on July 1, 1962. The full $300 
received on redemption of the certificate will be applied against the 
unrecovered cost of the tractor as of January 1, 1962, computed as 
follows:

Cost of tractor, July 1, 1959..................................   $2,200
  Less:
    Depreciation for 1959 (6 mos.)....................     $200
    Depreciation for 1960.............................      400
    Depreciation for 1961.............................      400
                                                       ----------

[[Page 39]]

 
                                                          1,000
                                                                --------
      Unrecovered cost on Jan. 1, 1962.........................    1,200
Adjustment as of Jan. 1, 1962, for proceeds of the redemption        300
 of the revolving fund certificate.............................
                                                       ----------
Unrecovered cost on Jan. 1, 1962, after adjustment.............      900
    Less: Salvage value........................................      200
                                                       ----------
      Basis for depreciation on Jan. 1, 1962...................      700
If P uses the tractor in his business until June 30,
 1964, he would be entitled to the following
 depreciation allowances with respect to the tractor:
  For 1962............................................      280
  For 1963............................................      280
  For 1964 (6 mos.)...................................      140
                                                       ----------
                                                            700
                                                                --------
Balance to be depreciated......................................        0
 

    Example (4). Assume the same facts as in example (3), except that P 
sells the tractor in 1961. The entire $300 received in 1962 in 
redemption of the revolving fund certificate is includible in the 
computation of P's gross income for the year 1962.

    (c) Special rule. If, for any taxable year ending before December 3, 
1959, a taxpayer treated any patronage dividend received in the form of 
a document described in paragraph (b) (1) (iii) or (iv) of this section 
in accordance with the regulations then applicable (whether such 
dividend is subject to paragraph (b) (1) or (3) of this section), such 
taxpayer is not required to change the treatment of such patronage 
dividends for any such prior taxable year. On the other hand, the 
taxpayer may, if he so desires, amend his income tax returns to treat 
the receipt of such patronage dividend in accordance with the provisions 
of this section, but no provision in this paragraph shall be construed 
as extending the period of limitations within which a claim for credit 
or refund may be filed under section 6511.
    (d) Per-unit retain certificates; tax treatment of cooperative 
associations; distribution and reinvestment alternative. (1)(i) In the 
case of a taxable year to which this paragraph applies to a cooperative 
association, such association shall, in computing the amount paid or 
returned to a patron with respect to products marketed for such patron, 
take into account the stated dollar amount of any per-unit retain 
certificate (as defined in paragraph (g) of this section)--
    (a) Which is issued during the payment period for such year (as 
defined in subparagraph (3) of this paragraph) with respect to such 
products,
    (b) With respect to which the patron is a qualifying patron (as 
defined in subparagraph (2) of this paragraph), and
    (c) Which clearly states the fact that the patron has agreed to 
treat the stated dollar amount thereof as representing a cash 
distribution to him which he has reinvested in the cooperative 
association.
    (ii) No amount shall be taken into account by a cooperative 
association by reason of the issuance of a per-unit retain certificate 
to a patron who was not a qualifying patron with respect to such 
certificate. However, any amount paid in redemption of a per-unit retain 
certificate which was issued to a patron who was not a qualifying patron 
with respect to such certificate shall be taken into account by the 
cooperative in the year of redemption, as an amount paid or returned to 
such patron with respect to products marketed for him. This subdivision 
shall apply only to per-unit retain certificates issued with respect to 
taxable years of the cooperative association to which this paragraph 
applied to the association (that is, taxable years with respect to which 
per-unit retain certificates were issued to one or more patrons who are 
qualifying patrons).
    (2)(i) A patron shall be considered to be a ``qualifying patron'' 
with respect to a per-unit retain certificate if there is in effect an 
agreement between the cooperative association and such patron which 
clearly provides that such patron agrees to treat the stated dollar 
amounts of all per-unit retain certificates issued to him by the 
association as representing cash distributions which he has 
constructively received and which he has, of his own choice, reinvested 
in the cooperative association. Such an agreement may be included in a 
by-law of the cooperative which is adopted prior to the time the 
products to which the per-unit retain certificates relate are marketed. 
However, except where there is in effect a ``written agreement'' 
described in subdivision (ii) of this subparagraph, a patron shall not 
be considered to be a ``qualifying patron'' with respect to a per-unit 
retain certificate if it has been

[[Page 40]]

established by a determination of the Tax Court of the United States, or 
any other court of competent jurisdiction, which has become final, that 
the stated dollar amount of such certificate, or of a similar 
certificate issued under similar circumstances to such patron or any 
other patron by the cooperative association, is not required to be 
included (as ordinary income) in the gross income of such patron, or 
such other patron, for the taxable year of the patron in which received.
    (ii) The ``written agreement'' referred to in subdivision (i) of 
this subparagraph is an agreement in writing, signed by the patron, on 
file with the cooperative association, and revocable as provided in this 
subdivision. Unless such an agreement specifically provides to the 
contrary, it shall be effective for per-unit retain certificates issued 
with respect to the taxable year of the cooperative association in which 
the agreement is received by the association, and unless revoked, for 
per-unit retain certificates issued with respect to all subsequent 
taxable years. A ``written agreement'' must be revocable by the patron 
at any time after the close of the taxable year in which it is made. To 
be effective, a revocation must be in writing, signed by the patron, and 
furnished to the cooperative association. A revocation shall be 
effective only for per-unit retain certificates issued with respect to 
taxable years of the cooperative association following the taxable year 
in which it is furnished to the association. Notwithstanding the 
preceding sentence, a revocation shall not be effective for per-unit 
retain certificates issued with respect to products marketed for the 
patron under a pooling arrangement in which such patron participated 
before such revocation. The following is an example of an agreement 
which would meet the requirements of this subparagraph:

    I agree that, for purposes of determining the amount I have received 
from this cooperative in payment for my goods, I shall treat the face 
amount of any per-unit retain certificates issued to me on and after --
-------- as representing a cash distribution which I have constructively 
received and which I have reinvested in the cooperative.

________________________________________________________________________
                                                                (Signed)

    (3) For purposes of this paragraph and paragraph (e) of this 
section, the payment period for any taxable year of the cooperative is 
the period beginning with the first day of such taxable year and ending 
with the 15th day of the 9th month following the close of such year.
    (4) This paragraph shall apply to any taxable year of a cooperative 
association if, with respect to such taxable year, the association has 
issued per-unit retain certificates to one or more of its patrons who 
are qualifying patrons with respect to such certificates within the 
meaning of subparagraph (2) of this paragraph.
    (e) Tax treatment of cooperative association; taxable years for 
which paragraph (d) does not apply. (1) In the case of a taxable year to 
which paragraph (d) of this section does not apply to a cooperative 
association, such association shall, in computing the amount paid or 
returned to a patron with respect to products marketed for such patron, 
take into account the fair market value (at the time of issue) of any 
per-unit retain certificates which are issued by the association with 
respect to such products during the payment period for such taxable 
year.
    (2) An amount paid in redemption of a per-unit retain certificate 
issued with respect to a taxable year of the cooperative association for 
which paragraph (d) of this section did not apply to the association, 
shall, to the extent such amount exceeds the fair market value of the 
certificate at the time of its issue, be taken into account by the 
association in the year of redemption, as an amount paid or returned to 
a patron with respect to products marketed for such patron.
    (3) For purposes of this paragraph and paragraph (f)(2) of this 
section, any per-unit retain certificate containing an unconditional 
promise to pay a fixed sum of money on demand or at a fixed or 
determinable time shall be considered to have a fair market value at the 
time of its issue, unless it is clearly established to the contrary. On 
the other hand, any per-unit retain certificate (other than capital 
stock) which is redeemable only in the discretion of the cooperative 
association, or

[[Page 41]]

which is otherwise subject to conditions beyond the control of the 
patron, shall be considered not to have any fair market value at the 
time of its issue, unless it is clearly established to the contrary.
    (f) Tax treatment of patron. (1) The following rules apply for 
purposes of computing the amount includible in gross income with respect 
to a per-unit retain certificate which was issued to a patron by a 
cooperative association with respect to a taxable year of such 
association for which paragraph (d) of this section applies.
    (i) If the patron is a qualifying patron with respect to such 
certificate (within the meaning of paragraph (d) (2) of this section), 
he shall, in accordance with his agreement, include (as ordinary income) 
the stated dollar amount of the certificate in gross income for his 
taxable year in which the certificate is received by him.
    (ii) If the patron is not a qualifying patron with respect to such 
certificate, no amount is includible in gross income on the receipt of 
the certificate; however, any gain on the redemption, sale, or other 
disposition of such certificate shall, to the extent of the stated 
dollar amount thereof, be considered as gain from the sale or exchange 
of property which is not a capital asset.
    (2) The amount of the fair market value of a per-unit retain 
certificate which is issued to a patron by a cooperative association 
with respect to a taxable year of the association for which paragraph 
(d) of this section does not apply shall be included, as ordinary 
income, in the gross income of the patron for the taxable year in which 
the certificate is received. Any gain on the redemption, sale, or other 
disposition of such a per-unit retain certificate shall, to the extent 
its stated dollar amount exceeds its fair market value at the time of 
issue, be treated as gain on the redemption, sale, or other disposition 
of property which is not a capital asset.
    (g) ``Per-unit retain certificate'' defined. For purposes of 
paragraphs (d), (e), and (f), of this section, the term ``per-unit 
retain certificate'' means any capital stock, revolving fund 
certificate, retain certificate, certificate of indebtedness, letter of 
advice, or other written notice--
    (1) Which is issued to a patron with respect to products marketed 
for such patron;
    (2) Which discloses to the patron the stated dollar amount allocated 
to him on the books of the cooperative association; and
    (3) The stated dollar amount of which is fixed without reference to 
net earnings.
    (h) Effective date. This section shall not apply to any amount the 
tax treatment of which is prescribed in section 1385 and Sec. 1.1385-1. 
Paragraphs (d), (e), and (f) of this section shall apply to per-unit 
retain certificates as defined in paragraph (g) of this section issued 
by a cooperative association during taxable years of the association 
beginning after April 30, 1966, with respect to products marketed for 
patrons during such years.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6855, 30 FR 
13134, Oct. 15, 1965]



Sec. 1.61-6  Gains derived from dealings in property.

    (a) In general. Gain realized on the sale or exchange of property is 
included in gross income, unless excluded by law. For this purpose 
property includes tangible items, such as a building, and intangible 
items, such as goodwill. Generally, the gain is the excess of the amount 
realized over the unrecovered cost or other basis for the property sold 
or exchanged. The specific rules for computing the amount of gain or 
loss are contained in section 1001 and the regulations thereunder. When 
a part of a larger property is sold, the cost or other basis of the 
entire property shall be equitably apportioned among the several parts, 
and the gain realized or loss sustained on the part of the entire 
property sold is the difference between the selling price and the cost 
or other basis allocated to such part. The sale of each part is treated 
as a separate transaction and gain or loss shall be computed separately 
on each part. Thus, gain or loss shall be determined at the time of sale 
of each part and not deferred until the entire property has been 
disposed of.

[[Page 42]]

This rule may be illustrated by the following examples:

    Example (1). A, a dealer in real estate, acquires a 10-acre tract 
for $10,000, which he divides into 20 lots. The $10,000 cost must be 
equitably apportioned among the lots so that on the sale of each A can 
determine his taxable gain or deductible loss.
    Example (2). B purchases for $25,000 property consisting of a used 
car lot and adjoining filling station. At the time, the fair market 
value of the filling station is $15,000 and the fair market value of the 
used car lot is $10,000. Five years later B sells the filling station 
for $20,000 at a time when $2,000 has been properly allowed as 
depreciation thereon. B's gain on this sale is $7,000, since $7,000 is 
the amount by which the selling price of the filling station exceeds the 
portion of the cost equitably allocable to the filling station at the 
time of purchase reduced by the depreciation properly allowed.

    (b) Nontaxable exchanges. Certain realized gains or losses on the 
sale or exchange of property are not ``recognized'', that is, are not 
included in or deducted from gross income at the time the transaction 
occurs. Gain or loss from such sales or exchanges is generally 
recognized at some later time. Examples of such sales or exchanges are 
the following:
    (1) Certain formations, reorganizations, and liquidations of 
corporations, see sections 331, 333, 337, 351, 354, 355, and 361;
    (2) Certain formations and distributions of partnerships, see 
sections 721 and 731;
    (3) Exchange of certain property held for productive use or 
investment for property of like kind, see section 1031;
    (4) A corporation's exchange of its stock for property, see section 
1032;
    (5) Certain involuntary conversions of property if replaced, see 
section 1033;
    (6) Sale or exchange of residence if replaced, see section 1034;
    (7) Certain exchanges of insurance policies and annuity contracts, 
see section 1035; and
    (8) Certain exchanges of stock for stock in the same corporation, 
see section 1036.
    (c) Character of recognized gain. Under Subchapter P, Chapter 1 of 
the Code, relating to capital gains and losses, certain gains derived 
from dealings in property are treated specially, and under certain 
circumstances the maximum rate of tax on such gains is 25 percent, as 
provided in section 1201. Generally, the property subject to this 
treatment is a ``capital asset'', or treated as a ``capital asset''. For 
definition of such assets, see sections 1221 and 1231, and the 
regulations thereunder. For some of the rules either granting or denying 
this special treatment, see the following sections and the regulations 
thereunder:
    (1) Transactions between partner and partnership, section 707;
    (2) Sale or exchange of property used in the trade or business and 
involuntary conversions, section 1231;
    (3) Payment of bonds and other evidences of indebtedness, section 
1232;
    (4) Gains and losses from short sales, section 1233;
    (5) Options to buy or sell, section 1234;
    (6) Sale or exchange of patents, section 1235;
    (7) Securities sold by dealers in securities, section 1236;
    (8) Real property subdivided for sale, section 1237;
    (9) Amortization in excess of depreciation, section 1238;
    (10) Gain from sale of certain property between spouses or between 
an individual and a controlled corporation, section 1239;
    (11) Taxability to employee of termination payments, section 1240.



Sec. 1.61-7  Interest.

    (a) In general. As a general rule, interest received by or credited 
to the taxpayer constitutes gross income and is fully taxable. Interest 
income includes interest on savings or other bank deposits; interest on 
coupon bonds; interest on an open account, a promissory note, a 
mortgage, or a corporate bond or debenture; the interest portion of a 
condemnation award; usurious interest (unless by State law it is 
automatically converted to a payment on the principal); interest on 
legacies; interest on life insurance proceeds held under an agreement to 
pay interest thereon; and interest on refunds of Federal taxes. For 
rules determining the taxable year in which interest, including interest 
accrued or constructively received, is included in gross income, see 
section 451 and the regulations thereunder. For the inclusion of

[[Page 43]]

interest in income for the purpose of the retirement income credit, see 
section 37 and the regulations thereunder. For credit of tax withheld at 
source on interest on tax-free covenant bonds, see section 32 and the 
regulations thereunder. For rules relating to interest on certain 
deferred payments, see section 483 and the regulations thereunder.
    (b) Interest on Government obligations--(1) Wholly tax-exempt 
interest. Interest upon the obligations of a State, Territory, or a 
possession of the United States, or any political subdivision of any of 
the foregoing, or of the District of Columbia, is wholly exempt from 
tax. Interest on certain United States obligations issued before March 
1, 1941, is exempt from tax to the extent provided in the acts of 
Congress authorizing the various issues. See section 103 and the 
regulations thereunder.
    (2) Partially tax-exempt interest. Interest earned on certain United 
States obligations is partly tax exempt and partly taxable. For example, 
the interest on United States Treasury bonds issued before March 1, 
1941, to the extent that the principal of such bonds exceeds $5,000, is 
exempt from normal tax but is subject to surtax. See sections 35 and 
103, and the regulations thereunder.
    (3) Fully taxable interest. In general, interest on United States 
obligations issued on or after March 1, 1941, and obligations issued by 
any agency or instrumentality of the United States after that date, is 
fully taxable; but see section 103 and the regulations thereunder. A 
taxpayer using the cash receipts and disbursements method of accounting 
who owns United States savings bonds issued at a discount has an 
election as to when he will report the interest; see section 454 and the 
regulations thereunder.
    (c) Obligations bought at a discount; bonds bought when interest 
defaulted or accrued. When notes, bonds, or other certificates of 
indebtedness are issued by a corporation or the Government at a discount 
and are later redeemed by the debtor at the face amount, the original 
discount is interest, except as otherwise provided by law. See also 
paragraph (b) of this section for the rules relating to Government 
bonds. If a taxpayer purchases bonds when interest has been defaulted or 
when the interest has accrued but has not been paid, any interest which 
is in arrears but has accrued at the time of purchase is not income and 
is not taxable as interest if subsequently paid. Such payments are 
returns of capital which reduce the remaining cost basis. Interest which 
accrues after the date of purchase, however, is taxable interest income 
for the year in which received or accrued (depending on the method of 
accounting used by the taxpayer).
    (d) Bonds sold between interest dates; amounts received in excess of 
original issue discount; interest on life insurance. When bonds are sold 
between interest dates, part of the sales price represents interest 
accrued to the date of the sale and must be reported as interest income. 
Amounts received in excess of the original issue discount upon the 
retirement or sale of a bond or other evidence of indebtedness may under 
some circumstances constitute capital gain instead of ordinary income. 
See section 1232 and the regulations thereunder. Interest payments on 
amounts payable as employees' death benefits (whether or not section 
101(b) applies thereto) and on the proceeds of life insurance policies 
payable by reason of the insured's death constitute gross income under 
some circumstances. See section 101 and the regulations thereunder for 
details. Where accrued interest on unwithdrawn insurance policy 
dividends is credited annually and is subject to withdrawal annually by 
the taxpayer, such interest credits constitute gross income to such 
taxpayer as of the year of credit. However, if under the terms of the 
insurance policy the interest on unwithdrawn policy dividends is subject 
to withdrawal only on the anniversary date of the policy (or some other 
date specified therein), then such interest shall constitute gross 
income to the taxpayer for the taxable year in which such anniversary 
date (or other specified date) falls.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6723, 29 FR 
5342, Apr. 21, 1964; T.D. 6873, 31 FR 941, Jan. 25, 1966]

[[Page 44]]



Sec. 1.61-8  Rents and royalties.

    (a) In general. Gross income includes rentals received or accrued 
for the occupancy of real estate or the use of personal property. For 
the inclusion of rents in income for the purpose of the retirement 
income credit, see section 37 and the regulations thereunder. Gross 
income includes royalties. Royalties may be received from books, 
stories, plays, copyrights, trademarks, formulas, patents, and from the 
exploitation of natural resources, such as coal, gas, oil, copper, or 
timber. Payments received as a result of the transfer of patent rights 
may under some circumstances constitute capital gain instead of ordinary 
income. See section 1235 and the regulations thereunder. For special 
rules for certain income from natural resources, see Subchapter I 
(section 611 and following), Chapter 1 of the Code, and the regulations 
thereunder.
    (b) Advance rentals; cancellation payments. Except as provided in 
section 467 and the regulations thereunder and except as otherwise 
provided by the Commissioner in published guidance (see Sec. 
601.601(d)(2) of this chapter), gross income includes advance rentals, 
which must be included in income for the year of receipt regardless of 
the period covered or the method of accounting employed by the taxpayer. 
An amount received by a lessor from a lessee for cancelling a lease 
constitutes gross income for the year in which it is received, since it 
is essentially a substitute for rental payments. As to amounts received 
by a lessee for the cancellation of a lease, see section 1241 and the 
regulations thereunder.
    (c) Expenditures by lessee. As a general rule, if a lessee pays any 
of the expenses of his lessor such payments are additional rental income 
of the lessor. If a lessee places improvements on real estate which 
constitute, in whole or in part, a substitute for rent, such 
improvements constitute rental income to the lessor. Whether or not 
improvements made by a lessee result in rental income to the lessor in a 
particular case depends upon the intention of the parties, which may be 
indicated either by the terms of the lease or by the surrounding 
circumstances. For the exclusion from gross income of income (other than 
rent) derived by a lessor of real property on the termination of a 
lease, representing the value of such property attributable to buildings 
erected or other improvements made by a lessee, see section 109 and the 
regulations thereunder. For the exclusion from gross income of a lessor 
corporation of certain of its income taxes on rental income paid by a 
lessee corporation under a lease entered into before January 1, 1954, 
see section 110 and the regulations thereunder.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8820, 64 FR 26851, May 18, 1999; T.D. 9135, 69 FR 41192, 
July 8, 2004]



Sec. 1.61-9  Dividends.

    (a) In general. Except as otherwise specifically provided, dividends 
are included in gross income under sections 61 and 301. For the 
principal rules with respect to dividends includible in gross income, 
see section 316 and the regulations thereunder. As to distributions made 
or deemed to be made by regulated investment companies, see sections 851 
through 855, and the regulations thereunder. As to distributions made by 
real estate investment trusts, see sections 856 through 858, and the 
regulations thereunder. See section 116 for the exclusion from gross 
income of $100 ($50 for dividends received in taxable years beginning 
before January 1, 1964) of dividends received by an individual, except 
those from certain corporations. Furthermore, dividends may give rise to 
a credit against tax under section 34, relating to dividends received by 
individuals (for dividends received on or before December 31, 1964), and 
under section 37, relating to retirement income.
    (b) Dividends in kind; stock dividends; stock redemptions. Gross 
income includes dividends in property other than cash, as well as cash 
dividends. For amounts to be included in gross income when distributions 
of property are made, see section 301 and the regulations thereunder. A 
distribution of stock, or rights to acquire stock, in the corporation 
making the distribution is not a dividend except under the circumstances 
described in section 305(b). However, the term ``dividend'' includes

[[Page 45]]

a distribution of stock, or rights to acquire stock, in a corporation 
other than the corporation making the distribution. For determining when 
distributions in complete liquidation shall be treated as dividends, see 
section 333 and the regulations thereunder. For rules determining when 
amounts received in exchanges under section 354 or exchanges and 
distributions under section 355 shall be treated as dividends, see 
section 356 and the regulations thereunder.
    (c) Dividends on stock sold. When stock is sold, and a dividend is 
both declared and paid after the sale, such dividend is not gross income 
to the seller. When stock is sold after the declaration of a dividend 
and after the date as of which the seller becomes entitled to the 
dividend, the dividend ordinarily is income to the seller. When stock is 
sold between the time of declaration and the time of payment of the 
dividend, and the sale takes place at such time that the purchaser 
becomes entitled to the dividend, the dividend ordinarily is income to 
him. The fact that the purchaser may have included the amount of the 
dividend in his purchase price in contemplation of receiving the 
dividend does not exempt him from tax. Nor can the purchaser deduct the 
added amount he advanced to the seller in anticipation of the dividend. 
That added amount is merely part of the purchase price of the stock. In 
some cases, however, the purchaser may be considered to be the recipient 
of the dividend even though he has not received the legal title to the 
stock itself and does not himself receive the dividend. For example, if 
the seller retains the legal title to the stock as trustee solely for 
the purpose of securing the payment of the purchase price, with the 
understanding that he is to apply the dividends received from time to 
time in reduction of the purchase price, the dividends are considered to 
be income to the purchaser.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6777, 29 FR 
17807, Dec. 16, 1964]



Sec. 1.61-10  Alimony and separate maintenance payments; annuities; 
income from life insurance and endowment contracts.

    (a) In general. Alimony and separate maintenance payments, 
annuities, and income from life insurance and endowment contracts in 
general constitute gross income, unless excluded by law. Annuities paid 
by religious, charitable, and educational corporations are generally 
taxable to the same extent as other annuities. An annuity charged upon 
devised land is taxable to the donee-annuitant to the extent that it 
becomes payable out of the rents or other income of the land, whether or 
not it is a charge upon the income of the land.
    (b) Cross references. For the detailed rules relating to--
    (1) Alimony and separate maintenance payments, see section 71 and 
the regulations thereunder;
    (2) Annuities, certain proceeds of endowment and life insurance 
contracts, see section 72 and the regulations thereunder;
    (3) Life insurance proceeds paid by reason of death of insured, 
employees' death benefits, see section 101 and the regulations 
thereunder;
    (4) Annuities paid by employees' trusts, see section 402 and the 
regulations thereunder;
    (5) Annuities purchased for employee by employer, see section 403 
and the regulations thereunder.



Sec. 1.61-11  Pensions.

    (a) In general. Pensions and retirement allowances paid either by 
the Government or by private persons constitute gross income unless 
excluded by law. Usually, where the taxpayer did not contribute to the 
cost of a pension and was not taxable on his employer's contributions, 
the full amount of the pension is to be included in his gross income. 
But see sections 72, 402, and 403, and the regulations thereunder. When 
amounts are received from other types of pensions, a portion of the 
payment may be excluded from gross income. Under some circumstances, 
amounts distributed from a pension plan in excess of the employee's 
contributions may constitute long-term

[[Page 46]]

capital gain, rather than ordinary income.
    (b) Cross references. For the inclusion of pensions in income for 
the purpose of the retirement income credit, see section 37 and the 
regulations thereunder. Detailed rules concerning the extent to which 
pensions and retirement allowances are to be included in or excluded 
from gross income are contained in other sections of the Code and the 
regulations thereunder. Amounts received as pensions or annuities under 
the Social Security Act (42 U.S.C. ch. 7) or the Railroad Retirement Act 
(45 U.S.C. ch. 9) are excluded from gross income. For other partial and 
total exclusions from gross income, see the following:
    (1) Annuities in general, section 72 and the regulations thereunder;
    (2) Employees' annuities, sections 402 and 403 and the regulations 
thereunder;
    (3) References to other acts of Congress exempting veterans' 
pensions and railroad retirement annuities and pensions, section 122.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6856, 30 FR 
13316, Oct. 20, 1965]



Sec. 1.61-12  Income from discharge of indebtedness.

    (a) In general. The discharge of indebtedness, in whole or in part, 
may result in the realization of income. If, for example, an individual 
performs services for a creditor, who in consideration thereof cancels 
the debt, the debtor realizes income in the amount of the debt as 
compensation for his services. A taxpayer may realize income by the 
payment or purchase of his obligations at less than their face value. In 
general, if a shareholder in a corporation which is indebted to him 
gratuitously forgives the debt, the transaction amounts to a 
contribution to the capital of the corporation to the extent of the 
principal of the debt.
    (b) Proceedings under Bankruptcy Act. (1) Income is not realized by 
a taxpayer by virtue of the discharge, under section 14 of the 
Bankruptcy Act (11 U.S.C. 32), of his indebtedness as the result of an 
adjudication in bankruptcy, or by virtue of an agreement among his 
creditors not consummated under any provision of the Bankruptcy Act, if 
immediately thereafter the taxpayer's liabilities exceed the value of 
his assets. Furthermore, unless one of the principal purposes of seeking 
a confirmation under the Bankruptcy Act is the avoidance of income tax, 
income is not realized by a taxpayer in the case of a cancellation or 
reduction of his indebtedness under--
    (i) A plan of corporate reorganization confirmed under Chapter X of 
the Bankruptcy Act (11 U.S.C., ch. 10);
    (ii) An ``arrangement'' or a ``real property arrangement'' confirmed 
under Chapter XI or XII, respectively, of the Bankruptcy Act (11 U.S.C., 
ch. 11, 12); or
    (iii) A ``wage earner's plan'' confirmed under Chapter XIII of the 
Bankruptcy Act (11 U.S.C., ch. 13).
    (2) For adjustment of basis of certain property in the case of 
cancellation or reduction of indebtedness resulting from a proceeding 
under the Bankruptcy Act, see the regulations under section 1016.
    (c) Issuance and repurchase of debt instruments--(1) Issuance. An 
issuer does not realize gain or loss upon the issuance of a debt 
instrument. For rules relating to an issuer's interest deduction for a 
debt instrument issued with bond issuance premium, see Sec. 1.163-13.
    (2) Repurchase--(i) In general. An issuer does not realize gain or 
loss upon the repurchase of a debt instrument. However, if a debt 
instrument provides for payments denominated in, or determined by 
reference to, a nonfunctional currency, an issuer may realize a currency 
gain or loss upon the repurchase of the instrument. See section 988 and 
the regulations thereunder. For purposes of this paragraph (c)(2), the 
term repurchase includes the retirement of a debt instrument, the 
conversion of a debt instrument into stock of the issuer, and the 
exchange (including an exchange under section 1001) of a newly issued 
debt instrument for an existing debt instrument.
    (ii) Repurchase at a discount. An issuer realizes income from the 
discharge of indebtedness upon the repurchase of a debt instrument for 
an amount less than its adjusted issue price (within the meaning of 
Sec. 1.1275-

[[Page 47]]

1(b)). The amount of discharge of indebtedness income is equal to the 
excess of the adjusted issue price over the repurchase price. See 
section 108 and the regulations thereunder for additional rules relating 
to income from discharge of indebtedness. For example, to determine the 
repurchase price of a debt instrument that is repurchased through the 
issuance of a new debt instrument, see section 108(e)(10).
    (iii) Repurchase at a premium. An issuer may be entitled to a 
repurchase premium deduction upon the repurchase of a debt instrument 
for an amount greater than its adjusted issue price (within the meaning 
of Sec. 1.1275-1(b)). See Sec. 1.163-7(c) for the treatment of 
repurchase premium.
    (iv) Effective date. This paragraph (c)(2) applies to debt 
instruments repurchased on or after March 2, 1998.
    (d) Cross references. For exclusion from gross income of--
    (1) Income from discharge of indebtedness in certain cases, see 
sections 108 and 1017, and regulations thereunder;
    (2) Forgiveness of Government payments to encourage exploration, 
development, and mining for defense purposes, see section 621 and 
regulations thereunder.
    (e) Cross reference. For rules relating to the treatment of 
liabilities on the sale or other disposition of encumbered property, see 
Sec. 1.1001-2.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6984, 33 FR 
19174, Dec. 24, 1968; T.D. 7741, 45 FR 81745, Dec. 12, 1980; T.D. 8746, 
62 FR 68175, Dec. 31, 1997]



Sec. 1.61-13  Distributive share of partnership gross income; income 
in respect of a decedent; income from an interest in an estate or trust.

    (a) In general. A partner's distributive share of partnership gross 
income (under section 702(c)) constitutes gross income to him. Income in 
respect of a decedent (under section 691) constitutes gross income to 
the recipient. Income from an interest in an estate or trust constitutes 
gross income under the detailed rules of Part I (section 641 and 
following), Subchapter J, Chapter 1 of the Code. In many cases, these 
sections also determine who is to include in his gross income the income 
from an estate or trust.
    (b) Creation of sinking fund by corporation. If a corporation, for 
the sole purpose of securing the payment of its bonds or other 
indebtedness, places property in trust or sets aside certain amounts in 
a sinking fund under the control of a trustee who may be authorized to 
invest and reinvest such sums from time to time, the property or fund 
thus set aside by the corporation and held by the trustee is an asset of 
the corporation, and any gain arising therefrom is income of the 
corporation and shall be included as such in its gross income.



Sec. 1.61-14  Miscellaneous items of gross income.

    (a) In general. In addition to the items enumerated in section 
61(a), there are many other kinds of gross income. For example, punitive 
damages such as treble damages under the antitrust laws and exemplary 
damages for fraud are gross income. Another person's payment of the 
taxpayer's income taxes constitutes gross income to the taxpayer unless 
excluded by law. Illegal gains constitute gross income. Treasure trove, 
to the extent of its value in United States currency, constitutes gross 
income for the taxable year in which it is reduced to undisputed 
possession.
    (b) Cross references. (1) Prizes and awards, see section 74 and 
regulations thereunder;
    (2) Damages for personal injury or sickness, see section 104 and the 
regulations thereunder;
    (3) Income taxes paid by lessee corporation, see section 110 and 
regulations thereunder;
    (4) Scholarships and fellowship grants, see section 117 and 
regulations thereunder;
    (5) Miscellaneous exemptions under other acts of Congress, see 
section 122;
    (6) Tax-free covenant bonds, see section 1451 and regulations 
thereunder.
    (7) Notional principal contracts, see Sec. 1.446-3.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6856, 30 FR 
13316, Oct. 20, 1965; T.D. 8491, 58 FR 53127, Oct. 14, 1993]

[[Page 48]]



Sec. 1.61-15  Options received as payment of income.

    (a) In general. Except as otherwise provided in Sec. 1.61-
2(d)(6)(i) (relating to certain restricted property transferred after 
June 30, 1969), if any person receives an option in payment of an amount 
constituting compensation of such person (or any other person), such 
option is subject to the rules contained in Sec. 1.421-6 for purposes 
of determining when income is realized in connection with such option 
and the amount of such income. In this regard, the rules of Sec. 1.421-
6 apply to an option received in payment of an amount constituting 
compensation regardless of the form of the transaction. Thus, the rules 
of Sec. 1.421-6 apply to an option transferred for less than its fair 
market value in a transaction taking the form of a sale or exchange if 
the difference between the amount paid for the option and its fair 
market value at the time of transfer is the payment of an amount 
constituting compensation of the transferee or any other person. This 
section, for example, makes the rules of Sec. 1.421-6 applicable to 
options granted in whole or partial payment for services of an 
independent contractor. If an amount of money or property is paid for an 
option to which this paragraph applies, then the amount paid shall be 
part of the basis of such option.
    (b) Options to which paragraph (a) does not apply. (1) Paragraph (a) 
of this section does not apply to:
    (i) An option which is subject to the rules contained in section 
421; and
    (ii) An option which is not granted as the payment of an amount 
constituting compensation, such as an option which is acquired solely as 
an investment (including an option which is part of an investment unit 
described in paragraph (b) of Sec. 1.1232-3). For rules relating to the 
taxation of options described in this subdivision, see section 1234 and 
the regulations thereunder.
    (2) If a person acquires an option which is not subject to the rules 
contained in section 421, and if such option has a readily ascertainable 
fair market value, such person may establish that such option was not 
acquired as payment of an amount constituting compensation by showing 
that the amount of money or its equivalent paid for the option equaled 
the readily ascertainable fair market value of the option. If a person 
acquires an option which is not subject to the rules contained in 
section 421, and if such option does not have a readily ascertainable 
fair market value, then to establish that such option was not acquired 
as payment of an amount constituting compensation, such person must show 
that, from an examination of all the surrounding circumstances, there 
was no reason for the option to have been granted as the payment of an 
amount constituting compensation. For example, such person must show 
that he had neither rendered nor was obligated to render substantial 
services in consideration for the granting of the option. In determining 
whether an option, such as an option acquired in connection with an 
obligation as part of an investment unit, has been granted as 
compensation for services, the ordinary services performed by an 
investor in his own self-interest in connection with his investing 
activities will not be treated as the consideration for the grant of the 
option. For example, if a small business investment company takes an 
active part in the management of its debtor small business company, the 
rendering of such management services will not be treated as the 
consideration for the granting of the option, provided such services are 
rendered for an independent consideration, or are merely protective of 
the small business investment company's investment in the borrower. See 
paragraph (c) of Sec. 1.421-6 for the meaning of the term ``readily 
ascertainable fair market value.''
    (c) Statement required in connection with certain options. (1) Any 
person acquiring any option to purchase securities (other than an option 
described in subparagraph (2) of this paragraph) shall attach a 
statement to his income tax return for the taxable year in which the 
option was acquired. For the definition of the term ``securities'', see 
section 165(g)(2).
    (2) The statement otherwise required by subparagraph (1) of this 
paragraph shall not be required with respect to the following options:
    (i) Options subject to the rules contained in section 305(a) or 
section 421;

[[Page 49]]

    (ii) Options acquired as part of an investment unit consisting of an 
option and a debenture, note, or other similar obligation--
    (a) If such unit is acquired as part of a public offering and the 
amount of money or its equivalent paid for such unit is not less than 
the public offering price, or
    (b) If such unit is actively traded on an established market and the 
amount of money or its equivalent paid for such unit is not less than 
the price paid for such unit in contemporaneous purchases of such unit 
by persons independent of both the seller and the taxpayer;
    (iii) Options acquired as part of a public offering, if the amount 
of money or its equivalent paid for such option is not less than the 
public offering price; and
    (iv) Options which are actively traded on an established market and 
which are acquired for money or its equivalent at a price not less than 
the price paid for such options in contemporaneous purchases of such 
options by persons independent of both the seller and the taxpayer.
    (3) The statement required by subparagraph (1) of this paragraph 
shall contain the following information:
    (i) Name and address of the taxpayer;
    (ii) Description of the securities subject to the option (including 
number of shares of stock);
    (iii) Period during which the option is exercisable;
    (iv) Whether the option had a readily ascertainable fair market 
value at date of grant; and
    (v) Whether the option is subject to paragraph (a) of this section.
    (4) If the statement required by subparagraph (1) of this paragraph 
indicates either that the option is not subject to paragraph (a) of this 
section, or that the option is subject to paragraph (a) of this section 
but that such option had a readily ascertainable fair market value at 
date of grant, then such statement shall contain the following 
additional information:
    (i) Option price;
    (ii) Value at date of grant of securities subject to the option;
    (iii) Restrictions (if any) on exercise or transfer of option;
    (iv) Restrictions (if any) on transfer of securities subject to the 
option;
    (v) Value of the option (if readily ascertainable);
    (vi) How value of option was determined;
    (vii) Amount of money (or its equivalent) paid for the option;
    (viii) Person from whom the option was acquired;
    (ix) A concise description of the circumstances surrounding the 
acquisition of the option and any other factors relied upon by the 
taxpayer to establish that the option is not subject to paragraph (a) of 
this section, or, if the option is treated by the taxpayer as subject to 
paragraph (a) of this section, that the option had a readily 
ascertainable fair market value at date of grant.
    (d) Effective date. This section shall apply to options granted 
after July 11, 1963, other than options required to be granted pursuant 
to the terms of a written contract entered into on or before such date.

[T.D. 6696, 28 FR 13450, Dec. 12, 1963, as amended by T.D. 6706, 29 FR 
2911, Mar. 3, 1964; T.D. 6984, 33 FR 19175, Dec. 24, 1968; T.D. 7554, 43 
FR 31913, July 24, 1978]



Sec. 1.61-21  Taxation of fringe benefits.

    (a) Fringe benefits--(1) In general. Section 61(a)(1) provides that, 
except as otherwise provided in subtitle A of the Internal Revenue Code 
of 1986, gross income includes compensation for services, including 
fees, commissions, fringe benefits, and similar items. For an outline of 
the regulations under this section relating to fringe benefits, see 
paragraph (a)(7) of this section. Examples of fringe benefits include: 
an employer-provided automobile, a flight on an employer-provided 
aircraft, an employer-provided free or discounted commercial airline 
flight, an employer-provided vacation, an employer-provided discount on 
property or services, an employer-provided membership in a country club 
or other social club, and an employer-provided ticket to an 
entertainment or sporting event.
    (2) Fringe benefits excluded from income. To the extent that a 
particular fringe benefit is specifically excluded from gross income 
pursuant to another section of subtitle A of the Internal

[[Page 50]]

Revenue Code of 1986, that section shall govern the treatment of that 
fringe benefit. Thus, if the requirements of the governing section are 
satisfied, the fringe benefits may be excludable from gross income. 
Examples of excludable fringe benefits include qualified tuition 
reductions provided to an employee (section 117(d)); meals or lodging 
furnished to an employee for the convenience of the employer (section 
119); benefits provided under a dependent care assistance program 
(section 129); and no-additional-cost services, qualified employee 
discounts, working condition fringes, and de minimis fringes (section 
132). Similarly, the value of the use by an employee of an employer-
provided vehicle or a flight provided to an employee on an employer-
provided aircraft may be excludable from income under section 105 
(because, for example, the transportation is provided for medical 
reasons) if and to the extent that the requirements of that section are 
satisfied. Section 134 excludes from gross income ``qualified military 
benefits.'' An example of a benefit that is not a qualified military 
benefit is the personal use of an employer-provided vehicle. The fact 
that another section of subtitle A of the Internal Revenue Code 
addresses the taxation of a particular fringe benefit will not preclude 
section 61 and the regulations thereunder from applying, to the extent 
that they are not inconsistent with such other section. For example, 
many fringe benefits specifically addressed in other sections of 
subtitle A of the Internal Revenue Code are excluded from gross income 
only to the extent that they do not exceed specific dollar or percentage 
limits, or only if certain other requirements are met. If the limits are 
exceeded or the requirements are not met, some or all of the fringe 
benefit may be includible in gross income pursuant to section 61. See 
paragraph (b)(3) of this section.
    (3) Compensation for services. A fringe benefit provided in 
connection with the performance of services shall be considered to have 
been provided as compensation for such services. Refraining from the 
performance of services (such as pursuant to a covenant not to compete) 
is deemed to be the performance of services for purposes of this 
section.
    (4) Person to whom fringe benefit is taxable--(i) In general. A 
taxable fringe benefit is included in the income of the person 
performing the services in connection with which the fringe benefit is 
furnished. Thus, a fringe benefit may be taxable to a person even though 
that person did not actually receive the fringe benefit. If a fringe 
benefit is furnished to someone other than the service provider such 
benefit is considered in this section as furnished to the service 
provider, and use by the other person is considered use by the service 
provider. For example, the provision of an automobile by an employer to 
an employee's spouse in connection with the performance of services by 
the employee is taxable to the employee. The automobile is considered 
available to the employee and use by the employee's spouse is considered 
use by the employee.
    (ii) All persons to whom benefits are taxable referred to as 
employees. The person to whom a fringe benefit is taxable need not be an 
employee of the provider of the fringe benefit, but may be, for example, 
a partner, director, or an independent contractor. For convenience, the 
term ``employee'' includes any person performing services in connection 
with which a fringe benefit is furnished, unless otherwise specifically 
provided in this section.
    (5) Provider of a fringe benefit referred to as an employer. The 
``provider'' of a fringe benefit is that person for whom the services 
are performed, regardless of whether that person actually provides the 
fringe benefit to the recipient. The provider of a fringe benefit need 
not be the employer of the recipient of the fringe benefit, but may be, 
for example, a client or customer of the employer or of an independent 
contractor. For convenience, the term ``employer'' includes any provider 
of a fringe benefit in connection with payment for the performance of 
services, unless otherwise specifically provided in this section.
    (6) Effective date. Except as otherwise provided, this section is 
effective as of January 1, 1989 with respect to fringe benefits provided 
after December 31, 1988. See Sec. 1.61-2T for rules in effect from 
January 1, 1985, to December 31, 1988.

[[Page 51]]

    (7) Outline of this section. The following is an outline of the 
regulations in this section relating to fringe benefits:

Sec. 1.61-21 (a) Fringe benefits.
    (1) In general.
    (2) Fringe benefits excluded from income.
    (3) Compensation for services.
    (4) Person to whom fringe benefit is taxable.
    (5) Provider of a fringe benefit referred to as an employer.
    (6) Effective date.
    (7) Outline of this section.
Sec. 1.61-21 (b) Valuation of fringe benefits
    (1) In general.
    (2) Fair market value.
    (3) Exclusion from income based on cost.
    (4) Fair market value of the availability of an employer-provided 
vehicle.
    (5) Fair market value of chauffeur services.
    (6) Fair market value of a flight on an employer-provided piloted 
aircraft.
    (7) Fair market value of the use of an employer-provided aircraft 
for which the employer does not furnish a pilot.
Sec. 1.61-21 (c) Special valuation rules.
    (1) In general.
    (2) Use of the special valuation rules.
    (3) Additional rules for using special valuation.
    (4) Application of section 414 to employers.
    (5) Valuation formulae contained in the special valuation rules.
    (6) Modification of the special valuation rules.
    (7) Special accounting rule.
Sec. 1.61-21 (d) Automobile lease valuation rule.
    (1) In general.
    (2) Calculation of Annual Lease Value.
    (3) Services included in, or excluded from, the Annual Lease Value 
Table.
    (4) Availability of an automobile for less than an entire calendar 
year.
    (5) Fair market value.
    (6) Special rules for continuous availability of certain 
automobiles.
    (7) Consistency rules.
Sec. 1.61-21 (e) Vehicle cents-per-mile valuation rule.
    (1) In general.
    (2) Definition of vehicle.
    (3) Services included in, or excluded from, the cents-per-mile rate.
    (4) Valuation of personal use only.
    (5) Consistency rules.
Sec. 1.61-21 (f) Commuting valuation rule.
    (1) In general.
    (2) Special rules.
    (3) Commuting value.
    (4) Definition of vehicle.
    (5) Control employee defined--Non-government employer.
    (6) Control employee defined--Government employer.
    (7) ``Compensation'' defined.
Sec. 1.61-21 (g) Non-commercial flight valuation rule.
    (1) In general.
    (2) Eligible flights and eligible aircraft.
    (3) Definition of a flight.
    (4) Personal and non-personal flights.
    (5) Aircraft valuation formula.
    (6) Discretion to provide new formula.
    (7) Aircraft multiples.
    (8) Control employee defined--Non-government employer.
    (9) Control employee defined--Government employer.
    (10) ``Compensation'' defined.
    (11) Treatment of former employees.
    (12) Seating capacity rule.
    (13) Erroneous use of the non-commercial flight valuation rule.
    (14) Consistency rules.
Sec. 1.61-21 (h) Commercial flight valuation rule.
    (1) In general.
    (2) Space-available flight.
    (3) Commercial aircraft.
    (4) Timing of inclusion.
    (5) Consistency rules.
Sec. 1.61-21 (i) [Reserved]
Sec. 1.61-21 (j) Valuation of meals provided at an employer-operated 
          eating facility for employees.
    (1) In general.
    (2) Valuation formula.
Sec. 1.61-21 (k) Commuting valuation rule for certain employees.
    (1) In general.
    (2) Trip-by-trip basis.
    (3) Commuting value.
    (4) Definition of employer-provided transportation.
    (5) Unsafe conditions.
    (6) Qualified employee defined.
    (7) Examples.
    (8) Effective date.

    (b) Valuation of fringe benefits--(1) In general. An employee must 
include in gross income the amount by which the fair market value of the 
fringe benefit exceeds the sum of--
    (i) The amount, if any, paid for the benefit by or on behalf of the 
recipient, and
    (ii) The amount, if any, specifically excluded from gross income by 
some other section of subtitle A of the Internal Revenue Code of 1986.

Therefore, for example, if the employee pays fair market value for what 
is received, no amount is includible in the gross income of the 
employee. In general, the determination of the fair market value of a 
fringe benefit must be made before subtracting out the amount, if any, 
paid for the benefit and the amount, if any, specifically excluded from 
gross income by another

[[Page 52]]

section of subtitle A. See paragraphs (d)(2)(ii) and (e)(1)(iii) of this 
section.
    (2) Fair market value. In general, fair market value is determined 
on the basis of all the facts and circumstances. Specifically, the fair 
market value of a fringe benefit is the amount that an individual would 
have to pay for the particular fringe benefit in an arm's-length 
transaction. Thus, for example, the effect of any special relationship 
that may exist between the employer and the employee must be 
disregarded. Similarly, an employee's subjective perception of the value 
of a fringe benefit is not relevant to the determination of the fringe 
benefit's fair market value nor is the cost incurred by the employer 
determinative of its fair market value. For special rules relating to 
the valuation of certain fringe benefits, see paragraph (c) of this 
section.
    (3) Exclusion from income based on cost. If a statutory exclusion 
phrased in terms of cost applies to the provision of a fringe benefit, 
section 61 does not require the inclusion in the recipient's gross 
income of the difference between the fair market value and the 
excludable cost of that fringe benefit. For example, section 129 
provides an exclusion from an employee's gross income for amounts 
contributed by an employer to a dependent care assistance program for 
employees. Even if the fair market value of the dependent care 
assistance exceeds the employer's cost, the excess is not subject to 
inclusion under section 61 and this section. However, if the statutory 
cost exclusion is a limited amount, the fair market value of the fringe 
benefit attributable to any excess cost is subject to inclusion. This 
would be the case, for example, where an employer pays or incurs a cost 
of more than $5,000 to provide dependent care assistance to an employee.
    (4) Fair market value of the availability of an employer-provided 
vehicle--(i) In general. If the vehicle special valuation rules of 
paragraph (d), (e), or (f) of this section do not apply with respect to 
an employer-provided vehicle, the value of the availability of that 
vehicle is determined under the general valuation principles set forth 
in this section. In general, that value equals the amount that an 
individual would have to pay in an arm's-length transaction to lease the 
same or comparable vehicle on the same or comparable conditions in the 
geographic area in which the vehicle is available for use. An example of 
a comparable condition is the amount of time that the vehicle is 
available to the employee for use, e.g., a one-year period. Unless the 
employee can substantiate that the same or comparable vehicle could have 
been leased on a cents-per-mile basis, the value of the availability of 
the vehicle cannot be computed by applying a cents-per-mile rate to the 
number of miles the vehicle is driven.
    (ii) Certain equipment excluded. The fair market value of a vehicle 
does not include the fair market value of any specialized equipment not 
susceptible to personal use or any telephone that is added to or carried 
in the vehicle, provided that the presence of that equipment or 
telephone is necessitated by, and attributable to, the business needs of 
the employer. However, the value of specialized equipment must be 
included, if the employee to whom the vehicle is available uses the 
specialized equipment in a trade or business of the employee other than 
the employee's trade or business of being an employee of the employer.
    (5) Fair market value of chauffeur services--(i) Determination of 
value--(A) In general. The fair market value of chauffeur services 
provided to the employee by the employer is the amount that an 
individual would have to pay in an arm's-length transaction to obtain 
the same or comparable chauffeur services in the geographic area for the 
period in which the services are provided. In determining the applicable 
fair market value, the amount of time, if any, the chauffeur remains on-
call to perform chauffeur services must be included. For example, assume 
that A, an employee of corporation M, needs a chauffeur to be on-call to 
provide services to A during a twenty-four hour period. If during that 
twenty-four hour period, the chauffeur actually drives A for only six 
hours, the fair market value of the chauffeur services would have to be 
the value of having a chauffeur on-call for a twenty-four hour period. 
The cost of taxi fare or limousine service for the

[[Page 53]]

six hours the chauffeur actually drove A would not be an accurate 
measure of the fair market value of chauffeur services provided to A. 
Moreover, all other aspects of the chauffeur's services (including any 
special qualifications of the chauffeur (e.g., training in evasive 
driving skills) or the ability of the employee to choose the particular 
chauffeur) must be taken into consideration.
    (B) Alternative valuation with reference to compensation paid. 
Alternatively, the fair market value of the chauffeur services may be 
determined by reference to the compensation (as defined in paragraph 
(b)(5)(ii) of this section) received by the chauffeur from the employer.
    (C) Separate valuation for chauffeur services. The value of 
chauffeur services is determined separately from the value of the 
availability of an employer-provided vehicle.
    (ii) Definition of compensation--(A) In general. For purposes of 
this paragraph (b)(5)(ii), the term ``compensation'' means compensation 
as defined in section 414(q)(7) and the fair market value of nontaxable 
lodging (if any) provided by the employer to the chauffeur in the 
current year.
    (B) Adjustments to compensation--For purposes of this paragraph 
(b)(5)(ii), a chauffeur's compensation is reduced proportionately to 
reflect the amount of time during which the chauffeur performs 
substantial services for the employer other than as a chauffeur and is 
not on-call as a chauffeur. For example, assume a chauffeur is paid 
$25,000 a year for working a ten-hour day, five days a week and also 
receives $5,000 in nontaxable lodging. Further assume that during four 
hours of each day, the chauffeur is not on-call to perform services as a 
chauffeur because that individual is performing secretarial functions 
for the employer. Then, for purposes of determining the fair market 
value of this chauffeur's services, the employer may reduce the 
chauffeur's compensation by \4/10\ or $12,000 (.4x ($25,000+$5,000) = 
$12,000). Therefore, in this example, the fair market value of the 
chauffeur's services is $18,000 ($30,000 -$12,000). However, for 
purposes of this paragraph (b)(5)(ii), a chauffeur's compensation is not 
to be reduced by any amounts paid to the chauffeur for time spent ``on-
call,'' even though the chauffeur actually performs other services for 
the employer during such time. For purposes of this paragraph 
(b)(5)(ii), a determination that a chauffeur is performing substantial 
services for the employer other than as a chauffeur is based upon the 
facts and circumstances of each situation. An employee will be deemed to 
be performing substantial services for the employer other than as a 
chauffeur if a certain portion of each working day is regularly spent 
performing other services for the employer.
    (iii) Calculation of chauffeur services for personal purposes of the 
employee. The fair market value of chauffeur services provided to the 
employee for personal purposes may be determined by multiplying the fair 
market value of chauffeur services, as determined pursuant to paragraph 
(b)(5)(i) (A) or (B) of this section, by a fraction, the numerator of 
which is equal to the sum of the hours spent by the chauffeur actually 
providing personal driving services to the employee and the hours spent 
by the chauffeur in ``personal on-call time,'' and the denominator of 
which is equal to all hours the chauffeur spends in driving services of 
any kind paid for by the employer, including all hours that are ``on-
call.''
    (iv) Definition of on-call time. For purposes of this paragraph, the 
term ``on-call time'' means the total amount of time that the chauffeur 
is not engaged in the actual performance of driving services, but during 
which time the chauffeur is available to perform such services. With 
respect to a round-trip, time spent by a chauffeur waiting for an 
employee to make a return trip is generally not treated as on-call time; 
rather such time is treated as part of the round-trip.
    (v) Definition of personal on-call time. For purposes of this 
paragraph, the term ``personal on-call time'' means the amount of time 
outside the employee's normal working hours for the employer when the 
chauffeur is available to the employee to perform driving services.
    (vi) Presumptions. (A) An employee's normal working hours will be 
presumed

[[Page 54]]

to consist of a ten hour period during which the employee usually 
conducts business activities for that employer.
    (B) It will be presumed that if the chauffeur is on-call to provide 
driving services to an employee during the employee's normal working 
hours, then that on-call time will be performed for business purposes.
    (C) Similarly, if the chauffeur is on-call to perform driving 
services to an employee after normal working hours, then that on-call 
time will be presumed to be ``personal on-call time.''
    (D) The presumptions set out in paragraph (b)(5)(vi) (A), (B), and 
(C) of this section may be rebutted. For example, an employee may 
demonstrate by adequate substantiation that his or her normal working 
hours consist of more than ten hours. Furthermore, if the employee keeps 
adequate records and is able to substantiate that some portion of the 
driving services performed by the chauffeur after normal working hours 
is attributable to business purposes, then personal on-call time may be 
reduced by an amount equal to such personal on-call time multiplied by a 
fraction, the numerator of which is equal to the time spent by the 
chauffeur after normal working hours driving the employee for business 
purposes, and the denominator of which is equal to the total time spent 
by the chauffeur driving the employee after normal working hours for all 
purposes.
    (vii) Examples. The rules of this paragraph (b)(5) may be 
illustrated by the following examples:

    Example (1). An employer makes available to employee A an automobile 
and a full-time chauffeur B (who performs no other services for A's 
employer) for an entire calendar year. Assume that the automobile lease 
valuation rule of paragraph (d) of this section is used and that the 
Annual Lease Value of the automobile is $9,250. Assume further that B's 
compensation for the year is $12,000 (as defined in section 414(q)(7)) 
and that B is furnished lodging with a value of $3,000 that is 
excludable from B's gross income. The maximum amount subject to 
inclusion in A's gross income for use of the automobile and chauffeur is 
therefore $24,250 ($12,000+$3,000+$9,250). If 70 percent of the miles 
placed on the automobile during the year are for A's employer's 
business, then $6,475 is excludable from A's gross income with respect 
to the automobile as a working condition fringe ($9,250x.70). Thus, 
$2,775 is includible in A's gross income with respect to the automobile 
($9,250-$6,475). With respect to the chauffeur, if 20 percent of the 
chauffeur's time is spent actually driving A or being on-call to drive A 
for personal purposes; then $3,000 is includible in A's income 
(.20x$15,000). Eighty percent of $15,000, or $12,000, is excluded from 
A's income as a working condition fringe.
    Example (2). Assume the same facts as in example (1) except that in 
addition to providing chauffeur services, B is responsible for 
performing substantial non-chauffeur-related duties (such as clerical or 
secretarial functions) during which time B is not ``on-call'' as a 
chauffeur. If B spends only 75 percent of the time performing chauffeur 
services, then the maximum amount subject to inclusion in A's gross 
income for use of the automobile and chauffeur is $20,500 
(($15,000x.75)+$9,250). If B is actually driving A for personal purposes 
or is on-call to drive A for personal purposes for 20 percent of the 
time during which B is available to provide chauffeur services, then 
$2,250 is includible in A's gross income (.20x$11,250). The income 
inclusion with respect to the automobile is the same as in example (1).
    Example (3). Assume the same facts as in example (2) except that 
while B is performing non-chauffeur-related duties, B is on call as A's 
chauffeur. No part of B's compensation is excluded when determining the 
value of the benefit provided to A. Thus, as in example (1), $3,000 is 
includible in A's gross income with respect to the chauffeur.

    (6) Fair market value of a flight on an employer-provided piloted 
aircraft--(i) In general. If the non-commercial flight special valuation 
rule of paragraph (g) of this section does not apply, the value of a 
flight on an employer-provided piloted aircraft is determined under the 
general valuation principles set forth in this paragraph.
    (ii) Value of flight. If an employee takes a flight on an employer-
provided piloted aircraft and that employee's flight is primarily 
personal (see Sec. 1.162-2(b)(2)), the value of the flight is equal to 
the amount that an individual would have to pay in an arm's-length 
transaction to charter the same or a comparable piloted aircraft for 
that period for the same or a comparable flight. A flight taken under 
these circumstances may not be valued by reference to the cost of 
commercial airfare for the same or a comparable flight. The cost to 
charter the aircraft must be allocated among all employees on board the 
aircraft based on all the facts and circumstances unless one or more of 
the

[[Page 55]]

employees controlled the use of the aircraft. Where one or more 
employees control the use of the aircraft, the value of the flight shall 
be allocated solely among such controlling employees, unless a written 
agreement among all the employees on the flight otherwise allocates the 
value of such flight. Notwithstanding the allocation required by the 
preceding sentence, no additional amount shall be included in the income 
of any employee whose flight is properly valued under the special 
valuation rule of paragraph (g) of this section. For purposes of this 
paragraph (b)(6), ``control'' means the ability of the employee to 
determine the route, departure time and destination of the flight. The 
rules provided in paragraph (g)(3) of this section will be used for 
purposes of this section in defining a flight. Notwithstanding the 
allocation required by the preceding sentence, no additional amount 
shall be included in the income of an employee for that portion of any 
such flight which is excludible from income pursuant to section 132(d) 
or Sec. 1.132-5 as a working condition fringe.
    (iii) Examples. The rules of paragraph (b)(6) of this section may be 
illustrated by the following examples:

    Example (1). An employer makes available to employees A and B a 
piloted aircraft in New York, New York. A wants to go to Los Angeles, 
California for personal purposes. B needs to go to Chicago, Illinois for 
business purposes, and then wants to go to Los Angeles, California for 
personal purposes. Therefore, the aircraft first flies to Chicago, and B 
deplanes and then boards the plane again. The aircraft then flies to Los 
Angeles, California where A and B deplane. The value of the flight to 
employee A will be no more than the amount that an individual would have 
to pay in an arm's length transaction to charter the same or a 
comparable piloted aircraft for the same or comparable flight from New 
York City to Los Angeles. No amount will be imputed to employee A for 
the stop at Chicago. As to employee B, the value of the personal flight 
will be no more than the value or the flight from Chicago to Los 
Angeles. Pursuant to the rules set forth in Sec. 1.132-5(k), the flight 
from New York to Chicago will not be included in employee B's income 
since that flight was taken solely for business purposes. The charter 
cost must be allocated between A and B, since both employees controlled 
portions of the flight. Assume that the employer allocates according to 
the relative value of each employee's flight. If the charter value of 
A's flight from New York City to Los Angeles is $1,000 and the value of 
B's flight from Chicago to Los Angeles is $600 and the value of the 
actual flight from New York to Chicago to Los Angeles is $1,200, then 
the amount to be allocated to employee A is $750 ($1,000/
($1,000+$600)x$1,200) and the amount to be allocated to employee B is 
$450 ($600/($1000+$600)x$1,200).
    Example (2). Assume the same facts as in example (1), except that 
employee A also deplanes at Chicago, Illinois, but for personal 
purposes. The value of the flight to employee A then becomes the value 
of a flight from New York to Chicago to Los Angeles, i.e., $1,200. 
Therefore, the amount to be allocated to employee A is $800 ($1,200/
($1,200+$600)x$1,200) and the amount to be allocated to employee B is 
$400 ($600/($1,200+$600)x $1,200).

    (7) Fair market value of the use of an employer-provided aircraft 
for which the employer does not furnish a pilot. (i) In general. If the 
non-commercial flight special valuation rule of paragraph (g) of this 
section does not apply and if an employer provides an employee with the 
use of an aircraft without a pilot, the value of the use of the 
employer-provided aircraft is determined under the general valuation 
principles set forth in this paragraph (b)(7).
    (ii) Value of flight. In general, if an employee takes a flight on 
an employer-provided aircraft for which the employer does not furnish a 
pilot, the value of that flight is equal to the amount that an 
individual would have to pay in an arm's-length transaction to lease the 
same or comparable aircraft on the same or comparable terms for the same 
period in the geographic area in which the aircraft is used. For 
example, if an employer makes its aircraft available to an employee who 
will pilot the aircraft for a two-hour flight, the value of the use of 
the aircraft is the amount that an individual would have to pay in an 
arm's-length transaction to rent a comparable aircraft for that period 
in the geographic area in which the aircraft is used. As another 
example, assume that an employee uses an employer-provided aircraft to 
commute between home and work. The value of the use of the aircraft is 
the amount that an individual would have to pay in an arm's-length 
transaction to rent a comparable aircraft for commuting in the 
geographic area in which

[[Page 56]]

the aircraft is used. If the availability of the flight is of benefit to 
more than one employee, then such value shall be allocated among such 
employees on the basis of the relevant facts and circumstances.
    (c) Special valuation rules--(1) In general. Paragraphs (d) through 
(k) of this section provide special valuation rules that may be used 
under certain circumstances for certain commonly provided fringe 
benefits. For general rules relating to the valuation of fringe benefits 
not eligible for valuation under the special valuation rules or fringe 
benefits with respect to which the special valuation rules are not used, 
see paragraph (b) of this section.
    (2) Use of the special valuation rules--(i) For benefits provided 
before January 1, 1993. The special valuation rules may be used for 
income tax, employment tax, and reporting purposes. The employer has the 
option to use any of the special valuation rules. However, an employee 
may only use a special valuation rule if the employer uses the rule. 
Moreover, an employee may only use the special rule that the employer 
uses to value the benefit provided; the employee may not use another 
special rule to value that benefit. The employee may always use general 
valuation rules based on facts and circumstances (see paragraph (b) of 
this section) even if the employer uses a special rule. If a special 
rule is used, it must be used for all purposes. If an employer properly 
uses a special rule and the employee uses the special rule, the employee 
must include in gross income the amount determined by the employer under 
the special rule reduced by the sum of--
    (A) Any amount reimbursed by the employee to the employer, and
    (B) Any amount excludable from income under another section of 
subtitle A of the Internal Revenue Code of 1986. If an employer properly 
uses a special rule and properly determines the amount of an employee's 
working condition fringe under section 132 and Sec. 1.132-5 (under the 
general rule or under a special rule), and the employee uses the special 
valuation rule, the employee must include in gross income the amount 
determined by the employer less any amount reimbursed by the employee to 
the employer. The employer and employee may use the special rules to 
determine the amount of the reimbursement due the employer by the 
employee. Thus, if an employee reimburses an employer for the value of a 
benefit as determined under a special valuation rule, no amount is 
includable in the employee's gross income with respect to the benefit. 
The provisions of this paragraph are effective for benefits provided 
before January 1, 1993.
    (ii) For benefits provided after December 31, 1992. The special 
valuation rules may be used for income tax, employment tax, and 
reporting purposes. The employer has the option to use any of the 
special valuation rules. An employee may use a special valuation rule 
only if the employer uses that rule or the employer does not meet the 
condition of paragraph (c)(3)(ii)(A) of this section, but one of the 
other conditions of paragraph (c)(3)(ii) of this section is met. The 
employee may always use general valuation rules based on facts and 
circumstances (see paragraph (b) of this section) even if the employer 
uses a special rule. If a special rule is used, it must be used for all 
purposes. If an employer properly uses a special rule and the employee 
uses the special rule, the employee must include in gross income the 
amount determined by the employer under the special rule reduced by the 
sum of--
    (A) Any amount reimbursed by the employee to the employer; and
    (B) Any amount excludable from income under another section of 
subtitle A of the Internal Revenue Code of 1986. If an employer properly 
uses a special rule and properly determines the amount of an employee's 
working condition fringe under section 132 and Sec. 1.132-5 (under the 
general rule or under a special rule), and the employee uses the special 
valuation rule, the employee must include in gross income the amount 
determined by the employer less any amount reimbursed by the employee to 
the employer. The employer and employee may use the special rules to 
determine the amount of the reimbursement due the employer by the 
employee. Thus, if an employee reimburses an employer for the value

[[Page 57]]

of a benefit as determined under a special valuation rule, no amount is 
includible in the employee's gross income with respect to the benefit. 
The provisions of this paragraph are effective for benefits provided 
after December 31, 1992.
    (iii) Vehicle special valuation rules--(A) Vehicle by vehicle basis. 
Except as provided in paragraphs (d)(7)(v) and (e)(5)(v) of this 
section, the vehicle special valuation rules of paragraphs (d), (e), and 
(f) of this section apply on a vehicle by vehicle basis. An employer 
need not use the same vehicle special valuation rule for all vehicles 
provided to all employees. For example, an employer may use the 
automobile lease valuation rule for automobiles provided to some 
employees, and the commuting and vehicle cents-per-mile valuation rules 
for automobiles provided to other employees. For purposes of valuing the 
use or availability of a vehicle, the consistency rules provided in 
paragraphs (d)(7) and (e)(5) of this section (relating to the automobile 
lease valuation rule and the vehicle cents-per-mile valuation rule, 
respectively) apply.
    (B) Shared vehicle usage. If an employer provides a vehicle to 
employees for use by more than one employee at the same time, such as 
with an employer-sponsored vehicle commuting pool, the employer may use 
any of the special valuation rules that may be applicable to value the 
use of the vehicle by the employees. The employer must use the same 
special valuation rule to value the use of the vehicle by each employee 
who shares such use. The employer must allocate the value of the use of 
the vehicle based on the relevant facts and circumstances among the 
employees who share use of the vehicle. For example, assume that an 
employer provides an automobile to four of its employees and that the 
employees use the automobile in an employer-sponsored vehicle commuting 
pool. Assume further that the employer uses the automobile lease 
valuation rule of paragraph (d) of this section and that the Annual 
Lease Value of the automobile is $5,000.

The employer must treat $5,000 as the value of the availability of the 
automobile to the employees, and must apportion the $5,000 value among 
the employees who share the use of the automobile based on the relevant 
facts and circumstances. Each employee's share of the value of the 
availability of the automobile is then to be reduced by the amount, if 
any, of each employee's working condition fringe exclusion and the 
amount reimbursed by the employee to the employer.
    (iv) Commercial and noncommercial flight valuation rules. Except as 
otherwise provided, if either the commercial flight valuation rule or 
the non-commercial flight valuation rule is used, that rule must be used 
by an employer to value all eligible flights taken by all employees in a 
calendar year. See paragraph (g)(14) of this section for the applicable 
consistency rules.
    (3) Additional rules for using special valuation--(i) Election to 
use special valuation rules for benefits provided before January 1, 
1993. A particular special valuation rule is deemed to have been elected 
by the employer (and, if applicable, by the employee), if the employer 
(and, if applicable, the employee) determines the value of the fringe 
benefit provided by applying the special valuation rule and treats that 
value as the fair market value of the fringe benefit for income, 
employment tax, and reporting purposes. Neither the employer nor the 
employee must notify the Internal Revenue Service of the election. The 
provisions of this paragraph are effective for benefits provided before 
January 1, 1993.
    (ii) Conditions on the use of special valuation rules for benefits 
provided after December 31, 1992. Neither the employer nor the employee 
may use a special valuation rule to value a benefit provided after 
December 31, 1992, unless one of the following conditions is satisfied--
    (A) The employer treats the value of the benefit as wages for 
reporting purposes within the time for filing the returns for the 
taxable year (including extensions) in which the benefit is provided;
    (B) The employee includes the value of the benefit in income within 
the time for filing the returns for the taxable year (including 
extensions) in which the benefit is provided;

[[Page 58]]

    (C) The employee is not a control employee as defined in paragraphs 
(f)(5) and (f)(6) of this section; or
    (D) The employer demonstrates a good faith effort to treat the 
benefit correctly for reporting purposes.
    (4) Application of section 414 to employers. For purposes of 
paragraphs (c) through (k) of this section, except as otherwise provided 
therein, the term ``employer'' includes all entities required to be 
treated as a single employer under section 414 (b), (c), (m), or (o).
    (5) Valuation formulae contained in the special valuation rules. The 
valuation formula contained in the special valuation rules are provided 
only for use in connection with those rules. Thus, when a special 
valuation rule is properly applied to a fringe benefit, the Commissioner 
will accept the value calculated pursuant to the rule as the fair market 
value of that fringe benefit. However, when a special valuation rule is 
not properly applied to a fringe benefit (see, for example, paragraph 
(g)(13) of this section), or when a special valuation rule is used to 
value a fringe benefit by a taxpayer not entitled to use the rule, the 
fair market value of that fringe benefit may not be determined by 
reference to any value calculated under any special valuation rule. 
Under the circumstances described in the preceding sentence, the fair 
market value of the fringe benefit must be determined pursuant to the 
general valuation rules of paragraph (b) of this section.
    (6) Modification of the special valuation rules. The Commissioner 
may, to the extent necessary for tax administration, add, delete, or 
modify any special valuation rule, including the valuation formulae 
contained herein, on a prospective basis by regulation, revenue ruling 
or revenue procedure.
    (7) Special accounting rule. If the employer is using the special 
accounting rule provided in Announcement 85-113 (1985-31 I.R.B. 31, 
August 5, 1985) (see Sec. 601.601(d)(2)(ii)(b) of this chapter) 
(relating to the reporting of and withholding on the value of noncash 
fringe benefits), benefits which are deemed provided in a subsequent 
calendar year pursuant to that rule are considered as provided in that 
subsequent calendar year for purposes of the special valuation rules. 
Thus, if a particular special valuation rule is in effect for a calendar 
year, it applies to benefits deemed provided during that calendar year 
under the special accounting rule.
    (d) Automobile lease valuation rule--(1) In general--(i) Annual 
Lease Value. Under the special valuation rule of this paragraph (d), if 
an employer provides an employee with an automobile that is available to 
the employee for an entire calendar year, the value of the benefit 
provided is the Annual Lease Value (determined under paragraph (d)(2) of 
this section) of that automobile. Except as otherwise provided, for an 
automobile that is available to an employee for less than an entire 
calendar year, the value of the benefit provided is either a pro-rated 
Annual Lease Value or the Daily Lease Value (both as defined in 
paragraph (d)(4) of this section), whichever is applicable. Absent any 
statutory exclusion relating to the employer-provided automobile (see, 
for example, section 132(a)(3) and Sec. 1.132-5(b)), the amount of the 
Annual Lease Value (or a pro-rated Annual Lease Value or the Daily Lease 
Value, as applicable) is included in the gross income of the employee.
    (ii) Definition of automobile. For purposes of this paragraph (d), 
the term ``automobile'' means any four-wheeled vehicle manufactured 
primarily for use on public streets, roads, and highways.
    (2) Calculation of Annual Lease Value--(i) In general. The Annual 
Lease Value of a particular automobile is calculated as follows:
    (A) Determine the fair market value of the automobile as of the 
first date on which the automobile is made available to any employee of 
the employer for personal use. For an automobile first made available to 
any employee for personal use prior to January 1, 1985, determine the 
fair market value as of January l of the first year the special 
valuation rule of this paragraph (d) is used with respect to the 
automobile. For rules relating to determination of the fair market value 
of an automobile for purposes of this paragraph (d), see paragraph 
(d)(5) of this section.
    (B) Select the dollar range in column 1 of the Annual Lease Value 
Table, set

[[Page 59]]

forth in paragraph (d)(2)(iii) of this section corresponding to the fair 
market value of the automobile. Except as otherwise provided in 
paragraphs (d)(2) (iv) and (v) of this section, the Annual Lease Value 
for each year of availability of the automobile is the corresponding 
amount in column 2 of the Table.
    (ii) Calculation of Annual Lease Value of automobile owned or leased 
by both an employer and an employee--(A) Purchased automobiles. 
Notwithstanding anything in this section to the contrary, if an employee 
contributes an amount toward the purchase price of an automobile in 
return for a percentage ownership interest in the automobile, the Annual 
Lease Value or the Daily Lease Value, whichever is applicable, is 
determined by reducing the fair market value of the employer-provided 
automobile by the lesser of--
    (1) The amount contributed, or
    (2) An amount equal to the employee's percentage ownership interest 
multiplied by the unreduced fair market value of the automobile.

If the automobile is subsequently revalued, the revalued amount 
(determined without regard to this paragraph (d)(2)(ii)(A)) is reduced 
by an amount which is equal to the employee's percentage ownership 
interest in the vehicle). If the employee does not receive an ownership 
interest in the employer-provided automobile, then the Annual Lease 
Value or the Daily Lease Value, whichever is applicable, is determined 
without regard to any amount contributed. For purposes of this paragraph 
(d)(2)(ii)(A), an employee's ownership interest in an automobile will 
not be recognized unless it is reflected in the title of the automobile. 
An ownership interest reflected in the title of an automobile will not 
be recognized if under the facts and circumstances the title does not 
reflect the benefits and burdens of ownership.
    (B) Leased automobiles. Notwithstanding anything in this section to 
the contrary, if an employee contributes an amount toward the cost to 
lease an automobile in return for a percentage interest in the 
automobile lease, the Annual Lease Value or the Daily Lease Value, 
whichever is applicable, is determined by reducing the fair market value 
of the employer-provided automobile by the amount specified in the 
following sentence. The amount specified in this sentence is the 
unreduced fair market value of a vehicle multiplied by the lesser of--
    (1) The employee's percentage interest in the lease, or
    (2) A fraction, the numerator of which is the amount contributed and 
the denominator of which is the entire lease cost.

If the automobile is subsequently revalued, the revalued amount 
(determined without regard to this paragraph (d)(2)(ii)(B)) is reduced 
by an amount which is equal to the employee's percentage interest in the 
lease) multiplied by the revalued amount. If the employee does not 
receive an interest in the automobile lease, then the Annual Lease Value 
or the Daily Lease Value, whichever is applicable, is determined without 
regard to any amount contributed. For purposes of this paragraph 
(d)(2)(ii)(B), an employee's interest in an automobile lease will not be 
recognized unless the employee is a named co-lessee on the lease. An 
interest in a lease will not be recognized if under the facts and 
circumstances the lease does not reflect the true obligations of the 
lessees.
    (C) Example. The rules of paragraph (d)(2)(ii) (A) and (B) of this 
section are illustrated by the following example:

    Example. Assume that an employer pays $15,000 and an employee pays 
$5,000 toward the purchase of an automobile. Assume further that the 
employee receives a 25 percent interest in the automobile and is named 
as a co-owner on the title to the automobile. Under the rule of 
paragraph (d)(2)(ii)(A) of this section, the Annual Lease Value of the 
automobile is determined by reducing the fair market value of the 
automobile ($20,000) by the $5,000 employee contribution. Thus, the 
Annual Lease Value of the automobile under the table in paragraph 
(d)(2)(iii) of this section is $4,350. If the employee in this example 
does not receive an ownership interest in the automobile and is provided 
the use of the automobile for two years, the Annual Lease Value would be 
determined without regard to the $5,000 employee contribution. Thus, the 
Annual Lease Value would be $5,600. The $5,000 employee contribution 
would reduce the amount includible in the employee's income after taking 
into account the amount, if any, excluded from income under another 
provision of subtitle A of the

[[Page 60]]

Internal Revenue Code, such as the working condition fringe exclusion. 
Thus, if the employee places 50 percent of the mileage on the automobile 
for the employer's business each year, then the amount includible in the 
employee's income in the first year would be ($5,600-2,800-2,800), or 
$0, the amount includible in the employee's income in the second year 
would be ($5,600-2,800-2,200 ($5,000-2,800)) or $600 and the amount 
includible in the third year would be ($5,600-2,800) or $2,800 since the 
employee's contribution has been completely used in the first two years.

    (iii ) Annual Lease Value Table.

------------------------------------------------------------------------
                 Automobile fair market value                    Annual
--------------------------------------------------------------   lease
                                                                 value
                             (1)                              ----------
                                                                  (2)
------------------------------------------------------------------------
$0 to 999....................................................       $600
1,000 to 1,999...............................................        850
2,000 to 2,999...............................................      1,100
3,000 to 3,999...............................................      1,350
4,000 to 4,999...............................................      1,600
5,000 to 5,999...............................................      1,850
6,000 to 6,999...............................................      2,100
7,000 to 7,999...............................................      2,350
8,000 to 8,999...............................................      2,600
9,000 to 9,999...............................................      2,850
10,000 to 10,999.............................................      3,100
11,000 to 11,999.............................................      3,350
12,000 to 12,999.............................................      3,600
13,000 to 13,999.............................................      3,850
14,000 to 14,999.............................................      4,100
15,000 to 15,999.............................................      4,350
16,000 to 16,999.............................................      4,600
17,000 to 17,999.............................................      4,850
18,000 to 18,999.............................................      5,100
19,000 to 19,999.............................................      5,350
20,000 to 20,999.............................................      5,600
21,000 to 21,999.............................................      5,850
22,000 to 22,999.............................................      6,100
23,000 to 23,999.............................................      6,350
24,000 to 24,999.............................................      6,600
25,000 to 25,999.............................................      6,850
26,000 to 27,999.............................................      7,250
28,000 to 29,999.............................................      7,750
30,000 to 31,999.............................................      8,250
32,000 to 33,999.............................................      8,750
34,000 to 35,999.............................................      9,250
36,000 to 37,999.............................................      9,750
38,000 to 39,999.............................................     10,250
40,000 to 41,999.............................................     10,750
42,000 to 43,999.............................................     11,250
44,000 to 45,999.............................................     11,750
46,000 to 47,999.............................................     12,250
48,000 to 49,999.............................................     12,750
50,000 to 51,999.............................................     13,250
52,000 to 53,999.............................................     13,750
54,000 to 55,999.............................................     14,250
56,000 to 57,999.............................................     14,750
58,000 to 59,999.............................................     15,250
------------------------------------------------------------------------


For vehicles having a fair market value in excess of $59,999, the Annual 
Lease Value is equal to: (.25 x the fair market value of the automobile) 
+ $500.
    (iv) Recalculation of Annual Lease Value. The Annual Lease Values 
determined under the rules of this paragraph (d) are based on four-year 
lease terms. Therefore, except as otherwise provided in paragraph 
(d)(2)(v) of this section, the Annual Lease Value calculated by applying 
paragraph (d)(2) (i) or (ii) of this section shall remain in effect for 
the period that begins with the first date the special valuation rule of 
paragraph (d) of this section is applied by the employer to the 
automobile and ends on December 31 of the fourth full calendar year 
following that date. The Annual Lease Value for each subsequent four-
year period is calculated by determining the fair market value of the 
automobile as of the first January 1 following the period described in 
the previous sentence and selecting the amount in column 2 of the Annual 
Lease Value Table corresponding to the appropriate dollar range in 
column 1 of the Table. If, however, the employer is using the special 
accounting rule provided in Announcement 85-113 (1985-31 I.R.B. 31, 
August 5, 1985) (relating to the reporting of and withholding on the 
value of noncash fringe benefits), the employer may calculate the Annual 
Lease Value for each subsequent four-year period as of the beginning of 
the special accounting period that begins immediately prior to the 
January 1 described in the previous sentence. For example, assume that 
pursuant to Announcement 85-113, an employer uses the special accounting 
rule. Assume further that beginning on November 1, 1988, the special 
accounting period is November 1 to October 31 and that the employer 
elects to use the special valuation rule of this paragraph (d) as of 
January 1, 1989. The employer may recalculate the Annual Lease Value as 
of November 1, 1992, rather than as of January 1, 1993.
    (v) Transfer of the automobile to another employee. Unless the 
primary purpose of the transfer is to reduce Federal taxes, if an 
employer transfers the use of an automobile from one employee to another 
employee, the employer may recalculate the Annual Lease Value based on 
the fair market value of the automobile as of January 1 of the calendar 
year of transfer. If, however, the employer is using the special 
accounting rule provided in Announcement 85-113 (1985-31 I.R.B. 31,

[[Page 61]]

August 5, 1985) (relating to the reporting of and withholding on the 
value of noncash fringe benefits), the employer may recalculate the 
Annual Lease Value based on the fair market value of the automobile as 
of the beginning of the special accounting period in which the transfer 
occurs. If the employer does not recalculate the Annual Lease Value, and 
the employee to whom the automobile is transferred uses the special 
valuation rule, the employee may not recalculate the Annual Lease Value.
    (3) Services included in, or excluded from, the Annual Lease Value 
Table--(i) Maintenance and insurance included. The Annual Lease Values 
contained in the Annual Lease Value Table include the fair market value 
of maintenance of, and insurance for, the automobile. Neither an 
employer nor an employee may reduce the Annual Lease Value by the fair 
market value of any service included in the Annual Lease Value that is 
not provided by the employer, such as reducing the Annual Lease Value by 
the fair market value of a maintenance service contract or insurance. An 
employer or employee who wishes to take into account only the services 
actually provided with respect to an automobile may value the 
availability of the automobile under the general valuation rules of 
paragraph (b) of this section.
    (ii) Fuel excluded--(A) In general. The Annual Lease Values do not 
include the fair market value of fuel provided by the employer, whether 
fuel is provided in kind or its cost is reimbursed by or charged to the 
employer. Thus, if an employer provides fuel, the fuel must be valued 
separately for inclusion in income.
    (B) Valuation of fuel provided in kind. The provision of fuel in 
kind may be valued at fair market value based on all the facts and 
circumstances or, in the alternative, it may be valued at 5.5 cents per 
mile for all miles driven by the employee. However, the provision of 
fuel in kind may not be valued at 5.5 cents per mile for miles driven 
outside the United States, Canada or Mexico. For purposes of this 
section, the United States includes the United States, its possessions 
and its territories.
    (C) Valuation of fuel where cost reimbursed by or charged to an 
employer. The fair market value of fuel, the cost of which is reimbursed 
by or charged to an employer, is generally the amount of the actual 
reimbursement or the amount charged, provided the purchase of the fuel 
is at arm's-length.
    (D) Fleet-average cents-per-mile fuel cost. If an employer with a 
fleet of at least 20 automobiles that meets the requirements of 
paragraph (d)(5)(v)(D) of this section reimburses employees for the cost 
of fuel or allows employees to charge the employer for the cost of fuel, 
the fair market value of fuel provided to those automobiles may be 
determined by reference to the employer's fleet-average cents-per-mile 
fuel cost. The fleet-average cents-per-mile fuel cost is equal to the 
fleet-average per-gallon fuel cost divided by the fleet-average miles-
per-gallon rate. The averages described in the preceding sentence must 
be determined by averaging the per-gallon fuel costs and miles-per-
gallon rates of a representative sample of the automobiles in the fleet 
equal to the greater of ten percent of the automobiles in the fleet or 
20 automobiles for a representative period, such as a two-month period. 
In lieu of determining the fleet-average cents-per-mile fuel cost, if an 
employer is using the fleet-average valuation rule of paragraph 
(d)(5)(v) of this section and if determining the amount of the actual 
reimbursement or the amount charged for the purchase of fuel would 
impose unreasonable administrative burdens on the employer, the 
provision of fuel may be valued under the rule provided in paragraph 
(d)(3)(ii)(B) of this section.
    (iii) Treatment of other services. The fair market value of any 
service not specifically identified in paragraph (d)(3)(i) of this 
section that is provided by the employer with respect to an automobile 
(other than the services of a chauffeur) must be added to the Annual 
Lease Value of the automobile in determining the fair market value of 
the benefit provided. See paragraph (b) (5) of this section for rules 
relating to the valuation of chauffeur services.
    (4) Availability of an automobile for less than an entire calendar 
year--(i) Pro-rated Annual Lease Value used for continuous availability 
of at least 30 days.--

[[Page 62]]

(A) In general. Except as otherwise provided in paragraph (d)(4)(iv) of 
this section, for periods of continuous availability of at least 30 
days, but less than an entire calendar year, the value of the 
availability of an automobile provided by an employer electing to use 
the automobile lease valuation rule of this paragraph (d) is the pro-
rated Annual Lease Value. The pro-rated Annual Lease Value is calculated 
by multiplying the applicable Annual Lease Value by a fraction, the 
numerator of which is the number of days of availability and the 
denominator of which is 365.
    (B) Special rule for continuous availability of at least 30 days 
that straddles two reporting years. If an employee is provided with the 
continuous availability of an automobile for at least 30 days, but the 
continuous period straddles two calendar years (or two special 
accounting periods if the special accounting rule of Announcement 85-113 
(1985-31 I.R.B. 31, August 5, 1985) (relating to the reporting of and 
withholding on noncash fringe benefits) is used), the pro-rated Annual 
Lease Value, rather than the Daily Lease Value, may be applied with 
respect to such period of continuous availability.
    (ii) Daily Lease Value used for continuous availability of less than 
30 days. Except as otherwise provided in paragraph (d)(4)(iii) of this 
section, for periods of continuous availability of one or more but less 
than 30 days, the value of the availability of the employer-provided 
automobile is the Daily Lease Value. The Daily Lease Value is calculated 
by multiplying the applicable Annual Lease Value by a fraction, the 
numerator of which is four times the number of days of availability and 
the denominator of which is 365.
    (iii) Election to treat all periods as periods of at least 30 days. 
The value of the availability of an employer-provided automobile for a 
period of continuous availability of less than 30 days may be determined 
by applying the pro-rated Annual Lease Value by treating the automobile 
as if it had been available for 30 days, if doing so would result in a 
lower valuation than applying the Daily Lease Value to the shorter 
period of actual availability.
    (iv) Periods of unavailability--(A) General rule. In general, a pro-
rated Annual Lease Value (as provided in paragraph (d)(4)(i) of this 
section) is used to value the availability of an employer-provided 
automobile when the automobile is available to an employee for a 
continuous period of at least 30 days but less than the entire calendar 
year. Neither an employer nor an employee, however, may use a pro-rated 
Annual Lease Value when the reduction of Federal taxes is the primary 
reason the automobile is unavailable to an employee at certain times 
during the calendar year.
    (B) Unavailability for personal reasons of the employee. If an 
automobile is unavailable to an employee because of personal reasons of 
the employee, such as while the employee is on vacation, a pro-rated 
Annual Lease Value, if used, must not take into account such periods of 
unavailability. For example, assume that an automobile is available to 
an employee during the first five months of the year and during the last 
five months of the year. Assume further that the period of 
unavailability occurs because the employee is on vacation. The Annual 
Lease Value, if it is applied, must be applied with respect to the 
entire 12-month period. The Annual Lease Value may not be pro-rated to 
take into account the two-month period of unavailability.
    (5) Fair market value--(i) In general. For purposes of determining 
the Annual Lease Value of an automobile under the Annual Lease Value 
Table, the fair market value of an automobile is the amount that an 
individual would have to pay in an arm's-length transaction to purchase 
the particular automobile in the jurisdiction in which the vehicle is 
purchased or leased. That amount includes all amounts attributable to 
the purchase of an automobile such as sales tax and title fees as well 
as the purchase price of the automobile. Any special relationship that 
may exist between the employee and the employer must be disregarded. 
Also, the employee's subjective perception of the value of the 
automobile is not relevant to the determination of the automobile's fair 
market value, and, except as provided in paragraph

[[Page 63]]

(d)(5)(ii) of this section, the cost incurred by the employer in 
connection with the purchase or lease of the automobile is not 
determinative of the fair market value of the automobile.
    (ii) Safe-harbor valuation rule--(A) General rule. For purposes of 
calculating the Annual Lease Value of an automobile under this paragraph 
(d), the safe-harbor value of the automobile may be used as the fair 
market value of the automobile.
    (B) Automobiles owned by the employer. For an automobile owned by 
the employer, the safe-harbor value of the automobile is the employer's 
cost of purchasing the automobile (including sales tax, title, and other 
expenses attributable to such purchase), provided the purchase is made 
at arm's-length. Notwithstanding the preceding sentence, the safe-harbor 
value of this paragraph (d)(5)(ii)(B) is not available with respect to 
an automobile manufactured by the employer. Thus, for example, if one 
entity manufactures an automobile and sells it to an entity with which 
it is aggregated pursuant to paragraph (c)(4) of this section, this 
paragraph (d)(5)(ii)(B) does not apply to value the automobile by the 
aggregated employer. In this case, value must be determined under 
paragraph (d)(5)(i) of this section.
    (C) Automobiles leased by the employer. For an automobile leased but 
not manufactured by the employer, the safe-harbor value of the 
automobile is either the manufacturer's suggested retail price of the 
automobile less eight percent (including sales tax, title, and other 
expenses attributable to such purchase), or the value determined under 
paragraph (d)(5)(iii) of this section.
    (iii) Use of nationally recognized pricing sources. The fair market 
value of an automobile that is--
    (A) Provided to an employee prior to January 1, 1985,
    (B) Being revalued pursuant to paragraph (d)(2) (iv) or (v) of this 
section, or
    (C) A leased automobile being valued pursuant to paragraph 
(d)(5)(ii) of this section, may be determined by reference to the retail 
value of such automobile as reported by a nationally recognized pricing 
source that regularly reports new or used automobile retail values, 
whichever is applicable. That retail value must be reasonable with 
respect to the automobile being valued. Pricing sources consist of 
publications and electronic data bases.
    (iv) Fair market value of special equipment. When determining the 
fair market value of an automobile, the employer may exclude the fair 
market value of any specialized equipment or telephone that is added to 
or carried in the automobile provided that the presence of that 
equipment or telephone is necessitated by, and attributable to, the 
business needs of the employer. The value of the specialized equipment 
must be included if the employee to whom the automobile is available 
uses the specialized equipment in a trade or business of the employee 
other than the employee's trade or business of being an employee of the 
employer.
    (v) Fleet-average valuation rule--(A) In general. An employer with a 
fleet of 20 or more automobiles meeting the requirements of this 
paragraph (d)(5)(v) (including the business-use and fair market value 
conditions of paragraph (d)(5)(v)(D) of this section) may use a fleet-
average value for purposes of calculating the Annual Lease Values of the 
automobiles in the fleet. The fleet-average value is the average of the 
fair market values of all automobiles in the fleet. The fair market 
value of each automobile in the fleet shall be determined, pursuant to 
the rules of paragraphs (d)(5) (i) through (iv) of this section, as of 
the date described in paragraph (d)(2)(i)(A) of this section.
    (B) Period for use of rule. The fleet-average valuation rule of this 
paragraph (d)(5)(v) may be used by an employer as of January 1 of any 
calendar year following the calendar year in which the employer acquires 
a sufficient number of automobiles to total a fleet of 20 or more 
automobiles. The Annual Lease Value calculated for the automobiles in 
the fleet, based on the fleet-average value, shall remain in effect for 
the period that begins with the first January 1 the fleet-average 
valuation ru1e of this paragraph (d)(5)(v) is applied by the employer to 
the automobiles in the fleet and ends on December 31 of the subsequent 
calendar year. The Annual Lease Value for each subsequent two-

[[Page 64]]

year period is calculated by determining the fleet-average value of the 
automobiles in the fleet as of the first January 1 of such period. An 
employer may cease using the fleet-average valuation rule as of any 
January 1. If, however, the employer is using the special accounting 
rule provided in Announcement 85-113 (1985-31 I.R.B. 31, August 5, 1985) 
(relating to the reporting of and withholding on noncash fringe 
benefits), the employer may apply the rules of this paragraph 
(d)(5)(v)(B) on the basis of the special accounting period rather than 
the calendar year. (This is accomplished by substituting (1) the 
beginning of the special accounting period that begins immediately prior 
to the January 1 described in this paragraph (d)(5)(v)(B) for January 1 
wherever it appears in this paragraph (d)(5)(v) (B) and (2) the end of 
such accounting period for December 31.) If the number of qualifying 
automobiles in the employer's fleet declines to fewer than 20 for more 
than 50 percent of the days in a year, then the fleet-average valuation 
rule does not apply as of January 1 of such year. In this case, the 
Annual Lease Value must be determined separately for each remaining 
automobile. The revaluation rules of paragraphs (d)(2) (iv) and (v) of 
this section do not apply to automobiles valued under this paragraph 
(d)(5)(v).
    (C) Automobiles included in the fleet. An employer may include in a 
fleet any automobile that meets the requirements of this paragraph 
(d)(5)(v) and is available to any employee of the employer for personal 
use. An employer may include in the fleet only automobiles the 
availability of which is valued under the automobile lease valuation 
rule of this paragraph (d). An employer need not include in the fleet 
all automobiles valued under the automobile lease valuation rule. An 
employer may have more than one fleet for purposes of the fleet-average 
rule of this paragraph (d)(5)(v). For example, an employer may group 
automobiles in a fleet according to their physical type or use.
    (D) Limitations on use of fleet-average rule. The rule provided in 
this paragraph (d)(5)(v) may not be used for any automobile the fair 
market value of which (determined pursuant to paragraphs (d)(5) (i) 
through (iv) of this section as of either the first date on which the 
automobile is made available to any employee of the employer for 
personal use or, if later, January 1, 1985) exceeds $16,500. The fair 
market value limitation of $16,500 shall be adjusted pursuant to section 
280F(d)(7) of the Internal Revenue Code of 1986. The first such 
adjustment shall be for calendar year 1989 (substitute October 1986 for 
October 1987 in applying the formula). In addition, the rule provided in 
this paragraph (d)(5)(v) may only be used for automobiles that the 
employer reasonably expects will regularly be used in the employer's 
trade or business. For rules concerning when an automobile is regularly 
used in the employer's business, see paragraph (e)(1)(iv) of this 
section.
    (E) Additional automobiles added to the fleet. The fleet-average 
value in effect at the time an automobile is added to a fleet is treated 
as the fair market value of the additional automobile for purposes of 
determining the Annual Lease Value of the automobile until the fleet-
average value changes pursuant to paragraph (d)(5)(v)(B) of this 
section.
    (F) Use of the fleet-average rule by employees. An employee may only 
use the fleet-average rule if it is used by the employer. If an employer 
uses the fleet-average rule, and the employee uses the special valuation 
rule of paragraph (d) of this section, the employee must use the fleet-
average value determined by the employer.
    (6) Special rules for continuous availability of certain 
automobiles--(i) Fleet automobiles. If an employer is using the fleet-
average valuation ru1e of paragraph (d)(5)(v) of this section and the 
employer provides an employee with the continuous availability of an 
automobile from the same fleet during a period (though not necessarily 
the same fleet automobile for the entire period), the employee is 
treated as having the use of a single fleet automobile for the entire 
period, e.g., an entire calendar year. Thus, when applying the 
automobile lease valuation rule of this paragraph (d), the employer may 
treat the fleet-average value as the fair market value of the automobile 
deemed

[[Page 65]]

available to the employee for the period for purposes of calculating the 
Annual Lease Value, (or pro-rated Annual Lease Value or Daily Lease 
Value whichever is applicable) of the automobile. If an employer 
provides an employee with the continuous availability of more than one 
fleet automobile during a period, the employer may treat the fleet-
average value as the fair market value of each automobile provided to 
the employee provided that the rules of paragraph (d)(5)(v)(D) of this 
section are satisfied.
    (ii) Demonstration automobiles--(A) In general. If an automobile 
dealership provides an employee with the continuous availability of a 
demonstration automobile (as defined in Sec. 1.132-5(o)(3)) during a 
period (though not necessarily the same demonstration automobile for the 
entire period), the employee is treated as having the use of a single 
demonstration automobile for the entire period, e.g., an entire calendar 
year. If an employer provides an employee with the continuous 
availability of more than one demonstration automobile during a period, 
the employer may treat the value determined under paragraph 
(d)(6)(ii)(B) of this section as the fair market value of each 
automobile provided to the employee. For rules relating to the treatment 
as a working condition fringe of the qualified automobile demonstration 
use of a demonstration automobile by a full-time automobile salesman, 
see Sec. 1.132-5(o).
    (B) Determining the fair market value of a demonstration automobile. 
When applying the automobile lease valuation rule of this paragraph (d), 
the employer may treat the average of the fair market values of the 
demonstration automobiles which are available to an employee and held in 
the dealership's inventory during the calendar year as the fair market 
value of the demonstration automobile deemed available to the employee 
for the period for purposes of calculating the Annual Lease Value of the 
automobile. If under the facts and circumstances it is inappropriate to 
take into account, with respect to an employee, certain models of 
demonstration automobiles, the value of the benefit is determined 
without reference to the fair market values of such models. For example, 
assume that an employee has the continuous availability for an entire 
calendar year of one demonstration automobile, although not the same one 
for the entire year. Assume further that the fair market values of the 
automobiles in the dealership inventory during the year range from 
$8,000 to $20,000. If there is not a substantial period (such as three 
months) during the year when the employee uses demonstration automobiles 
valued at less than $16,000, then those automobiles are not considered 
in determining the value of the benefit provided to the employee. In 
this case, the average of the fair market values of the demonstration 
automobiles in the dealership's inventory valued at $16,000 or more is 
treated as the fair market value of the automobile deemed available to 
the employee for the calendar year for purposes of calculating the 
Annual Lease Value of the automobile.
    (7) Consistency rules--(i) Use of the automobile lease valuation 
rule by an employer. Except as provided in paragraph (d)(5)(v)(B) of 
this section, an employer may adopt the automobile lease valuation rule 
of this paragraph (d) for an automobile only if the rule is adopted to 
take effect by the later of--
    (A) January 1, 1989, or
    (B) The first day on which the automobile is made available to an 
employee of the employer for personal use (or, if the commuting 
valuation rule of paragraph (f) of this section is used when the 
automobile is first made available to an employee of the employer for 
personal use, the first day on which the commuting valuation rule is not 
used).
    (ii) An employer must use the automobile lease valuation rule for 
all subsequent years. Once the automobile lease valuation rule has been 
adopted for an automobile by an employer, the rule must be used by the 
employer for all subsequent years in which the employer makes the 
automobile available to any employee except that the employer may, for 
any year during which (or for any employee for whom) use of the 
automobile qualifies for the commuting valuation rule of paragraph (f) 
of this section, use the commuting valuation rule with respect to the 
automobile.

[[Page 66]]

    (iii) Use of the automobile lease valuation rule by an employee. An 
employee may adopt the automobile lease valuation rule for an automobile 
only if the rule is adopted--
    (A) By the employer, and
    (B) Beginning with the first day on which the automobile for which 
the employer (consistent with paragraph (d)(7)(i) of this section) 
adopted the rule is made available to that employee for personal use 
(or, if the commuting valuation rule of paragraph (f) of this section is 
used when the automobile is first made available to that employee for 
personal use, the first day on which the commuting valuation rule is not 
used).
    (iv) An employee must use the automobile lease valuation rule for 
all subsequent years. Once the automobile lease valuation rule has been 
adopted for an automobile by an employee, the rule must be used by the 
employee for all subsequent years in which the automobile for which the 
rule is used is available to the employee. However, the employee may, 
for any year during which use of the automobile qualifies for use of the 
commuting valuation rule of paragraph (f) of this section and for which 
the employer uses such rule, use the commuting valuation rule with 
respect to the automobile.
    (v) Replacement automobiles. Notwithstanding anything in this 
paragraph (d)(7) to the contrary, if the automobile lease valuation rule 
is used by an employer, or by an employer and an employee, with respect 
to a particular automobile, and a replacement automobile is provided to 
the employee for the primary purpose of reducing Federal taxes, then the 
employer, or the employer and the employee, using the rule must continue 
to use the rule with respect to the replacement automobile.
    (e) Vehicle cents-per-mile valuation rule--(1) In general--(i) 
General rule. Under the vehicle cents-per-mile valuation rule of this 
paragraph (e), if an employer provides an employee with the use of a 
vehicle that--
    (A) The employer reasonably expects will be regularly used in the 
employer's trade or business throughout the calendar year (or such 
shorter period as the vehicle may be owned or leased by the employer), 
or
    (B) Satisfies the requirements of paragraph (e)(1)(ii) of this 
section, the value of the benefit provided in the calendar year is the 
standard mileage rate provided in the applicable Revenue Ruling or 
Revenue Procedure (``cents-per-mile rate'') multiplied by the total 
number of miles the vehicle is driven by the employee for personal 
purposes. The cents-per-mile rate is to be applied prospectively from 
the first day of the taxable year following the date of publication of 
the applicable Revenue Ruling or Revenue Procedure. An employee who uses 
an employer-provided vehicle, in whole or in part, for a trade or 
business other than the employer's trade or business, may take a 
deduction for such business use based upon the vehicle cents-per-mile 
rule as long as such deduction is at the same standard mileage rate as 
that used in calculating the employee's income inclusion. The standard 
mileage rate must be applied to personal miles independent of business 
miles. Thus, for example, if the standard mileage rate were 24 cents per 
mile for the first 15,000 miles and 11 cents per mile for all miles over 
15,000 and an employee drives 20,000 personal miles and 45,000 business 
miles in a year, the value of the personal use of the vehicle is $4,150 
((15,000x$.24)+(5,000x$.11)). For purposes of this section, the use of a 
vehicle for personal purposes is any use of the vehicle other than use 
in the employee's trade or business of being an employee of the 
employer.
    (ii) Mileage rule. A vehicle satisfies the requirements of this 
paragraph (e)(1)(ii) for a calendar year if--
    (A) It is actually driven at least 10,000 miles in that year; and
    (B) Use of the vehicle during the year is primarily by employees. 
For example, if a vehicle is used by only one employee during the 
calendar year and that employee drives the vehicle at least 10,000 miles 
during the year, the vehicle satisfies the requirements of this 
paragraph (e)(1)(ii) even if all miles driven by the employee are 
personal. A vehicle is considered used during the year primarily by 
employees in accordance with the requirement of paragraph (e)(1)(ii)(B) 
of this section if

[[Page 67]]

employees use the vehicle on a consistent basis for commuting. If the 
employer does not own or lease the vehicle during a portion of the year, 
the 10,000 mile threshold is to be reduced proportionately to reflect 
the periods when the employer did not own or lease the vehicle. For 
purposes of this paragraph (e)(1)(ii), use of the vehicle by an 
individual (other than the employee) whose use would be taxed to the 
employee is not considered use by the employee.
    (iii) Limitation on use of the vehicle cents-per-mile valuation 
rule--(A) In general. Except as otherwise provided in the last sentence 
of this paragraph (e)(1)(iii)(A), the value of the use of an automobile 
(as defined in paragraph (d)(1)(ii) of this section) may not be 
determined under the vehicle cents-per-mile valuation rule of this 
paragraph (e) for a calendar year if the fair market value of the 
automobile (determined pursuant to paragraphs (d)(5) (i) through (iv) of 
this section as of the later of January 1, 1985, or the first date on 
which the automobile is made available to any employee of the employer 
for personal use) exceeds the sum of the maximum recovery deductions 
allowable under section 280F(a)(2) for a five-year period for an 
automobile first placed in service during that calendar year (whether or 
not the automobile is actually placed in service during that year) as 
adjusted by section 280F(d)(7). With respect to a vehicle placed in 
service prior to January 1, 1989, the limitation on value will be not 
less than $12,800. With respect to a vehicle placed in service in or 
after 1989, the limitation on value is $12,800 as adjusted by section 
280F(d)(7).
    (B) Application of limitation with respect to a vehicle owned by 
both an employer and an employee. If an employee contributes an amount 
towards the purchase price of a vehicle in return for a percentage 
ownership interest in the vehicle, for purposes of determining whether 
the limitation of this paragraph (e)(1)(iii) applies, the fair market 
value of the vehicle is reduced by the lesser of--
    (1) The amount contributed, or
    (2) An amount equal to the employee's percentage ownership interest 
multiplied by the unreduced fair market value of the vehicle. If the 
employee does not receive an ownership interest in the employer-provided 
vehicle, then the fair market value of the vehicle is determined without 
regard to any amount contributed. For purposes of this paragraph 
(e)(1)(iii)(B), an employee's ownership interest in a vehicle will not 
be recognized unless it is reflected in the title of the vehicle. An 
ownership interest reflected in the title of a vehicle will not be 
recognized if under the facts and circumstances the title does not 
reflect the benefits and burdens of ownership.
    (C) Application of limitation with respect to a vehicle leased by 
both an employer and employee. If an employee contributes an amount 
toward the cost to lease a vehicle in return for a percentage interest 
in the vehicle lease, for purposes of determining whether the limitation 
of this paragraph (e)(1)(iii) applies, the fair market value of the 
vehicle is reduced by the amount specified in the following sentence. 
The amount specified in this sentence is the unreduced fair market value 
of a vehicle multiplied by the lesser of--
    (1) The employee's percentage interest in the lease, or
    (2) A fraction, the numerator of which is the amount contributed and 
the denominator of which is the entire lease cost. If the employee does 
not receive an interest in the vehicle lease, then the fair market value 
is determined without regard to any amount contributed. For purposes of 
this paragraph (e)(1)(iii)(C), an employee's interest in a vehicle lease 
will not be recognized unless the employee is a named co-lessee on the 
lease. An interest in a lease will not be recognized if under the facts 
and circumstances, the lease does not reflect the true obligations of 
the lessees.
    (iv) Regular use in an employer's trade or business. Whether a 
vehicle is regularly used in an employer's trade or business is 
determined on the basis of all facts and circumstances. A vehicle is 
considered regularly used in an employer's trade or business for 
purposes of paragraph (e)(1)(i)(A) of this section if one of the 
following safe harbor conditions is satisfied:

[[Page 68]]

    (A) At least 50 percent of the vehicle's total annual mileage is for 
the employer's business; or
    (B) The vehicle is generally used each workday to transport at least 
three employees of the employer to and from work in an employer-
sponsored commuting vehicle pool. Infrequent business use of the 
vehicle, such as for occasional trips to the airport or between the 
employer's multiple business premises, does not constitute regular use 
of the vehicle in the employer's trade or business.
    (v) Application of rule to shared usage. If an employer regularly 
provides a vehicle to employees for use by more than one employee at the 
same time, such as with an employer-sponsored vehicle commuting pool, 
the employer may use the vehicle cents-per-mile valuation rule to value 
the use of the vehicle by each employee who shares such use. See Sec. 
1.61-21(c)(2)(ii)(B) for provisions relating to the allocation of the 
value of an automobile to more than one employee.
    (2) Definition of vehicle. For purposes of this paragraph (e), the 
term ``vehicle'' means any motorized wheeled vehicle manufactured 
primarily for use on public streets, roads, and highways. The term 
``vehicle'' includes an automobile as defined in paragraph (d)(1)(ii) of 
this section.
    (3) Services included in, or excluded from, the cents-per-mile 
rate--(i) Maintenance and insurance included. The cents-per-mile rate 
includes the fair market value of maintenance of, and insurance for, the 
vehicle. The cents-per-mile rate may not be reduced by the fair market 
value of any service included in the cents-per-mile rate but not 
provided by the employer. An employer or employee who wishes to take 
into account only the particular services provided with respect to a 
vehicle may value the availability of the vehicle under the general 
valuation rules of paragraph (b) of this section.
    (ii) Fuel provided by the employer--(A) Miles driven in the United 
States, Canada, or Mexico. With respect to miles driven in the United 
States, Canada, or Mexico, the cents-per-mile rate includes the fair 
market value of fuel provided by the employer. If fuel is not provided 
by the employer, the cents-per-mile rate may be reduced by no more than 
5.5 cents or the amount specified in any applicable Revenue Ruling or 
Revenue Procedure. For purposes of this section, the United States 
includes the United States, its possessions and its territories.
    (B) Miles driven outside the United States, Canada, or Mexico. With 
respect to miles driven outside the United States, Canada, or Mexico, 
the fair market value of fuel provided by the employer is not reflected 
in the cents-per-mile rate. Accordingly, the cents-per-mile rate may be 
reduced but by no more than 5.5 cents or the amount specified in any 
applicable Revenue Ruling or Revenue Procedure. If the employer provides 
the fuel in kind, it must be valued based on all the facts and 
circumstances. If the employer reimburses the employee for the cost of 
fuel or allows the employee to charge the employer for the cost of fuel, 
the fair market value of the fuel is generally the amount of the actual 
reimbursement or the amount charged, provided the purchase of fuel is at 
arm's length.
    (iii) Treatment of other services. The fair market value of any 
service not specifically identified in paragraph (e)(3)(i) of this 
section that is provided by the employer with respect to a vehicle is 
not reflected in the cents-per-mile rate. See paragraph (b)(5) of this 
section for rules relating to valuation of chauffeur services.
    (4) Valuation of personal use only. The vehicle cents-per-mile 
valuation rule of this paragraph (e) may only be used to value the miles 
driven for personal purposes. Thus, the employer must include an amount 
in an employee's income with respect to the use of a vehicle that is 
equal to the product of the number of personal miles driven by the 
employee and the appropriate cents-per-mile rate. The term ``personal 
miles'' means all miles for which the employee used the automobile 
except miles driven in the employee's trade or business of being an 
employee of the employer. Unless additional services are provided with 
respect to the vehicle (see paragraph (e)(3)(iii) of this section), the 
employer may not include in income a greater amount; for example,

[[Page 69]]

the employer may not include in income 100 percent (all business and 
personal miles) of the value of the use of the vehicle.
    (5) Consistency rules--(i) Use of the vehicle cents-per-mile 
valuation rule by an employer. An employer must adopt the vehicle cents-
per-mile valuation rule of this paragraph (e) for a vehicle to take 
effect by the later of--
    (A) January 1, 1989, or
    (B) The first day on which the vehicle is used by an employee of the 
employer for personal use (or, if the commuting valuation rule of 
paragraph (f) of this section is used when the vehicle is first used by 
an employee of the employer for personal use, the first day on which the 
commuting valuation rule is not used).
    (ii) An employer must use the vehicle cents-per-mile valuation rule 
for all subsequent years. Once the vehicle cents-per-mile valuation rule 
has been adopted for a vehicle by an employer, the rule must be used by 
the employer for all subsequent years in which the vehicle qualifies for 
use of the rule, except that the employer may, for any year during which 
use of the vehicle qualifies for the commuting valuation rule of 
paragraph (f) of this section, use the commuting valuation rule with 
respect to the vehicle. If the vehicle fails to qualify for use of the 
vehicle cents-per-mile valuation rule during a subsequent year, the 
employer may adopt for such subsequent year and thereafter any other 
special valuation rule for which the vehicle then qualifies. If the 
employer elects to use the automobile lease valuation rule of paragraph 
(d) of this section for a period in which the automobile does not 
qualify for use of the vehicle cents-per-mile valuation rule, then the 
employer must comply with the requirements of paragraph (d)(7) of this 
section. For purposes of paragraph (d)(7) of this section, the first day 
on which the automobile with respect to which the vehicle cents-per-mile 
rule had been used fails to qualify for use of the vehicle cents-per-
mile valuation rule may be deemed to be the first day on which the 
automobile is available to an employee of the employer for personal use.
    (iii) Use of the vehicle cents-per-mile valuation rule by an 
employee. An employee may adopt the vehicle cents-per-mile valuation 
rule for a vehicle only if the rule is adopted--
    (A) By the employer, and
    (B) Beginning with respect to the first day on which the vehicle for 
which the employer (consistent with paragraph (e)(5)(i) of this section) 
adopted the rule is available to that employee for personal use (or, if 
the commuting valuation rule of paragraph (f) of this section is used 
when the vehicle is first used by an employee for personal use, the 
first day on which the commuting valuation rule is not used).
    (iv) An employee must use the vehicle cents-per-mile valuation rule 
for all subsequent years. Once the vehicle cents-per-mile valuation rule 
has been adopted for a vehicle by an employee, the rule must be used by 
the employee for all subsequent years of personal use of the vehicle by 
the employee for which the rule is used by the employer. However, see 
paragraph (f) of this section for rules relating to the use of the 
commuting valuation rule for a subsequent year.
    (v) Replacement vehicles. Notwithstanding anything in this paragraph 
(e)(5) to the contrary, if the vehicle cents-per-mile valuation rule is 
used by an employer, or by an employer and an employee, with respect to 
a particular vehicle. and a replacement vehicle is provided to the 
employee for the primary purpose of reducing Federal taxes, then the 
employer, or the employer and the employee, using the rule must continue 
to use the rule with respect to the replacement vehicle if the 
replacement vehicle qualifies for use of the rule.
    (f) Commuting valuation rule--(1) In general. Under the commuting 
valuation rule of this paragraph (f), the value of the commuting use of 
an employer-provided vehicle may be determined pursuant to paragraph 
(f)(3) of this section if the following criteria are met by the employer 
and employees with respect to the vehicle:
    (i) The vehicle is owned or leased by the employer and is provided 
to one or more employees for use in connection with the employer's trade 
or business and is used in the employer's trade or business;

[[Page 70]]

    (ii) For bona fide noncompensatory business reasons, the employer 
requires the employee to commute to and/or from work in the vehicle;
    (iii) The employer has established a written policy under which 
neither the employee, nor any individual whose use would be taxable to 
the employee, may use the vehicle for personal purposes, other than for 
commuting or de minimis personal use (such as a stop for a personal 
errand on the way between a business delivery and the employee's home);
    (iv) Except for de minimis personal use, the employee does not use 
the vehicle for any personal purpose other than commuting; and
    (v) The employee required to use the vehicle for commuting is not a 
control employee of the employer (as defined in paragraphs (f) (5) and 
(6) of this section).

Personal use of a vehicle is all use of the vehicle by an employee that 
is not used in the employee's trade or business of being an employee of 
the employer. An employer-provided vehicle that is generally used each 
workday to transport at least three employees of the employer to and 
from work in an employer-sponsored commuting vehicle pool is deemed to 
meet the requirements of paragraphs (f)(1) (i) and (ii) of this section.
    (2) Special rules. Notwithstanding anything in paragraph (f)(1) of 
this section to the contrary, the following special rules apply--
    (i) Chauffeur-driven vehicles. If a vehicle is chauffeur-driven, the 
commuting valuation rule of this paragraph (f) may not be used to value 
the commuting use of any person (other than the chauffeur) who rides in 
the vehicle. (See paragraphs (d) and (e) of this section for other 
vehicle special valuation rules.) The special rule of this paragraph (f) 
may be used to value the commuting-only use of the vehicle by the 
chauffeur if the conditions of paragraph (f)(1) of this section are 
satisfied. For purposes of this paragraph (f)(2), an individual will not 
be considered a chauffeur if he or she performs non-driving services for 
the employer, is not available to perform driving services while 
performing such other services and whose only driving services consist 
of driving a vehicle used for commuting by other employees of the 
employer.
    (ii) Control employee exception. If the vehicle in which the 
employee is required to commute is not an automobile as defined in 
paragraph (d)(1)(ii) of this section, the restriction of paragraph 
(f)(1)(v) of this section (relating to control employees) does not 
apply.
    (3) Commuting value--(i) $1.50 per one-way commute. If the 
requirements of this paragraph (f) are satisfied, the value of the 
commuting use of an employer-provided vehicle is $1.50 per one-way 
commute (e.g., from home to work or from work to home). The value 
provided in this paragraph (f)(3) includes the value of any goods or 
services directly related to the vehicle (e.g., fuel).
    (ii) Value per employee. If there is more than one employee who 
commutes in the vehicle, such as in the case of an employer-sponsored 
commuting vehicle pool, the amount includible in the income of each 
employee is $1.50 per one-way commute. Thus, the amount includible for 
each round-trip commute is $3.00 per employee. See paragraphs (d)(7)(vi) 
and (e)(5)(vi) of this section for use of the automobile lease valuation 
and vehicle cents-per-mile valuation special rules for valuing the use 
or availability of the vehicle in the case of an employer-sponsored 
vehicle or automobile commuting pool.
    (4) Definition of vehicle. For purposes of this paragraph (f), the 
term ``vehicle'' means any motorized wheeled vehicle manufactured 
primarily for use on public streets, roads, and highways. The term 
``vehicle'' includes an automobile as defined in paragraph (d)(1)(ii) of 
this section.
    (5) Control employee defined--Non-government employer. For purposes 
of this paragraph (f), a control employee of a non-government employer 
is any employee--
    (i) Who is a Board- or shareholder-appointed, confirmed, or elected 
officer of the employer whose compensation equals or exceeds $50,000,
    (ii) Who is a director of the employer,
    (iii) Whose compensation equals or exceeds $100,000, or

[[Page 71]]

    (iv) Who owns a one-percent or greater equity, capital, or profits 
interest in the employer.

For purposes of determining who is a one-percent owner under paragraph 
(f)(5)(iv) of this section, any individual who owns (or is considered as 
owning under section 318(a) or principles similar to section 318(a) for 
entities other than corporations) one percent or more of the fair market 
value of an entity (the ``owned entity'') is considered a one-percent 
owner of all entities which would be aggregated with the owned entity 
under the rules of section 414 (b), (c), (m), or (o). For purposes of 
determining who is an officer or director with respect to an employer 
under this paragraph (f)(5), notwithstanding anything in this section to 
the contrary, if an entity would be aggregated with other entities under 
the rules of section 414 (b), (c), (m), or (o), the officer definition 
(but not the compensation requirement) and the director definition apply 
to each such separate entity rather tha to the aggregated employer. An 
employee who is an officer or a director of an entity (the ``first 
entity'') shall be treated as an officer or a director of all entities 
aggregated with the first entity under the rules of section 414 (b), 
(c), (m), or (o). Instead of applying the control employee definition of 
this paragraph (f)(5), an employer may treat all, and only, employees 
who are ``highly compensated'' employees (as defined in Sec. 1.132-
8(g)) as control employees for purposes of this paragraph (f).
    (6) Control employee defined--Government employer. For purposes of 
this paragraph (f), a control employee of a government employer is any--
    (i) Elected official, or
    (ii) Employee whose compensation equals or exceeds the compensation 
paid to a Federal Government employee holding a position at Executive 
Level V, determined under Chapter 11 of title 2, United States Code, as 
adjusted by section 5318 of Title 5 United States Code.

For purposes of this paragraph (f), the term ``government'' includes any 
Federal, state or local governmental unit, and any agency or 
instrumentality thereof. Instead of applying the control employee 
definition of paragraph (f)(6), an employer may treat all and only 
employees who are ``highly compensated'' employees (as defined in Sec. 
1.132-8(f)) as control employees for purposes of this paragraph (f).
    (7) ``Compensation'' defined. For purposes of this paragraph (f), 
the term ``compensation'' has the same meaning as in section 414(q)(7). 
Compensation includes all amounts received from all entities treated as 
a single employer under section 414 (b), (c), (m), or (o). Levels of 
compensation shall be adjusted at the same time and in the same manner 
as provided in section 415(d). The first such adjustment shall be for 
calendar year 1988.
    (g) Non-commercial flight valuation rule--(1) In general. Under the 
non-commercial flight valuation rule of this paragraph (g), except as 
provided in paragraph (g)(12) of this section, if an employee is 
provided with a flight on an employer-provided aircraft, the value of 
the flight is calculated using the aircraft valuation formula of 
paragraph (g)(5) of this section. For purposes of this paragraph (g), 
the value of a flight on an employer-provided aircraft by an individual 
who is less than two years old is deemed to be zero. See paragraph 
(b)(1) of this section for rules relating to the amount includible in 
income when an employee reimburses the employee's employer for all or 
part of the fair market value of the benefit provided.
    (2) Eligible flights and eligible aircraft. The valuation rule of 
this paragraph (g) may be used to value flights on all employer-provided 
aircraft, including helicopters. The valuation rule of this paragraph 
(g) may be used to value international as well as domestic flights. The 
valuation rule of this paragraph (g) may not be used to value a flight 
on any commercial aircraft on which air transportation is sold to the 
public on a per-seat basis. For a special valuation rule relating to 
certain flights on commercial aircraft, see paragraph (h) of this 
section.
    (3) Definition of a flight--(i) General rule. Except as otherwise 
provided in paragraph (g)(3)(iii) of this section (relating to 
intermediate stops), for purposes of this paragraph (g), a flight is the 
distance (in statute miles, i.e., 5,280 feet per statute mile) between 
the

[[Page 72]]

place at which the individual boards the aircraft and the place at which 
the individual deplanes.
    (ii) Valuation of each flight. Under the valuation rule of this 
paragraph (g), value is determined separately for each flight. Thus, a 
round-trip is comprised of at least two flights. For example, an 
employee who takes a personal trip on an employer-provided aircraft from 
New York City to Denver, then Denver to Los Angeles, and finally Los 
Angeles to New York City has taken three flights and must apply the 
aircraft valuation formula separately to each flight. The value of a 
flight must be determined on a passenger-by-passenger basis. For 
example, if an individual accompanies an employee and the flight taken 
by the individual would be taxed to the employee, the employee would be 
taxed on the special rule value of the flight by the employee and the 
flight by the individual.
    (iii) Intermediate stop. If a landing is necessitated by weather 
conditions, by an emergency, for purposes of refueling or obtaining 
other services relating to the aircraft or for any other purpose 
unrelated to the personal purposes of the employee whose flight is being 
valued, that landing is an intermediate stop. Additional mileage 
attributable to an intermediate stop is not considered when determining 
the distance of an employee's flight.
    (iv) Examples. The rules of paragraph (g)(3)(iii) of this section 
may be illustrated by the following examples:

    Example (1). Assume that an employee's trip originates in St. Louis, 
Missouri, with Seattle, Washington as its destination, but, because of 
weather conditions, the aircraft lands in Denver, Colorado, and the 
employee stays in Denver overnight. Assume further that the next day the 
aircraft flies to Seattle where the employee deplanes. The employee's 
flight is the distance between the airport in St. Louis and the airport 
in Seattle.
    Example (2). Assume that a trip originates in New York, New York, 
with five passengers and that the aircraft makes a stop in Chicago, 
Illinois, so that one of the passengers can deplane for a purpose 
unrelated to the personal purposes of the other passengers whose flights 
are being valued. The aircraft then goes on to Los Angeles, California, 
where the other four passengers will deplane. The flight of the 
passenger who deplaned in Chicago is the distance between the airport in 
New York and the airport in Chicago. The stop in Chicago is disregarded 
as an intermediate stop, however, when measuring the flights taken by 
each of the other four passengers. Their flights would be the distance 
between the airport in New York and the airport in Los Angeles.

    (4) Personal and non-personal flights--(i) In general. The valuation 
rule of this paragraph (g) applies to personal flights on employer-
provided aircraft. A personal flight is one the value of which is not 
excludable under another section of subtitle A of the Internal Revenue 
Code of 1986, such as under section 132(d) (relating to a working 
condition fringe). However, solely for purposes of paragraphs (g)(4)(ii) 
and (g)(4)(iii) of this section, references to personal flights do not 
include flights a portion of which would not be excludable from income 
by reason of section 274(c).
    (ii) Trip primarily for employer's business. If an employee 
combines, in one trip, personal and business flights on an employer-
provided aircraft and the employee's trip is primarily for the 
employer's business (see Sec. 1.162-2(b)(2)), the employee must include 
in income the excess of the value of all the flights that comprise the 
trip over the value of the flights that would have been taken had there 
been no personal flights but only business flights. For example, assume 
that an employee flies on an employer-provided aircraft from Chicago, 
Illinois, to Miami, Florida, for the employer's business and that from 
Miami the employee flies on the employer-provided aircraft to Orlando, 
Florida, for personal purposes and then flies back to Chicago. Assume 
further that the primary purpose of the trip is for the employer's 
business. The amount includible in income is the excess of the value of 
the three flights (Chicago to Miami, Miami to Orlando, and Orlando to 
Chicago), over the value of the flights that would have been taken had 
there been no personal flights but only business flights (Chicago to 
Miami and Miami to Chicago).
    (iii) Primarily personal trip. If an employee combines, in one trip, 
personal and business flights on an employer-provided aircraft and the 
employee's trip is primarily personal (see Sec. 1.162-2(b)(2)), the 
amount includible in the employee's income is the value of the

[[Page 73]]

personal flights that would have been taken had there been no business 
flights but only personal flights. For example, assume that an employee 
flies on an employer-provided aircraft from San Francisco, California, 
to Los Angeles, California, for the employer's business and that from 
Los Angeles the employee flies on an employer-provided aircraft to Palm 
Springs, California, primarily for personal reasons and then flies back 
to San Francisco. Assume further that the primary purpose of the trip is 
personal. The amount includible in the employee's income is the value of 
personal flights that would have been taken had there been no business 
flights but only personal flights (San Francisco to Palm Springs and 
Palm Springs to San Francisco).
    (iv) Application of section 274(c). The value of employer- provided 
travel outside the United States away from home may not be excluded from 
the employee's gross income as a working condition fringe, by either the 
employer or the employee, to the extent not deductible by reason of 
section 274(c). The valuation rule of this paragraph (g) applies to that 
portion of the value any flight not excludable by reason of section 
274(c). Such value is includible in income in addition to the amounts 
determined under paragraphs (g)(4)(ii) and (g)(4)(iii) of this section.
    (v) Flights by individuals who are not personal guests. If an 
individual who is not an employee of the employer providing the aircraft 
is on a flight, and the individual is not the personal guest of any 
employee of the employer, the flight by the individual is not taxable to 
any employee of the employer providing the aircraft. The rule in the 
preceding sentence applies where the individual is provided the flight 
by the employer for noncompensatory business reasons of the employer. 
For example, assume that G, an employee of company Y, accompanies A, an 
employee of company X, on company X's aircraft for the purpose of 
inspecting land under consideration for purchase by company X from 
company Y. The flight by G is not taxable to A. No inference may be 
drawn from this paragraph (g)(4)(v) concerning the taxation of a flight 
provided to an individual who is neither an employee of the employer nor 
a personal guest of any employee of the employer.
    (5) Aircraft valuation formula. Under the valuation rule of this 
paragraph (g), the value of a flight is determined under the base 
aircraft valuation formula (also known as the Standard Industry Fare 
Level formula or SIFL) by multiplying the SIFL cents-per-mile rates 
applicable for the period during which the flight was taken by the 
appropriate aircraft multiple (as provided in paragraph (g)(7) of this 
section) and then adding the applicable terminal charge. The SIFL cents-
per-mile rates in the formula and the terminal charge are calculated by 
the Department of Transportation and are revised semi-annually. The base 
aircraft valuation formula in effect from January 1, 1989 through June 
30, 1989, is as follows: a terminal charge of $26.48 plus ($.1449 per 
mile for the first 500 miles, $.1105 per mile for miles between 501 and 
1500, and $.1062 per mile for miles over 1500). For example, if a flight 
taken on January 15, 1989, by a non-control employee on an employer-
provided aircraft with a maximum certified takeoff weight of 26,000 lbs. 
is 2,000 miles long, the value of the flight determined under this 
paragraph (g)(5) is: $100.36 ((.313x(($.1449x500)+($.1105x1,000)+ 
($.1062x500)))+$26.48). The aircraft valuation formula applies 
separately to each flight being valued under this paragraph (g). 
Therefore, the number of miles an employee has flown on employer-
provided aircraft flights prior to the flight being valued does not 
affect the determination of the value of the flight.
    (6) Discretion to provide new formula. The Commissioner may 
prescribe a different base aircraft valuation formula by regulation, 
Revenue Ruling or Revenue Procedure in the event that the calculation of 
the Standard Industry Fare Level is discontinued.
    (7) Aircraft multiples--(i) In general. The aircraft multiples are 
based on the maximum certified takeoff weight of the aircraft. When 
applying the aircraft valuation formula to a flight, the appropriate 
aircraft multiple is multiplied by the product of the applicable SIFL 
cents-per-mile rates multiplied by the number of miles in the flight and 
then the terminal charge is added

[[Page 74]]

to the product. For purposes of applying the aircraft valuation formula 
described in paragraph (g)(5) of this section, the aircraft multiples 
are as follows:

------------------------------------------------------------------------
                                                  Aircraft     Aircraft
                                                  multiple     multiple
   Maximum certified take-off weight of the        for a      for a non-
                   aircraft                       control      control
                                                  employee     employee
                                                 (percent)    (percent)
------------------------------------------------------------------------
6,000 lbs. or less............................         62.5         15.6
6,001-10,000 lbs..............................        125           23.4
10,001-25,000 lbs.............................        300           31.3
25,001 lbs. or more...........................        400           31.3
------------------------------------------------------------------------

    (ii) Flights treated as provided to a control employee. Except as 
provided in paragraph (g)(12) of this section, any fIight provided to an 
individual whose flight would be taxable to a control employee (as 
defined in paragraphs (g) (8) and (9) of this section) as the recipient 
shall be valued as if such flight had been provided to that control 
employee. For example, assume that the chief executive officer of an 
employer, his spouse, and his two children fly on an employer-provided 
aircraft for personal purposes. Assume further that the maximum 
certified takeoff weight of the aircraft is 12,000 lbs. The amount 
includible in the employee's income is 4x((300 percentxthe applicable 
SIFL cents-per-mile rates provided in paragraph (g)(5) of this section 
multiplied by the number of miles in the flight) plus the applicable 
terminal charge).
    (8) Control employee defined--Non-government employer--(i) 
Definition. For purposes of this paragraph (g), a control employee of a 
non-government employer is any employee--
    (A) Who is a Board- or shareholder-appointed, confirmed, or elected 
officer of the employer, limited to the lesser of--
    (1) One percent of all employees (increased to the next highest 
integer, if not an integer) or
    (2) Ten employees;
    (B) Who is among the top one percent most highly-paid employees of 
the employer (increased to the next highest integer, if not an integer) 
limited to a maximum of 50;
    (C) Who owns a five-percent or greater equity, capital, or profits 
interest in the employer; or
    (D) Who is a director of the employer.
    (ii) Special rules for control employee definition--(A) In general. 
For purposes of this paragraph (g), any employee who is a family member 
(within the meaning of section 267(c)(4)) of a control employee is also 
a control employee. For purposes of paragraph (g)(8)(i)(B) of this 
section, the term ``employee'' does not include any individual unless 
such individual is a common-law employee, partner, or one-percent or 
greater shareholder of the employer. Pursuant to this paragraph (g)(8), 
an employee may be a control employee under more than one of the 
requirements listed in paragraphs (g)(8)(i) (A) through (D) of this 
section. For example, an employee may be both an officer under paragraph 
(g)(8)(i)(A) of this section and a highly-paid employee under paragraph 
(g)(8)(i)(B) of this section. In this case, for purposes of the officer 
limitation rule of paragraph (g)(8)(i)(A) of this section and the 
highly-paid employee limitation rule of paragraph (g)(8)(i)(B) of this 
section, the employee would be counted in applying both limitations. For 
purposes of determining the one-percent limitation under paragraphs 
(g)(8)(i) (A) and (B) of this section, an employer shall exclude from 
consideration employees described in Sec. 1.132-8(b)(3). Instead of 
applying the control employee definition of this paragraph (g)(8), an 
employer may treat all (and only) employees who are ``highly 
compensated'' employees (as defined in Sec. 1.132-8(f)) as control 
employees for purposes of this paragraph (g).
    (B) Special rules for officers, owners, and highly-paid control 
employees. In no event shall an employee whose compensation is less than 
$50,000 be a control employee under paragraph (g)(8)(i) (A) or (B) of 
this section. For purposes of determining who is a five-percent (or one-
percent) owner under this paragraph (g)(8), any individual who owns (or 
is considered as owning under section 318(a) or principles similar to 
section 318(a) for entities other than corporations) five percent (or 
one-percent) or more of the fair market value of an entity (the ``owned 
entity'') is considered a five-percent (or one-percent) owner of all 
entities which would be aggregated with the owned entity under the rules 
of section 414(b), (c),

[[Page 75]]

(m), or (o). For purposes of determining who is an officer or director 
with respect to an employer under this paragraph (g)(8), notwithstanding 
anything in this section to the contrary, if the employer would be 
aggregated with other employers under the rules of section 414 (b), (c), 
(m), or (o), the officer definition and the limitations and the director 
definition are applied to each such separate employer rather than to the 
aggregated employer. An employee who is an officer or director of one 
employer (the ``first employer'') shall not be counted as an officer or 
a director of any other employer aggregated with the first employer 
under the rules of section 414 (b), (c), or (m). If applicable, the 
officer limitations rule of paragraph (g)(8)(i)(A) of this section is 
applied to employees in descending order of their compensation. Thus, if 
an employer has 11 board-appointed officers and the limit imposed under 
paragraph (g)(8)(i)(A) of this section is 10 officers, the employee with 
the least compensation of those officers would not be a control employee 
under paragraph (g)(8)(i)(A) of this section.
    (9) Control employee defined--Government employer. For purposes of 
this paragraph (g), a control employee of a government employer is any--
    (i) Elected official, or
    (ii) Employee whose compensation equals or exceeds the compensation 
paid to a Federal Government employee holding a position at Executive 
Level V, determined under Chapter 11 of title 2, United States Code, as 
adjusted by section 5318 of title 5 United States Code.

For purposes of paragraph (f), the term ``government'' includes any 
Federal, state or local governmental unit, and any agency or 
instrumentality thereof. lnstead of applying the control employee 
definition of paragraph (f)(6), an employer may treat all and only 
employees who are ``highly compensated'' employees (as defined in Sec. 
1.132-8(f)) as control employees for purposes of this paragraph (f).
    (10) ``Compensation'' defined. For purposes of this paragraph (g), 
the term ``compensation'' has the same meaning as in section 414(q)(7). 
Compensation includes all amounts received from all entities treated as 
a single employer under section 414 (b), (c), (m), or (o). Levels of 
compensation shall be adjusted at the same time and in the same manner 
as provided in section 415(d). The first such adjustment was for 
calendar year 1988.
    (11) Treatment of former employees. For purposes of this paragraph 
(g), an employee who was a control employee of the employer (as defined 
in this paragraph (g)) at any time after reaching age 55, or within 
three years of separation from the service of the employer, is a control 
employee with respect to flights taken after separation from the service 
of the employer. An individual who is treated as a control employee 
under this paragraph (g)(11) is not counted when determining the 
limitation of paragraph (g)(8)(i) (A) and (B) of this section. Thus, the 
total number of individuals treated as control employees under such 
paragraphs may exceed the limitations of such paragraphs to the extent 
that this paragraph (g)(11) applies.
    (12) Seating capacity rule--(i) In general--(A) General rule. Where 
50 percent or more of the regular passenger seating capacity of an 
aircraft (as used by the employer) is occupied by individuals whose 
flights are primarily for the employer's business (and whose flights are 
excludable from income under section 132(d)), the value of a flight on 
that aircraft by any employee who is not flying primarily for the 
employer's business (or who is flying primarily for the employer's 
business but the value of whose flight is not excludable under section 
132(d) by reason of section 274(c)) is deemed to be zero. See Sec. 
1.132-5 which limits the working condition fringe exclusion under 
section 132(d) to situations where the employee receives the flight in 
connection with the performance of services for the employer providing 
the aircraft.
    (B) Special rules--(1) Definition of ``employee.'' For purposes of 
this paragraph (g)(12), the term ``employee'' includes only employees of 
the employer, including a partner of a partnership, providing the 
aircraft and does not include independent contractors and directors of 
the employer. A flight taken by an individual other than an ``employee'' 
as defined in the preceding sentence is considered a flight taken by

[[Page 76]]

an employee for purposes of this paragraph (g)(12) only if that 
individual is treated as an employee pursuant to section 132(f)(1) or 
that individual's flight is treated as a flight taken by an employee 
pursuant to section 132(f)(2). If--
    (i) A flight by an individual is not considered a flight taken by an 
employee (as defined in this paragraph (g)(12)(i)),
    (ii) The value of that individual's flight is not excludable under 
section 132(d), and
    (iii) The seating capacity rule of this paragraph (g) (12) otherwise 
applies, then the value of the flight provided to such an individual is 
the value of a flight provided to a non-control employee pursuant to 
paragraph (g)(5) of this section (even if the individual who would be 
taxed on the value of the flight is a control employee).
    (2) Example. The special rules of paragraph (g)(12)(i)(B)(1) of this 
section are illustrated by the following example:

    Example. Assume that 60 percent of the regular passenger seating 
capacity of an employer's aircraft is occupied by individuals whose 
flights are primarily for the employer's business and are excludable 
from income under section 132(d). If a control employee, his spouse, and 
his dependent child fly on the employer's aircraft for primarily 
personal reasons, the value of the three flights is deemed to be zero. 
If, however, the control employee's cousin were provided a flight on the 
employer's aircraft, the value of the flight taken by the cousin is 
determined by applying the aircraft valuation formula of paragraph 
(g)(5) of this section (including the terminal charge) and the non-
control employee aircraft multiples of paragraph (g)(7) of this section.

    (ii) Application of 50-percent test to multiple flights. The seating 
capacity rule of this paragraph (g)(12) must be met both at the time the 
individual whose flight is being valued boards the aircraft and at the 
time the individual deplanes. For example, assume that employee A boards 
an employer-provided aircraft for personal purposes in New York, New 
York, and that at that time 80 percent of the regular passenger seating 
capacity of the aircraft is occupied by individuals whose flights are 
primarily for the employer's business (and whose flights are excludable 
from income under section 132(d)) (``the business passengers''). If the 
aircraft flies directly to Hartford, Connecticut where all of the 
passengers, including A, deplane, the requirements of the seating 
capacity rule of this paragraph (g)(12) have been satisfied. If instead, 
some of the passengers, including A, remain on the aircraft in Hartford 
and the aircraft continues on to Boston, Massachusetts, where they all 
deplane, the requirements of the seating capacity rule of this paragraph 
(g)(12) will not be satisfied with respect to A's flight from New York 
to Boston unless at least 50 percent of the seats comprising the 
aircraft's regular passenger seating capacity were occupied by the 
business passengers at the time A deplanes in Boston.
    (iii) Regular passenger seating capacity. (A) General rule. Except 
as otherwise provided, the regular passenger seating capacity of an 
aircraft is the maximum number of seats that have at any time on or 
prior to the date of the flight been on the aircraft (while owned or 
leased by the employer). Except to the extent excluded pursuant to 
paragraph (g)(12)(v) of this section, regular seating capacity includes 
all seats which may be occupied by members of the flight crew. It is 
irrelevant that, on a particular flight, less than the maximum number of 
seats are available for use because, for example, some of the seats are 
removed.
    (B) Special rules. When determining the maximum number of seats that 
have at any time on or prior to the date of the flight been on the 
aircraft (while owned or leased by the employer), seats that could not 
at any time be legally used during takeoff and have not at any time been 
used during takeoff are not counted. As of the date an employer 
permanently reduces the seating capacity of an aircraft, the regular 
passenger seating capacity is the reduced number of seats on the 
aircraft. The previous sentence shall not apply if at any time within 24 
months after such reduction any seats are added in the aircraft. Unless 
the conditions of this paragraph (g)(12)(iii)(B) are satisfied, 
jumpseats and removable seats used solely for purposes of flight crew 
training are counted for purposes of the seating capacity rule of this 
paragraph (g)(12).

[[Page 77]]

    (iv) Examples. The rules of paragraph (g)(12)(iii) of this section 
are illustrated by the following examples:

    Example (1). Employer A and employer B order the same aircraft, 
except that A orders it with 10 seats and B orders it with eight seats. 
A always uses its aircraft as a 10-seat aircraft; B always uses its 
aircraft as an eight-seat aircraft. The regular passenger seating 
capacity of A's aircraft is 10 and of B's aircraft is eight.
    Example (2). Assume the same facts as in example (1), except that 
whenever A's chief executive officer and spouse use the aircraft eight 
seats are removed. Even if substantially all of the use of the aircraft 
is by the chief executive officer and spouse, the regular passenger 
seating capacity of the aircraft is 10.
    Example (3). Assume the same facts as in example (1), except that 
whenever more than eight people want to fly in B's aircraft, two extra 
seats are added. Even if substantially all of the use of the aircraft 
occurs with eight seats, the regular passenger seating capacity of the 
aircraft is 10.
    Example (4). Employer C purchases an aircraft with 12 seats. Three 
months later C remodels the interior of the aircraft and permanently 
removes four of the seats. Upon completion of the remodeling, the 
regular passenger seating capacity of the aircraft is eight. If, 
however, any seats are added within 24 months after the remodeling, the 
regular seating capacity of the aircraft is treated as 12 throughout the 
entire period.

    (v) Seats occupied by flight crew. When determining the regular 
passenger seating capacity of an aircraft, any seat occupied by a member 
of the flight crew (whether or not such individual is an employee of the 
employer providing the aircraft) shall not be counted, unless the 
purpose of the flight by such individual is not primarily to serve as a 
member of the flight crew. If the seat occupied by a member of the 
flight crew is not counted as a passenger seat pursuant to the previous 
sentence, such member of the flight crew is disregarded in applying the 
50-percent test described in the first sentence of paragraph (g)(12)(i) 
of this section. For example, assume that prior to application of this 
paragraph (g)(12)(v) the regular passenger seating capacity of an 
aircraft is one. Assume further that an employee pilots the aircraft and 
that the employee's flight is nor primarily for the employer's business. 
If the employee's spouse occupies the other seat for personal purposes, 
the seating capacity rule is not met and the value of both flights must 
be included in the employee's income. If, however, the employee's flight 
were primarily for the employer's business (unrelated to serving as a 
member of the flight crew), then the seating capacity rule is met and 
the value of the flight for the employee's spouse is deemed to be zero. 
If the employee's flight were primarily to serve as a member of the 
flight crew, then the seating capacity rule is not met and the value of 
a flight by any passenger for primarily personal reasons is not deemed 
to be zero.
    (13) Erroneous use of the non-commercial flight valuation rule--(i) 
Certain errors in the case of a flight by a control employee. If--
    (A) The non-commercial flight valuation rule of this paragraph (g) 
is applied by an employer or a control employee, as the case may be, on 
a return as originally filed or on an amended return on the grounds that 
either--
    (1) The control employee is not in fact a control employee, or
    (2) The aircraft is within a specific weight classification, and
    (B) Either position is subsequently determined to be erroneous, the 
valuation rule of this paragraph (g) is not available to value the 
flight taken by that control employee by the person or persons taking 
the erroneous position. With respect to the weight classifications, the 
previous sentence does not apply if the position taken is that the 
weight of the aircraft is greater than it is subsequently determined to 
be. If, with respect to a flight by a control employee, the seating 
capacity rule of paragraph (g)(12) of this section is used by an 
employer or the control employee, as the case may be, on a return as 
originally filed or on an amended return, the valuation rule of this 
paragraph (g) is not available to value the flight taken by that control 
employee by the person or persons taking the erroneous position.
    (ii) Value of flight excluded as a working condition fringe. If 
either an employer or an employee, on a return as originally filed or on 
an amended return, excludes from the employee's income or wages all or 
any part of the value of a flight on the grounds that the flight was 
excludable as a working

[[Page 78]]

condition fringe under section 132, and that position is subsequently 
determined to be erroneous, the valuation rule of this paragraph (g) is 
not available to value the flight taken by that employee by the person 
or persons taking the erroneous position. Instead, the general valuation 
rules of paragraphs (b) (5) and (6) of this section apply.
    (14) Consistency rules--(i) Use by the employer. Except as otherwise 
provided in paragraph (g)(13) of this section or Sec. 1.132-5 (m)(4), 
if the non-commercial flight valuation rule of this paragraph (g) is 
used by an employer to value any flight provided to an employee in a 
calendar year, the rule must be used to value all flights provided to 
all employees in the calendar year.
    (ii) Use by the employee. Except as otherwise provided in paragraph 
(g)(13) of this section or Sec. 1.132-5 (m)(4), if the non-commercial 
flight valuation rule of this paragraph (g) is used by an employee to 
value a flight provided by an employer in a calendar year, the rule must 
be used to value all flights provided to the employee by that employer 
in the calendar year.
    (h) Commercial flight valuation rule--(1) In general. Under the 
commercial flight valuation rule of this paragraph (h), the value of a 
space-available flight (as defined in paragraph (h) (2) of this section) 
on a commercial aircraft is 25 percent of the actual carrier's highest 
unrestricted coach fare in effect for the particular flight taken. The 
rule of this paragraph (h) is available only to an individual described 
in Sec. 1.132-1(b)(1).
    (2) Space-available flight. The commercial flight valuation rule of 
this paragraph (h) is available to value a space-available flight. The 
term ``space-available flight'' means a flight on a commercial 
aircraft--
    (i) Which is subject to the same types of restrictions customarily 
associated with flying on an employee ``stand-by'' or ``space-
available'' basis, and
    (ii) Which meets the definition of a no-additional-cost service 
under section 132(b), except that the flight is provided to an 
individual other than the employee or an individual treated as the 
employee under section 132(f). Thus, a flight is not a space-available 
flight if the employer guarantees the employee a seat on the flight or 
if the nondiscrimination requirements of section 132(h)(1) and Sec. 
1.132-8 are not satisfied. A flight may be a space-available flight even 
if the airline that is the actual carrier is not the employer of the 
employee.
    (3) Commercial aircraft. If the actual carrier does not offer, in 
the ordinary course of its business, air transportation to customers on 
a per-seat basis, the commercial flight valuation rule of this paragraph 
(h) is not available. Thus, if, in the ordinary course of its line of 
business, the employer only offers air transportation to customers on a 
charter basis, the commercial flight valuation rule of this paragraph 
(h) may not be used to value a space-available flight on the employer's 
aircraft. If the commercial flight valuation rule is not available, the 
flight may be valued under the non-commercial flight valuation rule of 
paragraph (g) of this section.
    (4) Timing of inclusion. The date that the flight is taken is the 
relevant date for purposes of applying section 61(a)(1) and this section 
to a space-available flight on a commercial aircraft. The date of 
purchase or issuance of a pass or ticket is not relevant. Thus, this 
section applies to a flight taken on or after January 1, 1989, 
regardless of the date on which the pass or ticket for the flight was 
purchased or issued.
    (5) Consistency rules--(i) Use by employer. If the commercial flight 
valuation rule of this paragraph (h) is used by an employer to value any 
flight provided in a calendar year, the rule must be used to value all 
flights eligible for use of the rule provided in the calendar year.
    (ii) Use by employee. If the commercial flight valuation rule of 
this paragraph (h) is used by an employee to value a flight provided by 
an employer in a calendar year, the rule must be used to value all 
flights provided by that employer eligible for use of the rule taken by 
such employee in the calendar year.
    (i) [Reserved]
    (j) Valuation of meals provided at an employer-operated eating 
facility for employees--(1) In general. The valuation rule of this 
paragraph (j) may be used

[[Page 79]]

to value a meal provided at an employer-operated eating facility for 
employees (as defined in Sec. 1.132-7). For rules relating to an 
exclusion for the value of meals provided at an employer-operated eating 
facility for employees, see section 132(e)(2) and Sec. 1.132-7.
    (2) Valuation formula--(i) In general. The value of all meals 
provided at an employer-operated eating facility for employees during a 
calendar year (``total meal value'') is 150 percent of the direct 
operating costs of the eating facility determined separately with 
respect to such eating facility whether or not the direct operating 
costs test is applied separately to such eating facility under Sec. 
1.132-7(b)(2). For purposes of this paragraph (j), the definition of 
direct operating costs provided in Sec. 1.132-7(b) and the adjustments 
specified in Sec. 1.132-7(a)(2) apply. The taxable value of meals 
provided at an eating facility may be determined in two ways. The 
``individual meal subsidy'' may be treated as the taxable value of a 
meal provided at the eating facility (see paragraph (j)(2)(ii) of this 
section) to a particular employee. Alternatively, the employer may 
allocate the ``total meal subsidy'' among employees (see paragraph 
(j)(2)(iii) of this section).
    (ii) ``Individual meal subsidy'' defined. The ``individual meal 
subsidy'' is determined by multiplying the amount paid by the employee 
for a particular meal by a fraction, the numerator of which is the total 
meal value and the denominator of which is the gross receipts of the 
eating facility for the calendar year and then subtracting the amount 
paid by the employee for the meal. The taxable value of meals provided 
to a particular employee during a calendar year, therefore, is the sum 
of the individual meal subsidies provided to the employee during the 
calendar year. This rule is available only if there is a charge for each 
meal selection and if each employee is charged the same price for any 
given meal selection.
    (iii) Allocation of ``total meal subsidy.'' Instead of using the 
individual meal subsidy method provided in paragraph (j)(2)(ii) of this 
section, the employer may allocate the ``total meal subsidy'' (total 
meal value less the gross receipts of the facility) among employees in 
any manner reasonable under the circumstances. It will be presumed 
reasonable for an employer to allocate the total meal subsidy on a per-
employee basis if the employer has information that would substantiate 
to the satisfaction of the Commissioner that each employee was provided 
approximately the same number of meals at the facility.
    (k) Commuting valuation rule for certain employees--(1) In general. 
Under the rule of this paragraph (k), the value of the commuting use of 
employer-provided transportation may be determined under paragraph 
(k)(3) of this section if the following criteria are met by the employer 
and employee with respect to the transportation:
    (i) The transportation is provided, solely because of unsafe 
conditions, to an employee who would ordinarily walk or use public 
transportation for commuting to or from work;
    (ii) The employer has established a written policy (e.g., in the 
employer's personnel manual) under which the transportation is not 
provided for the employee's personal purposes other than for commuting 
due to unsafe conditions and the employer's practice in fact corresponds 
with the policy;
    (iii) The transportation is not used for personal purposes other 
than commuting due to unsafe conditions; and
    (iv) The employee receiving the employer-provided transportation is 
a qualified employee of the employer (as defined in paragraph (k)(6) of 
this section).
    (2) Trip-by-trip basis. The special valuation rule of this paragraph 
(k) applies on a trip-by-trip basis. If an employer and employee fail to 
meet the criteria of paragraph (k)(1) of this section with respect to 
any trip, the value of the transportation for that trip is not 
determined under paragraph (k)(3) of this section and the amount 
includible in the employee's income is determined by reference to the 
fair market value of the transportation.
    (3) Commuting value--(i) $1.50 per one-way commute. If the 
requirements of this paragraph (k) are satisfied, the value of the 
commuting use of the employer-provided transportation is $1.50 per one-
way commute (i.e., from home to work or from work to home).

[[Page 80]]

    (ii) Value per employee. If transportation is provided to more than 
one qualified employee at the same time, the amount includible in the 
income of each employee is $1.50 per one-way commute.
    (4) Definition of employer-provided transportation. For purposes of 
this paragraph (k), ``employer-provided transportation'' means 
transportation by vehicle (as defined in paragraph (f)(4) of this 
section) that is purchased by the employer (or that is purchased by the 
employee and reimbursed by the employer) from a party that is not 
related to the employer for the purpose of transporting a qualified 
employee to or from work. Reimbursements made by an employer to an 
employee to cover the cost of purchasing transportation (e.g., hiring 
cabs) must be made under a bona fide reimbursement arrangement.
    (5) Unsafe conditions. Unsafe conditions exist if a reasonable 
person would, under the facts and circumstances, consider it unsafe for 
the employee to walk to or from home, or to walk to or use public 
transportation at the time of day the employee must commute. One of the 
factors indicating whether it is unsafe is the history of crime in the 
geographic area surrounding the employee's workplace or residence at the 
time of day the employee must commute.
    (6) Qualified employee defined--(i) In general. For purposes of this 
paragraph (k), a qualified employee is one who meets the following 
requirements with respect to the employer:
    (A) The employee performs services during the current year, is paid 
on an hourly basis, is not claimed under section 213(a)(1) of the Fair 
Labor Standards Act of 1938 (as amended), 29 U.S.C. 201-219 (FLSA), to 
be exempt from the minimum wage and maximum hour provisions of the FLSA, 
and is within a classification with respect to which the employer 
actually pays, or has specified in writing that it will pay, 
compensation for overtime equal to or exceeding one and one-half times 
the regular rate as provided by section 207 of the FLSA; and
    (B) The employee does not receive compensation from the employer in 
excess of the amount permitted by section 414(q)(1)(C) of the Code.
    (ii) ``Compensation'' and ``paid on an hourly basis'' defined. For 
purposes of this paragraph (k), ``compensation'' has the same meaning as 
in section 414(q)(7). Compensation includes all amounts received from 
all entities treated as a single employer under section 414 (b), (c), 
(m), or (o). Levels of compensation shall be adjusted at the same time 
and in the same manner as provided in section 415(d). If an employee's 
compensation is stated on an annual basis, the employee is treated as 
``paid on an hourly basis'' for purposes of this paragraph (k) as long 
as the employee is not claimed to be exempt from the minimum wage and 
maximum hour provisions of the FLSA and is paid overtime wages either 
equal to or exceeding one and one-half the employee's regular hourly 
rate of pay.
    (iii) FLSA compliance required. An employee will not be considered a 
qualified employee for purposes of this paragraph (k), unless the 
employer is in compliance with the recordkeeping requirements concerning 
that employee's wages, hours, and other conditions and practices of 
employment as provided in section 211(c) of the FLSA and 29 CFR part 
516.
    (iv) Issues arising under the FLSA. If questions arise concerning an 
employee's classification under the FLSA, the pronouncements and rulings 
of the Administrator of the Wage and Hour Division, Department of Labor 
are determinative.
    (v) Non-qualified employees. If an employee is not a qualified 
employee within the meaning of this paragraph (k)(6), no portion of the 
value of the commuting use of employer-provided transportation is 
excluded under this paragraph (k).
    (7) Examples. This paragraph (k) is illustrated by the following 
examples:

    Example 1. A and B are word-processing clerks employed by Y, an 
accounting firm in a large metropolitan area, and both are qualified 
employees under paragraph (k)(6) of this section. The normal working 
hours for A and B are from 11:00 p.m. until 7:00 a.m. and public 
transportation, the only means of transportation available to A or B, 
would be considered unsafe by a reasonable person at the time they are 
required to commute from home to work. In response, Y hires a car

[[Page 81]]

service to pick up A and B at their homes each evening for purposes of 
transporting them to work. The amount includible in the income of both A 
and B is $1.50 for the one-way commute from home to work.
    Example 2. Assume the same facts as in Example 1, except that Y also 
hires a car service to return A and B to their homes each morning at the 
conclusion of their shifts and public transportation would not be 
considered unsafe by a reasonable person at the time of day A and B 
commute to their homes. The value of the commute from work to home is 
includible in the income of both A and B by reference to fair market 
value since unsafe conditions do not exist for that trip.
    Example 3. C is an associate for Z, a law firm in a metropolitan 
area. The normal working hours for C's law firm are from 9 a.m. until 6 
p.m., but C's ordinary office hours are from 10 a.m. until 8 p.m. Public 
transportation, the only means of transportation available to C at the 
time C commutes from work to home during the evening, would be 
considered unsafe by a reasonable person. In response, Z hires a car 
service to take C home each evening. C does not receive annual 
compensation from Z in excess of the amount permitted by section 
414(q)(1)(C) of the Code. However, C is treated as an employee exempt 
from the provisions of the FLSA and, accordingly, is not paid overtime 
wages. Therefore, C is not a qualified employee within the meaning of 
paragraph (k)(6) of this section. The value of the commute from work to 
home is includible in C's income by reference to fair market value.

    (8) Effective date. This paragraph (k) applies to employer-provided 
transportation provided to a qualified employee on or after July 1, 
1991.

[T.D. 8256, 54 FR 28582, July 6, 1989, as amended by T.D. 8389, 57 FR 
1870, Jan. 16, 1992; T.D. 8457, 57 FR 62195, Dec. 30, 1992]



Sec. 1.61-22  Taxation of split-dollar life insurance arrangements.

    (a) Scope--(1) In general. This section provides rules for the 
taxation of a split-dollar life insurance arrangement for purposes of 
the income tax, the gift tax, the Federal Insurance Contributions Act 
(FICA), the Federal Unemployment Tax Act (FUTA), the Railroad Retirement 
Tax Act (RRTA), and the Self-Employment Contributions Act of 1954 
(SECA). For the Collection of Income Tax at Source on Wages, this 
section also provides rules for the taxation of a split-dollar life 
insurance arrangement, other than a payment under a split-dollar life 
insurance arrangement that is a split-dollar loan under Sec. 1.7872-
15(b)(1). A split-dollar life insurance arrangement (as defined in 
paragraph (b) of this section) is subject to the rules of paragraphs (d) 
through (g) of this section, Sec. 1.7872-15, or general tax rules. For 
rules to determine which rules apply to a split-dollar life insurance 
arrangement, see paragraph (b)(3) of this section.
    (2) Overview. Paragraph (b) of this section defines a split-dollar 
life insurance arrangement and provides rules to determine whether an 
arrangement is subject to the rules of paragraphs (d) through (g) of 
this section, Sec. 1.7872-15, or general tax rules. Paragraph (c) of 
this section defines certain other terms. Paragraph (d) of this section 
sets forth rules for the taxation of economic benefits provided under a 
split-dollar life insurance arrangement. Paragraph (e) of this section 
sets forth rules for the taxation of amounts received under a life 
insurance contract that is part of a split-dollar life insurance 
arrangement. Paragraph (f) of this section provides rules for additional 
tax consequences of a split-dollar life insurance arrangement, including 
the treatment of death benefit proceeds. Paragraph (g) of this section 
provides rules for the transfer of a life insurance contract (or an 
undivided interest in the contract) that is part of a split-dollar life 
insurance arrangement. Paragraph (h) of this section provides examples 
illustrating the application of this section. Paragraph (j) of this 
section provides the effective date of this section.
    (b) Split-dollar life insurance arrangement--(1) In general. A 
split-dollar life insurance arrangement is any arrangement between an 
owner and a non-owner of a life insurance contract that satisfies the 
following criteria--
    (i) Either party to the arrangement pays, directly or indirectly, 
all or any portion of the premiums on the life insurance contract, 
including a payment by means of a loan to the other party that is 
secured by the life insurance contract;
    (ii) At least one of the parties to the arrangement paying premiums 
under paragraph (b)(1)(i) of this section is entitled to recover (either 
conditionally or unconditionally) all or any portion of those premiums 
and such recovery is

[[Page 82]]

to be made from, or is secured by, the proceeds of the life insurance 
contract; and
    (iii) The arrangement is not part of a group-term life insurance 
plan described in section 79 unless the group-term life insurance plan 
provides permanent benefits to employees (as defined in Sec. 1.79-0).
    (2) Special rule--(i) In general. Any arrangement between an owner 
and a non-owner of a life insurance contract is treated as a split-
dollar life insurance arrangement (regardless of whether the criteria of 
paragraph (b)(1) of this section are satisfied) if the arrangement is 
described in paragraph (b)(2)(ii) or (iii) of this section.
    (ii) Compensatory arrangements. An arrangement is described in this 
paragraph (b)(2)(ii) if the following criteria are satisfied--
    (A) The arrangement is entered into in connection with the 
performance of services and is not part of a group-term life insurance 
plan described in section 79;
    (B) The employer or service recipient pays, directly or indirectly, 
all or any portion of the premiums; and
    (C) Either--
    (1) The beneficiary of all or any portion of the death benefit is 
designated by the employee or service provider or is any person whom the 
employee or service provider would reasonably be expected to designate 
as the beneficiary; or
    (2) The employee or service provider has any interest in the policy 
cash value of the life insurance contract.
    (iii) Shareholder arrangements. An arrangement is described in this 
paragraph (b)(2)(iii) if the following criteria are satisfied--
    (A) The arrangement is entered into between a corporation and 
another person in that person's capacity as a shareholder in the 
corporation;
    (B) The corporation pays, directly or indirectly, all or any portion 
of the premiums; and
    (C) Either--
    (1) The beneficiary of all or any portion of the death benefit is 
designated by the shareholder or is any person whom the shareholder 
would reasonably be expected to designate as the beneficiary; or
    (2) The shareholder has any interest in the policy cash value of the 
life insurance contract.
    (3) Determination of whether this section or Sec. 1.7872-15 applies 
to a split-dollar life insurance arrangement--(i) Split-dollar life 
insurance arrangements involving split-dollar loans under Sec. 1.7872-
15. Except as provided in paragraph (b)(3)(ii) of this section, 
paragraphs (d) through (g) of this section do not apply to any split-
dollar loan as defined in Sec. 1.7872-15(b)(1). Section 1.7872-15 
applies to any such loan. See paragraph (b)(5) of this section for the 
treatment of a payment made by a non-owner under a split-dollar life 
insurance arrangement if the payment is not a split-dollar loan.
    (ii) Exceptions. Paragraphs (d) through (g) of this section apply 
(and Sec. 1.7872-15 does not apply) to any split-dollar life insurance 
arrangement if--
    (A) The arrangement is entered into in connection with the 
performance of services, and the employer or service recipient is the 
owner of the life insurance contract (or is treated as the owner of the 
contract under paragraph (c)(1)(ii)(A)(1) of this section); or
    (B) The arrangement is entered into between a donor and a donee (for 
example, a life insurance trust) and the donor is the owner of the life 
insurance contract (or is treated as the owner of the contract under 
paragraph (c)(1)(ii)(A)(2) of this section).
    (4) Consistency requirement. A split-dollar life insurance 
arrangement described in paragraph (b)(1) or (2) of this section must be 
treated in the same manner by the owner and the non-owner of the life 
insurance contract under either the rules of this section or Sec. 
1.7872-15. In addition, the owner and non-owner must fully account for 
all amounts under the arrangement under paragraph (b)(5) of this 
section, paragraphs (d) through (g) of this section, or Sec. 1.7872-15.
    (5) Non-owner payments that are not split-dollar loans. If a non-
owner of a life insurance contract makes premium payments (directly or 
indirectly) under a split-dollar life insurance arrangement, and the 
payments are neither split-dollar loans nor consideration for economic 
benefits described in paragraph (d) of this section, then neither the 
rules of paragraphs (d) through (g)

[[Page 83]]

of this section nor the rules in Sec. 1.7872-15 apply to such payments. 
Instead, general income tax, employment tax, self-employment tax, and 
gift tax principles apply to the premium payments. See, for example, 
Sec. 1.61-2(d)(2)(ii)(A).
    (6) Waiver, cancellation, or forgiveness. If a repayment obligation 
described in Sec. 1.7872-15(a)(2) is waived, cancelled, or forgiven at 
any time, then the parties must take the amount waived, cancelled, or 
forgiven into account in accordance with the relationships between the 
parties (for example, as compensation in the case of an employee-
employer relationship).
    (7) Change in the owner. If payments made by a non-owner to an owner 
were treated as split-dollar loans under Sec. 1.7872-15 and the split-
dollar life insurance arrangement is modified such that, after the 
modification, the non-owner is the owner (within the meaning of 
paragraph (c)(1) of this section) of the life insurance contract under 
the arrangement, paragraphs (d) through (g) of this section apply to the 
split-dollar life insurance arrangement from the date of the 
modification. The payments made (both before and after the modification) 
are not treated as split-dollar loans under Sec. 1.7872-15 on or after 
the date of the modification. The non-owner of the life insurance 
contract under the modified split-dollar life insurance arrangement must 
fully take into account all economic benefits provided under the 
arrangement under paragraph (d) of this section on or after the date of 
the modification. For the treatment of a transfer of the contract when 
the unmodified arrangement is governed by paragraphs (d) through (g) of 
this section, see paragraph (g) of this section.
    (c) Definitions. The following definitions apply for purposes of 
this section:
    (1) Owner--(i) In general. With respect to a life insurance 
contract, the person named as the policy owner of such contract 
generally is the owner of such contract. If two or more persons are 
named as policy owners of a life insurance contract and each person has, 
at all times, all the incidents of ownership with respect to an 
undivided interest in the contract, each person is treated as the owner 
of a separate contract to the extent of such person's undivided 
interest. If two or more persons are named as policy owners of a life 
insurance contract but each person does not have, at all times, all the 
incidents of ownership with respect to an undivided interest in the 
contract, the person who is the first-named policy owner is treated as 
the owner of the entire contract.
    (ii) Special rule for certain arrangements--(A) In general. 
Notwithstanding paragraph (c)(1)(i) of this section--
    (1) An employer or service recipient is treated as the owner of a 
life insurance contract under a split-dollar life insurance arrangement 
that is entered into in connection with the performance of services if, 
at all times, the only economic benefit that will be provided under the 
arrangement is current life insurance protection as described in 
paragraph (d)(3) of this section; and
    (2) A donor is treated as the owner of a life insurance contract 
under a split-dollar life insurance arrangement that is entered into 
between a donor and a donee (for example, a life insurance trust) if, at 
all times, the only economic benefit that will be provided under the 
arrangement is current life insurance protection as described in 
paragraph (d)(3) of this section.
    (B) Modifications. If an arrangement described in paragraph 
(c)(1)(ii)(A) of this section is modified such that the arrangement is 
no longer described in paragraph (c)(1)(ii)(A) of this section, the 
following rules apply:
    (1) If, immediately after such modification, the employer, service 
recipient, or donor is the owner of the life insurance contract under 
the split-dollar life insurance arrangement (determined without regard 
to paragraph (c)(1)(ii)(A) of this section), the employer, service 
recipient, or donor continues to be treated as the owner of the life 
insurance contract.
    (2) If, immediately after such modification, the employer, service 
recipient, or donor is not the owner of the life insurance contract 
under the split-dollar life insurance arrangement (determined without 
regard to paragraph (c)(1)(ii)(A) of this section), the employer, 
service recipient, or donor is treated as having made a transfer of the 
entire life insurance contract to the employee, service provider, or

[[Page 84]]

donee under the rules of paragraph (g) of this section as of the date of 
such modification.
    (3) For purposes of this paragraph (c)(1)(ii)(B), entering into a 
successor split-dollar life insurance arrangement that has the effect of 
providing any economic benefit in addition to that described in 
paragraph (d)(3) of this section is treated as a modification of the 
prior split-dollar life insurance arrangement.

    (iii) Attribution rules for compensatory arrangements. For purposes 
of this section, if a split-dollar life insurance arrangement is entered 
into in connection with the performance of services, the employer or 
service recipient is treated as the owner of the life insurance contract 
if the owner (within the meaning of paragraph (c)(1)(i) of this section) 
of the life insurance contract under the split-dollar life insurance 
arrangement is--
    (A) A trust described in section 402(b);
    (B) A trust that is treated as owned (within the meaning of sections 
671 through 677) by the employer or the service recipient;
    (C) A welfare benefit fund within the meaning of section 419(e)(1); 
or
    (D) A member of the employer or service recipient's controlled group 
(within the meaning of section 414(b)) or a trade or business that is 
under common control with the employer or service recipient (within the 
meaning of section 414(c)).
    (iv) Life insurance contracts owned by partnerships. [Reserved]
    (2) Non-owner--(i) Definition. With respect to a life insurance 
contract, a non-owner is any person (other than the owner of such 
contract under paragraph (c)(1) of this section) that has any direct or 
indirect interest in such contract (but not including a life insurance 
company acting only in its capacity as the issuer of a life insurance 
contract).
    (ii) Example. The following example illustrates the provisions of 
this paragraph (c)(2):

    Example. (i) On January 1, 2009, Employer R and Trust T, an 
irrevocable life insurance trust that is not treated under sections 671 
through 677 as owned by a grantor or other person, enter into a split-
dollar life insurance arrangement in connection with the performance of 
services under which R will pay all the premiums on the life insurance 
contract until the termination of the arrangement or the death of E, an 
employee of R. C, the beneficiary of T, is E's child. R is the owner of 
the contract under paragraph (c)(1)(i) of this section. E is the insured 
under the life insurance contract. Upon termination of the arrangement 
or E's death, R is entitled to receive the lesser of the aggregate 
premiums or the policy cash value of the contract and T will be entitled 
to receive any remaining amounts. Under the terms of the arrangement and 
applicable state law, the policy cash value is fully accessible by R and 
R's creditors but T has the right to borrow or withdraw at any time the 
portion of the policy cash value exceeding the amount payable to R.
    (ii) Because E and T each have an indirect interest in the life 
insurance contract that is part of the split-dollar life insurance 
arrangement, each is a non-owner under paragraph (c)(2)(i) of this 
section. E and T each are provided economic benefits described in 
paragraph (d)(2) of this section pursuant to the split-dollar life 
insurance arrangement. Economic benefits are provided by owner R to E as 
a payment of compensation, and separately provided by E to T as a gift.

    (3) Transfer of entire contract or undivided interest therein. A 
transfer of the ownership of a life insurance contract (or an undivided 
interest in such contract) that is part of a split-dollar life insurance 
arrangement occurs on the date that a non-owner becomes the owner 
(within the meaning of paragraph (c)(1) of this section) of the entire 
contract or of an undivided interest in the contract.
    (4) Undivided interest. An undivided interest in a life insurance 
contract consists of an identical fractional or percentage interest or 
share in each right, benefit, and obligation with respect to the 
contract. In the case of any arrangement purporting to create undivided 
interests where, in substance, the rights, benefits or obligations are 
shared to any extent among the holders of such interests, the 
arrangement will be treated as a split-dollar life insurance 
arrangement.
    (5) Employment tax. The term employment tax means any tax imposed 
by, or collected under, the Federal Insurance Contributions Act (FICA), 
the Federal Unemployment Tax Act (FUTA), the Railroad Retirement Tax Act 
(RRTA),

[[Page 85]]

and the Collection of Income Tax at Source on Wages.
    (6) Self-employment tax. The term self-employment tax means the tax 
imposed by the Self-Employment Contributions Act of 1954 (SECA).
    (d) Economic benefits provided under a split-dollar life insurance 
arrangement--(1) In general. In the case of a split-dollar life 
insurance arrangement subject to the rules of paragraphs (d) through (g) 
of this section, economic benefits are treated as being provided to the 
non-owner of the life insurance contract. The non-owner (and the owner 
for gift and employment tax purposes) must take into account the full 
value of all economic benefits described in paragraph (d)(2) of this 
section, reduced by the consideration paid directly or indirectly by the 
non-owner to the owner for those economic benefits. Depending on the 
relationship between the owner and the non-owner, the economic benefits 
may constitute a payment of compensation, a distribution under section 
301, a contribution to capital, a gift, or a transfer having a different 
tax character. Further, depending on the relationship between or among a 
non-owner and one or more other persons (including a non-owner or non-
owners), the economic benefits may be treated as provided from the owner 
to the non-owner and as separately provided from the non-owner to such 
other person or persons (for example, as a payment of compensation from 
an employer to an employee and as a gift from the employee to the 
employee's child).
    (2) Value of economic benefits. The value of the economic benefits 
provided to a non-owner for a taxable year under the arrangement 
equals--
    (i) The cost of current life insurance protection provided to the 
non-owner as determined under paragraph (d)(3) of this section;
    (ii) The amount of policy cash value to which the non-owner has 
current access within the meaning of paragraph (d)(4)(ii) of this 
section (to the extent that such amount was not actually taken into 
account for a prior taxable year); and
    (iii) The value of any economic benefits not described in paragraph 
(d)(2)(i) or (ii) of this section provided to the non-owner (to the 
extent not actually taken into account for a prior taxable year).
    (3) Current life insurance protection--(i) Amount of current life 
insurance protection. In the case of a split-dollar life insurance 
arrangement described in paragraph (d)(1) of this section, the amount of 
the current life insurance protection provided to the non-owner for a 
taxable year (or any portion thereof in the case of the first year or 
the last year of the arrangement) equals the excess of the death benefit 
of the life insurance contract (including paid-up additions thereto) 
over the total amount payable to the owner (including any outstanding 
policy loans that offset amounts otherwise payable to the owner) under 
the split-dollar life insurance arrangement, less the portion of the 
policy cash value actually taken into account under paragraph (d)(1) of 
this section or paid for by the non-owner under paragraph (d)(1) of this 
section for the current taxable year or any prior taxable year.
    (ii) Cost of current life insurance protection. The cost of current 
life insurance protection provided to the non-owner for any year (or any 
portion thereof in the case of the first year or the last year of the 
arrangement) equals the amount of the current life insurance protection 
provided to the non-owner (determined under paragraph (d)(3)(i) of this 
section) multiplied by the life insurance premium factor designated or 
permitted in guidance published in the Internal Revenue Bulletin (see 
Sec. 601.601(d)(2)(ii) of this chapter).
    (4) Policy cash value--(i) In general. For purposes of this 
paragraph (d), policy cash value is determined disregarding surrender 
charges or other similar charges or reductions. Policy cash value 
includes policy cash value attributable to paid-up additions.
    (ii) Current access. For purposes of this paragraph (d), a non-owner 
has current access to that portion of the policy cash value--
    (A) To which, under the arrangement, the non-owner has a current or 
future right; and

[[Page 86]]

    (B) That currently is directly or indirectly accessible by the non-
owner, inaccessible to the owner, or inaccessible to the owner's general 
creditors.
    (5) Valuation date--(i) General rules. For purposes of this 
paragraph (d), the amount of the current life insurance protection and 
the policy cash value shall be determined on the same valuation date. 
The valuation date is the last day of the non-owner's taxable year, 
unless the owner and non-owner agree to instead use the policy 
anniversary date as the valuation date. Notwithstanding the previous 
sentence, if the split-dollar life insurance arrangement terminates 
during the taxable year of the non-owner, the value of such economic 
benefits is determined on the day that the arrangement terminates.
    (ii) Consistency requirement. The owner and non-owner of the split-
dollar life insurance arrangement must use the same valuation date. In 
addition, the same valuation date must be used for all years prior to 
termination of the split-dollar life insurance arrangement unless the 
parties receive consent of the Commissioner to change the valuation 
date.
    (iii) Artifice or device. Notwithstanding paragraph (d)(5)(i) of 
this section, if any artifice or device is used to understate the amount 
of any economic benefit on the valuation date in paragraph (d)(5)(i) of 
this section, then, for purposes of this paragraph (d), the date on 
which the amount of the economic benefit is determined is the date on 
which the amount of the economic benefit is greatest during that taxable 
year.
    (iv) Special rule for certain taxes. For purposes of employment tax 
(as defined in paragraph (c)(5) of this section), self-employment tax 
(as defined in paragraph (c)(6) of this section), and sections 6654 and 
6655 (relating to the failure to pay estimated income tax), the portions 
of the current life insurance protection and the policy cash value that 
are treated as provided by the owner to the non-owner shall be treated 
as so provided on the last day of the taxable year of the non-owner. 
Notwithstanding the previous sentence, if the split-dollar life 
insurance arrangement terminates during the taxable year of the non-
owner, such portions of the current life insurance protection and the 
policy cash value shall be treated as so provided on the day that the 
arrangement terminates.
    (6) Examples. The following examples illustrate the rules of this 
paragraph (d). Except as otherwise provided, both examples assume the 
following facts: employer (R) is the owner (as defined in paragraph 
(c)(1)(i) of this section) and employee (E) is the non-owner (as defined 
in paragraph (c)(2)(i) of this section) of a life insurance contract 
that is part of a split-dollar life insurance arrangement that is 
subject to the provisions of paragraphs (d) through (g) of this section; 
the contract is a life insurance contract as defined in section 7702 and 
not a modified endowment contract as defined in section 7702A; R does 
not withdraw or obtain a loan of any portion of the policy cash value 
and does not surrender any portion of the life insurance contract; the 
compensation paid to E is reasonable; E is not provided any economic 
benefits described in paragraph (d)(2)(iii) of this section; E does not 
make any premium payments; E's taxable year is the calendar year; the 
value of the economic benefits is determined on the last day of E's 
taxable year; and E reports on E's Federal income tax return for each 
year that the split-dollar life insurance arrangement is in effect the 
amount of income required to be reported under paragraph (d) of this 
section. The examples are as follows:

    Example 1. (i) Facts. On January 1 of year 1, R and E enter into the 
split-dollar life insurance arrangement. Under the arrangement, R pays 
all of the premiums on the life insurance contract until the termination 
of the arrangement or E's death. The arrangement provides that upon 
termination of the arrangement or E's death, R is entitled to receive 
the lesser of the aggregate premiums paid or the policy cash value of 
the contract and E is entitled to receive any remaining amounts. Under 
the terms of the arrangement and applicable state law, the policy cash 
value is fully accessible by R and R's creditors but E has the right to 
borrow or withdraw at any time the portion of the policy cash value 
exceeding the amount payable to R. To fund the arrangement, R purchases 
a life insurance contract with constant death benefit protection equal 
to $1,500,000. R

[[Page 87]]

makes premium payments on the life insurance contract of $60,000 in each 
of years 1, 2, and 3. The policy cash value equals $55,000 as of 
December 31 of year 1, $140,000 as of December 31 of year 2, and 
$240,000 as of December 31 of year 3.
    (ii) Analysis. Under the terms of the split-dollar life insurance 
arrangement, E has the right for year 1 and all subsequent years to 
borrow or withdraw the portion of the policy cash value exceeding the 
amount payable to R. Thus, under paragraph (d)(4)(ii) of this section, E 
has current access to such portion of the policy cash value for each 
year that the arrangement is in effect. In addition, because R pays all 
of the premiums on the life insurance contract, R provides to E all of 
the economic benefits that E receives under the arrangement. Therefore, 
under paragraph (d)(1) of this section, E includes in gross income the 
value of all economic benefits described in paragraphs (d)(2)(i) and 
(ii) of this section provided to E under the arrangement.
    (iii) Results for year 1. For year 1, E is provided, under paragraph 
(d)(2)(ii) of this section, $0 of policy cash value (excess of $55,000 
policy cash value determined as of December 31 of year 1 over $55,000 
payable to R). For year 1, E is also provided, under paragraph (d)(2)(i) 
of this section, current life insurance protection of $1,445,000 
($1,500,000 minus $55,000 payable to R). Thus, E includes in gross 
income for year 1 the cost of $1,445,000 of current life insurance 
protection.
    (iv) Results for year 2. For year 2, E is provided, under paragraph 
(d)(2)(ii) of this section, $20,000 of policy cash value ($140,000 
policy cash value determined as of December 31 of year 2 minus $120,000 
payable to R). For year 2, E is also provided, under paragraph (d)(2)(i) 
of this section, current life insurance protection of $1,360,000 
($1,500,000 minus the sum of $120,000 payable to R and the aggregate of 
$20,000 of policy cash value that E actually includes in income on E's 
year 1 and year 2 federal income tax returns). Thus, E includes in gross 
income for year 2 the sum of $20,000 of policy cash value and the cost 
of $1,360,000 of current life insurance protection.
    (v) Results for year 3. For year 3, E is provided, under paragraph 
(d)(2)(ii) of this section, $40,000 of policy cash value ($240,000 
policy cash value determined as of December 31 of year 3 minus the sum 
of $180,000 payable to R and $20,000 of aggregate policy cash value that 
E actually included in gross income on E's year 1 and year 2 federal 
income tax returns). For year 3, E is also provided, under paragraph 
(d)(2)(i) of this section, current life insurance protection of 
$1,260,000 ($1,500,000 minus the sum of $180,000 payable to R and 
$60,000 of aggregate policy cash value that E actually includes in gross 
income on E's year 1, year 2, and year 3 federal income tax returns). 
Thus, E includes in gross income for year 3 the sum of $40,000 of policy 
cash value and the cost of $1,260,000 of current life insurance 
protection.
    Example 2. (i) Facts. The facts are the same as in Example 1 except 
that E cannot directly or indirectly access any portion of the policy 
cash value, but the terms of the split-dollar life insurance arrangement 
or applicable state law provide that the policy cash value in excess of 
the amount payable to R is inaccessible to R's general creditors.
    (ii) Analysis. Under the terms of the split-dollar life insurance 
arrangement or applicable state law, the portion of the policy cash 
value exceeding the amount payable to R is inaccessible to R's general 
creditors and E has a current or future right to that portion of the 
cash value. Thus, under paragraph (d)(4)(ii) of this section, E has 
current access to such portion of the policy cash value for each year 
that the arrangement is in effect. In addition, because R pays all of 
the premiums on the life insurance contract, R provides to E all of the 
economic benefits that E receives under the arrangement. Therefore, 
under paragraph (d)(1) of this section, E includes in gross income the 
value of all economic benefits described in paragraphs (d)(2)(i) and 
(ii) of this section provided to E under the arrangement.
    (iii) Results for years 1, 2 and 3. The results for this example are 
the same as the results in Example 1.

    (e) Amounts received under the contract--(1) In general. Except as 
otherwise provided in paragraph (f)(3) of this section, any amount 
received under a life insurance contract that is part of a split-dollar 
life insurance arrangement subject to the rules of paragraphs (d) 
through (g) of this section (including, but not limited to, a policy 
owner dividend, proceeds of a specified policy loan described in 
paragraph (e)(2) of this section, or the proceeds of a withdrawal from 
or partial surrender of the life insurance contract) is treated, to the 
extent provided directly or indirectly to a non-owner of the life 
insurance contract, as though such amount had been paid to the owner of 
the life insurance contract and then paid by the owner to the non-owner. 
The amount received is taxable to the owner in accordance with the rules 
of section 72. The non-owner (and the owner for gift tax and employment 
tax purposes) must take the amount described in paragraph (e)(3) of this 
section into account as a payment of compensation, a distribution under 
section 301, a contribution to capital, a gift, or

[[Page 88]]

other transfer depending on the relationship between the owner and the 
non-owner.
    (2) Specified policy loan. A policy loan is a specified policy loan 
to the extent--
    (i) The proceeds of the loan are distributed directly from the 
insurance company to the non-owner;
    (ii) A reasonable person would not expect that the loan will be 
repaid by the non-owner; or
    (iii) The non-owner's obligation to repay the loan to the owner is 
satisfied or is capable of being satisfied upon repayment by either 
party to the insurance company.
    (3) Amount required to be taken into account. With respect to a non-
owner (and the owner for gift tax and employment tax purposes), the 
amount described in this paragraph (e)(3) is equal to the excess of--
    (i) The amount treated as received by the owner under paragraph 
(e)(1) of this section; over
    (ii) The amount of all economic benefits described in paragraphs 
(d)(2)(ii) and (iii) of this section actually taken into account by the 
non-owner (and the owner for gift tax and employment tax purposes) plus 
any consideration described in paragraph (d)(1) of this section paid by 
the non-owner for such economic benefits described in paragraphs 
(d)(2)(ii) and (iii) of this section. The amount determined under the 
preceding sentence applies only to the extent that neither this 
paragraph (e)(3)(ii) nor paragraph (g)(1)(ii) of this section previously 
has applied to such economic benefits.
    (f) Other tax consequences--(1) Introduction. In the case of a 
split-dollar life insurance arrangement subject to the rules of 
paragraphs (d) through (g) of this section, this paragraph (f) sets 
forth other tax consequences to the owner and non-owner of a life 
insurance contract that is part of the arrangement for the period prior 
to the transfer (as defined in paragraph (c)(3) of this section) of the 
contract (or an undivided interest therein) from the owner to the non-
owner. See paragraph (g) of this section and Sec. 1.83-6(a)(5) for tax 
consequences upon the transfer of the contract (or an undivided interest 
therein).
    (2) Investment in the contract--(i) To the non-owner. A non-owner 
does not receive any investment in the contract under section 72(e)(6) 
with respect to a life insurance contract that is part of a split-dollar 
life insurance arrangement subject to the rules of paragraphs (d) 
through (g) of this section.
    (ii) To owner. Any premium paid by an owner under a split-dollar 
life insurance arrangement subject to the rules of paragraphs (d) 
through (g) of this section is included in the owner's investment in the 
contract under section 72(e)(6). No premium or amount described in 
paragraph (d) of this section is deductible by the owner (except as 
otherwise provided in Sec. 1.83-6(a)(5)). Any amount paid by a non-
owner, directly or indirectly, to the owner of the life insurance 
contract for current life insurance protection or for any other economic 
benefit under the life insurance contract is included in the owner's 
gross income and is included in the owner's investment in the life 
insurance contract for purposes of section 72(e)(6) (but only to the 
extent not otherwise so included by reason of having been paid by the 
owner as a premium or other consideration for the contract).
    (3) Treatment of death benefit proceeds--(i) Death benefit proceeds 
to beneficiary (other than the owner). Any amount paid to a beneficiary 
(other than the owner) by reason of the death of the insured is excluded 
from gross income by such beneficiary under section 101(a) as an amount 
received under a life insurance contract to the extent such amount is 
allocable to current life insurance protection provided to the non-owner 
pursuant to the split-dollar life insurance arrangement, the cost of 
which was paid by the non-owner, or the value of which the non-owner 
actually took into account pursuant to paragraph (d)(1) of this section.
    (ii) Death benefit proceeds to owner as beneficiary. Any amount paid 
or payable to an owner in its capacity as a beneficiary by reason of the 
death of the insured is excluded from gross income of the owner under 
section 101(a) as an amount received under a life insurance contract to 
the extent such amount is not allocable to current life insurance 
protection provided to the

[[Page 89]]

non-owner pursuant to the split-dollar life insurance arrangement, the 
cost of which was paid by the non-owner, or the value of which the non-
owner actually took into account pursuant to paragraph (d)(1) of this 
section.
    (iii) Transfers of death benefit proceeds. Death benefit proceeds 
paid to a party to a split-dollar life insurance arrangement (or the 
estate or beneficiary of that party) that are not excludable from that 
party's income under section 101(a) to the extent provided in paragraph 
(f)(3)(i) or (ii) of this section, are treated as transferred to that 
party in a separate transaction. The death benefit proceeds treated as 
so transferred will be taxed in a manner similar to other transfers. For 
example, if death benefit proceeds paid to an employee, the employee's 
estate, or the employee's beneficiary are not excludable from the 
employee's gross income under section 101(a) to the extent provided in 
paragraph (f)(3)(i) of this section, then such payment is treated as a 
payment of compensation by the employer to the employee.
    (g) Transfer of entire contract or undivided interest therein--(1) 
In general. Upon a transfer within the meaning of paragraph (c)(3) of 
this section of a life insurance contract (or an undivided interest 
therein) to a non-owner (transferee), the transferee (and the owner 
(transferor) for gift tax and employment tax purposes) takes into 
account the excess of the fair market value of the life insurance 
contract (or the undivided interest therein) transferred to the 
transferee at that time over the sum of--
    (i) The amount the transferee pays to the transferor to obtain the 
contract (or the undivided interest therein); and
    (ii) The amount of all economic benefits described in paragraph 
(d)(2)(ii) and (iii) of this section actually taken into account by the 
transferee (and the transferor for gift tax and employment tax 
purposes), plus any consideration described in paragraph (d)(1) of this 
section paid by the transferee for such economic benefits described in 
paragraphs (d)(2)(ii) and (iii) of this section. The amount determined 
under the preceding sentence applies only to the extent that neither 
this paragraph (g)(1)(ii) nor paragraph (e)(3)(ii) of this section 
previously has applied to such economic benefits.
    (2) Determination of fair market value. For purposes of paragraph 
(g)(1) of this section, the fair market value of a life insurance 
contract is the policy cash value and the value of all other rights 
under such contract (including any supplemental agreements thereto and 
whether or not guaranteed), other than the value of current life 
insurance protection. Notwithstanding the preceding sentence, the fair 
market value of a life insurance contract for gift tax purposes is 
determined under Sec. 25.2512-6(a) of this chapter.
    (3) Exception for certain transfers in connection with the 
performance of services. To the extent the ownership of a life insurance 
contract (or undivided interest in such contract) is transferred in 
connection with the performance of services, paragraph (g)(1) of this 
section does not apply until such contract (or undivided interest in 
such contract) is taxable under section 83. For purposes of paragraph 
(g)(1) of this section, fair market value is determined disregarding any 
lapse restrictions and at the time the transfer of such contract (or 
undivided interest in such contract) is taxable under section 83.
    (4) Treatment of non-owner after transfer--(i) In general. After a 
transfer of an entire life insurance contract (except when such transfer 
is in connection with the performance of services and the transfer is 
not yet taxable under section 83), the person who previously had been 
the non-owner is treated as the owner of such contract for all purposes, 
including for purposes of paragraph (b) of this section and for purposes 
of Sec. 1.61-2(d)(2)(ii)(A). After the transfer of an undivided 
interest in a life insurance contract (or, if later, at the time such 
transfer is taxable under section 83), the person who previously had 
been the non-owner is treated as the owner of a separate contract 
consisting of that interest for all purposes, including for purposes of 
paragraph (b) of this section and for purposes of Sec. 1.61-
2(d)(2)(ii)(A).
    (ii) Investment in the contract after transfer--(A) In general. The 
amount treated as consideration paid to acquire the contract under 
section

[[Page 90]]

72(g)(1), in order to determine the aggregate premiums paid by the 
transferee for purposes of section 72(e)(6)(A) after the transfer (or, 
if later, at the time such transfer is taxable under section 83), equals 
the greater of the fair market value of the contract or the sum of the 
amounts determined under paragraphs (g)(1)(i) and (ii) of this section.
    (B) Transfers between a donor and a donee. In the case of a transfer 
of a contract between a donor and a donee, the amount treated as 
consideration paid by the transferee to acquire the contract under 
section 72(g)(1), in order to determine the aggregate premiums paid by 
the transferee for purposes of section 72(e)(6)(A) after the transfer, 
equals the sum of the amounts determined under paragraphs (g)(1)(i) and 
(ii) of this section except that--
    (1) The amount determined under paragraph (g)(1)(i) of this section 
includes the aggregate of premiums or other consideration paid or deemed 
to have been paid by the transferor; and
    (2) The amount of all economic benefits determined under paragraph 
(g)(1)(ii) of this section actually taken into account by the transferee 
does not include such benefits to the extent such benefits were 
excludable from the transferee's gross income at the time of receipt.
    (C) Transfers of an undivided interest in a contract. If a portion 
of a contract is transferred to the transferee, then the amount to be 
included as consideration paid to acquire the contract is determined by 
multiplying the amount determined under paragraph (g)(4)(ii)(A) of this 
section (as modified by paragraph (g)(4)(ii)(B) of this section, if the 
transfer is between a donor and a donee) by a fraction, the numerator of 
which is the fair market value of the portion transferred and the 
denominator of which is the fair market value of the entire contract.
    (D) Example. The following example illustrates the rules of this 
paragraph (g)(4)(ii):

    Example. (i) In year 1, donor D and donee E enter into a split-
dollar life insurance arrangement as defined in paragraph (b)(1) of this 
section. D is the owner of the life insurance contract under paragraph 
(c)(1) of this section. The life insurance contract is not a modified 
endowment contract as defined in section 7702A. In year 5, D 
gratuitously transfers the contract, within the meaning of paragraph 
(c)(3) of this section, to E. At the time of the transfer, the fair 
market value of the contract is $200,000 and D had paid $50,000 in 
premiums under the arrangement. In addition, by the time of the 
transfer, E had current access to $80,000 of policy cash value which was 
excludable from E's gross income under section 102.
    (ii) E's investment in the contract is $50,000, consisting of the 
$50,000 of premiums paid by D. The $80,000 of policy cash value to which 
E had current access is not included in E's investment in the contract 
because such amount was excludable from E's gross income when E had 
current access to that policy cash value.

    (iii) No investment in the contract for current life insurance 
protection. Except as provided in paragraph (g)(4)(ii)(B) of this 
section, no amount allocable to current life insurance protection 
provided to the transferee (the cost of which was paid by the transferee 
or the value of which was provided to the transferee) is treated as 
consideration paid to acquire the contract under section 72(g)(1) to 
determine the aggregate premiums paid by the transferee for purposes of 
determining the transferee's investment in the contract under section 
72(e) after the transfer.
    (h) Examples. The following examples illustrate the rules of this 
section. Except as otherwise provided, each of the examples assumes that 
the employer (R) is the owner (as defined in paragraph (c)(1) of this 
section) of a life insurance contract that is part of a split-dollar 
life insurance arrangement subject to the rules of paragraphs (d) 
through (g) of this section, that the employee (E) is not provided any 
economic benefits described in paragraph (d)(2)(iii) of this section, 
that the life insurance contract is not a modified endowment contract 
under section 7702A, that the compensation paid to E is reasonable, and 
that E makes no premium payments. The examples are as follows:

    Example 1. (i) In year 1, R purchases a life insurance contract on 
the life of E. R is named as the policy owner of the contract. R and E 
enter into an arrangement under which R will pay all the premiums on the 
life insurance contract until the termination of the arrangement or E's 
death. Upon termination of the arrangement or E's death, R is

[[Page 91]]

entitled to receive the greater of the aggregate premiums or the policy 
cash value of the contract. The balance of the death benefit will be 
paid to a beneficiary designated by E.
    (ii) Because R is designated as the policy owner of the contract, R 
is the owner of the contract under paragraph (c)(1)(i) of this section. 
In addition, R would be treated as the owner of the contract regardless 
of whether R were designated as the policy owner under paragraph 
(c)(1)(i) of this section because the split-dollar life insurance 
arrangement is described in paragraph (c)(1)(ii)(A)(1) of this section. 
E is a non-owner of the contract. Under the arrangement between R and E, 
a portion of the death benefit is payable to a beneficiary designated by 
E. The arrangement is a split-dollar life insurance arrangement under 
paragraph (b)(1) or (2) of this section. Because R pays all the premiums 
on the life insurance contract, R provides to E the entire amount of the 
current life insurance protection E receives under the arrangement. 
Therefore, for each year that the split-dollar life insurance 
arrangement is in effect, E must include in gross income under paragraph 
(d)(1) of this section the value of current life insurance protection 
described in paragraph (d)(2)(i) of this section provided to E in each 
year.
    Example 2. (i) The facts are the same as in Example 1 except that, 
upon termination of the arrangement or E's death, R is entitled to 
receive the lesser of the aggregate premiums or the policy cash value of 
the contract. Under the terms of the arrangement and applicable state 
law, the policy cash value is fully accessible by R and R's creditors 
but E has the right to borrow or withdraw at any time the portion of the 
policy cash value exceeding the amount payable to R.
    (ii) Because R is designated as the policy owner, R is the owner of 
the contract under paragraph (c)(1)(i) of this section. E is a non-owner 
of the contract. For each year that the split-dollar life insurance 
arrangement is in effect, E has the right to borrow or withdraw at any 
time the portion of the policy cash value exceeding the amount payable 
to R. Thus, under paragraph (d)(4)(ii) of this section, E has current 
access to such portion of the policy cash value for each year that the 
arrangement is in effect. In addition, because R pays all the premiums 
on the life insurance contract, R provides to E all the economic 
benefits that E receives under the arrangement. Therefore, for each year 
that the split-dollar life insurance arrangement is in effect, E must 
include in gross income under paragraph (d)(1) of this section, the 
value of all economic benefits described in paragraph (d)(2)(i) and (ii) 
of this section provided to E in each year.
    Example 3. (i) The facts are the same as in Example 1 except that in 
year 5, R and E modify the split-dollar life insurance arrangement to 
provide that, upon termination of the arrangement or E's death, R is 
entitled to receive the greater of the aggregate premiums or one-half 
the policy cash value of the contract. Under the terms of the modified 
arrangement and applicable state law, the policy cash value is fully 
accessible by R and R's creditors but E has the right to borrow or 
withdraw at any time the portion of the policy cash value exceeding the 
amount payable to R.
    (ii) For each year that the split-dollar life insurance arrangement 
is in effect, E must include in gross income under paragraph (d)(1) of 
this section the value of the economic benefits described in paragraph 
(d)(2)(i) of this section provided to E under the arrangement during 
that year. In year 5 (and subsequent years), E has the right to borrow 
or withdraw at any time the portion of the policy cash value exceeding 
the amount payable to R. Thus, under paragraph (d)(4)(ii) of this 
section, E has current access to such portion of the policy cash value. 
Thus, in year 5 (and each subsequent year), E must also include in gross 
income under paragraph (d)(1) of this section the value of the economic 
benefits described in paragraph (d)(2)(ii) of this section provided to E 
in each year.
    (iii) The arrangement is not described in paragraph (c)(1)(ii)(A)(1) 
of this section after it is modified in year 5. Because R is the 
designated owner of the life insurance contract, R continues to be 
treated as the owner of the contract under paragraph (c)(1)(ii)(B)(1) of 
this section after the arrangement is modified. In addition, because the 
modification made by R and E in year 5 does not involve the transfer 
(within the meaning of paragraph (c)(3) of this section) of an undivided 
interest in the life insurance contract from R to E, the modification is 
not a transfer for purposes of paragraph (g) of this section.
    Example 4. (i) The facts are the same as in Example 2 except that in 
year 7, R and E modify the split-dollar life insurance arrangement to 
provide that, upon termination of the arrangement or E's death, R will 
be paid the lesser of 80 percent of the aggregate premiums or the policy 
cash value of the contract. Under the terms of the modified arrangement 
and applicable state law, the policy cash value is fully accessible by R 
and R's creditors but E has the right to borrow or withdraw at any time 
the portion of the policy cash value exceeding the lesser of 80 percent 
of the aggregate premiums paid by R or the policy cash value of the 
contract.
    (ii) Commencing in year 7 (and in each subsequent year), E must 
include in gross income the economic benefits described in paragraph 
(d)(2)(ii) of this section as provided in this Example 4(ii) rather than 
as provided in Example 2(ii). Thus, in year 7 (and in each subsequent 
year) E must include in

[[Page 92]]

gross income under paragraph (d) of this section, the excess of the 
policy cash value over the lesser of 80 percent of the aggregate 
premiums paid by R or the policy cash value of the contract (to the 
extent E did not actually include such amounts in gross income for a 
prior taxable year). In addition, in year 7 (and each subsequent year) E 
must also include in gross income the value of the economic benefits 
described in paragraph (d)(2)(i) of this section provided to E under the 
arrangement in each such year.
    Example 5. (i) The facts are the same as in Example 3 except that in 
year 7, E is designated as the policy owner. At that time, E's rights to 
the contract are substantially vested as defined in Sec. 1.83-3(b).
    (ii) In year 7, R is treated as having made a transfer (within the 
meaning of paragraph (c)(3) of this section) of the life insurance 
contract to E. E must include in gross income the amount determined 
under paragraph (g)(1) of this section.
    (iii) After the transfer of the contract to E, E is the owner of the 
contract and any premium payments by R will be included in E's income 
under paragraph (b)(5) of this section and Sec. 1.61-2(d)(2)(ii)(A) 
(unless R's payments are split-dollar loans as defined in Sec. 1.7872-
15(b)(1)).
    Example 6. (i) In year 1, E and R enter into a split-dollar life 
insurance arrangement as defined in paragraph (b)(2) of this section. 
Under the arrangement, R is required to make annual premium payments of 
$10,000 and E is required to make annual premium payments of $500. In 
year 5, a $500 policy owner dividend payable to E is declared by the 
insurance company. E directs the insurance company to use the $500 as 
E's premium payment for year 5.
    (ii) For each year the arrangement is in effect, E must include in 
gross income the value of the economic benefits provided during the 
year, as required by paragraph (d)(2) of this section, over the $500 
premium payments paid by E. In year 5, E must also include in gross 
income as compensation the excess, if any, of the $500 distributed to E 
from the proceeds of the policy owner dividend over the amount 
determined under paragraph (e)(3)(ii) of this section.
    (iii) R must include in income the premiums paid by E during the 
years the split-dollar life insurance arrangement is in effect, 
including the $500 of the premium E paid in year 5 with proceeds of the 
policy owner dividend. R's investment in the contract is increased in an 
amount equal to the premiums paid by E, including the $500 of the 
premium paid by E in year 5 from the proceeds of the policy owner 
dividend. In year 5, R is treated as receiving a $500 distribution under 
the contract, which is taxed pursuant to section 72.
    Example 7. (i) The facts are the same as in Example 2 except that in 
year 10, E withdraws $100,000 from the cash value of the contract.
    (ii) In year 10, R is treated as receiving a $100,000 distribution 
from the insurance company. This amount is treated as an amount received 
by R under the contract and taxed pursuant to section 72. This amount 
reduces R's investment in the contract under section 72(e). R is treated 
as paying the $100,000 to E as cash compensation, and E must include 
that amount in gross income less any amounts determined under paragraph 
(e)(3)(ii) of this section.
    Example 8. (i) The facts are the same as in Example 7 except E 
receives the proceeds of a $100,000 specified policy loan directly from 
the insurance company.
    (ii) The transfer of the proceeds of the specified policy loan to E 
is treated as a loan by the insurance company to R. Under the rules of 
section 72(e), the $100,000 loan is not included in R's income and does 
not reduce R's investment in the contract. R is treated as paying the 
$100,000 of loan proceeds to E as cash compensation. E must include that 
amount in gross income less any amounts determined under paragraph 
(e)(3)(ii) of this section.

    (i) [Reserved]
    (j) Effective date--(1) General rule--(i) In general. This section 
applies to any split-dollar life insurance arrangement (as defined in 
paragraph (b)(1) or (2) of this section) entered into after September 
17, 2003.
    (ii) Determination of when an arrangement is entered into. For 
purposes of paragraph (j) of this section, a split-dollar life insurance 
arrangement is entered into on the latest of the following dates:
    (A) The date on which the life insurance contract under the 
arrangement is issued;
    (B) The effective date of the life insurance contract under the 
arrangement;
    (C) The date on which the first premium on the life insurance 
contract under the arrangement is paid;
    (D) The date on which the parties to the arrangement enter into an 
agreement with regard to the policy; or
    (E) The date on which the arrangement satisfies the definition of a 
split-dollar life insurance arrangement (as defined in paragraph (b)(1) 
or (2) of this section).
    (2) Modified arrangements treated as new arrangements--(i) In 
general. For

[[Page 93]]

purposes of paragraph (j)(1) of this section, if an arrangement entered 
into on or before September 17, 2003 is materially modified after 
September 17, 2003, the arrangement is treated as a new arrangement 
entered into on the date of the modification.
    (ii) Non-material modifications. The following is a non-exclusive 
list of changes that are not material modifications under paragraph 
(j)(2)(i) of this section (either alone or in conjunction with other 
changes listed in paragraphs (j)(2)(ii)(A) through (I) of this 
section)--
    (A) A change solely in the mode of premium payment (for example, a 
change from monthly to quarterly premiums);
    (B) A change solely in the beneficiary of the life insurance 
contract, unless the beneficiary is a party to the arrangement;
    (C) A change solely in the interest rate payable under the life 
insurance contract on a policy loan;
    (D) A change solely necessary to preserve the status of the life 
insurance contract under section 7702;
    (E) A change solely to the ministerial provisions of the life 
insurance contract (for example, a change in the address to send 
payment);
    (F) A change made solely under the terms of any agreement (other 
than the life insurance contract) that is a part of the split-dollar 
life insurance arrangement if the change is non-discretionary by the 
parties and is made pursuant to a binding commitment (whether set forth 
in the agreement or otherwise) in effect on or before September 17, 
2003;
    (G) A change solely in the owner of the life insurance contract as a 
result of a transaction to which section 381(a) applies and in which 
substantially all of the former owner's assets are transferred to the 
new owner of the policy;
    (H) A change to the policy solely if such change is required by a 
court or a state insurance commissioner as a result of the insolvency of 
the insurance company that issued the policy; or
    (I) A change solely in the insurance company that administers the 
policy as a result of an assumption reinsurance transaction between the 
issuing insurance company and the new insurance company to which the 
owner and the non-owner were not a party.
    (iii) Delegation to Commissioner. The Commissioner, in revenue 
rulings, notices, and other guidance published in the Internal Revenue 
Bulletin, may provide additional guidance with respect to other 
modifications that are not material for purposes of paragraph (j)(2)(i) 
of this section. See Sec. 601.601(d)(2)(ii) of this chapter.

[T.D. 9092, 68 FR 54344, Sept. 17, 2003; 68 FR 63735, Nov. 10, 2003]



Sec. 1.62-1  Adjusted gross income.

    (a)-(b) [Reserved]
    (c) Deductions allowable in computing adjusted gross income. The 
deductions specified in section 62(a) for purposes of computing adjusted 
gross income are--
    (1) Deductions set forth in Sec. 1.62-1T(c); and
    (2) Deductions allowable under part VI, subchapter B, chapter 1 of 
the Internal Revenue Code, (section 161 and following) that consist of 
expenses paid or incurred by the taxpayer in connection with the 
performance of services as an employee under a reimbursement or other 
expense allowance arrangement (as defined in Sec. 1.62-2) with his or 
her employer. For the rules pertaining to expenses paid or incurred in 
taxable years beginning before January 1, 1989, see Sec. 1.62-1T (c)(2) 
and (f) (as contained in 26 CFR part 1 (Sec. Sec. 1.61 to 1.169) 
revised April 1, 1992).
    (d) through (h) [Reserved]
    (i) Effective date. Paragraph (c) of this section is effective for 
taxable years beginning on or after January 1, 1989.

[T.D. 8451, 57 FR 57668, Dec. 7, 1992; 57 FR 60568, Dec. 21, 1992]



Sec. 1.62-1T  Adjusted gross income (temporary).

    (a) Basis for determining the amount of certain deductions. The term 
``adjusted gross income'' means the gross income computed under section 
61 minus such of the deductions allowed by chapter 1 of the Code as are 
specified in section 62(a). Adjusted gross income is used as the basis 
for determining the following:
    (1) The limitation on the amount of miscellaneous itemized 
deductions (under section 67).

[[Page 94]]

    (2) The limitation on the amount of the deduction for casualty 
losses (under section 165(h)(2)),
    (3) The limitation on the amount of the deduction for charitable 
contributions (under section 170(b)(1)),
    (4) The limitation on the amount of the deduction for medical and 
dental expenses (under section 213),
    (5) The limitation on the amount of the deduction for qualified 
retirement contributions for active participants in certain pension 
plans (under section 219(g)), and
    (6) The phase-out of the exemption from the disallowance of passive 
activity losses and credits (under section 469(i)(3)).
    (b) Double deduction not permitted. Section 62 (a) merely specifies 
which of the deductions provided in chapter 1 of the Code shall be 
allowed in computing adjusted gross income. It does not create any new 
deductions. The fact that a particular item may be described in more 
than one of the paragraphs under section 62(a) does not permit the item 
to be deducted twice in computing adjusted gross income or taxable 
income.
    (c) Deductions allowable in computing adjusted gross income. The 
deductions specified in section 62(a) for purposes of computing adjusted 
gross income are:
    (1) Deductions allowable under chapter 1 of the Code (other than by 
part VII (section 211 and folllowing), subchapter B of such chapter) 
that are attributable to a trade or business carried on by the taxpayer 
not consisting of services performed as an employee;
    (2) [Reserved]
    (3) For taxable years beginning after December 31, 1986, deductions 
allowable under section 162 that consist of expenses paid or incurred by 
a qualified performing artist (as defined in section 62(b)) in 
connection with the performance by him or her of services in the 
performing arts as an employee;
    (4) Deductions allowable under part VI as losses from the sale or 
exchange of property;
    (5) Deductions allowable under part VI, section 212, or section 611 
that are attributable to property held for the production of rents or 
royalties;
    (6) Deductions for depreciation or depletion allowable under 
sections 167 or 611 to a life tenant of property or to an income 
beneficiary of property held in trust or to an heir, legatee, or devisee 
of an estate;
    (7) Deductions allowed by section 404 for contributions on behalf of 
a self-employed individual;
    (8) Deductions allowed by section 219 for contributions to an 
individual retirement account described in section 408(a), or for an 
individual retirement annuity described in section 408(b);
    (9) Deductions allowed by section 402(e)(3) with respect to a lump-
sum distribution;
    (10) For taxable years beginning after December 31, 1972, deductions 
allowed by section 165 for losses incurred in any transaction entered 
into for profit though not connected with a trade or business, to the 
extent that such losses include amounts forfeited to a bank, mutual 
savings bank, savings and loan association, building and loan 
association, cooperative bank or homestead association as a penalty for 
premature withdrawal of funds from a time savings account, certificate 
of deposit, or similar class of deposit;
    (11) For taxable years beginning after December 31, 1976, deductions 
for alimony and separate maintenance payments allowed by section 215;
    (12) Deductions allowed by section 194 for the amortization of 
reforestation expenditures; and
    (13) Deductions allowed by section 165 for the repayment (made in a 
taxable year beginning after December 28, 1980) to a trust described in 
paragraph (9) or (17) of section 501(c) of supplemental unemployment 
compensation benefits received from such trust if such repayment is 
required because of the receipt of trade readjustment allowances under 
section 231 or 232 of the Trade Act of 1974 (19 U.S.C. 2291 and 2292).
    (d) Expenses directly related to a trade or business. For the 
purpose of the deductions specified in section 62, the performance of 
personal services as an employee does not constitute the carrying on of 
a trade or business, except as otherwise expressly provided. The 
practice of a profession, not as an employee, is considered the conduct 
of a trade or business within the meaning of such section. To be 
deductible for the purposes of determining adjusted gross income, 
expenses must be those

[[Page 95]]

directly, and not those merely remotely, connected with the conduct of a 
trade or business. For example, taxes are deductible in arriving at 
adjusted gross income only if they constitute expenditures directly 
attributable to a trade or business or to property from which rents or 
royalties are derived. Thus, property taxes paid or incurred on real 
property used in a trade or business are deductible, but state taxes on 
net income are not deductible even though the taxpayer's income is 
derived from the conduct of a trade or business.
    (e) Reimbursed and unreimbursed employee expenses--(1) In general. 
Expenses paid or incurred by an employee that are deductible from gross 
income under part VI in computing taxable income (determined without 
regard to section 67) and for which the employee is reimbursed by the 
employer, its agent, or third party (for whom the employee performs a 
benefit as an employee of the employer) under an express agreement for 
reimbursement or pursuant to an express expense allowance arrangement 
may be deducted from gross income in computing adjusted gross income. 
Except as provided in paragraphs (e)(2) and (e)(4) of this section, for 
taxable years beginning after December 31, 1986, if the amount of a 
reimbursement made by an employer, its agent, or third party to an 
employee is less than the total amount of the business expenses paid or 
incurred by the employee, the determination of to which of the 
employee's business expenses the reimbursement applies and the amount of 
each expense that is covered by the reimbursement is made on the basis 
of all of the facts and circumstances of the particular case.
    (2) Facts and circumstances unclear on business expenses for meals 
and entertainment. If--
    (i) The facts and circumstances do not make clear--
    (A) That a reimbursement does not apply to business expenses for 
meals or entertainment, or
    (B) The amount of business expenses for meals or entertainment that 
is covered by the reimbursement, and
    (ii) The employee pays or incurs business expenses for meals or 
entertainment,

the amount of the reimbursement that applies to such expenses (or 
portion thereof with respect to which the facts and circumstances are 
unclear) shall be determined by multiplying the amount of the employee's 
business expenses for meals and entertainment (or portion thereof with 
respect to which the facts and circumstances are unclear) by a fraction, 
the numerator of which is the total amount of the reimbursement (or 
portion thereof with respect to which the facts and circumstances are 
unclear) and the denominator of which is the aggregate amount of all the 
business expenses of the employee (or portion thereof with respect to 
which the facts and circumstances are unclear).
    (3) Deductibility of unreimbursed expenses. The amount of expenses 
that is determined not to be reimbursed pursuant to paragraph (e) (1) or 
(2) of this section is deductible from adjusted gross income in 
determining the employee's taxable income subject to the limitations 
applicable to such expenses (e.g., the 2-percent floor of section 67 and 
the 80-percent limitation on meal and entertainment expenses provided 
for in section 274(n)).
    (4) Unreimbursed expenses of State legislators. For taxable years 
beginning after December 31, 1986, any portion of the amount allowed as 
a deduction to State legislators pursuant to section 162(h)1)(B) that is 
not reimbursed by the State or a third party shall be allocated between 
lodging and meals in the same ratio as the amounts allowable for lodging 
and meals under the Federal per diem applicable to the legislator's 
State capital at the end of the legislator's taxable year (see Appendix 
1-A of the Federal Travel Regulations (FTR), which as of March 28, 1988, 
are contained in GSA Bulletin FPMR A-40, Supplement 20). For purposes of 
this paragraph (e)(4), the amount allowable for meals under the Federal 
per diem shall be the amount of the Federal per diem allowable for meals 
and incidental expenses reduced by $2 per legislative day (or other 
amount allocated to incidental expenses in 1-7.5(a)(2) of the FTR). The 
unreimbursed portion of each type of expense is deductible from adjusted 
gross income in determining the State legislator's taxable income 
subject to the limitations applicable to

[[Page 96]]

such expenses. For example, the unreimbursed portion allocable to meals 
shall be reduced by 20 percent pursuant to section 274(n) before being 
subjected to the 2-percent floor of section 67 for purposes of computing 
the taxable income of a State legislator. See Sec. 1.67-1T(a)(2).
    (5) Expenses paid directly by an employer, its agent, or third 
party. In the case of an employer, its agent, or a third party who 
provides property or services to an employee or who pays an employee's 
expenses directly instead of reimbursing the employee, see section 132 
and the regulations thereunder for the income tax treatment of such 
expenses.
    (6) Examples. The provisions of this paragraph (e) may be 
illustrated by the following examples:

    Example (1). During 1987, A, an employee, while on business trips 
away from home pays $300 for travel fares, $200 for lodging and $100 for 
meals. In addition, A pays $50 for business meals in the area of his 
place of employment (``local meals''), $250 for continuing education 
courses, and $100 for business-related entertainment (other than meals). 
The total amount of the reimbursements received by A for his employee 
expenses from his employer is $750, and it is assumed that A's expenses 
meet the deductibility requirements of sections 162 and 274. A includes 
the amount of the reimbursement in his gross income. A's employer 
designates the reimbursement to cover in full A's expenses for travel 
fares, lodging, and meals while away from home, local meals, and 
entertainment, and no facts or circumstances indicate a contrary 
intention of the employer. Because the facts and circumstances make 
clear the amount of A's business expenses for meals and entertainment 
that is covered by the reimbursement, the reimbursement will be 
allocated to these expenses. In determining his adjusted gross income 
under section 62, A may deduct the full amount of the reimbursement for 
travel fares, lodging, and meals while away from home, local meals, and 
entertainment. In determining his taxable income under section 63, A may 
deduct his expenses for continuing education courses to the extent 
allowable by sections 67 and 162.
    Example (2). Assume the facts are the same as in example (1) except 
that the facts and circumstances make clear that the reimbursement 
covers all types of deductible expenses but they do not make clear the 
amount of each type of expense that is covered by the reimbursement. The 
amount of the reimbursement that is allocated to A's business expenses 
for meals and entertainment is $187.50. This amount is determined by 
multiplying the total amount of A's business expenses for meals and 
entertainment ($250) by the ratio of A's total reimbursement to A's 
total business expenses ($750/$1,000). The remaining amount of the 
reimbursement, $562.50 ($750-$187.50), is allocated to A's business 
expenses other than meal and entertainment expenses. Therefore, in 
determining his adjusted gross income under section 62, A may deduct 
$750 for reimbursed business expenses (including meals and 
entertainment). In determining his taxable income under section 63, A 
may deduct (subject to the limitations and conditions of sections 67, 
162, and 274) the unreimbursed portion of his expenses for meals and 
entertainment ($62.50 ($250-$187.50), and other employee business 
expenses ($187.50 ($750-$562.50)).
    Example (3). Assume the facts are the same as in example (1) except 
that the amount of the reimbursement is $500. Assume further that the 
facts and circumstances make clear that the reimbursement covers $100 of 
expenses for meals and that the remaining $400 of the reimbursement 
covers all types of deductible expenses (including any expenses for 
meals in excess of the $100 already designated) other than expenses for 
entertainment. The amount of the reimbursement that is allocated to A's 
business expenses for meals and entertainment is $125. This amount is 
equal to the sum of the amount of the reimbursement that clearly applies 
to meals ($100) and the amount of the reimbursement with respect to 
which the facts are unclear that is allocated to meals ($25). The latter 
amount is determined by multiplying the total amount of A's business 
expenses for meals and entertainment with respect to which the facts are 
unclear ($50) by the ratio of A's total reimbursement with respect to 
which the facts are unclear to A's total business expenses with respect 
to which the facts are unclear ($400/$800). The remaining amount of the 
reimbursement, $375 ($500-$125) is allocated to A's business expenses 
other than meals and entertainment. Therefore, in determining his 
adjusted gross income under section 62, A may deduct $500 for reimbursed 
business expenses (including meals). In determining his taxable income 
under section 63, A may deduct (subject to the limitations and 
conditions of sections 67, 162, and 274) the unreimbursed portion of his 
expenses for meals ($25 ($150-$125)), entertainment ($100), and other 
employee business expenses ($375 ($750-$375)).
    Example (4). During 1987 B, a research scientist, is employed by 
Corporation X. B gives a speech before members of Association Y, a 
professional organization of scientists, describing her most recent 
research findings. Pursuant to a reimbursement arrangement,

[[Page 97]]

Y reimburses B for the full amount of her travel fares to the site of 
the speech and for the full amount of her expenses for lodging and meals 
while there. B includes the amount of the reimbursement in her gross 
income. B may deduct the full amount of her travel expenses pursuant to 
section 62(a)(2)(A) in computing her adjusted gross income.

    (f) [Reserved]
    (g) Moving expenses. For taxable years beginning after December 31, 
1986, a taxpayer described in section 217(a) shall not take into account 
the deduction described in section 217 relating to moving expenses in 
computing adjusted gross income under section 62 even if the taxpayer is 
reimbursed for his or her moving expenses. Such a taxpayer shall include 
the amount of any reimbursement for moving expenses in income pursuant 
to section 82. The deduction described in section 217 shall be taken 
into account in computing the taxable income of the taxpayer under 
section 63. Pursuant to section 67(b)(6), the 2-percent floor described 
in section 67(a) does not apply to moving expenses.
    (h) Cross-reference. See 26 CFR 1.62-1 (Rev. as of April 1, 1986) 
with respect to pre-1987 deductions for travel, meal, lodging, 
transportation, and other trade or business expenses of an employee, 
reimbursed expenses of an employee, expenses of an outside salesperson, 
long-term capital gains, contributions described in section 405(c) to a 
bond purchase plan on behalf of a self-employed individual, moving 
expenses, amounts not received as benefits pursuant to section 
1379(b)(3), and retirement bonds described in section 409 (allowed by 
section 219).

[T.D. 8189, 53 FR 9873, Mar. 28, 1988, as amended by T.D. 8276, 54 FR 
51024, Dec. 12, 1989; T.D. 8324, 55 FR 51691, Dec. 17, 1990; T.D. 8451, 
57 FR 57668, Dec. 7, 1992]



Sec. 1.62-2  Reimbursements and other expense allowance arrangements.

    (a) Table of contents. The contents of this section are as follows:

(a) Table of contents.
(b) Scope.
(c) Reimbursement or other expense allowance arrangement.
(1) Defined.
(2) Accountable plans.
(i) In general.
(ii) Special rule for failure to return excess.
(3) Nonaccountable plans.
(i) In general.
(ii) Special rule for failure to return excess.
(4) Treatment of payments under accountable plans.
(5) Treatment of payments under nonaccountable plans.
(d) Business connection.
(1) In general.
(2) Other bona fide expenses.
(3) Reimbursement requirement.
(i) In general.
(ii) Per diem allowances.
(e) Substantiation.
(1) In general.
(2) Expenses governed by section 274(d).
(3) Expenses not governed by section 274(d).
(f) Returning amounts in excess of expenses.
(1) In general.
(2) Per diem or mileage allowances.
(g) Reasonable period.
(1) In general.
(2) Safe harbors.
(i) Fixed date method.
(ii) Periodic payment method.
(3) Pattern of overreimbursements.
(h) Withholding and payment of employment taxes.
(1) When excluded from wages.
(2) When included in wages.
(i) Accountable plans.
(A) General rule.
(B) Per diem or mileage allowances.
(1) In general.
(2) Reimbursements.
(3) Advances.
(4) Special rules.
(ii) Nonaccountable plans.
(i) Application.
(j) Examples.
(k) Anti-abuse provision.
(l) Cross references.
(m) Effective dates.

    (b) Scope. For purposes of determining ``adjusted gross income,'' 
section 62(a)(2)(A) allows an employee a deduction for expenses allowed 
by part VI (section 161 and following), subchapter B, chapter 1 of the 
Code, paid by the employee, in connection with the performance of 
services as an employee of the employer, under a reimbursement or other 
expense allowance arrangement with a payor (the employer, its agent, or 
a third party). Section 62(c) provides that an arrangement will not be 
treated as a reimbursement or other expense allowance arrangement for 
purposes of section 62(a)(2)(A) if--
    (1) Such arrangement does not require the employee to substantiate 
the

[[Page 98]]

expenses covered by the arrangement to the payor, or
    (2) Such arrangement provides the employee the right to retain any 
amount in excess of the substantiated expenses covered under the 
arrangement.

This section prescribes rules relating to the requirements of section 
62(c).
    (c) Reimbursement or other expense allowance arrangement--(1) 
Defined. For purposes of Sec. Sec. 1.62-1, 1.62-1T, and 1.62-2, the 
phrase ``reimbursement or other expense allowance arrangement'' means an 
arrangement that meets the requirements of paragraphs (d) (business 
connection, (e) (substantiation), and (f) (returning amounts in excess 
of expenses) of this section. A payor may have more than one arrangement 
with respect to a particular employee, depending on the facts and 
circumstances. See paragraph (d)(2) of this section (payor treated as 
having two arrangements under certain circumstances).
    (2) Accountable plans--(i) In general. Except as provided in 
paragraph (c)(2)(ii) of this section, if an arrangement meets the 
requirements of paragraphs (d), (e), and (f) of this section, all 
amounts paid under the arrangement are treated as paid under an 
``accountable plan.''
    (ii) Special rule for failure to return excess. If an arrangement 
meets the requirements of paragraphs (d), (e), and (f) of this section, 
but the employee fails to return, within a reasonable period of time, 
any amount in excess of the amount of the expenses substantiated in 
accordance with paragraph (e) of this section, only the amounts paid 
under the arrangement that are not in excess of the substantiated 
expenses are treated as paid under an accountable plan.
    (3) Nonaccountable plans--(i) In general. If an arrangement does not 
satisfy one or more of the requirements of paragraphs (d), (e), or (f) 
of this section, all amounts paid under the arrangement are treated as 
paid under a ``nonaccountable plan.'' If a payor provides a 
nonaccountable plan, an employee who receives payments under the plan 
cannot compel the payor to treat the payments as paid under an 
accountable plan by voluntarily substantiating the expenses and 
returning any excess to the payor.
    (ii) Special rule for failure to return excess. If an arrangement 
meets the requirements of paragraphs (d), (e), and (f) of this section, 
but the employee fails to return, within a reasonable period of time, 
any amount in excess of the amount of the expenses substantiated in 
accordance with paragraph (e) of this section, the amounts paid under 
the arrangement that are in excess of the substantiated expenses are 
treated as paid under a nonaccountable plan.
    (4) Treatment of payments under accountable plans. Amounts treated 
as paid under an accountable plan are excluded from the employee's gross 
income, are not reported as wages or other compensation on the 
employee's Form W-2, and are exempt from the withholding and payment of 
employment taxes (Federal Insurance Contributions Act (FICA), Federal 
Unemployment Tax Act (FUTA), Railroad Retirement Tax Act (RRTA), 
Railroad Unemployment Repayment Tax (RURT), and income tax.) See 
paragraph (l) of this section for cross references.
    (5) Treatment of payments under nonaccountable plans. Amounts 
treated as paid under a nonaccountable plan are included in the 
employee's gross income, must be reported as wages or other compensation 
on the employee's Form W-2, and are subject to withholding and payment 
of employment taxes (FICA, FUTA, RRTA, RURT, and income tax). See 
paragraph (h) of this section. Expenses attributable to amounts included 
in the employee's gross income may be deducted, provided the employee 
can substantiate the full amount of his or her expenses (i.e., the 
amount of the expenses, if any, the reimbursement for which is treated 
as paid under an accountable plan as well as those for which the 
employee is claiming the deduction) in accordance with Sec. Sec. 1.274-
5T and 1.274(d)-1 or Sec. 1.162-17, but only as a miscellaneous 
itemized deduction subject to the limitations applicable to such 
expenses (e.g., the 80-percent limitation on meal and entertainment 
expenses provided in section 274(n) and the 2-percent floor provided in 
section 67).

[[Page 99]]

    (d) Business connection--(1) In general. Except as provided in 
paragraphs (d)(2) and (d)(3) of this section, an arrangement meets the 
requirements of this paragraph (d) if it provides advances, allowances 
(including per diem allowances, allowances only for meals and incidental 
expenses, and mileage allowances), or reimbursements only for business 
expenses that are allowable as deductions by part VI (section 161 and 
the following), subchapter B, chapter 1 of the Code, and that are paid 
or incurred by the employee in connection with the performance of 
services as an employee of the employer. The payment may be actually 
received from the employer, its agent, or a third party for whom the 
employee performs a service as an employee of the employer, and may 
include amounts charged directly or indirectly to the payor through 
credit card systems or otherwise. In addition, if both wages and the 
reimbursement or other expense allowance are combined in a single 
payment, the reimbursement or other expense allowance must be identified 
either by making a separate payment or by specifically identifying the 
amount of the reimbursement or other expense allowance.
    (2) Other bona fide expenses. If an arrangement provides advances, 
allowances, or reimbursements for business expenses described in 
paragraph (d)(1) of this section (i.e., deductible employee business 
expenses) and for other bona fide expenses related to the employer's 
business (e.g., travel that is not away from home) that are not 
deductible under part VI (section 161 and the following), subchapter B, 
chapter 1 of the Code, the payor is treated as maintaining two 
arrangements. The portion of the arrangement that provides payments for 
the deductible employee business expenses is treated as one arrangement 
that satisfies this paragraph (d). The portion of the arrangement that 
provides payments for the nondeductible employee expenses is treated as 
a second arrangement that does not satisfy this paragraph (d) and all 
amounts paid under this second arrangement will be treated as paid under 
a nonaccountable plan. See paragraphs (c)(5) and (h) of this section.
    (3) Reimbursement requirement--(i) In general. If a payor arranges 
to pay an amount to an employee regardless of whether the employee 
incurs (or is reasonably expected to incur) business expenses of a type 
described in paragraph (d)(1) or (d)(2) of this section, the arrangement 
does not satisfy this paragraph (d) and all amounts paid under the 
arrangement are treated as paid under a nonaccountable plan. See 
paragraphs (c)(5) and (h) of this section.
    (ii) Per diem allowances. An arrangement providing a per diem 
allowance for travel expenses of a type described in paragraph (d)(1) or 
(d)(2) of this section that is computed on a basis similar to that used 
in computing the employee's wages or other compensation (e.g., the 
number of hours worked, miles traveled, or pieces produced) meets the 
requirements of this paragraph (d) only if, on December 12, 1989, the 
per diem allowance was identified by the payor either by making a 
separate payment or by specifically identifying the amount of the per 
diem allowance, or a per diem allowance computed on that basis was 
commonly used in the industry in which the employee is employed. See 
section 274(d) and Sec. 1.274(d)-1. A per diem allowance described in 
this paragraph (d)(3)(ii) may be adjusted in a manner that reasonably 
reflects actual increases in employee business expenses occurring after 
December 12, 1989.
    (e) Substantiation--(1) In general. An arrangement meets the 
requirements of this paragraph (e) if it requires each business expense 
to be substantiated to the payor in accordance with paragraph (e)(2) or 
(e)(3) of this section, whichever is applicable, within a reasonable 
period of time. See Sec. 1.274-5T or Sec. 1.162-17.
    (2) Expenses governed by section 274(d). An arrangement that 
reimburses travel, entertainment, use of a passenger automobile or other 
listed property, or other business expenses governed by section 274(d) 
meets the requirements of this paragraph (e)(2) if information 
sufficient to satisfy the substantiation requirements of section 274(d) 
and the regulations thereunder is submitted to the payor. See Sec. 
1.274-5. Under section 274(d), information sufficient to substantiate 
the requisite elements of

[[Page 100]]

each expenditure or use must be submitted to the payor. For example, 
with respect to travel away from home, Sec. 1.274-5(b)(2) requires that 
information sufficient to substantiate the amount, time, place, and 
business purpose of the expense must be submitted to the payor. 
Similarly, with respect to use of a passenger automobile or other listed 
property, Sec. 1.274-5(b)(6) requires that information sufficient to 
substantiate the amount, time, use, and business purpose of the expense 
must be submitted to the payor. See Sec. 1.274-5(g) and (j), which 
grant the Commissioner the authority to establish optional methods of 
substantiating certain expenses. Substantiation of the amount of a 
business expense in accordance with rules prescribed pursuant to the 
authority granted by Sec. 1.274-5(g) or (j) will be treated as 
substantiation of the amount of such expense for purposes of this 
section.
    (3) Expenses not governed by section 274(d). An arrangement that 
reimburses business expenses not governed by section 274(d) meets the 
requirements of this paragraph (e)(3) if information is submitted to the 
payor sufficient to enable the payor to identify the specific nature of 
each expense and to conclude that the expense is attributable to the 
payor's business activities. Therefore, each of the elements of an 
expenditure or use must be substantiated to the payor. It is not 
sufficient if an employee merely aggregates expenses into broad 
categories (such as ``travel'') or reports individual expenses through 
the use of vague, nondescriptive terms (such as ``miscellaneous business 
expenses''). See Sec. 1.162-17(b).
    (f) Returning amounts in excess of expenses--(1) In general. Except 
as provided in paragraph (f)(2) of this section, an arrangement meets 
the requirements of this paragraph (f) if it requires the employee to 
return to the payor within a reasonable period of time may amount paid 
under the arrangement in excess of the expenses substantiated in 
accordance with paragraph (e) of this section. The determination of 
whether an arrangement requires an employee to return amounts in excess 
of substantiated expenses will depend on the facts and circumstances. An 
arrangement whereby money is advanced to an employee to defray expenses 
will be treated as satisfying the requirements of this paragraph (f) 
only if the amount of money advanced is reasonably calculated not to 
exceed the amount of anticipated expenditures, the advance of money is 
made on a day within a reasonable period of the day that the anticipated 
expenditures are paid or incurred, and any amounts in excess of the 
expenses substantiated in accordance with paragraph (e) of this section 
are required to be returned to the payor within a reasonable period of 
time after the advance is received.
    (2) Per diem or mileage allowances. The Commissioner may, in his 
discretion, prescribe rules in pronouncements of general applicability 
under which a reimbursement or other expense allowance arrangement that 
provides per diem allowances providing for ordinary and necessary 
expenses of traveling away from home (exclusive of transportation costs 
to and from destination) or mileage allowances providing for ordinary 
and necessary expenses of local travel and tranportation while traveling 
away from home will be treated as satisfying the requirements of this 
paragraph (f), even though the arrangement does not require the employee 
to return the portion of such an allowance that relates to the days or 
miles of travel substantiated and that exceeds the amount of the 
employee's expenses deemed substantiated pursuant to rules prescribed 
under section 274(d), provided the allowance is paid at a rate for each 
day or mile of travel that is reasonably calculated not to exceed the 
amount of the employee's expenses or anticipated expenses and the 
employee is required to return to the payor within a reasonable period 
of time any portion of such allowance which relates to days or miles of 
travel not substantiated in accordance with paragraph (e) of this 
section.
    (g) Reasonable period--(1) In general. The determination of a 
reasonable period of time will depend on the facts and circumstances.
    (2) Safe harbors--(i) Fixed date method. An advance made within 30 
days of when an expense is paid or incurred, an expense substantiated to 
the payor

[[Page 101]]

within 60 days after it is paid or incurred, or an amount returned to 
the payor within 120 days after an expense is paid or incurred will be 
treated as having occurred within a reasonable period of time.
    (ii) Periodic statement method. If a payor provides employees with 
periodic statements (no less frequently than quarterly) stating the 
amount, if any, paid under the arrangement in excess of the expenses the 
employee has substantiated in accordance with paragraph (e) of this 
section, and requesting the employee to substantiate any additional 
business expenses that have not yet been substantiated (whether or not 
such expenses relate to the expenses with respect to which the original 
advance was paid) and/or to return any amounts remaining unsubstantiated 
within 120 days of the statement, an expense substantiated or an amount 
returned within that period will be treated as being substantiated or 
returned within a reasonable period of time.
    (3) Pattern of overreimbursements. If, under a reimbursement or 
other expense allowance arrangement, a payor has a plan or practice to 
provide amounts to employees in excess of expenses substantiated in 
accordance with paragraph (e) of this section and to avoid reporting and 
withholding on such amounts, the payor may not use either of the safe 
harbors provided in paragraph (g)(2) of this section for any years 
during which such plan or practice exists.
    (h) Withholding and payment of employment taxes--(1) When excluded 
from wages. If an arrangement meets the requirements of paragraphs (d), 
(e), and (f) of this section, the amounts paid under the arrangement 
that are not in excess of the expenses substantiated in accordance with 
paragraph (e) of this section (i.e., the amounts treated as paid under 
an accountable plan) are not wages and are not subject to withholding 
and payment of employment taxes. If an arrangement provides advances, 
allowances, or reimbursements for meal and entertainment expenses and a 
portion of the payment is treated as paid under a nonaccountable plan 
under paragraph (d)(2) of this section due solely to section 274(n), 
then notwithstanding paragraph (h)(2)(ii) of this section, these 
nondeductible amounts are neither treated as gross income nor subject to 
withholding and payment of employment taxes.
    (2) When included in wages--(i) Accountable plans--(A) General rule. 
Except as provided in paragraph (h)(2)(i)(B) of this section, if the 
expenses covered under an arrangement that meets the requirements of 
paragraphs (d), (e), and (f) of this section are not substantiated to 
the payor in accordance with paragraph (e) of this section within a 
reasonable period of time or if any amounts in excess of the 
substantiated expenses are not returned to the payor in accordance with 
paragraph (f) of this section within a reasonable period of time, the 
amount which is treated as paid under a nonaccountable plan under 
paragraph (c)(3)(ii) of this section is subject to withholding and 
payment of employment taxes no later than the first payroll period 
following the end of the reasonable period. A payor may treat any amount 
not substantiated or returned within the periods specified in paragraph 
(g)(2) of this section as not substantiated or returned within a 
reasonable period of time.
    (B) Per diem or mileage allowances--(1) In general. If a payor pays 
a per diem or mileage allowance under an arrangement that meets the 
requirements of the paragraphs (d), (e), and (f) of this section, the 
portion, if any, of the allowance paid that relates to days or miles of 
travel substantiated in accordance with paragraph (e) of this section 
and that exceeds the amount of the employee's expenses deemed 
substantiated for such travel pursuant to rules prescribed under section 
274(d) and Sec. 1.274(d)-1 or Sec. 1.274-5T(j) is treated as paid 
under a nonaccountable plan. See paragraph (c)(3)(ii) of this section. 
Because the employee is not required to return this excess portion, the 
reasonable period of time provisions of paragraph (g) of this section 
(relating to the return of excess amounts) do not apply to this excess 
portion.
    (2) Reimbursements. Except as provided in paragraph (h)(2)(i)(B)(4) 
of this section, in the case of a per diem or mileage allowance paid as 
a reimbursement at a rate for each day or mile of

[[Page 102]]

travel that exceeds the amounts of the employee's expenses deemed 
substantiated for a day or mile of travel, the excess portion described 
in paragraph (h)(2)(i) of this section is subject to withholding and 
payment of employment taxes in the payroll period in which the payor 
reimburses the expenses for the days or miles of travel substantiated in 
accordance with paragraph (e) of this section.
    (3) Advances. Except as provided in paragraph (h)(2)(i)(B)(4) of 
this section, in the case of a per diem or mileage allowance paid as an 
advance at a rate for each day or mile of travel that exceeds the amount 
of the employee's expenses deemed substantiated for a day or mile of 
travel, the excess portion described in paragraph (h)(2)(i) of this 
section is subject to withholding and payment of employment taxes no 
later than the first payroll period following the payroll period in 
which the expenses with respect to which the advance was paid (i.e., the 
days or miles of travel) are substantiated in accordance with paragraph 
(e) of this section. The expenses with respect to which the advance was 
paid must be substantiated within a reasonable period of time. See 
paragraph (g) of this section.
    (4) Special rules. The Commissioner may, in his discretion, 
prescribe special rules in pronouncements of general applicability 
regarding the timing of withholding and payment of employment taxes on 
per diem and mileage allowances.
    (ii) Nonaccountable plans. If an arrangement does not satisfy one or 
more of the requirements of paragraphs (d), (e), or (f) of this section, 
all amounts paid under the arrangement are wages and are subject to 
withholding and payment of employment taxes when paid.
    (i) Application. The requirements of paragraphs (d) (business 
connection), (e) (substantiation), and (f) (returning amounts in excess 
of expenses) of this section will be applied on an employee-by-employee 
basis. Thus, for example, the failure by one employee to substantiate 
expenses under an arrangement in accordance with paragraph (e) of this 
section will not cause amounts paid to other employees to be treated as 
paid under a nonaccountable plan.
    (j) Examples. The rules contained in this section may be illustrated 
by the following examples:

    Example (1). Reimbursement requirement. Employer S pays its 
engineers $200 a day. On those days that an engineer travels away from 
home on business for Employer S, Employer S designates $50 of the $200 
as paid to reimburse the engineer's travel expenses. Because Employer S 
would pay an engineer $200 a day regardless of whether the engineer was 
traveling away from home, the arrangement does not satisfy the 
reimbursement requirement of paragraph (d)(3)(i) of this section. Thus, 
no part of the $50 Employer S designated as a reimbursement is treated 
as paid under an accountable plan. Rather, all payments under the 
arrangement are treated as paid under a nonaccountable plan. Employer S 
must report the entire $200 as wages or other compensation on the 
employees' Forms W-2 and must withhold and pay employment taxes on the 
entire $200 when paid.
    Example (2). Reimbursement requirement, multiple arrangements. 
Airline T pays all its employees a salary. Airline T also pays an 
allowance under an arrangement that otherwise meets the requirements of 
paragraphs (d), (e), and (f) of this section to its pilots and flight 
attendants who travel away from their home base airports, whether or not 
they are ``away from home.'' Because the allowance is paid only to those 
employees who incur (or are reasonably expected to incur) expenses of a 
type described in paragraph (d)(1) or (d)(2) of this section, the 
arrangement satisfies the reimbursement requirement of paragraph 
(d)(3)(i) of this section. Under paragraph (d)(2) of this section, 
Airline T is treated as maintaining two arrangements. The portion of the 
arrangement providing the allowances for away from home travel is 
treated as an accountable plan. The portion of the arrangement providing 
the allowances for non-away from home travel is treated as a 
nonaccountable plan. Airline T must report the non-away from home 
allowances as wages or other compensation on the employees' Forms W-2 
and must withhold and pay employment taxes on these payments when paid.
    Example (3). Reimbursement requirement. Corporation R pays all its 
salespersons a salary. Corporation R also pays a travel allowance under 
an arrangement that otherwise meets the requirements of paragraphs (d), 
(e), and (f) of this section. This allowance is paid to all 
salespersons, including salespersons that Corporation R knows, or has 
reason to know, do not travel away from their offices on Corporation R 
business and would not be reasonably expected to incur travel expenses. 
Because the allowance is not paid only to those employees who incur (or 
are reasonably expected to incur) expenses of a type described in 
paragraph (d)(1) or (d)(2)

[[Page 103]]

of this section, the arrangement does not satisfy the reimbursement 
requirement of paragraph (d)(3)(i) of this section. Thus, no part of the 
allowance Corporation R designated as a reimbursement is treated as paid 
under an accountable plan. Rather, all payments under the arrangement 
are treated as paid under a nonaccountable plan. Corporation R must 
report all payments under the arrangement as wages or other compensation 
on the employees' Forms W-2 and must withhold and pay employment taxes 
on the payments when paid.
    Example (4). Separate arrangement, miscellaneous expenses. Under an 
arrangement that meets the requirements of paragraphs (d), (e), and (f) 
of this section, County U reimburses its employees for lodging and meal 
expenses incurred when they travel away from home on County U business. 
For its own convenience, County U also separately pays certain of its 
employees a $25 monthly allowance to cover the cost of small 
miscellaneous office expenses. County U does not require its employees 
to substantiate these miscellaneous expenses and does not require them 
to return the amounts by which the monthly allowance exceeds the 
miscellaneous expenses. The monthly allowance arrangement is a 
nonaccountable plan. County U must report the monthly allowances as 
wages or other compensation on the employees' Forms W-2 and must 
withhold and pay employment taxes on the monthly allowances when paid. 
The nonaccountable plan providing the monthly allowances is treated as 
separate from the accountable plan providing reimbursements for lodging 
and meal expenses incurred for travel away from home on County U 
business.
    Example (5). Excessive advances. In anticipation of employee 
business expenses that Corporation V does not reasonably expect to 
exceed $400 in any quarter, Corporation V nonetheless advances $1,000 to 
Employee A for such expenses. Whenever Employee A substantiates an 
expense in accordance with paragraph (e) of this section, Corporation V 
provides an additional advance in an amount equal to the amount 
substantiated, thereby providing a continuing advance of $1,000. Because 
the amounts advanced under this arrangement are not reasonably 
calculated so as not to exceed the amount of anticipated expenditures 
and because the advance of money is not made on a day within a 
reasonable period of the day that the anticipated expenditures are paid 
or incurred, the arrangement is a nonaccountable plan. The arrangement 
fails to satisfy the requirements of paragraphs (d) (business 
connection) and (f) (reasonable calculation of advances) of this 
section. Thus, Corporation V must report the entire amount of each 
advance as wages or other compensation and must withhold and pay 
employment taxes on the entire amount of each advance when paid.
    Example (6). Excess mileage advance. Under an arrangement that meets 
the requirements of paragraphs (d), (e), and (f) of this section, 
Employer W pays its employees a mileage allowance at a rate of 30 cents 
per mile (when the amount deemed substantiated for each mile of travel 
substantiated is 26 cents per mile) to cover automobile business 
expenses. The allowance is paid at a rate for each mile of travel that 
is reasonably calculated not to exceed the amount of the employee's 
expenses or anticipated expenses. Employer W does not require the return 
of the portion of the mileage allowance (4 cents) that exceeds the 
amount deemed substantiated for each mile of travel substantiated in 
accordance with paragraph (e) of this section. In June, Employer W 
advances Employee B $150 for 500 miles to be traveled by Employee B 
during the month. In July, Employee B substantiates 500 miles of 
business travel. The amount deemed substantiated by Employee B is $130. 
However, Employer W does not require Employee B to return the remaining 
$20 of the advance. No later than the first payroll period following the 
payroll period in which the business miles of travel are substantiated, 
Employer W must withhold and pay employment taxes on $20 (500 miles x 4 
cents per mile).
    Example (7). Excess per diem reimbursement. Under an arrangement 
that meets the requirements of paragraphs (d), (e), and (f) of this 
section, Employer X pays its employees a per diem allowance to cover 
lodging, meal, and incidental expenses incurred for travel away from 
home on Employer X business at a rate equal to 120 percent of the amount 
deemed substantiated for each day of travel to the localities to which 
the employees travel. Employer X does not require the employees to 
return the 20 percent by which the reimbursement for those expenses 
exceeds the amount deemed substantiated for each day of travel 
substantiated in accordance with paragraph (e) of this section. Employee 
C substantiates six days of business travel away from home: Two days in 
a locality for which the amount deemed substantiated is $100 a day and 
four days in a locality for which the amount deemed substantiated is 
$125 a day. Employer X reimburses Employee C $840 for the six days of 
travel away from home (2x(120%x$100)+4x(120%x$125)), and does not 
require Employee C to return the excess portion ($140 excess portion = 
(2 daysx$20 ($120-$100)+4 daysx$25 ($150-$125)). For the payroll period 
in which Employer X reimburses the expenses, Employer X must withhold 
and pay employment taxes on $140.
    Example (8). Return Requirement. Employer Y provides expense 
allowances to certain of its employees to cover business expenses of a 
type described in paragraph (d)(1) of this section under an arrangement 
that requires the employees to substantiate their expenses

[[Page 104]]

within a reasonable period of time and to return any excess amounts 
within a reasonable period of time. Each time an employee returns an 
excess amount to Employer Y, however, Employer Y pays the employee a 
``bonus'' equal to the amount returned by the employee. The arrangement 
fails to satisfy the requirements of paragraph (f) (returning amounts in 
excess of expenses) of this section. Thus, Employer Y must report the 
entire amount of the expense allowance payments as wages or other 
compensation and must withhold and pay employment taxes on the payments 
when paid. Compare example (6) (where the employee is not required to 
return the portion of the mileage allowance that exceeds the amount 
deemed substantiated for each mile of travel substantiated).
    Example (9). Timely substantiation. Employer Z provides a $500 
advance to Employee D for a trip away from home on Employer Z business. 
Employee D incurs $500 in business expenses on the trip. Employer Z uses 
the periodic statement method safe harbor. At the end of the quarter 
during which the trip occurred, Employer Z sends a quarterly statement 
to Employee D stating that $500 was advanced to Employee D during the 
quarter and that no expenses were substantiated and no excess amounts 
returned. The statement advises Employee D that Employee D must 
substantiate any additional business expenses within 120 days of the 
date of the statement, and must return any unsubstantiated excess within 
the 120-day period. Employee D fails to substantiate any expenses or to 
return the excess within the 120-day period. Employer Z treats the $500 
as wages and withholds and pays employment taxes on the $500. After the 
120-day period has expired, Employee D substantiates the $500 in travel 
expenses in accordance with paragraph (e) of this section. Employer Z 
properly reported and withheld and paid employment taxes on the $500 and 
no adjustments may be made. Employee D must include the $500 in gross 
income and may deduct the $500 of expenses as a miscellaneous itemized 
deduction subject to the 2-percent floor provided in section 67.

    (k) Anti-abuse provision. If a payor's reimbursement or other 
expense allowance arrangement evidences a pattern of abuse of the rules 
of section 62(c) and this section, all payments made under the 
arrangement will be treated as made under a nonaccountable plan.
    (l) Cross references. For employment tax regulations relating to 
reimbursement and expense allowance arrangements, see Sec. Sec. 31.3121 
(a)-3, 31.3231(e)-(3), 31.3306(b)-2, and 31.3401(a)-4, which generally 
apply to payments made under reimbursement or other expense allowance 
arrangements received by an employee on or after July 1, 1990 with 
respect to expenses paid or incurred on or after July 1, 1990. For 
reporting requirements, see Sec. 1.6041-3(i), which generally applies 
to payments made under reimbursement or other expense allowance 
arrangements received by an employee on or after January 1, 1989 with 
respect to expenses paid or incurred on or after January 1, 1989.
    (m) Effective dates. This section generally applies to payments made 
under reimbursement or other expense allowance arrangements received by 
an employee in taxable years of the employee beginning on or after 
January 1, 1989, with respect to expenses paid or incurred in taxable 
years beginning on or after January 1, 1989. Paragraph (h) of this 
section generally applies to payments made under reimbursement or other 
expense allowance arrangements received by an employee on or after July 
1, 1990 with respect to expenses paid or incurred on or after July 1, 
1990. Paragraphs (d)(3)(ii) and (h)(2)(i)(B) of this section apply to 
payments made under reimbursement or other expense allowance 
arrangements received by an employee on or after January 1, 1991 with 
respect to expenses paid or incurred on or after January 1, 1991. 
Paragraph (e)(2) of this section applies to payments made under 
reimbursement or other expense allowance arrangements received by an 
employee with respect to expenses paid or incurred after December 31, 
1997.

[T.D. 8324, 55 FR 51691, Dec. 17, 1990; 56 FR 8911, Mar. 4, 1991, as 
amended by T.D. 8451, 57 FR 57668, Dec. 7, 1992; T.D. 8666, 61 FR 27005, 
May 30, 1996; T.D. 8784, 63 FR 52600, Oct. 1, 1998; T.D. 8864, 65 FR 
4122, Jan. 26, 2000; T.D. 9064, 68 FR 39011, July 1, 2003]



Sec. 1.63-1  Change of treatment with respect to the zero bracket amount 
and itemized deductions.

    (a) In general. An individual who files a return on which the 
individual itemizes deductions in accordance with section 63(g) may 
later make a change of treatment by recomputing taxable income for the 
taxable year to which that return relates without itemizing deductions. 
Similarly, an individual

[[Page 105]]

who files a return on which the individual computes taxable income 
without itemizing deductions may later make a change of treatment by 
itemizing deductions in accordance with section 63(g) in recomputing 
taxable income for the taxable year to which that return relates.
    (b) No extension of time for claiming credit or refund. A change of 
treatment described in paragraph (a) of this section does not extend the 
period of time prescribed in section 6511 within which the taxpayer may 
make a claim for credit or refund of tax.
    (c) Special requirements if spouse filed separate return--(1) 
Requirements. If the spouse of the taxpayer filed a separate return for 
a taxable year corresponding to the taxable year of the taxpayer, the 
taxpayer may not make a change of treatment described in paragraph (a) 
of this section for that year unless--
    (i) The spouse makes a change of treatment on the separate return 
consistent with the change of treatment sought by the taxpayer; and
    (ii) The taxpayer and the taxpayer's spouse file a consent in 
writing to the assessment of any deficiency of either spouse to the 
extent attributable to the change of treatment, even though the 
assessment of the deficiency would otherwise be prevented by the 
operation of any law or rule of law. The consent must be filed with the 
district director for the district in which the taxpayer applies for the 
change of treatment, and the period during which a deficiency may be 
assessed shall be established by agreement of the spouses and the 
district director.
    (2) Corresponding taxable year. A taxable year of one spouse 
corresponds to a taxable year of the other spouse if both taxable years 
end in the same calendar year. If the taxable year of one spouse ends 
with death, however, the corresponding taxable year of the surviving 
spouse is that in which the death occurs.
    (d) Inapplicable if tax liability has been compromised. The taxpayer 
may not make a change of treatment described in paragraph (a) of this 
section for any taxable year if--
    (1) The tax liability of the taxpayer for the taxable year has been 
compromised under section 7122; or
    (2) The tax liability of the taxpayer's spouse for a taxable year 
corresponding to the taxable year of the taxpayer has been compromised 
under section 7122. See paragraph (c)(2) of this section for the 
determination of a corresponding taxable year.
    (e) Effective date. This section applies to taxable years beginning 
after 1976.

[T.D. 7585, 44 FR 1105, Jan. 4, 1979]



Sec. 1.63-2  Cross reference.

    For rules with respect to charitable contribution deductions for 
nonitemizing taxpayers, see section 63 (b)(1)(C) and (i) and section 
170(i) of the Internal Revenue Code of 1954.

(Secs. 170(a)(1) and 7805 of the Internal Revenue Code of 1954 (68A 
Stat. 58, 26 U.S.C. 170(a)(1); 68A Stat. 917, 26 U.S.C. 7805)

[T.D. 8002, 49 FR 50666, Dec. 31, 1984]



Sec. 1.66-1  Treatment of community income.

    (a) In general. Married individuals domiciled in a community 
property state who do not elect to file a joint individual Federal 
income tax return under section 6013 generally must report half of the 
total community income earned by the spouses during the taxable year 
except at times when one of the following exceptions applies:
    (1) The spouses live apart and meet the qualifications of Sec. 
1.66-2.
    (2) The Secretary denies a spouse the Federal income tax benefits 
resulting from community property law under Sec. 1.66-3, because that 
spouse acted as if solely entitled to the income and failed to notify 
his or her spouse of the nature and amount of the income prior to the 
due date for the filing of his or her spouse's return.
    (3) A requesting spouse qualifies for traditional relief from the 
Federal income tax liability resulting from the operation of community 
property law under Sec. 1.66-4(a).
    (4) A requesting spouse qualifies for equitable relief from the 
Federal income tax liability resulting from the operation of community 
property law under Sec. 1.66-4(b).
    (b) Applicability. (1) The rules of this section apply only to 
community income, as defined by state law. The

[[Page 106]]

rules of this section do not apply to income that is not community 
income. Thus, the rules of this section do not apply to income from 
property that was formerly community property, but in accordance with 
state law, has ceased to be community property, becoming, e.g., separate 
property or property held by joint tenancy or tenancy in common.
    (2) When taxpayers report income under paragraph (a) of this 
section, all community income for the calendar year is treated in 
accordance with the rules provided by section 879(a). Unlike the other 
provisions under section 66, section 66(a) does not permit inclusion on 
an item-by-item basis.
    (c) Transferee liability. The provisions of section 66 do not negate 
liability that arises under the operation of other laws. Therefore, a 
spouse who is not subject to Federal income tax on community income may 
nevertheless remain liable for the unpaid tax (including additions to 
tax, penalties, and interest) to the extent provided by Federal or state 
transferee liability or property laws (other than community property 
laws). For the rules regarding the liability of transferees, see 
sections 6901 through 6904 and the regulations thereunder.

[T.D. 9074, 68 FR 41070, July 10, 2003]



Sec. 1.66-2  Treatment of community income where spouses live apart.

    (a) Community income of spouses domiciled in a community property 
state will be treated in accordance with the rules provided by section 
879(a) if all of the following requirements are satisfied--
    (1) The spouses are married to each other at any time during the 
calendar year;
    (2) The spouses live apart at all times during the calendar year;
    (3) The spouses do not file a joint return with each other for a 
taxable year beginning or ending in the calendar year;
    (4) One or both spouses have earned income that is community income 
for the calendar year; and
    (5) No portion of such earned income is transferred (directly or 
indirectly) between such spouses before the close of the calendar year.
    (b) Living apart. For purposes of this section, living apart 
requires that spouses maintain separate residences. Spouses who maintain 
separate residences due to temporary absences are not considered to be 
living apart. Spouses who are not members of the same household under 
Sec. 1.6015-3(b) are considered to be living apart for purposes of this 
section.
    (c) Transferred income. For purposes of this section, transferred 
income does not include a de minimis amount of earned income that is 
transferred between the spouses. In addition, any amount of earned 
income transferred for the benefit of the spouses' child will not be 
treated as an indirect transfer to one spouse. Additionally, income 
transferred between spouses is presumed to be a transfer of earned 
income. This presumption is rebuttable.
    (d) Examples. The following examples illustrate the rules of this 
section:

    Example 1. Living apart. H and W are married, domiciled in State A, 
a community property state, and have lived apart the entire year of 
2002. W, who is in the Army, was stationed in Korea for the entire 
calendar year. During their separation, W intended to return home to H, 
and H intended to live with W upon W's return. H and W do not file a 
joint return for taxable year 2002. H and W may not report their income 
under this section because a temporary absence due to military service 
is not living apart as contemplated under this section.
    Example 2. Transfer of earned income--de minimis exception. H and W 
are married, domiciled in State B, a community property state, and have 
lived apart the entire year of 2002. H and W are estranged and intend to 
live apart indefinitely. H and W do not file a joint return for taxable 
year 2002. H occasionally visits W and their two children, who live with 
W. When H visits, he often buys gifts for the children, takes the 
children out to dinner, and occasionally buys groceries or gives W money 
to buy the children new clothes for school. Both W and H have earned 
income in the year 2002 that is community income under the laws of State 
B. H and W may report their income on separate returns under this 
section.
    Example 3. Transfer of earned income--source of transfer. H and W 
are married, domiciled in State C, a community property state, and have 
lived apart the entire year of 2002. H and W are estranged and intend to 
live apart indefinitely. H and W do not file a joint return for taxable 
year 2002. W provides H $1,000 a month from March 2002 through August 
2002 while H is working part-time and

[[Page 107]]

seeking full-time employment. W is not legally obligated to make the 
$1,000 payments. W earns $75,000 in 2002 in wage income. W also receives 
$10,000 in capital gains income in December 2002. H wants to report his 
income in accordance with this section, alleging that the $6,000 that he 
received from W was not from W's earned income, but from the capital 
gains income W received in 2002. The facts and circumstances surrounding 
the periodic payments to H from W do not indicate that W made the 
payments out of her capital gains. H and W may not report their income 
in accordance with this section, as the $6,000 W transferred to H is 
presumed to be from W's earned income, and H has not presented any facts 
to rebut the presumption.

[T.D. 9074, 68 FR 41070, July 10, 2003]



Sec. 1.66-3  Denial of the Federal income tax benefits resulting from 
the operation of community property law where spouse not notified.

    (a) In general. The Secretary may deny the Federal income tax 
benefits of community property law to any spouse with respect to any 
item of community income if that spouse acted as if solely entitled to 
the income and failed to notify his or her spouse of the nature and 
amount of the income before the due date (including extensions) for the 
filing of the return of his or her spouse for the taxable year in which 
the item of income was derived. Whether a spouse has acted as if solely 
entitled to the item of income is a facts and circumstances 
determination. This determination focuses on whether the spouse used, or 
made available, the item of income for the benefit of the marital 
community.
    (b) Effect. The item of community income will be included, in its 
entirety, in the gross income of the spouse to whom the Secretary denied 
the Federal income tax benefits resulting from community property law. 
The tax liability arising from the inclusion of the item of community 
income must be assessed in accordance with section 6212 against this 
spouse.
    (c) Examples. The following examples illustrate the rules of this 
section:

    Example 1. Acting as if solely entitled to income. (i) H and W are 
married and are domiciled in State A, a community property state. W's 
Form W-2 for taxable year 2000 showed wage income of $35,000. W also 
received a Form 1099-INT, ``Interest Income,'' showing $1,000 W received 
in taxable year 2000. W's wage income was directly deposited into H and 
W's joint account, from which H and W paid bills and household expenses. 
W did not inform H of her interest income or the Form 1099-INT, but W 
gave H a copy of the W-2 when she received it in January 2001. W did not 
use her interest income for bills or household expenses. Instead W gave 
her interest income to her brother, who was unemployed. Neither the 
separate return filed by H nor the separate return filed by W included 
the interest income. In 2002, the IRS audits both H and W. The Internal 
Revenue Service (IRS) may raise section 66(b) as to W's interest income, 
denying W the Federal income tax benefit resulting from community 
property law as to this item of income.
    (ii) H and W are married and are domiciled in State B, a community 
property state. For taxable year 2000, H receives $45,000 in wage income 
that H places in a separate account. H and W maintain separate 
residences. H's wage income is community income under the laws of State 
B. That same year, W loses her job, and H pays W's mortgage and 
household expenses for several months while W seeks employment. Neither 
H nor W files a return for 2000, the taxable year for which the IRS 
subsequently audits them. The IRS may not raise section 66(b) and deny H 
the Federal income tax benefits resulting from the operation of 
community property law as to H's wage income of $45,000, as H has not 
treated this income as if H were solely entitled to it.
    Example 2. Notification of nature and amount of the income. H and W 
are married and domiciled in State C, a community property state. H and 
W do not file a joint return for taxable year 2001. H's and W's earned 
income for 2001 is community income under the laws of State C. H 
receives $50,000 in wage income in 2001. In January 2002, H receives a 
Form W-2 that erroneously states that H earned $45,000 in taxable year 
2001. H provides W a copy of H's Form W-2 in February 2002. W files for 
an extension prior to April 15, 2002. H receives a corrected Form W-2 
reflecting wages of $50,000 in May 2002. H provides a copy of the 
corrected Form W-2 to W in May 2002. W files a separate return in June 
2002, but reports one half of $45,000 ($22,500) of wage income that H 
earned. H files a separate return reporting half of $50,000 ($25,000) in 
wage income. The IRS audits both H and W. Even if H had acted as if 
solely entitled to the wage income, the IRS may not raise section 66(b) 
as to this income because H notified W of the nature and amount of the 
income prior to the due date of W's return (including extensions).

[T.D. 9074, 68 FR 41070, July 10, 2003]

[[Page 108]]



Sec. 1.66-4  Request for relief from the Federal income tax liability 
resulting from the operation of community property law.

    (a) Traditional relief--(1) In general. A requesting spouse will 
receive relief from the Federal income tax liability resulting from the 
operation of community property law for an item of community income if--
    (i) The requesting spouse did not file a joint Federal income tax 
return for the taxable year for which he or she seeks relief;
    (ii) The requesting spouse did not include in gross income for the 
taxable year an item of community income properly includible therein, 
which, under the rules contained in section 879(a), would be treated as 
the income of the nonrequesting spouse;
    (iii) The requesting spouse establishes that he or she did not know 
of, and had no reason to know of, the item of community income; and
    (iv) Taking into account all of the facts and circumstances, it is 
inequitable to include the item of community income in the requesting 
spouse's individual gross income.
    (2) Knowledge or reason to know. (i) A requesting spouse had 
knowledge or reason to know of an item of community income if he or she 
either actually knew of the item of community income, or if a reasonable 
person in similar circumstances would have known of the item of 
community income. All of the facts and circumstances are considered in 
determining whether a requesting spouse had reason to know of an item of 
community income. The relevant facts and circumstances include, but are 
not limited to, the nature of the item of community income, the amount 
of the item of community income relative to other income items, the 
couple's financial situation, the requesting spouse's educational 
background and business experience, and whether the item of community 
income was reflected on prior years' returns (e.g., investment income 
omitted that was regularly reported on prior years' returns).
    (ii) If the requesting spouse is aware of the source of community 
income or the income-producing activity, but is unaware of the specific 
amount of the nonrequesting spouse's community income, the requesting 
spouse is considered to have knowledge or reason to know of the item of 
community income. The requesting spouse's lack of knowledge of the 
specific amount of community income does not provide a basis for relief 
under this section.
    (3) Inequitable. All of the facts and circumstances are considered 
in determining whether it is inequitable to hold a requesting spouse 
liable for a deficiency attributable to an item of community income. One 
relevant factor for this purpose is whether the requesting spouse 
benefitted, directly or indirectly, from the omitted item of community 
income. A benefit includes normal support, but does not include de 
minimis amounts. Evidence of direct or indirect benefit may consist of 
transfers of property or rights to property, including transfers 
received several years after the filing of the return. Thus, for 
example, if a requesting spouse receives from the nonrequesting spouse 
property (including life insurance proceeds) that is traceable to items 
of community income attributable to the nonrequesting spouse, the 
requesting spouse will have benefitted from those items of community 
income. Other factors may include, if the situation warrants, desertion, 
divorce or separation. Factors relevant to whether it would be 
inequitable to hold a requesting spouse liable, more specifically 
described under the applicable administrative procedure issued under 
section 66(c) (Revenue Procedure 2000-15 (2000-1 C.B. 447) (See Sec. 
601.601(d)(2) of this chapter), or other applicable guidance published 
by the Secretary), are to be considered in making a determination under 
this paragraph.
    (b) Equitable relief. Equitable relief may be available when the 
four requirements of paragraph (a)(1) of this section are not satisfied, 
but it would be inequitable to hold the requesting spouse liable for the 
unpaid tax or deficiency. Factors relevant to whether it would be 
inequitable to hold a requesting spouse liable, more specifically 
described under the applicable administrative procedure issued under 
section 66(c) (Revenue Procedure 2000-15 (2000-1 C.B. 447), or other 
applicable guidance published by the Secretary), are to be

[[Page 109]]

considered in making a determination under this paragraph.
    (c) Applicability. Traditional relief under paragraph (a) of this 
section applies only to deficiencies arising out of items of omitted 
income. Equitable relief under paragraph (b) of this section applies to 
any deficiency or any unpaid tax (or any portion of either). Equitable 
relief is available only for the portion of liabilities that were unpaid 
as of July 22, 1998, and for liabilities that arise after July 22, 1998.
    (d) Effect of relief. When the requesting spouse qualifies for 
relief under paragraph (a) or (b) of this section, the IRS must assess 
any deficiency of the nonrequesting spouse arising from the granting of 
relief to the requesting spouse in accordance with section 6212.
    (e) Examples. The following examples illustrate the rules of this 
section:

    Example 1. Item-by-item approach. H and W are married, living 
together, and domiciled in State A (a community property state). H and W 
file separate returns for taxable year 2002 on April 15, 2003. H earns 
$56,000 in wages, and W earns $46,000 in wages, in 2002. H reports half 
of his wage income as shown on his Form W-2, in the amount of $28,000, 
and half of W's wage income as shown on her Form W-2, in the amount of 
$23,000. W reports half of her wage income as shown on her W-2, in the 
amount of $23,000, and half of H's wage income as shown on his Form W-2, 
in the amount of $28,000. Neither H nor W reports W's income from her 
sole proprietorship of $34,000 or W's investment income of $5,000 for 
taxable year 2002. The Internal Revenue Service (IRS) proposes 
deficiencies with respect to H's and W's taxable year 2002 returns due 
to the omission of W's income from her sole proprietorship and 
investments. H timely requests relief under section 66(c). Because the 
IRS determines that H satisfies the four requirements of the traditional 
relief provision of section 66(c) with respect to W's omitted investment 
income, the IRS grants H's request for relief as to the omitted 
investment income. The IRS determines that H does not satisfy the four 
requirements of the traditional relief provision of section 66(c) as to 
W's sole proprietorship income. The IRS further determines that, under 
the equitable relief provision of section 66(c), it is not inequitable 
to hold H liable for the sole proprietorship income. Relief is 
applicable on an item-by-item basis. Thus, H is liable for the tax on 
half of his wage income in the amount of $28,000, half of W's wage 
income in the amount of $23,000, half of W's sole proprietorship income 
in the amount of $17,000, but none of W's investment income, for which H 
obtained relief under section 66(c). W is liable for the tax on half of 
H's wage income in the amount of $28,000, half of W's wage income in the 
amount of $23,000, half of W's sole proprietorship income in the amount 
of $17,000, and all of W's investment income in the amount of $5,000, 
because H obtained relief under section 66(c).
    Example 2. Benefit. H and W are married, living together, and 
domiciled in State B (a community property state). Neither H nor W files 
a return for taxable year 2000. H earns $60,000 in 2000, which he 
deposits in a joint account. H and W pay the mortgage payment, household 
bills, and other family expenses out of the joint account. W earns 
$20,000 in 2000. W uses a portion of the $20,000 to make monthly loan 
payments on the family cars, but loses the remainder at the local 
racetrack. In 2002, the IRS audits H and W. H requests relief under 
section 66(c), stating that he did not know or have reason to know of 
W's additional income, as H travels extensively while W handles the 
family finances. Regardless of whether H had knowledge or reason to know 
of the source of W's income, H is not eligible for traditional relief 
under section 66(c) because H benefitted from W's income. H's benefit, 
the portion of W's income used to make monthly payments on the car 
loans, was more than a de minimis amount. While this benefit was not in 
excess of normal support, it is enough to preclude relief under the 
traditional relief provision of section 66(c). H may still qualify for 
equitable relief under section 66(c), depending on all of the facts and 
circumstances.

    (f) Fraudulent scheme. If the Secretary establishes that a spouse 
transferred assets to his or her spouse as part of a fraudulent scheme, 
relief is not available under this section. For purposes of this 
section, a fraudulent scheme includes a scheme to defraud the Secretary 
or another third party, such as a creditor, ex-spouse, or business 
partner.
    (g) Definitions--(1) Requesting spouse. A requesting spouse is an 
individual who does not file a joint Federal income tax return with the 
nonrequesting spouse for the taxable year in question, and who requests 
relief from the Federal income tax liability resulting from the 
operation of community property law under this section for the portion 
of the liability arising from his or her share of community income for 
such taxable year.
    (2) Nonrequesting spouse. A nonrequesting spouse is the individual 
to

[[Page 110]]

whom the requesting spouse was married and whose income or deduction 
gave rise to the tax liability from which the requesting spouse seeks 
relief in whole or in part.
    (h) Effect of prior closing agreement or offer in compromise. A 
requesting spouse is not entitled to relief from the Federal income tax 
liability resulting from the operation of community property law under 
section 66 for any taxable year for which the requesting spouse has 
entered into a closing agreement (other than an agreement pursuant to 
section 6224(c) relating to partnership items) with the Secretary that 
disposes of the same liability that is the subject of the request for 
relief. In addition, a requesting spouse is not entitled to relief from 
the Federal income tax liability resulting from the operation of 
community property law under section 66 for any taxable year for which 
the requesting spouse has entered into an offer in compromise with the 
Secretary. For rules relating to the effect of closing agreements and 
offers in compromise, see sections 7121 and 7122, and the regulations 
thereunder.
    (i) [Reserved]
    (j) Time and manner for requesting relief--(1) Requesting relief. To 
request relief from the Federal income tax liability resulting from the 
operation of community property law under this section, a requesting 
spouse must file, within the time period prescribed in paragraph (j)(2) 
of this section, Form 8857, ``Request for Innocent Spouse Relief'' (or 
other specified form), or other written request, signed under penalties 
of perjury, stating why relief is appropriate. The requesting spouse 
must include the nonrequesting spouse's name and taxpayer identification 
number in the written request. The requesting spouse must also comply 
with the Secretary's reasonable requests for information that will 
assist the Secretary in identifying and locating the nonrequesting 
spouse.
    (2) Time period for filing a request for relief--(i) Traditional 
relief. The earliest time for submitting a request for relief from the 
Federal income tax liability resulting from the operation of community 
property law under paragraph (a) of this section, for an amount 
underreported on, or omitted from, the requesting spouse's separate 
return, is the date the requesting spouse receives notification of an 
audit or a letter or notice from the IRS stating that there may be an 
outstanding liability with regard to that year (as described in 
paragraph (j)(2)(iii) of this section). The latest time for requesting 
relief under paragraph (a) of this section is 6 months before the 
expiration of the period of limitations on assessment, including 
extensions, against the nonrequesting spouse for the taxable year that 
is the subject of the request for relief, unless the examination of the 
requesting spouse's return commences during that 6-month period. If the 
examination of the requesting spouse's return commences during that 6-
month period, the latest time for requesting relief under paragraph (a) 
of this section is 30 days after the commencement of the examination.
    (ii) Equitable relief. The earliest time for submitting a request 
for relief from the Federal income tax liability resulting from the 
operation of community property law under paragraph (b) of this section 
is the date the requesting spouse receives notification of an audit or a 
letter or notice from the IRS stating that there may be an outstanding 
liability with regard to that year (as described in paragraph 
(j)(2)(iii) of this section). A request for equitable relief from the 
Federal income tax liability resulting from the operation of community 
property law under paragraph (b) of this section for a liability that is 
properly reported but unpaid is properly submitted with the requesting 
spouse's individual Federal income tax return, or after the requesting 
spouse's individual Federal income tax return is filed.
    (iii) Premature requests for relief. The Secretary will not consider 
a premature request for relief under this section. The notices or 
letters referenced in this paragraph (j)(2) do not include notices 
issued pursuant to section 6223 relating to TEFRA partnership 
proceedings. These notices or letters include notices of computational 
adjustment to a partner or partner's spouse (Notice of Income Tax 
Examination Changes) that reflect a computation of the liability 
attributable to

[[Page 111]]

partnership items of the partner or the partner's spouse.
    (k) Nonrequesting spouse's notice and opportunity to participate in 
administrative proceedings--(1) In general. When the Secretary receives 
a request for relief from the Federal income tax liability resulting 
from the operation of community property law under this section, the 
Secretary must send a notice to the nonrequesting spouse's last known 
address that informs the nonrequesting spouse of the requesting spouse's 
request for relief. The notice must provide the nonrequesting spouse 
with an opportunity to submit any information for consideration in 
determining whether to grant the requesting spouse relief from the 
Federal income tax liability resulting from the operation of community 
property law. The Secretary will share with each spouse the information 
submitted by the other spouse, unless the Secretary determines that the 
sharing of this information will impair tax administration.
    (2) Information submitted. The Secretary will consider all of the 
information (as relevant to the particular relief provision) that the 
nonrequesting spouse submits in determining whether to grant relief from 
the Federal income tax liability resulting from the operation of 
community property law under this section.

[T.D. 9074, 68 FR 41070, July 10, 2003]



Sec. 1.66-5  Effective date.

    Sections 1.66-1 through 1.66-4 are applicable on July 10, 2003. In 
addition, Sec. 1.66-4 applies to any request for relief filed prior to 
July 10, 2003, for which the Internal Revenue Service has not issued a 
preliminary determination as of July 10, 2003.

[T.D. 9074, 68 FR 41070, July 10, 2003]



Sec. 1.67-1T  2-percent floor on miscellaneous itemized deductions 
(temporary).

    (a) Type of expenses subject to the floor--(1) In general. With 
respect to individuals, section 67 disallows deductions for 
miscellaneous itemized deductions (as defined in paragraph (b) of this 
section) in computing taxable income (i.e., so-called ``below-the-line'' 
deductions) to the extent that such otherwise allowable deductions do 
not exceed 2 percent of the individual's adjusted gross income (as 
defined in section 62 and the regulations thereunder). Examples of 
expenses that, if otherwise deductible, are subject to the 2-percent 
floor include but are not limited to--
    (i) Unreimbursed employee expenses, such as expenses for 
transportation, travel fares and lodging while away from home, business 
meals and entertainment, continuing education courses, subscriptions to 
professional journals, union or professional dues, professional 
uniforms, job hunting, and the business use of the employee's home.
    (ii) Expenses for the production or collection of income for which a 
deduction is otherwise allowable under section 212 (1) and (2), such as 
investment advisory fees, subscriptions to investment advisory 
publications, certain attorneys' fees, and the cost of safe deposit 
boxes,
    (iii) Expenses for the determination of any tax for which a 
deduction is otherwise allowable under section 212(3), such as tax 
counsel fees and appraisal fees, and
    (iv) Expenses for an activity for which a deduction is otherwise 
allowable under section 183.

See section 62 with respect to deductions that are allowable in 
computing adjusted gross income (i.e., so-called ``above-the-line'' 
deductions).
    (2) Other limitations. Except as otherwise provided in paragraph (d) 
of this section, to the extent that any limitation or restriction is 
placed on the amount of a miscellaneous itemized deduction, that 
limitation shall apply prior to the application of the 2-percent floor. 
For example, in the case of an expense for food or beverages, only 80 
percent of which is allowable as a deduction because of the limitations 
provided in section 274(n), the otherwise deductible 80 percent of the 
expense is treated as a miscellaneous itemized deduction and is subject 
to the 2-percent limitation of section 67.
    (b) Definition of miscellaneous itemized deductions. For purposes of 
this section,

[[Page 112]]

the term ``miscellaneous itemized deductions'' means the deductions 
allowable from adjusted gross income in determining taxable income, as 
defined in section 63, other than--
    (1) The standard deduction as defined in section 63(c),
    (2) Any deduction allowable for impairment-related work expenses as 
defined in section 67(d),
    (3) The deduction under section 72(b)(3) (relating to deductions if 
annuity payments cease before the investment is recovered),
    (4) The deductions allowable under section 151 for personal 
exemptions,
    (5) The deduction under section 163 (relating to interest),
    (6) The deduction under section 164 (relating to taxes),
    (7) The deduction under section 165(a) for losses described in 
subsection (c)(3) or (d) of section 165,
    (8) The deduction under section 170 (relating to charitable 
contributions and gifts),
    (9) The deduction under section 171 (relating to deductions for 
amortizable bond premiums),
    (10) The deduction under section 213 (relating to medical and dental 
expenses),
    (11) The deduction under section 216 (relating to deductions in 
connection with cooperative housing corporations),
    (12) The deduction under section 217 (relating to moving expenses),
    (13) The deduction under section 691(c) (relating to the deduction 
for estate taxes in the case of income in respect of the decedent),
    (14) The deduction under 1341 (relating to the computation of tax if 
a taxpayer restores a substantial amount held under claim of right), and
    (15) Any deduction allowable in connection with personal property 
used in a short sale.
    (c) Allocation of expenses. If a taxpayer incurs expenses that 
relate to both a trade or business activity (within the meaning of 
section 162) and a production of income or tax preparation activity 
(within the meaning of section 212), the taxpayer shall allocate such 
expenses between the activities on a reasonable basis.
    (d) Members of Congress--(1) In general. With respect to the 
deduction for living expenses of Members of Congress referred to in 
section 162(a), the 2-percent floor described in section 67 and 
paragraph (a) of this section shall be applied to the deduction before 
the application of the $3,000 limitation on deductions for living 
expenses referred to in section 162(a). (For purposes of this paragraph 
(d), the term ``Member(s) of Congress'' includes any Delegate or 
Resident Commissioner.) The amount of miscellaneous itemized deductions 
of a Member of Congress that is disallowed pursuant to section 67 and 
paragraph (a) of this section shall be allocated between deductions for 
living expenses (within the meaning of section 162(a)) and other 
miscellaneous itemized deductions. The amount of deductions for living 
expenses of a Member of Congress that is disallowed pursuant to section 
67 and paragraph (a) of this section is determined by multiplying the 
aggregate amount of such living expenses (determined without regard to 
the $3,000 limitation of section 162(a) but with regard to any other 
limitations) by a fraction, the numerator of which is the aggregate 
amount disallowed pursuant to section 67 and paragraph (a) of this 
section with respect to miscellaneous itemized deductions of the Member 
of Congress and the denominator of which is the amount of miscellaneous 
itemized deductions (including deductions for living expenses) of the 
Member of Congress (determined without regard to the $3,000 limitation 
of section 162(a) but without regard to any other limitations). The 
amount of deductions for miscellaneous itemized deductions (other than 
deductions for living expenses) of a Member of Congress that are 
disallowed pursuant to section 67 and paragraph (a) of this section is 
determined by multiplying the amount of miscellaneous itemized 
deductions (other than deductions for living expenses) of the Member of 
Congress (determined with regard to any limitations) by the fraction 
described in the preceding sentence.
    (2) Example. The provisions of this paragraph (d) may be illustrated 
by the following example:


[[Page 113]]


    Example For 1987 A, a Member of Congress, has adjusted gross income 
of $100,000, and miscellaneous itemized deductions of $10,750 of which 
$3,750 is for meals, $3,000 is for other living expenses, and $4,000 is 
for other miscellaneous itemized deductions (none of which is subject to 
any percentage limitations other than the 2-percent floor of section 
67). The amount of A's business meal expenses that are disallowed under 
section 274(n) is $750 ($3,750x20%). The amount of A's miscellaneous 
itemized deductions that are disallowed under section 67 is $2,000 
($100,000x2%). The portion of the amount disallowed under section 67 
that is allocated to A's living expenses is $1,200. This portion is 
equal to the amount of A's deductions for living expenses allowable 
after the application of section 274(n) and before the application of 
section 67 ($6,000) multiplied by the ratio of A's total miscellaneous 
itemized deductions disallowed under section 67 to A's total 
miscellaneous itemized deductions, determined without regard to the 
$3,000 limitation of section 162(a) ($2,000/$10,000). Thus, after 
application of section 274(n) and section 67, A's deduction for living 
expenses is $4,800 ($6,750-$750-$1,200). However, pursuant to section 
162(a), A may deduct only $3,000 of such expenses. The amount of A's 
other miscellaneous itemized deductions that are disallowed under 
section 67 is $800 ($4,000x$2,000/$10,000). Thus, $3,200 ($4,000-$800) 
of A's miscellaneous itemized deductions (other than deductions for 
living expenses) are allowable after application of section 67. A's 
total allowable miscellaneous itemized deductions are $6,200 
($3,000+$3,200).

    (e) State legislators. See Sec. 1.62-1T(e)(4) with respect to rules 
regarding state legislator's expenses.

[T.D. 8189, 53 FR 9875, Mar. 28, 1988]



Sec. 1.67-2T  Treatment of pass-through entities (temporary).

    (a) Application of section 67. This section provides rules for the 
application of section 67 to partners, shareholders, beneficiaries, 
participants, and others with respect to their interests in pass-through 
entities (as defined in paragraph (g) of this section). In general, an 
affected investor (as defined in paragraph (h) of this section) in a 
pass-through entity shall separately take into account as an item of 
income and as an item of expense an amount equal to his or her allocable 
share of the affected expenses (as defined in paragraph (i) of this 
section) of the pass-through entity for purposes of determining his or 
her taxable income. Except as provided in paragraph (e)(1)(ii)(B) of 
this section, the expenses so taken into account shall be treated as 
paid or incurred by the affected investor in the same manner as paid or 
incurred by the pass-through entity. For rules regarding the application 
of section 67 to affected investors in--
    (1) Partnerships, S corporations, and grantor trusts, see paragraph 
(b) of this section,
    (2) Real estate mortgage investment conduits, see paragraph (c) of 
this section,
    (3) Common trust funds, see paragraph (d) of this section,
    (4) Nonpublicly offered regulated investment companies, see 
paragraph (e) of this section, and
    (5) Publicly offered regulated investment companies, see paragraph 
(p) of this section.
    (b) Partnerships, S corporations, and grantor trusts--(1) In 
general. Pursuant to section 702(a) and 1366(a) of the Code and the 
regulations thereunder, each partner of a partnership or shareholder of 
an S corporation shall take into account separately his or her 
distributive or pro rata share of any items of deduction of such 
partnership or corporation that are defined as miscellaneous itemized 
deductions pursuant to section 67(b). The 2-percent limitation described 
in section 67 does not apply to the partnership or corporation with 
respect to such deductions, but such deductions shall be included in the 
deductions of the partner or shareholder to which that limitation 
applies. Similarly, the limitation applies to the grantor or other 
person treated as the owner of a grantor trust with respect to items 
that are paid or incurred by a grantor trust and are treated as 
miscellaneous itemized deductions of the grantor or other person 
pursuant to Subpart E, Part 1, Subchapter J, Chapter 1 of the Code, but 
not to the trust itself. The 2-percent limitation applies to amounts 
otherwise deductible in taxable years of partners, shareholders, or 
grantors beginning after December 31, 1986, regardless of the taxable 
year of the partnership, corporation, or trust.
    (2) Example. The provisions of this paragraph (b) may be illustrated 
by the following example:


[[Page 114]]


    Example. P, a partnership, incurs $1,000 in expenses to which 
section 212 applies during its taxable year. A, an individual, is a 
partner in P. A's distributive share of the expenses to which section 
212 applies is $20, determined without regard to the 2-percent 
limitation of section 67. Pursuant to section 702(a), A must take $20 of 
expenses to which section 212 applies into account in determining his 
income tax. Pursuant to section 67, in determining his taxable income A 
may deduct his miscellaneous itemized deductions (including his $20 
distributive share of deductions from P) to the extent the total amount 
exceeds 2 percent of his adjusted gross income.

    (c) Real estate mortgage investment conduit. See Sec. 1.67-3T for 
rules regarding the application of section 67 to holders of interests in 
REMICs.
    (d) Common trust funds--(1) In general. For purposes of determining 
the taxable income of an affected investor that is a participant in a 
common trust fund--
    (i) The ordinary taxable income and ordinary net loss of the common 
trust fund shall be computed under section 584(d)(2) without taking into 
account any affected expenses, and
    (ii) Each affected investor shall be treated as having paid or 
incurred an expense described in section 212 in an amount equal to the 
affected investor's proportionate share of the affected expenses.

The 2-percent limitation described in section 67 applies to amounts 
otherwise deductible in taxable years of participants beginning after 
December 31, 1986, regardless of the taxable year of the common trust 
fund.
    (2) Example. The provisions of this paragraph (d) may be illustrated 
by the following example:

    Example. During 1987, the gross income and deductions of common 
trust fund C, a calendar year taxpayer, consist of the following items: 
(i) $50,000 of short-term capital gains; (ii) $150,000 of long-term 
capital gains; (iii) $1,000,000 of dividend income; (iv) $10,000 of 
deductions that are not affected expenses; and (v) $60,000 of deductions 
that are affected expenses. The proportionate share of Trust T in the 
income and losses of C is one percent. In computing its taxable income 
for 1987, T, a calendar year taxpayer, shall take into account the 
following items: (A) $500 of short-term capital gains (one percent of 
$50,000, C's short-term capital gains); (B) $1,500 of long-term capital 
gains (one percent of $150,000, C's long-term capital gains); (C) $9,900 
of ordinary taxable income (one percent of $990,000, the excess of 
$100,000, C's gross income after excluding capital gains and losses, 
over $10,000, C's deductions that are not affected expenses); (D) $600 
of expenses described in section 212 (one percent of $60,000, C's 
affected expenses).

    (e) Nonpublicly offered regulated investment companies--(1) In 
general. For purposes of determining the taxable income of an affected 
investor that is a shareholder of a nonpublicly offered regulated 
investment company (as defined in paragraph (g)(3) of this section) 
during a calendar year--
    (i) The current earnings and profits of the nonpublicly offered 
regulated investment company shall be computed without taking into 
account any affected RIC expenses that are allocated among affected 
investors, and
    (ii) The affected investor shall be treated--
    (A) As having received or accrued a dividend in an amount equal to 
the affected investor's allocable share of the affected RIC expenses of 
the nonpublicly offered regulated investment company for the calendar 
year, and
    (B) As having paid or incurred an expense described in section 212 
(or section 162 in the case of an affected investor that is a 
nonpublicly offered regulated investment company) in an amount equal to 
the affected investor's allocable share of the affected RIC expenses of 
the nonpublicly offered regulated investment company for the calendar 
year

in the affected investor's taxable year with which (or within which) the 
calendar year with respect to which the expenses are allocated ends. An 
affected investor's allocable share of the affected RIC expenses is the 
amount allocated to that affected investor pursuant to paragraph (k) of 
this section.
    (2) Shareholders that are not affected investors. A shareholder of a 
nonpublicly offered regulated investment company that is not an affected 
investor shall not take into account in computing its taxable income any 
amount of income or expense with respect to its allocable share of 
affected RIC expenses.
    (3) Example. The provisions of this paragraph (e) may be illustrated 
by the following example:


[[Page 115]]


    Example. During calendar year 1987, nonpublicly offered regulated 
investment company M distributes to individual shareholder A, a calendar 
year taxpayer, capital gain dividends of $1,000 and other dividends of 
$5,000. A's allocable share of the affected RIC expenses of M is $200. 
In computing A's taxable income for 1987, A shall take into account the 
following items: (i) $1,000 of long-term capital gains (the capital gain 
dividends received by A); (ii) $5,200 of dividend income (the sum of the 
other dividends received by A and A's allocable share of the affected 
RIC expenses of M); and (iii) $200 of expenses described in section 212 
(A's allocable share of the affected RIC expenses of M). A is allowed a 
deduction for miscellaneous itemized deductions (including A's $200 
allocable share of the affected RIC expenses of M, which is treated as 
an expense described in section 212) for 1987 only to the extent the 
aggregate of such deductions exceeds 2 percent of A's adjusted gross 
income for 1987.

    (f) Cross-reference. See Sec. 1.67-1T with respect to limitations 
on deductions for expenses described in section 212 (including amounts 
treated as such expenses under this section).
    (g) Pass-through entity--(1) In general. Except as provided in 
paragraph (g)(2) of this section, for purposes of section 67(c) and this 
section, a pass-through entity is--
    (i) A trust (or any portion thereof) to which Subpart E, Part 1, 
Subchapter J, Chapter 1 of the Code applies,
    (ii) A partnership,
    (iii) An S corporation,
    (iv) A common trust fund described in section 584,
    (v) A nonpublicly offered regulated investment company,
    (vi) A real estate mortgage investment conduit, and
    (vii) Any other person--
    (A) Which is not subject to the income tax imposed by Subtitle A, 
Chapter 1, or which is allowed a deduction in computing such tax for 
distributions to owners or beneficiaries, and
    (B) The character of the income of which may affect the character of 
the income recognized with respect to that person by its owners or 
beneficiaries.

Entities that do not meet the requirements of paragraph (g)(1)(vii) (A) 
and (B) of this section, such as qualified pension plans, individual 
retirement accounts, and insurance companies holding assets in separate 
asset accounts to fund variable contracts defined in section 817(d), are 
not described in this paragraph (g)(1).
    (2) Exception. For purposes of section 67(c) and this section, a 
pass-through entity does not include:
    (i) An estate;
    (ii) A trust (or any portion thereof) not described in paragraph 
(g)(1)(i) of this section,
    (iii) A cooperative described in section 1381(a)(2), determined 
without regard to subparagraphs (A) and (C) thereof, or
    (iv) A real estate investment trust.
    (3) Nonpublicly offered regulated investment company--(i) In 
general. For purposes of this section, the term ``nonpublicly offered 
regulated investment company'' means a regulated investment company to 
which Part I of Subchapter M of the Code applies that is not a publicly 
offered regulated investment company.
    (ii) Publicly offered regulated investment company. For purposes of 
this section, the term ``publicly offered regulated investment company'' 
means a regulated investment company to which Part I of Subchapter M of 
the Code applies the shares of which are--
    (A) Continuously offered pursuant to a public offering (within the 
meaning of section 4 of the Securities Act of 1933, as amended (15 
U.S.C. 77a to 77aa)),
    (B) Regularly traded on an established securities market, or
    (C) Held by or for no fewer than 500 persons at all times during the 
taxable year.
    (h) Affected investor--(1) In general. For purposes of this section, 
the term ``affected investor'' means a partner, shareholder, 
beneficiary, participant, or other interest holder in a pass-through 
entity at any time during the pass-through entity's taxable year that 
is--
    (i) An individual (other than a nonresident alien whose income with 
respect to his or her interest in the pass-through entity is not 
effectively connected with the conduct of a trade or business within the 
United States),
    (ii) A person, including a trust or estate, that computes its 
taxable income in the same manner as in the case of an individual; or

[[Page 116]]

    (iii) A pass-through entity if one or more of its partners, 
shareholders, beneficiaries, participants, or other interest holders is 
(A) a pass-through entity or (B) a person described in paragraph (h)(1) 
(i) or (ii) of this section.
    (2) Examples. The provisions of this paragraph (h) may be 
illustrated by the following examples:

    Example (1). Corporation X holds shares of nonpublicly offered 
regulated investment company R in its capacity as a nominee or custodian 
for individual A, the beneficial owner of the shares. Because the owner 
of the shares for Federal income tax purposes is an individual, the 
shares are owned by an affected investor.
    Example (2). Individual retirement account I owns shares of a 
nonpublicly offered regulated investment company. Because an individual 
retirement account is not a person described in paragraph (h)(1) of this 
section, the shares are not owned by an affected investor.

    (i) Affected expenses--(1) In general. In general, for purposes of 
this section, the term ``affected expenses'' means expenses that, if 
paid or incurred by an individual, would be deductible, if at all, as 
miscellaneous itemized deductions as defined in section 67(b).
    (2) Special rule for nonpublicly offered regulated investment 
companies. In the case of a nonpublicly offered regulated investment 
company, the term ``affected expenses'' means only affected RIC 
expenses.
    (j) Affected RIC expenses--(1) In general. In general, for purposes 
of this section the term ``affected RIC expenses'' means the excess of--
    (i) The aggregate amount of the expenses (other than expenses 
described in sections 62(a)(3) and 67(b) and Sec. 1.67-1T(b)) paid or 
incurred in the calendar year that are allowable as a deduction in 
determining the investment company taxable income (without regard to 
section 852(b)(2)(D)) of the nonpublicly offered regulated investment 
company for a taxable year that begins or ends with or within the 
calendar year, over
    (ii) The amount of expenses taken into account under paragraph 
(j)(1)(i) of this section that are allocable to the following items 
(whether paid separately or included as part of a fee paid to an 
investment advisor or other person for a variety of services):
    (A) Registration fees;
    (B) Directors' or trustees' fees;
    (C) Periodic meetings of directors, trustees, or shareholders;
    (D) Transfer agent fees;
    (E) Legal and accounting fees (other than fees for income tax return 
preparation or income tax advice); and
    (F) Shareholder communications required by law (e.g. the preparation 
and mailing of prospectuses and proxy statements).

Expenses described in paragraph (j)(1)(ii) (A) through (F) of this 
section do not include, for example, expenses allocable to investment 
advice, marketing activities, shareholder communications and other 
services not specifically described in paragraph (j)(1)(ii) (A) through 
(F) of this section, and custodian fees.
    (2) Safe harbor. If a nonpublicly offered regulated investment 
company makes an election under this paragraph (j)(2), the affected RIC 
expenses for a calendar year shall be treated as equal to 40 percent of 
the amount determined under paragraph (j)(1)(i) of this section for that 
calendar year. The nonpublicly offered regulated investment company 
shall make the election by attaching to its income tax return for the 
taxable year that includes the last day of the first calendar year for 
which the nonpublicly offered regulated investment company makes the 
election a statement that it is making an election under paragraph 
(j)(2) of this section. An election made pursuant to this paragraph 
(j)(2) shall remain in effect for all subsequent calendar years unless 
revoked with the consent of the Commissioner.
    (3) Reduction for unused RIC expenses. The amount determined under 
paragraph (j)(1)(i) of this section shall be reduced by the nonpublicly 
offered regulated investment company's net operating loss, if any, for 
the taxable year ending with or within the calendar year. In computing 
the nonpublicly offered regulated investment company's net operating 
loss for purposes of this section, the deduction for dividends paid 
shall not be allowed and any net capital gain for the taxable year shall 
be excluded.

[[Page 117]]

    (4) Exception. The affected RIC expenses of a nonpublicly offered 
regulated investment company will be treated as zero if the amount of 
its gross income for the calendar year (determined without regard to 
capital gain net income) is not greater than 1 percent of the sum of (i) 
such gross income and (ii) the amount of its interest income for the 
calendar year that is not includible in gross income pursuant to section 
103.
    (k) Allocation of expenses among nonpublicly offered regulated 
investment company shareholders--(1) General rule. A nonpublicly offered 
regulated investment company shall allocate to each of its affected 
investors that is a shareholder at any time during the calendar year, 
the affected investor's allocable share of the affected RIC expenses of 
the nonpublicly offered regulated investment company for that calendar 
year. (See paragraph (m) of this section for rules regarding estimates 
with respect to the amount of an affected investor's share of affected 
RIC expenses upon which certain persons can rely for certain purposes.) 
A nonpublicly offered regulated investment company may use any 
reasonable method to make the allocation. A method of allocation shall 
not be reasonable if--
    (i) The method can be expected to have the effect, if applied to all 
affected RIC expenses and all shareholders (whether or not affected 
investors), of allocating to the shareholders an amount of affected RIC 
expenses that is less than the affected RIC expenses of the nonpublicly 
offered regulated investment company for the calendar year,
    (ii) The method can be expected to have the effect of allocating a 
disproportionately high share of the affected RIC expenses of the 
nonpublicly offered regulated investment company to shareholders that 
are not affected investors or affected investors, the amount of whose 
miscellaneous itemized deductions (including their allocable share of 
affected RIC expenses) exceeds the 2-percent floor described in section 
67, or
    (iii) A principal purpose of the method of allocation is to avoid 
allocating affected RIC expenses to persons described in paragraph 
(h)(1) (i) or (ii) of this section whose miscellaneous itemized 
deductions (inclusive of their allocable share of affected RIC expenses) 
may not exceed the 2-percent floor described in section 67.
    (2) Reasonable allocation method described--(i) In general. The 
allocation method described in this paragraph (k)(2) shall be treated as 
a reasonable allocation method. Under the method described in this 
paragraph, an affected investor's allocable share of the affected RIC 
expenses of a nonpublicly offered regulated investment company is the 
amount that bears the same ratio to the amount of affected RIC expenses 
of the nonpublicly offered regulated investment company for the calendar 
year as--
    (A) The amount of dividends paid to the affected investor during the 
calendar year, bears to
    (B) The sum of--
    (1) The aggregate amount of dividends paid by the nonpublicly 
offered regulated investment company during the calendar year to all 
shareholders, and
    (2) Any amount on which tax is imposed under section 852(b)(1) for 
any taxable year of the nonpublicly offered regulated investment company 
ending within or with the calendar year.
    (ii) Exception. Paragraph (k)(2)(i) of this section does not apply 
if the amount of the deduction for dividends paid during the calendar 
year is zero.
    (iii) Dividends paid. For purposes of this paragraph (k)(2)--
    (A) Dividends that are treated as paid during a calendar year 
pursuant to section 852(b)(7) are treated as paid during that calendar 
year and not during the succeeding calendar year.
    (B) The term ``dividends paid'' does not include capital gain 
dividends (as defined in section 852(b)(3)(C)), exempt-interest 
dividends (as defined in section 852(b)(5)(A)), or any amount to which 
section 302(a) applies.
    (C) The dividends paid during a calendar year is determined without 
regard to section 855(a).
    (3) Reasonable allocation made by District Director. If a 
nonpublicly offered regulated investment company does not make a 
reasonable allocation of affected RIC expenses to its affected investors 
as required by paragraph (k)(1)

[[Page 118]]

of this section, a reasonable allocation shall be made by the District 
Director of the internal revenue district in which the principal place 
of business or principal office or agency of the nonpublicly offered 
regulated investment company is located.
    (4) Examples. The provisions of this paragraph (k) may be 
illustrated by the following examples:

    Example (1). Nonpublicly offered regulated investment company M, in 
calculating its investment company taxable income, claims a dividends 
paid deduction for a portion of redemption distributions (to which 
section 302(a) applies) to shareholders, as well as for nonredemption 
distributions. M allocates affected expenses among shareholders who have 
received nonredemption distributions by multiplying the amount of 
nonredemption distributions distributed to each shareholder by a 
fraction, the numerator of which is the affected RIC expenses of M and 
the denominator of which is M's investment company taxable income, 
determined on a calendar year basis and without regard to deductions 
described in section 852(b)(2)(D). No affected RIC expenses are 
allocated with respect to the redemption distributions. This allocation 
method can be expected to have the effect of allocating among the 
shareholders an amount of expenses that is less than the total amount of 
affected RIC expenses of M. Accordingly, the allocation method is not 
reasonable.
    Example (2). Nonpublicly offered regulated investment company N has 
two classes of stock, a ``capital'' class and an ``income'' class. 
Owners of the capital class receive the benefit of all capital 
appreciation on the stocks owned by N, and bear the burden of certain 
capital expenditures of N; owners of the income class receive the 
benefit of all other income of N, and bear the burden of all expenses of 
N that are deductible under section 162. M allocates all affected RIC 
expenses among shareholders of the income class shares under a method 
that would be reasonable if the income class were the only class of N 
stock. Corporations and other shareholders that are not affected 
investors own a higher proportion of income class shares than of capital 
class shares. The affected RIC expenses of N are properly allocated 
among the shareholders who bear the burden of those expenses. 
Accordingly, the allocation method does not have the effect of 
allocating a disproportionately high share of the affected RIC expenses 
of N to shareholders that are not affected investors merely because a 
disproportionate share of income class shares are owned by shareholders 
that are not affected investors. The allocation method is reasonable.
    Example (3). Nonpublicly offered regulated investment company O has 
two classes of stock, Class A and Class B. Shares of Class A, which may 
be purchased without payment of a sales or brokerage commission, are 
charged with the expenses of a Rule 12b-1 distribution plan of O. Shares 
of Class B, which may be purchased only upon payment of a sales or 
brokerage commission, are not charged with the expenses of the Rule 12b-
1 distribution plan of O. O allocates all affected RIC expenses among 
shareholders of Class A and Class B shares under a method that would be 
reasonable if Class A or Class B shares, respectively, were the only 
class of O stock. The affected RIC expenses attributable to the Rule 
12b-1 plan are allocated to the shareholders of Class A shares. 
Shareholders that are not affected investors own a higher proportion of 
Class A shares than of Class B shares. The affected RIC expenses of O 
are properly allocated among the shareholders who bear the burden of 
those expenses. Accordingly, the allocation method does not have the 
effect of allocating a disproportionately high share of the affected RIC 
expenses of O to shareholders that are not affected investors merely 
because a disproportionately high share of Class A shares are owned by 
persons that are not affected investors. The allocation method is 
reasonable.
    Example (4). Assume the facts are the same as in example (3) except 
that a portion of the affected RIC expenses attributable to the Rule 
12b-1 plan are allocated to the shareholders of Class B shares, and 
shareholders that are not affected investors own a higher proportion of 
Class B shares than of Class A shares. Thus, the affected RIC expenses 
are not allocated among the class of shareholders that bear the burden 
of the expenses. Accordingly, the allocation method has the effect of 
allocating a disproportionate share of the affected RIC expenses of O to 
the shareholders of Class B shares. Because shareholders that are not 
affected investors own a higher proportion of Class B shares than Class 
A shares, the method can be expected to allocate a disproportionately 
high share of the affected RIC expenses of O to shareholders that are 
not affected investors. Accordingly, the allocation method is not 
reasonable.

    (l) Affected RIC expenses not subject to backup withholding. The 
amount of dividend income that an affected investor in a nonpublicly 
offered regulated investment company is treated as having received or 
accrued under paragraph (e)(1)(ii) of this section is not subject to 
backup withholding under section 3406.
    (m) Reliance by nominees and pass-through investors on notices--(1) 
General

[[Page 119]]

rule. Persons described in paragraph (m)(3) of this section may, for the 
purposes described in that paragraph (m)(3), treat an affected 
investor's allocable share of the affected RIC expenses of a nonpublicly 
offered regulated investment company as being equal to an amount 
determined by the nonpublicly offered regulated investment company on 
the basis of a reasonable estimate (e.g., of allocable expenses as a 
percentage of dividend distributions or allocable expenses per share) 
that is (i) reported in writing by the nonpublicly offered regulated 
investment company to the person or (ii) reported in a newspaper or 
financial publication having a nationwide circulation (e.g., the Wall 
Street Journal or Standard and Poor's Weekly Dividend Record).
    (2) Estimates must be reasonable. In general, for purposes of 
paragraph (m)(1) of this section, estimates of affected RIC expenses of 
a nonpublicly offered regulated investment company will be treated as 
reasonable only if the nonpublicly offered regulated investment company 
makes a reasonable effort to offset material understatements (or 
overstatements) of affected RIC expenses for a period by increasing (or 
decreasing) estimates of affected RIC expenses for a subsequent period. 
Understatements or overstatements of affected RIC expenses that are not 
material may be corrected by making offsetting adjustments in future 
periods, provided that understatements and overstatements are treated 
consistently.
    (3) Application. Paragraph (m)(1) of this section shall apply to the 
following persons for the following purposes:
    (i) A nominee who, pursuant to section 6042(a)(1)(B) and paragraph 
(n)(2) of this section, is required to report dividends paid by a 
nonpublicly offered regulated investment company to the Internal Revenue 
Service and to the person to whom the payment is made, for purposes of 
reporting to the Internal Revenue Service and the person to whom the 
payment is made the amount of affected RIC expenses allocated to such 
person.
    (ii) An affected investor to whom a nominee (to which paragraph 
(m)(3)(i) of this section applies) reports, for purposes of calculating 
the affected investor's taxable income and the amount of its affected 
expenses.
    (iii) A shareholder that is a pass-through entity, for purposes of 
calculating its taxable income and the amount of its affected expenses.
    (n) Return of information and reporting to affected investors by a 
nonpublicly offered regulated investment company--(1) In general--(i) 
Return of information. A nonpublicly offered regulated investment 
company shall make an information return (e.g., Form 1099-DIV, Dividends 
and Distributions, for 1987) with respect to each affected investor to 
which an allocation of affected RIC expenses is required to be made 
pursuant to paragraph (k) of this section and for which the nonpublicly 
offered regulated investment company is required to make an information 
return to the Internal Revenue Service pursuant to section 6042 (or 
would be required to make such information return but for the $10 
threshold described in section 6042 (a)(1) (A) and (B). The nonpublicly 
offered regulated investment company shall make the information return 
for each calendar year and shall state separately on such return--
    (A) The amount of affected RIC expenses required to be allocated to 
the affected investor for the calendar year pursuant to paragraph (k) of 
this section,
    (B) The sum of--
    (1) The aggregate amount of the dividends paid to the affected 
investor during the calendar year, and
    (2) The amount of the affected RIC expenses required to be allocated 
to the affected investor for the calendar year pursuant to paragraph (k) 
of this section, and
    (C) Such other information as may be specified by the form or its 
instructions.
    (ii) Statement to be furnished to affected investors. A nonpublicly 
offered regulated investment company shall provide to each affected 
investor for each calendar year (whether or not the nonpublicly offered 
regulated investment company is required to make an information return 
with respect to the affected investor pursuant to section

[[Page 120]]

6042), a written statement showing the following information:
    (A) The information described in paragraph (n)(1)(i) of this section 
with respect to the affected investor;
    (B) The name and address of the nonpublicly offered regulated 
investment company;
    (C) The name and address of the affected investor; and
    (D) If the nonpublicly offered regulated investment company is 
required to report the amount of the affected investor's allocation of 
affected RIC expense to the Internal Revenue Service pursuant to 
paragraph (n)(1)(i) of this section a statement to that effect.
    (iii) Affected investor's shares held by a nominee. If an affected 
investor's shares in a nonpublicly offered regulated investment company 
are held in the name of a nominee, the nonpublicly offered regulated 
investment company may make the information return described in 
paragraph (n)(1)(i) of this section with respect to the nominee in lieu 
of the affected investor and may provide the written statement described 
in paragraph (n)(1)(ii) of this section to such nominee in lieu of the 
affected investor.
    (2) By a nominee--(i) In general. Except as otherwise provided for 
in paragraph (n)(2)(iii) of this section, in any case in which a 
nonpublicly offered regulated investment company provides, pursuant to 
paragraph (n)(1)(iii) of this section, a written statement to the 
nominee of an affected investor for a calendar year, the nominee shall--
    (A) If the nominee is required to make an information return 
pursuant to section 6042 (or would be required to make an information 
return but for the $10 threshold described in section 6042(a)(1) (A) and 
(B), make an information return (e.g., Form 1099-DIV, Dividends and 
Distributions, for 1987) for the calendar year with respect to each 
affected investor and state separately on such information return the 
information described in paragraph (n)(1)(i) of this section, and
    (B) Furnish each affected investor with a written statement for the 
calendar year showing the information required by paragraph (n)(2)(ii) 
of this section (whether or not the nominee is required to make an 
information return with respect to the affected investor pursuant to 
section 6042).
    (ii) Form of statement. The written statement required to be 
furnished for a calendar year pursuant to paragraph (n)(2)(i)(B) of this 
section shall show the following information:
    (A) The affected investor's proportionate share of the items 
described in paragraph (n)(1)(i) of this section for the calendar year,
    (B) The name and address of the nominee,
    (C) The name and address of the affected investor, and
    (D) If the nominee is required to report the affected investor's 
share of the allocable investment expenses to the Internal Revenue 
Service pursuant to paragraph (n)(2)(i)(A) of this section, a statement 
to that effect.
    (iii) Return not required. A nominee is not required to make an 
information return with respect to an affected investor pursuant to 
paragraph (n)(2)(i)(A) of this section if the nominee is excluded from 
the requirements of section 6042 pursuant to Sec. 1.6042-2(a)(1) (ii) 
or (iii).
    (iv) Statement not required. A nominee is not required to furnish a 
written statement to an affected investor pursuant to paragraph 
(n)(2)(i)(B) of this section if the nonpublicly offered regulated 
investment company furnishes the written statement to the affected 
investor pursuant to an agreement with the nominee described in Sec. 
1.6042-2(a)(1)(iii).
    (v) Special rule. Paragraph (n)(1) (i) and (ii) of this section 
applies to a nonpublicly offered regulated investment company that 
agrees with the nominee to satisfy the requirements of section 6042 as 
described in Sec. 1.6042-2(a)(1)(iii) with respect to the affected 
investor.
    (3) Time and place for furnishing returns. The returns required by 
paragraph (n)(1)(i) and (2)(i)(A) of this section for any calendar year 
shall be filed at the time and place that a return required under 
section 6042 is required to be filed. See Sec. 1.6042-2(c) .
    (4) Time for furnishing statements. The statements required by 
paragraph (n)(1)(ii) and (2)(i)(B) of this section to be furnished by a 
nonpublicly offered regulated investment company and a nominee, 
respectively, to an affected

[[Page 121]]

investor for a calendar year shall be furnished to such affected 
investor on or before January 31 of the following year.
    (5) Duplicative returns and statements not required--(i) Information 
return. The requirements of paragraph (n)(1)(i) and (2)(i)(A) of this 
section for the making of an information return shall be met by the 
timely filing of an information return pursuant to section 6042 that 
contains the information required by paragraph (n)(1)(i).
    (ii) Written statement. The requirements of paragraph (n)(1)(ii) and 
(2)(i)(B) of this section for the furnishing of a written statement 
(including the statement required by paragraph (n)(1)(ii)(D) and 
(2)(ii)(D) of this section) shall be met by furnishing the affected 
investor a copy of the information return to which section 6042 applies 
(whether or not the nonpublicly offered regulated investment company or 
nominee is required to file an information return with respect to the 
affected investor pursuant to section 6042) that contains the 
information required by paragraph (n)(1)(ii) or (2)(ii), whichever is 
applicable, of this section. Nonpublicly offered regulated investment 
companies and nominees may use a substitute form that contains 
provisions substantially similar to those of the prescribed form if the 
nonpublicly offered regulated investment company or nominee complies 
with all revenue procedures relating to substitute forms in effect at 
the time. The statement shall be furnished either in person or in a 
statement mailed by first-class mail that includes adequate notice that 
the statement is enclosed. A statement shall be considered to be 
furnished to an affected investor within the meaning of this section if 
it is mailed to such affected investor at its last known address.
    (o) Return of information by a common trust fund. With respect to 
each affected investor to which paragraph (d) of this section applies, 
the common trust fund shall state on the return it is required to make 
pursuant to section 6032 for its taxable year, the following 
information:
    (1) The amount of the affected investor's proportionate share of the 
affected expenses for the taxable year as described in paragraph 
(d)(1)(ii) of this section.
    (2) The amount of the affected investor's proportionate share of 
ordinary taxable income or ordinary net loss for the taxable year 
determined pursuant to paragraph (d)(1)(i) of this section, and
    (3) Such other information as may be specified by the form or its 
instructions.
    (p) Publicly offered regulated investment companies. [Reserved]

[T.D. 8189, 53 FR 9876, Mar. 28, 1988; 53 FR 13464, Apr. 25, 1988]



Sec. 1.67-3  Allocation of expenses by real estate mortgage investment 
conduits.

    (a) Allocation of allocable investment expenses. [Reserved]
    (b) Treatment of allocable investment expenses. [Reserved]
    (c) Computation of proportionate share. [Reserved]
    (d) Example. [Reserved]
    (e) Allocable investment expenses not subject to backup withholding. 
[Reserved]
    (f) Notice to pass-through interest holders--(1) Information 
required. A REMIC must provide to each pass-through interest holder to 
which an allocation of allocable investment expense is required to be 
made under Sec. 1.67-3T(a)(1) notice of the following--
    (i) If, pursuant to paragraph (f)(2)(i) or (ii) of this section, 
notice is provided for a calendar quarter, the aggregate amount of 
expenses paid or accrued during the calendar quarter for which the REMIC 
is allowed a deduction under section 212;
    (ii) If, pursuant to paragraph (f)(2)(ii) of this section, notice is 
provided to a regular interest holder for a calendar year, the aggregate 
amount of expenses paid or accrued during each calendar quarter that the 
regular interest holder held the regular interest in the calendar year 
and for which the REMIC is allowed a deduction under section 212; and
    (iii) The proportionate share of these expenses allocated to that 
pass-through interest holder, as determined under Sec. 1.67-3T(c).
    (2) Statement to be furnished--(i) To residual interest holder. For 
each calendar

[[Page 122]]

quarter, a REMIC must provide to each pass-through interest holder who 
holds a residual interest during the calendar quarter the notice 
required under paragraph (f)(1) of this section on Schedule Q (Form 
1066), as required in Sec. 1.860F-4(e).
    (ii) To regular interest holder. For each calendar year, a single-
class REMIC (as described in Sec. 1.67-3T(a)(2)(ii)(B)) must provide to 
each pass-through interest holder who held a regular interest during the 
calendar year the notice required under paragraph (f)(1) of this 
section. Quarterly reporting is not required. The information required 
to be included in the notice may be separately stated on the statement 
described in Sec. 1.6049-7(f) instead of on a separate statement 
provided in a separate mailing. See Sec. 1.6049-7(f)(4). The separate 
statement provided in a separate mailing must be furnished to each pass-
through interest holder no later than the last day of the month 
following the close of the calendar year.
    (3) Returns to the Internal Revenue Service--(i) With respect to 
residual interest holders. Any REMIC required under paragraphs (f)(1) 
and (2)(i) of this section to furnish information to any pass-through 
interest holder who holds a residual interest must also furnish such 
information to the Internal Revenue Service as required in Sec. 1.860F-
4(e)(4).
    (ii) With respect to regular interest holders. A single-class REMIC 
(as described in Sec. 1.67-3T(a)(2)(ii)(B)) must make an information 
return on Form 1099 for each calendar year, with respect to each pass-
through interest holder who holds a regular interest to which an 
allocation of allocable investment expenses is required to be made 
pursuant to Sec. 1.67-3T(a)(1) and (2)(ii). The preceding sentence 
applies with respect to a holder for a calendar year only if the REMIC 
is required to make an information return to the Internal Revenue 
Service with respect to that holder for that year pursuant to section 
6049 and Sec. 1.6049-7(b)(2)(i) (or would be required to make an 
information return but for the $10 threshold described in section 
6049(a)(1) and Sec. 1.6049-7(b)(2)(i)). The REMIC must state on the 
information return--
    (A) The sum of--
    (1) The aggregate amounts includible in gross income as interest (as 
defined in Sec. 1.6049-7(a)(1)(i) and (ii)), for the calendar year; and
    (2) The sum of the amount of allocable investment expenses required 
to be allocated to the pass-through interest holder for each calendar 
quarter during the calendar year pursuant to Sec. 1.67-3T(a); and
    (B) Any other information specified by the form or its instructions.
    (4) Interest held by nominees and other specified persons--(i) Pass-
through interest holder's interest held by a nominee. If a pass-through 
interest holder's interest in a REMIC is held in the name of a nominee, 
the REMIC may make the information return described in paragraphs 
(f)(3)(i) and (ii) of this section with respect to the nominee in lieu 
of the pass-through interest holder and may provide the written 
statement described in paragraphs (f)(2)(i) and (ii) of this section to 
that nominee in lieu of the pass-through interest holder.
    (ii) Regular interests in a single-class REMIC held by certain 
persons. If a person specified in Sec. 1.6049-7(e)(4) holds a regular 
interest in a single-class REMIC (as described in Sec. 1.67-
3T(a)(2)(ii)(B)), then the single-class REMIC must provide the 
information described in paragraphs (f)(1) and (f)(3)(ii)(A) and (B) of 
this section to that person with the information specified in Sec. 
1.6049-7(e)(2) as required in Sec. 1.6049-7(e).
    (5) Nominee reporting--(i) In general. In any case in which a REMIC 
provides information pursuant to paragraph (f)(4) of this section to a 
nominee of a pass-through interest holder for a calendar quarter or, as 
provided in paragraph (f)(2)(ii) of this section, for a calendar year--
    (A) The nominee must furnish each pass-through interest holder with 
a written statement described in paragraph (f)(2)(i) or (ii) of this 
section, whichever is applicable, showing the information described in 
paragraph (f)(1) of this section; and
    (B) The nominee must make an information return on Form 1099 for 
each calendar year, with respect to the pass-through interest holder and 
state on

[[Page 123]]

this information return the information described in paragraphs 
(f)(3)(ii) (A) and (B) of this section, if--
    (1) The nominee is a nominee for a pass-through interest holder who 
holds a regular interest in a single-class REMIC (as described in Sec. 
1.67-3T(a)(2)(ii)(B)); and
    (2) The nominee is required to make an information return pursuant 
to section 6049 and Sec. 1.6049-7 (b)(2)(i) and (b)(2)(ii)(B) (or would 
be required to make an information return but for the $10 threshold 
described in section 6049(a)(2) and Sec. 1.6049-7(b)(2)(i)) with 
respect to the pass-through interest holder.
    (ii) Time for furnishing statement. The statement required by 
paragraph (f)(5)(i)(A) of this section to be furnished by a nominee to a 
pass-through interest holder for a calendar quarter or calendar year 
must be furnished to this holder no later than 30 days after receiving 
the written statement described in paragraph (f)(2)(i) or (ii) of this 
section from the REMIC. If, however, pursuant to paragraph (f)(2)(ii) of 
this section, the information is separately stated on the statement 
described in Sec. 1.6049-7(f), then the information must be furnished 
to the pass-through interest holder in the time specified in Sec. 
1.6049-7(f)(5).
    (6) Special rules--(i) Time and place for furnishing returns. The 
returns required by paragraphs (f)(3)(ii) and (f)(5)(i)(B) of this 
section for any calendar year must be filed at the time and place that a 
return required under section 6049 and Sec. 1.6049-7(b)(2) is required 
to be filed. See Sec. 1.6049-4(g) and Sec. 1.6049-7(b)(2)(iv).
    (ii) Duplicative returns not required. The requirements of 
paragraphs (f)(3)(ii) and (f)(5)(i)(B) of this section for the making of 
an information return are satisfied by the timely filing of an 
information return pursuant to section 6049 and Sec. 1.6049-7(b)(2) 
that contains the information required by paragraph (f)(3)(ii) of this 
section.

[T.D. 8431, 57 FR 40321, Sept. 3, 1992]



Sec. 1.67-3T  Allocation of expenses by real estate mortgage investment 
conduits (temporary).

    (a) Allocation of allocable investment expenses--(1) In general. A 
real estate mortgage investment conduit or REMIC (as defined in section 
860D) shall allocate to each of its pass-through interest holders that 
holds an interest at any time during the calendar quarter the holder's 
proportionate share (as determined under paragraph (c) of this section) 
of the aggregate amount of allocable investment expenses of the REMIC 
for the calendar quarter.
    (2) Pass-through interest holder--(i) In general--(A) Meaning of 
term. Except as provided in paragraph (a)(2)(ii) of this section, the 
term ``pass-through interest holder'' means any holder of a REMIC 
residual interest (as definition in section 860G(a)(2)) that is--
    (1) An individual (other than a nonresident alien whose income with 
respect to his or her interest in the REMIC is not effectively connected 
with the conduct of a trade or business within the United States),
    (2) A person, including a trust or estate, that computes its taxable 
income in the same manner as in the case of an individual, or
    (3) A pass-through entity (as defined in paragraph (a)(3) of this 
section) if one or more of its partners, shareholders, beneficiaries, 
participants, or other interest holders is (i) a pass-through entity or 
(ii) a person described in paragraph (a)(2)(i)(A) (1) or (2) of this 
section.
    (B) Examples. The provisions of this paragraph (a)(2)(i) may be 
illustrated by the following examples:

    Example (1). Corporation X holds a residual interest in REMIC R in 
its capacity as a nominee or custodian for individual A, the beneficial 
owner of the interest. Because the owner of the interest for Federal 
income tax purposes is an individual, the interest is owned by a pass-
through interest holder.
    Example (2). Individual retirement account I holds a residual 
interest in a REMIC. Because an individual retirement account is not a 
person described in paragraph (a)(2)(i)(A) of this section, the interest 
is not held by a pass-through interest holder.

    (ii) Single-class REMIC--(A) In general. In the case of a single-
class REMIC, the term ``pass-through interest holder'' means any holder 
of either--
    (1) A REMIC regular interest (as defined in section 860G(a)(1)), or

[[Page 124]]

    (2) A REMIC residual interest, that is described in paragraph 
(a)(2)(i)(A) (1), (2), or (3) of this section.
    (B) Single-class REMIC. For purposes of paragraph (a)(2)(ii)(A) of 
this section, a single-class REMIC IS either--
    (1) A REMIC that would be classified as an investment trust under 
Sec. 301.7701-4(c)(1) but for its qualification as a REMIC under 
section 860D and Sec. 1.860D-1T, or
    (2) A REMIC that--
    (i) Is substantially similar to an investment trust under Sec. 
301.7701-4(c)(1), and
    (ii) Is structured with the principal purpose of avoiding the 
requirement of paragraphs (a)(1) and (2)(ii)(A) of this section to 
allocate allocable investment expenses to pass-through interest holders 
that hold regular interests in the REMIC.

For purposes of this paragraph (a)(2)(ii)(B), in determining whether a 
REMIC would be classified as an investment trust or is substantially 
similar to an investment trust, all interests in the REMIC shall be 
treated as ownership interests in the REMIC, without regard to whether 
or not they would be classified as debt for Federal income tax purposes 
in the absence of a REMIC election.
    (C) Examples. The provisions of paragraph (a)(2)(ii) of this section 
must be illustrated by the following examples:

    Example (1). Corporation M transfers mortgages to a bank under a 
trust agreement as described in Example (2) of Sec. 301.7701-4(c)(2). 
There are two classes of certificates. Holders of class C certificates 
are entitled to receive 90 percent of the payment of principal and 
interest on the mortgages; holders of class D certificates are entitled 
to receive the remaining 10 percent. The two classes of certificates are 
identical except that, in the event of a default on the underlying 
mortgages, the payment rights of class D certificates holders are 
subordinated to the rights of class C certificate holders. M sells the 
class C certificates to investors and retains the class D certificates. 
The trust would be classified as an investment trust under Sec. 
301.7701-4(c)(1) but for its qualification a REMIC under section 860D 
the class C certificates represent regular interests in the REMIC and 
the class D certificates represent residual interest in the REMIC. The 
REMIC is a single-class REMIC within the meaning of paragraph 
(a)(2)(ii)(B)(1) of this section and, accordingly, holders of both the 
class C and class D certificates who are described in paragraph 
(a)(2)(i)(A) (1), (2), or (3) of this section are treated as pass-
through interest holders.
    Example (2). Assume that the facts are the same as in Example (1) 
except that M structures the REMIC to include a second regular interest 
represented by class E certificates. The principal purpose of M in 
structuring the REMIC to include class E certificates is to avoid 
allocating allocable investment expenses to class C certificate holders. 
The class E certificate holders are entitled to receive the payments 
otherwise due the class D certificate holders until they have been paid 
a stated amount of principal plus interest. The fair market value of the 
class E certificate is ten percent of the fair market value of the class 
D certificate and, therefore, less than one percent of the fair market 
value of the REMIC. The REMIC would not be classified as an investment 
trust under Sec. 301.7701-4(c)(1) because the existence of the class E 
certificates is not incidental to the trust's purpose of facilitating 
direct investment in the assets of the trust. Nevertheless, because the 
fair market value of the class E certificates is de minimis, the REMIC 
is substantially similar to an investment trust under Sec. 301.7701-
4(c)(1). In addition, avoidance of the requirement to allocate allocable 
investment expenses to regular interest holders is the principal purpose 
of M in structuring the REMIC to include class E certificates. 
Therefore, the REMIC is a single-class REMIC within the meaning of 
paragraph (a)(2)(ii)(B)(2) of this section, and, accordingly, holders of 
both residual and regular interests who are described in paragraph 
(a)(2)(i)(A) (1), (2), or (3) of this section are treated as pass-
through interest holders.

    (3) Pass-through entity--(i) In general. Except as provided in 
paragraph (a)(3)(ii) of this section, for purposes of this section, a 
pass-through entity is--
    (A) A trust (or any portion thereof) to which Subpart E, Part 1, 
Subchapter J, Chapter 1 of the Code applies,
    (B) A partnership,
    (C) An S corporation,
    (D) A common trust fund described in section 584,
    (E) A nonpublicly offered regulated investment company (as defined 
in paragraph (a)(5)(i) of this section),
    (F) A REMIC, and
    (G) Any other person--
    (1) Which is not subject to income tax imposed by Subtitle A, 
Chapter 1, or which is allowed a deduction in computing such tax for 
distributions to owners or beneficiaries, and

[[Page 125]]

    (2) The character of the income of which may affect the character of 
the income recognized with respect to that person by its owners or 
beneficiaries.


Entities that do not meet the requirements of paragraphs (a)(3)(i)(G) 
(1) and (2), such as qualified pension plans, individual retirement 
accounts, and insurance companies holding assets in separate asset 
accounts to fund variable contracts defined in section 817(d), are not 
described in this paragraph (a)(3)(i).
    (ii) Exception. For purposes of this section, a pass-through entity 
does not include--
    (A) An estate,
    (B) A trust (or any portion thereof) not described in paragraph 
(a)(3)(i)(A) of this section,
    (C) A cooperative described without regard to subparagraphs (A) and 
(C) thereof, or
    (D) A real estate investment trust.
    (4) Allocable investment expenses. The term ``allocable investment 
expenses'' means the aggregate amount of the expenses paid or accrued in 
the calendar quarter for which a deduction is allowable under section 
212 in determining the taxable income of the REMIC for the calendar 
quarter.
    (5) Nonpublicly offered regulated investment company--(i) In 
general. For purposes of this section, the term ``nonpublicly offered 
regulated investment company'' means a regulated investment company to 
which Part I of Subchapter M of the Code applies that is not a publicly 
offered regulated investment company.
    (ii) Publicly offered regulated investment company. For purposes of 
this section, the term ``publicly offered regulated investment company'' 
means a regulated investment company to which Part I of subchapter M of 
the Code applies, the shares of which are--
    (A) Continuously offered pursuant to a public offering (within the 
meaning of section 4 of the Securities Act of 1933, as amended (15 
U.S.C. 77a to 77aa)),
    (B) Regularly traded on an established securities market, or
    (C) Held by or for no fewer than 500 persons at all times during the 
taxable year.
    (b) Treatment of allocable investment expenses--(1) By pass-through 
interest holders--(i) Taxable year ending with calendar quarter. A pass-
through interest holder whose taxable year is the calendar year or ends 
with a calendar quarter shall be treated as having--
    (A) Received or accrued income, and
    (B) Paid or incurred an expense described in section 212 (or section 
162 in the case of a pass-through interest holder that is a regulated 
investment company), in an amount equal to the pass-through interest 
holder's proportionate share of the allocable investment expenses of the 
REMIC for those calendar quarters that fall within the holder's taxable 
year.
    (ii) Taxable year not ending with calendar quarter. A pass-through 
interest holder whose taxable year does not end with a calendar quarter 
shall be treated as having--
    (A) Received or accrued income, and
    (B) Paid or incurred an expense described in section 212 (or section 
162 in the case of a pass-through interest holder that is a regulated 
investment company), in an amount equal to the sum of--
    (C) The pass-through interest holder's proportionate share of the 
allocable investment expenses of the REMIC for those calendar quarters 
that fall within the holder's taxable year, and
    (D) For each calendar quarter that overlaps the beginning or end of 
the taxable year, the sum of the daily amounts of the allocable 
investment expenses allocated to the holder pursuant to paragraph 
(c)(1)(ii) of this section for the days in the quarter that fall within 
the holder's taxable year.
    (2) Proportionate share of allocable investment expenses. For 
purposes of paragraph (b) of this section, a pass-through interest 
holder's proportionate share of the allocable investment expenses is the 
amount allocated to the pass-through interest holder pursuant to 
paragraph (a)(1) of this section.
    (3) Cross-reference. See Sec. 1.67-1T with respect to limitations 
on deductions for expenses described in section 212 (including amounts 
treated as such expenses under this section).
    (4) Interest income to holders of regular interests in certain 
REMICs. Any amount

[[Page 126]]

allocated under this section to the holder of a regular interest in a 
single-class REMIC (as described in paragraph (a)(2)(ii)(B) of this 
section) shall be treated as interest income.
    (5) No adjustment to basis. The basis of any holder's interest in a 
REMIC shall not be increased or decreased by the amount of the holder's 
proportionate share of allocable investment expenses.
    (6) Interest holders other than pass-through interest holders. An 
interest holder of a REMIC that is not a pass-through interest holder 
shall not take into account in computing its taxable income any amount 
of income or expense with respect to its proportionate share of 
allocable investment expenses.
    (c) Computation of proportionate share--(1) In general. For purposes 
of paragraph (a)(1) of this section, a REMIC shall compute a pass-
through interest holder's proportionate share of the REMIC's allocable 
investment expenses by--
    (i) Determining the daily amount of the allocable investment 
expenses for the calendar quarter by dividing the total amount of such 
expenses by the number of days in that calendar quarter.
    (ii) Allocating the daily amount of the allocable investment 
expenses to the pass-through interest holder in proportion to its 
respective holdings on that day, and
    (iii) Totaling the interest holder's daily amounts of allocable 
investment expenses for the calendar quarter.
    (2) Other holders taken into account. For purposes of paragraph 
(c)(1)(ii) of this section, a pass-through interest holder's 
proportionate share of the daily amount of the allocable investment 
expenses is determined by taking into account all holders of residual 
interests in the REMIC, whether or not pass-through interest holders.
    (3) Single-class REMIC--(i) Daily allocation. In lieu of the 
allocation specified in paragraph (c)(1)(ii) of this section, a single-
class REMIC (as described in paragraph (a)(2)(ii)(B) of this section) 
shall allocate the daily amount of the allocable investment expenses to 
each pass-through interest holder in proportion to the amount of income 
accruing to the holder with respect to its interest in the REMIC on that 
day.
    (ii) Other holders taken into account. For purposes of paragraph 
(c)(3)(i) of this section, the amount of the allocable investment 
expenses that is allocated on any day to each pass-through interest 
holder shall be determined by multiplying the daily amount of allocable 
investment expenses (determined pursuant to paragraph (c)(1)(i) of this 
section) by a fraction, the numerator of which is equal to the amount of 
income that accrues (but not less than zero) to the pass-through 
interest holder on that day and the denominator of which is the total 
amount of income (as determined under paragraph (c)(3)(iii) of this 
section) that accrues to all regular and residual interest holders, 
whether or not pass-through interest holders, on that day.
    (iii) Total income accruing. The total amount of income that accrues 
to all regular and residual interest holders is the sum of--
    (A) The amount includible under section 860B in the gross income 
(but not less than zero) of the regular interest holders, and
    (B) The amount of REMIC taxable income (but not less than zero) 
taken into account under section 860C by the residual interest holders.
    (4) Dates of purchase and disposition. For purposes of this section, 
a pass-through interest holder holds an interest on the date of its 
purchase but not on the date of its disposition.
    (d) Example. The provisions of this section may be illustrated by 
the following example:

    Example. (i) During the calendar quarter ending March 31, 1989, 
REMIC X, which is not a single-class REMIC, incurs $900 of allocable 
investment expenses. At the beginning of the calendar quarter, X has 4 
residual interest holders, who hold equal proportionate shares, and 10 
regular interest holders. The residual interest holders, all of whom 
have calendar-year taxable years, are as follows:
    A, an individual,
    C, a C corporation that is a nominee for individual I.
    S, an S corporation, and
    M, a C corporation that is not a nominee.
    (ii) Except for A, all of the residual interest holders hold their 
interests in X for the entire calendar quarter. On January 31, 1989, A 
sells his interest to S. Thus, for the first month of the calendar 
quarter, each residual

[[Page 127]]

interest holder holds a 25 percent interest (100%/4 interest holders) in 
X. For the last two months, S's holding is increased to 50 percent and 
A's holding is decreased to zero. The daily amount of allocable 
investment expenses for the calendar quarter is $10 ($900/90 days).
    (iii) The amount of allocable investment expenses apportioned to the 
residual interest holders is as follows:
    (A) $75 ($10 x 25% x 30 days) is allocated to A for the 30 days that 
A holds an interest in X during the calendar quarter. A includes $75 in 
gross income in calendar year 1989. The amount of A's expenses described 
in section 212 is increased by $75 in calendar year 1989. A's deduction 
under section 212 (including the $75 amount of the allocation) is 
subject to the limitations contained in section 67.
    (B) $225 ($10 x 25% x 90 days) is allocated to C. Because C is a 
nominee for I, C does not include $225 in gross income or increase its 
deductible expenses by $225. Instead, I includes $225 in gross income in 
calendar year 1989, her taxable year. The amount of I's expenses 
described in section 212 is increased by $225. I's deduction under 
section 212 (including the $225 amount of the allocation) is subject to 
the limitations contained in section 67.
    (C) $375 (($10 x 25% x 30 days) + ($10 x 50% x 60 days)) is 
allocated to S. S includes in gross income $375 of allocable investment 
expenses in calendar year 1989. The amount of S's expenses described in 
section 212 for that taxable year is increased by $375. S allocates the 
$375 to its shareholders in accordance with the rules described in 
sections 1366 and 1377 in calendar year 1989. Thus, each shareholder of 
S includes its pro rata share of the $375 in gross income in its taxable 
year in which or with which calendar year 1989 ends. The amount of each 
shareholder's expenses described in section 212 is increased by the 
amount of the shareholder's allocation for the shareholder's taxable 
year in which or with which calendar year 1989 ends. The shareholder's 
deduction under section 212 (including the allocation under this 
section) is subject to the limitations contained in section 67.
    (D) No amount is allocated to M. However, M's interest is taken into 
account for purposes of determining the proportionate share of those 
residual interest holders to whom an allocation is required to be made.
    (iv) No allocation is made to the 10 regular interest holders 
pursuant to paragraph (a) of this section. In addition, the interests 
held by these interest holders are not taken into account for purposes 
of determining the proportionate share of the residual interest holders 
to whom an allocation is required to be made.

    (e) Allocable investment expenses not subject to backup withholding. 
The amount of allocable investment expenses required to be allocated to 
a pass-through interest holder pursuant to paragraph (a)(1) of this 
section is not subject to backup withholding under section 3406.
    (f) Notice to pass-through interest holders--(1) Information 
required. A REMIC must provide to each pass-through interest holder to 
which an allocation of allocable investment expense is required to be 
made under paragraph (a)(1) of this section notice of the following--
    (i) If, pursuant to paragraph (f)(2) (i) or (ii) of this section, 
notice is provided for a calendar quarter, the aggregate amount of 
expenses paid or accrued during the calendar quarter for which the REMIC 
is allowed a deduction under section 212;
    (ii) If, pursuant to paragraph (f)(2)(ii) of this section, notice is 
provided to a regular interest holder for a calendar year, the aggregate 
amount of expenses paid or accrued during each calendar quarter that the 
regular interest holder held the regular interest in the calendar year 
and for which the REMIC is allowed a deduction under section 212; and
    (iii) The proportionate share of these expenses allocated to that 
pass-through interest holder, as determined under paragraph (c) of this 
section.
    (2) Statement to be furnished--(i) To residual interest holder. For 
each calendar quarter, a REMIC shall provide to each pass-through 
interest holder who holds a residual interest during the calendar 
quarter the notice required under paragraph (f)(1) of this section on 
Schedule Q (Form 1066), as required in Sec. 1.860F-4(e).
    (ii) To regular interest holder--(A) In general. For each calendar 
year, a single-class REMIC (as described in paragraph (a)(2)(ii)(B) of 
this section) must provide to each pass-through interest holder who held 
a regular interest during the calendar year the notice required under 
paragraph (f)(1) of this section. Quarterly reporting is not required. 
The information required to be included in the notice may be separately 
stated on the statement described in Sec. 1.6049-7(f) instead of on a 
separate statement provided in a separate mailing. See Sec. 1.6049-
7(f)(4). The

[[Page 128]]

separate statement provided in a separate mailing must be furnished to 
each pass-through interest holder no later than the last day of the 
month following the close of the calendar year.
    (B) Special rule for 1987. The information required under paragraph 
(f)(2)(ii)(A) of this section for any calendar quarter of 1987 shall be 
mailed (or otherwise delivered) to each pass-through interest holder who 
holds a regular interest during that calendar quarter no later than 
March 28, 1988.
    (3) Returns to the Internal Revenue Service--(i) With respect to 
residual interest holders. Any REMIC required under paragraphs (f)(1) 
and (2)(i) of this section to furnish information to any pass-through 
interest holder who holds a residual interest shall also furnish such 
information to the Internal Revenue Service as required in Sec. 1.860F-
4(e)(4).
    (ii) With respect to regular interest holders. A single-class REMIC 
(as described in paragraph (a)(2)(ii)(B) of this section) shall make an 
information return on Form 1099 for each calendar year beginning after 
December 31, 1987, with respect to each pass-through interest holder who 
holds a regular interest to which an allocation of allocable investment 
expenses is required to be made pursuant to paragraphs (a)(1) and 
(2)(ii) of this section. The preceding sentence applies with respect to 
a holder for a calendar year only if the REMIC is required to make an 
information return to the Internal Revenue Service with respect to that 
holder for that year pursuant to section 6049 and Sec. 1.6049-
7(b)(2)(i) (or would be required to make an information return but for 
the $10 threshold described in section 6049(a)(1) and Sec. 1.6049-
7(b)(2)(i)). The REMIC shall state on the information return--
    (A) The sum of--
    (1) The aggregate amounts includible in gross income as interest (as 
defined in Sec. 1.6049-7(a)(1) (i) and (ii)), for the calendar year, 
and
    (2) The sum of the amount of allocable investment expenses required 
to be allocated to the pass-through interest holder for each calendar 
quarter during the calendar year pursuant to paragraph (a) of this 
section, and
    (B) Any other information specified by the form or its instructions.
    (4) Interest held by nominees and other specified persons--(i) Pass-
through interest holder's interest held by a nominee. If a pass-through 
interest holder's interest in a REMIC is held in the name of a nominee, 
the REMIC may make the information return described in paragraphs (f)(3) 
(i) and (ii) of this section with respect to the nominee in lieu of the 
pass-through interest holder and may provide the written statement 
described in paragraphs (f)(2) (i) and (ii) of this section to that 
nominee in lieu of the pass-through interest holder.
    (ii) Regular interests in a single-class REMIC held by certain 
persons. For calendar quarters and calendar years after December 31, 
1991, if a person specified in Sec. 1.6049-7(e)(4) holds a regular 
interest in a single-class REMIC (as described in paragraph 
(a)(2)(ii)(B) of this section), then the single-class REMIC must provide 
the information described in paragraphs (f)(1) and (f)(3)(ii) (A) and 
(B) of this section to that person with the information specified in 
Sec. 1.6049-7(e)(2) as required in Sec. 1.6049-7(e).
    (5) Nominee reporting--(i) In general. In any case in which a REMIC 
provides information pursuant to paragraph (f)(4) of this section to a 
nominee of a pass-through interest holder for a calendar quarter or, as 
provided in paragraph (f)(2)(ii) of this section, for a calendar year--
    (A) The nominee shall furnish each pass-through interest holder with 
a written statement described in paragraph (f)(2) (i) or (ii) of this 
section, whichever is applicable, showing the information described in 
paragraph (f)(1) of this section, and
    (B) If--
    (1) The nominee is a nominee for a pass-through interest holder who 
holds a regular interest in a single-class REMIC (as described in 
paragraph (a)(2)(ii)(B) of this section), and
    (2) The nominee is required to make an information return pursuant 
to section 6049 and Sec. 1.6049-7(b)(2)(i) and (b)(2)(ii)(B) (or would 
be required to make an information return but for the $10 threshold 
described in section 6049(a)(2) and Sec. 1.6049-7(b)(2)(i)) with 
respect to the pass-through interest holder,

[[Page 129]]


the nominee shall make an information return on Form 1099 for each 
calendar year beginning after December 31, 1987, with respect to the 
pass-through interest holder and state on this information return the 
information described in paragraph (f)(3)(ii) (A) and (B) of this 
section.
    (ii) Time for furnishing statement. The statement required by 
paragraph (f)(5)(i)(A) of this section to be furnished by a nominee to a 
pass-through interest holder for a calendar quarter or calendar year 
shall be furnished to this holder no later than 30 days after receiving 
the written statement described in paragraph (f)(2) (i) or (ii) of this 
section from the REMIC. If, however, pursuant to paragraph (f)(2)(ii) of 
this section, the information is separately stated on the statement 
described in Sec. 1.6049-7(f), then the information must be furnished 
to the pass-through interest holder in the time specified in Sec. 
1.6049-7(f)(5).
    (6) Special rules--(i) Time and place for furnishing returns. The 
returns required by paragraphs (f)(3)(ii) and (f)(5)(i)(B) of this 
section for any calendar year shall be filed at the time and place that 
a return required under section 6049 and Sec. 1.6049-7(b)(2) is 
required to be filed. See Sec. 1.6049-4(g) and Sec. 1.6049-
7(b)(2)(iv).
    (ii) Duplicative returns not required. The requirements of 
paragraphs (f)(3)(ii) and (f)(5)(i)(B) of this section for the making of 
an information return shall be met by the timely filing of an 
information return pursuant to section 6049 and Sec. 1.6049-7(b)(2) 
that contains the information required by paragraph (f)(3)(ii) of this 
section.

[T.D. 8186, 53 FR 7507, Mar 9, 1988, as amended by T.D. 8366, 56 FR 
49515, Sept. 30, 1991]



Sec. 1.67-4T  Allocation of expenses by nongrantor trusts and estates 
(temporary). [Reserved]

               Items Specifically Included in Gross Income



Sec. 1.71-1  Alimony and separate maintenance payments; income to wife 
or former wife.

    (a) In general. Section 71 provides rules for treatment in certain 
cases of payments in the nature of or in lieu of alimony or an allowance 
for support as between spouses who are divorced or separated. For 
convenience, the payee spouse will hereafter in this section be referred 
to as the ``wife'' and the spouse from whom she is divorced or separated 
as the ``husband.'' See section 7701(a)(17). For rules relative to the 
deduction by the husband of periodic payments not attributable to 
transferred property, see section 215 and the regulations thereunder. 
For rules relative to the taxable status of income of an estate or trust 
in case of divorce, etc., see section 682 and the regulations 
thereunder.
    (b) Alimony or separate maintenance payments received from the 
husband--(1) Decree of divorce or separate maintenance. (i) In the case 
of divorce or legal separation, paragraph (1) of section 71(a) requires 
the inclusion in the gross income of the wife of periodic payments 
(whether or not made at regular intervals) received by her after a 
decree of divorce or of separate maintenance. Such periodic payments 
must be made in discharge of a legal obligation imposed upon or incurred 
by the husband because of the marital or family relationship under a 
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.
    (ii) For treatment of payments attributable to property transferred 
(in trust or otherwise), see paragraph (c) of this section.
    (2) Written separation agreement. (i) Where the husband and wife are 
separated and living apart and do not file a joint income tax return for 
the taxable year, paragraph (2) of section 71(a) requires the inclusion 
in the gross income of the wife of periodic payments (whether or not 
made at regular intervals) received by her pursuant to a written 
separation agreement executed after August 16, 1954. The periodic 
payments must be made under the terms of the written separation 
agreement after its execution and because of the marital or family 
relationship. Such payments are includable in the wife's gross income 
whether or not the agreement is a legally enforceable instrument. 
Moreover, if the wife is divorced or legally separated subsequent to the

[[Page 130]]

written separation agreement, payments made under such agreement 
continue to fall within the provisions of section 71(a)(2).
    (ii) For purposes of section 71(a)(2) any written separation 
agreement executed on or before August 16, 1954, which is altered or 
modified in writing by the parties in any material respect after that 
date will be treated as an agreement executed after August 16, 1954, 
with respect to payments made after the date of alteration or 
modification.
    (iii) For treatment of payments attributable to property transferred 
(in trust or otherwise), see paragraph (c) of this section.
    (3) Decree for support. (i) Where the husband and wife are separated 
and living apart and do not file a joint income tax return for the 
taxable year, paragraph (3) of section 71(a) requires the inclusion in 
the gross income of the wife of periodic payments (whether or not made 
at regular intervals) received by her after August 16, 1954, from her 
husband under any type of court order or decree (including an 
interlocutory decree of divorce or a decree of alimony pendente lite) 
entered after March 1, 1954, requiring the husband to make the payments 
for her support or maintenance. It is not necessary for the wife to be 
legally separated or divorced from her husband under a court order or 
decree; nor is it necessary for the order or decree for support to be 
for the purpose of enforcing a written separation agreement.
    (ii) For purposes of section 71(a)(3), any decree which is altered 
or modified by a court order entered after March 1, 1954, will be 
treated as a decree entered after such date.
    (4) Scope of section 71(a). Section 71(a) applies only to payments 
made because of the family or marital relationship in recognition of the 
general obligation to support which is made specific by the decree, 
instrument, or agreement. Thus, section 71(a) does not apply to that 
part of any periodic payment which is attributable to the repayment by 
the husband of, for example, a bona fide loan previously made to him by 
the wife, the satisfaction of which is specified in the decree, 
instrument, or agreement as a part of the general settlement between the 
husband and wife.
    (5) Year of inclusion. Periodic payments are includible in the 
wife's income under section 71(a) only for the taxable year in which 
received by her. As to such amounts, the wife is to be treated as if she 
makes her income tax returns on the cash receipts and disbursements 
method, regardless of whether she normally makes such returns on the 
accrual method. However, if the periodic payments described in section 
71(a) are to be made by an estate or trust, such periodic payments are 
to be included in the wife's taxable year in which they are includible 
according to the rules as to income of estates and trusts provided in 
sections 652, 662, and 682, whether or not such payments are made out of 
the income of such estates or trusts.
    (6) Examples. The foregoing rules are illustrated by the following 
examples in which it is assumed that the husband and wife file separate 
income tax returns on the calendar year basis:

    Example (1). W files suit for divorce from H in 1953. In 
consideration of W's promise to relinquish all marital rights and not to 
make public H's financial affairs, H agrees in writing to pay $200 a 
month to W during her lifetime if a final decree of divorce is granted 
without any provision for alimony. Accordingly, W does not request 
alimony and no provision for alimony is made under a final decree of 
divorce entered December 31, 1953. During 1954, H pays W $200 a month, 
pursuant to the promise. The $2,400 thus received by W is includible in 
her gross income under the provisions of section 71(a)(1). Under section 
215, H is entitled to a deduction of $2,400 from his gross income.
    Example (2). During 1945, H and W enter into an antenuptial 
agreement, under which, in consideration of W's relinquishment of all 
marital rights (including dower) in H's property, and, in order to 
provide for W's support and household expenses, H promises to pay W $200 
a month during her lifetime. Ten years after their marriage, W sues H 
for divorce but does not ask for or obtain alimony because of the 
provision already made for her support in the antenuptial agreement. 
Likewise, the divorce decree is silent as to such agreement and H's 
obligation to support W. Section 71(a) does not apply to such a case. 
If, however, the decree were modified so as to refer to the antenuptial 
agreement, or if reference had been made to the antenuptial

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agreement in the court's decree or in a written instrument incident to 
the divorce status, section 71(a)(1) would require the inclusion in W's 
gross income of the payments received by her after the decree. 
Similarly, if a written separation agreement were executed after August 
16, 1954, and incorporated the payment provisions of the antenuptial 
agreement, section 71(a)(2) would require the inclusion in W's income of 
payments received by W after W begins living apart from H, whether or 
not the divorce decree was subsequently entered and whether or not W was 
living apart from H when the separation agreement was executed, provided 
that such payments were made after such agreement was executed and 
pursuant to its terms. As to including such payments in W's income, if 
made by a trust created under the antenuptial agreement, regardless of 
whether referred to in the decree or a later instrument, or created 
pursuant to the written separation agreement, see section 682 and the 
regulations thereunder.
    Example (3). H and W are separated and living apart during 1954. W 
sues H for support and on February 1, 1954, the court enters a decree 
requiring H to pay $200 a month to W for her support and maintenance. No 
part of the $200 a month support payments is includible in W's income 
under section 71(a)(3) or deductible by H under section 215. If, 
however, the decree had been entered after March 1, 1954, or had been 
altered or modified by a court order entered after March 1, 1954, the 
payments received by W after August 16, 1954, under the decree as 
altered or modified would be includible in her income under section 
71(a)(3) and deductible by H under section 215.
    Example (4). W sues H for divorce in 1954. On January 15, 1954, the 
court awards W temporary alimony of $25 a week pending the final decree. 
On September 1, 1954, the court grants W a divorce and awards her $200 a 
month permanent alimony. No part of the $25 a week temporary alimony 
received prior to the decree is includible in W's income under section 
71(a), but the $200 a month received during the remainder of 1954 by W 
is includible in her income for 1954. Under section 215, H is entitled 
to deduct such $200 payments from his income. If, however, the decree 
awarding W temporary alimony had been entered after March 1, 1954, or 
had been altered or modified by a court order entered after March 1, 
1954, temporary alimony received by her after August 16, 1954, would be 
includible in her income under section 71(a)(3) and deductible by H 
under section 215.

    (c) Alimony and separate maintenance payments attributable to 
property. (1)(i) In the case of divorce or legal separation, paragraph 
(1) of section 71(a) requires the inclusion in the gross income of the 
wife of periodic payments (whether or not made at regular intervals) 
attributable to property transferred, in trust or otherwise, and 
received by her after a decree of divorce or of separate maintenance. 
Such property must have been transferred in discharge of a legal 
obligation imposed upon or incurred by the husband because of the 
marital or family relationship under a decree of divorce or separate 
maintenance or under a written instrument incident to such divorce 
status or legal separation status.
    (ii) Where the husband and wife are separated and living apart and 
do not file a joint income tax return for the taxable year, paragraph 
(2) of section 71(a) requires the inclusion in the gross income of the 
wife of periodic payments (whether or not made at regular intervals) 
received by her which are attributable to property transferred, in trust 
or otherwise, under a written separation agreement executed after August 
16, 1954. The property must be transferred because of the marital or 
family relationship. The periodic payments attributable to the property 
must be received by the wife after the written separation agreement is 
executed.
    (iii) The periodic payments received by the wife attributable to 
property transferred under subdivisions (i) and (ii) of this 
subparagraph and includible in her gross income are not to be included 
in the gross income of the husband.
    (2) The full amount of periodic payments received under the 
circumstances described in section 71(a) (1), (2), and (3) is required 
to be included in the gross income of the wife regardless of the source 
of such payments. Thus, it matters not that such payments are 
attributable to property in trust, to life insurance, endowment, or 
annuity contracts, or to any other interest in property, or are paid 
directly or indirectly by the husband from his income or capital. For 
example, if in order to meet an alimony or separate maintenance 
obligation of $500 a month the husband purchases or assigns for the 
benefit of his wife a commercial annuity contract paying such amount, 
the full $500 a month received by the wife is includible in her

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income, and no part of such amount is includible in the husband's income 
or deductible by him. See section 72(k) and the regulations thereunder. 
Likewise, if property is transferred by the husband, subject to an 
annual charge of $5,000, payable to his wife in discharge of his alimony 
or separate maintenance obligation under the divorce or separation 
decree or written instrument incident to the divorce status or legal 
separation status or if such property is transferred pursuant to a 
written separation agreement and subject to a similar annual charge, the 
$5,000 received annually is, under section 71(a) (1) or (2), includible 
in the wife's income, regardless of whether such amount is paid out of 
income or principal of the property.
    (3) The same rule applies to periodic payments attributable to 
property in trust. The full amount of periodic payments to which section 
71(a) (1) and (2) applies is includible in the wife's income regardless 
of whether such payments are made out of trust income. Such periodic 
payments are to be included in the wife's income under section 71(a) (1) 
or (2) and are to be excluded from the husband's income even though the 
income of the trust would otherwise be includible in his income under 
Subpart E, Part I, Subchapter J, Chapter 1 of the Code, relating to 
trust income attributable to grantors and others as substantial owners. 
As to periodic payments received by a wife attributable to property in 
trust in cases to which section 71(a) (1) or (2) does not apply because 
the husband's obligation is not specified in the decree or an instrument 
incident to the divorce status or legal separation status or the 
property was not transferred under a written separation agreement, see 
section 682 and the regulations thereunder.
    (4) Section 71(a) (1) or (2) does not apply to that part of any 
periodic payment attributable to that portion of any interest in 
property transferred in discharge of the husband's obligation under the 
decree or instrument incident to the divorce status or legal separation 
status, or transferred pursuant to the written separation agreement, 
which interest originally belonged to the wife. It will apply, however, 
if she received such interest from her husband in contemplation of or as 
an incident to the divorce or separation without adequate and full 
consideration in money or money's worth, other than the release of the 
husband or his property from marital obligations. An example of the 
first rule is a case where the husband and wife transfer securities, 
which were owned by them jointly, in trust to pay an annuity to the 
wife. In this case, the full amount of that part of the annuity received 
by the wife attributable to the husband's interest in the securities 
transferred in discharge of his obligation under the decree, or 
instrument incident to the divorce status or legal separation status, or 
transferred under the written separation agreement, is taxable to her 
under section 71(a) (1) or (2), while that portion of the annuity 
attributable to the wife's interest in the securities so transferred is 
taxable to her only to the extent it is out of trust income as provided 
in Part I (sections 641 and following), Subchapter J, Chapter 1 of the 
Code. If, however, the husband's transfer to his wife is made before 
such property is transferred in discharge of his obligation under the 
decree or written instrument, or pursuant to the separation agreement in 
an attempt to avoid the application of section 71(a) (1) or (2) to part 
of such payments received by his wife, such transfers will be considered 
as a part of the same transfer by the husband of his property in 
discharge of his obligation or pursuant to such agreement. In such a 
case, section 71(a) (1) or (2) will be applied to the full amount 
received by the wife. As to periodic payments received under a joint 
purchase of a commercial annuity contract, see section 72 and the 
regulations thereunder.
    (d) Periodic and installment payments. (1) In general, installment 
payments discharging a part of an obligation the principal sum of which 
is, in terms of money or property, specified in the decree, instrument, 
or agreement are not considered ``periodic payments'' and therefore are 
not to be included under section 71(a) in the wife's income.
    (2) An exception to the general rule stated in subparagraph (1) of 
this paragraph is provided, however, in cases where such principal sum, 
by the terms

[[Page 133]]

of the decree, instrument, or agreement, may be or is to be paid over a 
period ending more than 10 years from the date of such decree, 
instrument, or agreement. In such cases, the installment payment is 
considered a periodic payment for the purposes of section 71(a) but only 
to the extent that the installment payment, or sum of the installment 
payments, received during the wife's taxable year does not exceed 10 
percent of the principal sum. This 10-percent limitation applies to 
installment payments made in advance but does not apply to delinquent 
installment payments for a prior taxable year of the wife made during 
her taxable year.
    (3)(i) Where payments under a decree, instrument, or agreement are 
to be paid over a period ending 10 years or less from the date of such 
decree, instrument, or agreement, such payments are not installment 
payments discharging a part of an obligation the principal sum of which 
is, in terms of money or property, specified in the decree, instrument, 
or agreement (and are considered periodic payments for the purposes of 
section 71(a)) only if such payments meet the following two conditions:
    (a) Such payments are subject to any one or more of the 
contingencies of death of either spouse, remarriage of the wife, or 
change in the economic status of either spouse, and
    (b) Such payments are in the nature of alimony or an allowance for 
support.
    (ii) Payments meeting the requirements of subdivision (i) are 
considered periodic payments for the purposes of section 71(a) 
regardless of whether--
    (a) The contingencies described in subdivision (i)(a) of this 
subparagraph are set forth in the terms of the decree, instrument, or 
agreement, or are imposed by local law, or
    (b) The aggregate amount of the payments to be made in the absence 
of the occurrence of the contingencies described in subdivision (i)(a) 
of this subparagraph is explicitly stated in the decree, instrument, or 
agreement or may be calculated from the face of the decree, instrument, 
or agreement, or
    (c) The total amount which will be paid may be calculated 
actuarially.
    (4) Where payments under a decree, instrument, or agreement are to 
be paid over a period ending more than ten years from the date of such 
decree, instrument, or agreement, but where such payments meet the 
conditions set forth in subparagraph (3)(i) of this paragraph, such 
payments are considered to be periodic payments for the purpose of 
section 71 without regard to the rule set forth in subparagraph (2) of 
this paragraph. Accordingly, the rules set forth in subparagraph (2) of 
this paragraph are not applicable to such payments.
    (5) The rules as to periodic and installment payments are 
illustrated by the following examples:

    Example (1). Under the terms of a written instrument, H is required 
to make payments to W which are in the nature of alimony, in the amount 
of $100 a month for nine years. The instrument provides that if H or W 
dies the payments are to cease. The payments are periodic.
    Example (2). The facts are the same as in example (1) except that 
the written instrument explicitly provides that H is to pay W the sum of 
$10,800 in monthly payments of $100 over a period of nine years. The 
payments are periodic.
    Example (3). Under the terms of a written instrument, H is to pay W 
$100 a month over a period of nine years. The monthly payments are not 
subject to any of the contingencies of death of H or W, remarriage of W, 
or change in the economic status of H or W under the terms of the 
written instrument or by reason of local law. The payments are not 
periodic.
    Example (4). A divorce decree in 1954 provides that H is to pay W 
$20,000 each year for the next five years, beginning with the date of 
the decree, and then $5,000 each year for the next ten years. Assuming 
the wife makes her returns on the calendar year basis, each payment 
received in the years 1954 to 1958, inclusive, is treated as a periodic 
payment under section 71(a)(1), but only to the extent of 10 percent of 
the principal sum of $150,000. Thus, for such taxable years, only 
$15,000 of the $20,000 received is includible under section 71(a)(1) in 
the wife's income and is deductible by the husband under section 215. 
For the years 1959 to 1968, inclusive, the full $5,000 received each 
year by the wife is includible in her income and is deductible from the 
husband's income.

    (e) Payments for support of minor children. Section 71(a) does not 
apply to that part of any periodic payment which, by the terms of the 
decree, instrument, or agreement under section

[[Page 134]]

71(a), is specifically designated as a sum payable for the support of 
minor children of the husband. The statute prescribes the treatment in 
cases where an amount or portion is so fixed but the amount of any 
periodic payment is less than the amount of the periodic payment 
specified to be made. In such cases, to the extent of the amount which 
would be payable for the support of such children out of the originally 
specified periodic payment, such periodic payment is considered a 
payment for such support. For example, if the husband is by terms of the 
decree, instrument, or agreement required to pay $200 a month to his 
divorced wife, $100 of which is designated by the decree, instrument, or 
agreement to be for the support of their minor children, and the husband 
pays only $150 to his wife, $100 is nevertheless considered to be a 
payment by the husband for the support of the children. If, however, the 
periodic payments are received by the wife for the support and 
maintenance of herself and of minor children of the husband without such 
specific designation of the portion for the support of such children, 
then the whole of such amounts is includible in the income of the wife 
as provided in section 71(a). Except in cases of a designated amount or 
portion for the support of the husband's minor children, periodic 
payments described in section 71(a) received by the wife for herself and 
any other person or persons are includible in whole in the wife's 
income, whether or not the amount or portion for such other person or 
persons is designated.



Sec. 1.71-1T  Alimony and separate maintenance payments (temporary).

    (a) In general.
    Q-1 What is the income tax treatment of alimony or separate 
maintenance payments?
    A-1 Alimony or separate maintenance payments are, under section 71, 
included in the gross income of the payee spouse and, under section 215, 
allowed as a deduction from the gross income of the payor spouse.
    Q-2 What is an alimony or separate maintenance payment?
    A-2 An alimony or separate maintenance payment is any payment 
received by or on behalf of a spouse (which for this purpose includes a 
former spouse) of the payor under a divorce or separation instrument 
that meets all of the following requirements:
    (a) The payment is in cash (see A-5).
    (b) The payment is not designated as a payment which is excludible 
from the gross income of the payee and nondeductible by the payor (see 
A-8).
    (c) In the case of spouses legally separated under a decree of 
divorce or separate maintenance, the spouses are not members of the same 
household at the time the payment is made (see A-9).
    (d) The payor has no liability to continue to make any payment after 
the death of the payee (or to make any payment as a substitute for such 
payment) and the divorce or separation instrument states that there is 
no such liability (see A-10).
    (e) The payment is not treated as child support (see A-15).
    (f) To the extent that one or more annual payments exceed $10,000 
during any of the 6-post-separation years, the payor is obligated to 
make annual payments in each of the 6-post-separation years (see A-19).
    Q-3 In order to be treated as alimony or separate maintenance 
payments, must the payments be ``periodic'' as that term was defined 
prior to enactment of the Tax Reform Act of 1984 or be made in discharge 
of a legal obligation of the payor to support the payee arising out of a 
marital or family relationship?
    A-3 No. The Tax Reform Act of 1984 replaces the old requirements 
with the requirements described in A-2 above. Thus, the requirements 
that alimony or separate maintenance payments be ``periodic'' and be 
made in discharge of a legal obligation to support arising out of a 
marital or family relationship have been eliminated.
    Q-4 Are the instruments described in section 71(a) of prior law the 
same as divorce or separation instruments described in section 71, as 
amended by the Tax Reform Act of 1984?
    A-4 Yes.
    (b) Specific requirements.
    Q-5 May alimony or separate maintenance payments be made in a form 
other than cash?

[[Page 135]]

    A-5 No. Only cash payments (including checks and money orders 
payable on demand) qualify as alimony or separate maintenance payments. 
Transfers of services or property (including a debt instrument of a 
third party or an annuity contract), execution of a debt instrument by 
the payor, or the use of property of the payor do not qualify as alimony 
or separate maintenance payments.
    Q-6 May payments of cash to a third party on behalf of a spouse 
qualify as alimony or separate maintenance payments if the payments are 
pursuant to the terms of a divorce or separation instrument?
    A-6 Yes. Assuming all other requirements are satisfied, a payment of 
cash by the payor spouse to a third party under the terms of the divorce 
or separation instrument will qualify as a payment of cash which is 
received ``on behalf of a spouse''. For example, cash payments of rent, 
mortgage, tax, or tuition liabilities of the payee spouse made under the 
terms of the divorce or separation instrument will qualify as alimony or 
separate maintenance payments. Any payments to maintain property owned 
by the payor spouse and used by the payee spouse (including mortgage 
payments, real estate taxes and insurance premiums) are not payments on 
behalf of a spouse even if those payments are made pursuant to the terms 
of the divorce or separation instrument. Premiums paid by the payor 
spouse for term or whole life insurance on the payor's life made under 
the terms of the divorce or separation instrument will qualify as 
payments on behalf of the payee spouse to the extent that the payee 
spouse is the owner of the policy.
    Q-7 May payments of cash to a third party on behalf of a spouse 
qualify as alimony or separate maintenance payments if the payments are 
made to the third party at the written request of the payee spouse?
    A-7 Yes. For example, instead of making an alimony or separate 
maintenance payment directly to the payee, the payor spouse may make a 
cash payment to a charitable organization if such payment is pursuant to 
the written request, consent or ratification of the payee spouse. Such 
request, consent or ratification must state that the parties intend the 
payment to be treated as an alimony or separate maintenance payment to 
the payee spouse subject to the rules of section 71, and must be 
received by the payor spouse prior to the date of filing of the payor's 
first return of tax for the taxable year in which the payment was made.
    Q-8 How may spouses designate that payments otherwise qualifying as 
alimony or separate maintenance payments shall be excludible from the 
gross income of the payee and nondeductible by the payor?
    A-8 The spouses may designate that payments otherwise qualifying as 
alimony or separate maintenance payments shall be nondeductible by the 
payor and excludible from gross income by the payee by so providing in a 
divorce or separation instrument (as defined in section 71(b)(2)). If 
the spouses have executed a written separation agreement (as described 
in section 71(b)(2)(B)), any writing signed by both spouses which 
designates otherwise qualifying alimony or separate maintenance payments 
as nondeductible and excludible and which refers to the written 
separation agreement will be treated as a written separation agreement 
(and thus a divorce or separation instrument) for purposes of the 
preceding sentence. If the spouses are subject to temporary support 
orders (as described in section 71(b)(2)(C)), the designation of 
otherwise qualifying alimony or separate payments as nondeductible and 
excludible must be made in the original or a subsequent temporary 
support order. A copy of the instrument containing the designation of 
payments as not alimony or separate maintenance payments must be 
attached to the payee's first filed return of tax (Form 1040) for each 
year in which the designation applies.
    Q-9 What are the consequences if, at the time a payment is made, the 
payor and payee spouses are members of the same household?
    A-9 Generally, a payment made at the time when the payor and payee 
spouses are members of the same household cannot qualify as an alimony 
or separate maintenance payment if the spouses are legally separated 
under a decree of divorce or of

[[Page 136]]

separate maintenance. For purposes of the preceding sentence, a dwelling 
unit formerly shared by both spouses shall not be considered two 
separate households even if the spouses physically separate themselves 
within the dwelling unit. The spouses will not be treated as members of 
the same household if one spouse is preparing to depart from the 
household of the other spouse, and does depart not more than one month 
after the date the payment is made. If the spouses are not legally 
separated under a decree of divorce or separate maintenance, a payment 
under a written separation agreement or a decree described in section 
71(b)(2)(C) may qualify as an alimony or separate maintenance payment 
notwithstanding that the payor and payee are members of the same 
household at the time the payment is made.
    Q-10 Assuming all other requirements relating to the qualification 
of certain payments as alimony or separate maintenance payments are met, 
what are the consequences if the payor spouse is required to continue to 
make the payments after the death of the payee spouse?
    A-10 None of the payments before (or after) the death of the payee 
spouse qualify as alimony or separate maintenance payments.
    Q-11 What are the consequences if the divorce or separation 
instrument fails to state that there is no liability for any period 
after the death of the payee spouse to continue to make any payments 
which would otherwise qualify as alimony or separate maintenance 
payments?
    A-11 If the instrument fails to include such a statement, none of 
the payments, whether made before or after the death of the payee 
spouse, will qualify as alimony or separate maintenance payments.

    Example (1). A is to pay B $10,000 in cash each year for a period of 
10 years under a divorce or separation instrument which does not state 
that the payments will terminate upon the death of B. None of the 
payments will qualify as alimony or separate maintenance payments.
    Example (2). A is to pay B $10,000 in cash each year for a period of 
10 years under a divorce or separation instrument which states that the 
payments will terminate upon the death of B. In addition, under the 
instrument, A is to pay B or B's estate $20,000 in cash each year for a 
period of 10 years. Because the $20,000 annual payments will not 
terminate upon the death of B, these payments will not qualify as 
alimony or separate maintenance payments. However, the separate $10,000 
annual payments will qualify as alimony or separate maintenance 
payments.

    Q-12 Will a divorce or separation instrument be treated as stating 
that there is no liability to make payments after the death of the payee 
spouse if the liability to make such payments terminates pursuant to 
applicable local law or oral agreement?
    A-12 No. Termination of the liability to make payments must be 
stated in the terms of the divorce or separation instrument.
    Q-13 What are the consequences if the payor spouse is required to 
make one or more payments (in cash or property) after the death of the 
payee spouse as a substitute for the continuation of pre-death payments 
which would otherwise qualify as alimony or separate maintenance 
payments?
    A-13 If the payor spouse is required to make any such substitute 
payments, none of the otherwise qualifying payments will qualify as 
alimony or separate maintenance payments. The divorce or separation 
instrument need not state, however, that there is no liability to make 
any such substitute payment.
    Q-14 Under what circumstances will one or more payments (in cash or 
property) which are to occur after the death of the payee spouse be 
treated as a substitute for the continuation of payments which would 
otherwise qualify as alimony or separate maintenance payments?
    A-14 To the extent that one or more payments are to begin to be 
made, increase in amount, or become accelerated in time as a result of 
the death of the payee spouse, such payments may be treated as a 
substitute for the continuation of payments terminating on the death of 
the payee spouse which would otherwise qualify as alimony or separate 
maintenance payments. The determination of whether or not such payments 
are a substitute for the continuation of payments which would otherwise 
qualify as alimony or separate maintenance payments, and of the

[[Page 137]]

amount of the otherwise qualifying alimony or separate maintenance 
payments for which any such payments are a substitute, will depend on 
all of the facts and circumstances.

    Example (1). Under the terms of a divorce decree, A is obligated to 
make annual alimony payments to B of $30,000, terminating on the earlier 
of the expiration of 6 years or the death of B. B maintains custody of 
the minor children of A and B. The decree provides that at the death of 
B, if there are minor children of A and B remaining, A will be obligated 
to make annual payments of $10,000 to a trust, the income and corpus of 
which are to be used for the benefit of the children until the youngest 
child attains the age of majority. These facts indicate that A's 
liability to make annual $10,000 payments in trust for the benefit of 
his minor children upon the death of B is a substitute for $10,000 of 
the $30,000 annual payments to B. Accordingly, $10,000 of each of the 
$30,000 annual payments to B will not qualify as alimony or separate 
maintenance payments.
    Example (2). Under the terms of a divorce decree, A is obligated to 
make annual alimony payments to B of $30,000, terminating on the earlier 
of the expiration of 15 years or the death of B. The divorce decree 
provides that if B dies before the expiration of the 15 year period, A 
will pay to B's estate the difference between the total amount that A 
would have paid had B survived, minus the amount actually paid. For 
example, if B dies at the end of the 10th year in which payments are 
made, A will pay to B's estate $150,000 ($450,000-$300,000). These facts 
indicate that A's liability to make a lump sum payment to B's estate 
upon the death of B is a substitute for the full amount of each of the 
annual $30,000 payments to B. Accordingly, none of the annual $30,000 
payments to B will qualify as alimony or separate maintenance payments. 
The result would be the same if the lump sum payable at B's death were 
discounted by an appropriate interest factor to account for the 
prepayment.

    (c) Child support payments.
    Q-15 What are the consequences of a payment which the terms of the 
divorce or separation instrument fix as payable for the support of a 
child of the payor spouse?
    A-15 A payment which under the terms of the divorce or separation 
instrument is fixed (or treated as fixed) as payable for the support of 
a child of the payor spouse does not qualify as an alimony or separate 
maintenance payment. Thus, such a payment is not deductible by the payor 
spouse or includible in the income of the payee spouse.
    Q-16 When is a payment fixed (or treated as fixed) as payable for 
the support of a child of the payor spouse?
    A-16 A payment is fixed as payable for the support of a child of the 
payor spouse if the divorce or separation instrument specifically 
designates some sum or portion (which sum or portion may fluctuate) as 
payable for the support of a child of the payor spouse. A payment will 
be treated as fixed as payable for the support of a child of the payor 
spouse if the payment is reduced (a) on the happening of a contingency 
relating to a child of the payor, or (b) at a time which can clearly be 
associated with such a contingency. A payment may be treated as fixed as 
payable for the support of a child of the payor spouse even if other 
separate payments specifically are designated as payable for the support 
of a child of the payor spouse.
    Q-17 When does a contingency relate to a child of the payor?
    A-17 For this purpose, a contingency relates to a child of the payor 
if it depends on any event relating to that child, regardless of whether 
such event is certain or likely to occur. Events that relate to a child 
of the payor include the following: the child's attaining a specified 
age or income level, dying, marrying, leaving school, leaving the 
spouse's household, or gaining employment.
    Q-18 When will a payment be treated as to be reduced at a time which 
can clearly be associated with the happening of a contingency relating 
to a child of the payor?
    A-18 There are two situations, described below, in which payments 
which would otherwise qualify as alimony or separate maintenance 
payments will be presumed to be reduced at a time clearly associated 
with the happening of a contingency relating to a child of the payor. In 
all other situations, reductions in payments will not be treated as 
clearly associated with the happening of a contingency relating to a 
child of the payor.
    The first situation referred to above is where the payments are to 
be reduced not more than 6 months before or after the date the child is 
to attain the age of 18, 21, or local age of majority. The second 
situation is where the

[[Page 138]]

payments are to be reduced on two or more occasions which occur not more 
than one year before or after a different child of the payor spouse 
attains a certain age between the ages of 18 and 24, inclusive. The 
certain age referred to in the preceding sentence must be the same for 
each such child, but need not be a whole number of years.
    The presumption in the two situations described above that payments 
are to be reduced at a time clearly associated with the happening of a 
contingency relating to a child of the payor may be rebutted (either by 
the Service or by taxpayers) by showing that the time at which the 
payments are to be reduced was determined independently of any 
contingencies relating to the children of the payor. The presumption in 
the first situation will be rebutted conclusively if the reduction is a 
complete cessation of alimony or separate maintenance payments during 
the sixth post-separation year (described in A-21) or upon the 
expiration of a 72-month period. The presumption may also be rebutted in 
other circumstances, for example, by showing that alimony payments are 
to be made for a period customarily provided in the local jurisdiction, 
such as a period equal to one-half the duration of the marriage.

    Example: A and B are divorced on July 1, 1985, when their children, 
C (born July 15, 1970) and D (born September 23, 1972), are 14 and 12, 
respectively. Under the divorce decree, A is to make alimony payments to 
B of $2,000 per month. Such payments are to be reduced to $1,500 per 
month on January 1, 1991 and to $1,000 per month on January 1, 1995. On 
January 1, 1991, the date of the first reduction in payments, C will be 
20 years 5 months and 17 days old. On January 1, 1995, the date of the 
second reduction in payments, D will be 22 years 3 months and 9 days 
old. Each of the reductions in payments is to occur not more than one 
year before or after a different child of A attains the age of 21 years 
and 4 months. (Actually, the reductions are to occur not more than one 
year before or after C and D attain any of the ages 21 years 3 months 
and 9 days through 21 years 5 months and 17 days.) Accordingly, the 
reductions will be presumed to clearly be associated with the happening 
of a contingency relating to C and D. Unless this presumption is 
rebutted, payments under the divorce decree equal to the sum of the 
reduction ($1,000 per month) will be treated as fixed for the support of 
the children of A and therefore will not qualify as alimony or separate 
maintenance payments.

    (d) Excess front-loading rules.
    Q-19 What are the excess front-loading rules?
    A-19 The excess front-loading rules are two special rules which may 
apply to the extent that payments in any calendar year exceed $10,000. 
The first rule is a minimum term rule, which must be met in order for 
any annual payment, to the extent in excess of $10,000, to qualify as an 
alimony or separate maintenance payment (see A-2(f)). This rule requires 
that alimony or separate maintenance payments be called for, at a 
minimum, during the 6 ``post-separation years''. The second rule is a 
recapture rule which characterizes payments retrospectively by requiring 
a recalculation and inclusion in income by the payor and deducation by 
the payee of previously paid alimony or separate maintenance payment to 
the extent that the amount of such payments during any of the 6 ``post-
separation years'' falls short of the amount of payments during a prior 
year by more than $10,000.
    Q-20 Do the excess front-loading rules apply to payments to the 
extent that annual payments never exceed $10,000?
    A-20 No. For example, A is to make a single $10,000 payment to B. 
Provided that the other requirements of section 71 are met, the payment 
will qualify as an alimony or separate maintenance payment. If A were to 
make a single $15,000 payment to B, $10,000 of the payment would qualify 
as an alimony or separate maintenance payment and $5,000 of the payment 
would be disqualified under the minimum term rule because payments were 
not to be made for the minimum period.
    Q-21 Do the excess front-loading rules apply to payments received 
under a decree described in section 71(b)(2)(C)?
    A-21 No. Payments under decrees described in section 71(b)(2)(C) are 
to be disregarded entirely for purposes of applying the excess front-
loading rules.
    Q-22 Both the minimum term rule and the recapture rule refer to 6 
``post-separation years''. What are the 6 ``post separation years''?

[[Page 139]]

    A-22 The 6 ``post-separation years'' are the 6 consecutive calendar 
years beginning with the first calendar year in which the payor pays to 
the payee an alimony or separate maintenance payment (except a payment 
made under a decree described in section 71(b)(2)(C)). Each year within 
this period is referred to as a ``post-separation year''. The 6-year 
period need not commence with the year in which the spouses separate or 
divorce, or with the year in which payments under the divorce or 
separation instrument are made, if no payments during such year qualify 
as alimony or separate maintenance payments. For example, a decree for 
the divorce of A and B is entered in October, 1985. The decree requires 
A to make monthly payments to B commencing November 1, 1985, but A and B 
are members of the same household until February 15, 1986 (and as a 
result, the payments prior to January 16, 1986, do not qualify as 
alimony payments). For purposes of applying the excess front-loading 
rules to payments from A to B, the 6 calendar years 1986 through 1991 
are post-separation years. If a spouse has been making payments pursuant 
to a divorce or separation instrument described in section 71(b)(2) (A) 
or (B), a modification of the instrument or the substitution of a new 
instrument (for example, the substitution of a divorce decree for a 
written separation agreement) will not result in the creation of 
additional post-separation years. However, if a spouse has been making 
payments pursuant to a divorce or separation instrument described in 
section 71(b)(2)(C), the 6-year period does not begin until the first 
calendar year in which alimony or separate maintenance payments are made 
under a divorce or separation instrument described in section 71(b)(2) 
(A) or (B).
    Q-23 How does the minimum term rule operate?
    A-23 The minimum term rule operates in the following manner. To the 
extent payments are made in excess of $10,000, a payment will qualify as 
an alimony or separate maintenance payment only if alimony or separate 
maintenance payments are to be made in each of the 6 post-separation 
years. For example, pursuant to a divorce decree, A is to make alimony 
payments to B of $20,000 in each of the 5 calendar years 1985 through 
1989. A is to make no payment in 1990. Under the minimum term rule, only 
$10,000 will qualify as an alimony payment in each of the calendar years 
1985 through 1989. If the divorce decree also required A to make a $1 
payment in 1990, the minimum term rule would be satisfied and $20,000 
would be treated as an alimony payment in each of the calendar years 
1985 through 1989. The recapture rule would, however, apply for 1990. 
For purposes of determining whether alimony or separate maintenance 
payments are to be made in any year, the possible termination of such 
payments upon the happening of a contingency (other than the passage of 
time) which has not yet occurred is ignored (unless such contingency may 
cause all or a portion of the payment to be treated as a child support 
payment).
    Q-24 How does the recapture rule operate?
    A-24 The recapture rule operates in the following manner. If the 
amount of alimony or separate maintenance payments paid in any post-
separation year (referred to as the ``computation year'') falls short of 
the amount of alimony or separate maintenance payments paid in any prior 
post-separation year by more than $10,000, the payor must compute an 
``excess amount'' for the computation year. The excess amount for any 
computation year is the sum of excess amounts determined with respect to 
each prior post-separation year. The excess amount determined with 
respect to a prior post-separation year is the excess of (1) the amount 
of alimony or separate maintenance payments paid by the payor spouse 
during such prior post-separation year, over (2) the amount of the 
alimony or separate maintenance payments paid by the payor spouse during 
the computation year plus $10,000. For purposes of this calculation, the 
amount of alimony or separate maintenance payments made by the payor 
spouse during any post-separation year preceding the computation year is 
reduced by any excess amount previously determined with respect to such 
year. The rules set forth above may be illustrated by the following 
example. A

[[Page 140]]

makes alimony payments to B of $25,000 in 1985 and $12,000 in 1986. The 
excess amount with respect to 1985 that is recaptured in 1986 is $3,000 
($25,000- ($12,000+$10,000)). For purposes of subsequent computation 
years, the amount deemed paid in 1985 is $22,000. If A makes alimony 
payments to B of $1,000 in 1987, the excess amount that is recaptured in 
1987 will be $12,000. This is the sum of an $11,000 excess amount with 
respect to 1985 ($22,000-$1,000+$10,000)) and a $1,000 excess amount 
with respect to 1986 ($12,000-($1,000+$10,000)). If, prior to the end of 
1990, payments decline further, additional recapture will occur. The 
payor spouse must include the excess amount in gross income for his/her 
taxable year begining with or in the computation year. The payee spouse 
is allowed a deduction for the excess amount in computing adjusted gross 
income for his/her taxable year beginning with or in the computation 
year. However, the payee spouse must compute the excess amount by 
reference to the date when payments were made and not when payments were 
received.
    Q-25 What are the exceptions to the recapture rule?
    A-25 Apart from the $10,000 threshold for application of the 
recapture rule, there are three exceptions to the recapture rule. The 
first exception is for payments received under temporary support orders 
described in section 71(b)(2)(C) (see A-21). The second exception is for 
any payment made pursuant to a continuing liability over the period of 
the post-separation years to pay a fixed portion of the payor's income 
from a business or property or from compensation for employment or self-
employment. The third exception is where the alimony or separate 
manitenance payments in any post-separation year cease by reason of the 
death of the payor or payee or the remarriage (as defined under 
applicable local law) of the payee before the close of the computation 
year. For example, pursuant to a divorce decree, A is to make cash 
payments to B of $30,000 in each of the calendar years 1985 through 
1990. A makes cash payments of $30,000 in 1985 and $15,000 in 1986, in 
which year B remarries and A's alimony payments cease. The recapture 
rule does not apply for 1986 or any subsequent year. If alimony or 
separate maintenance payments made by A decline or cease during a post-
separation year for any other reason (including a failure by the payor 
to make timely payments, a modification of the divorce or separation 
instrument, a reduction in the support needs of the payee, or a 
reduction in the ability of the payor to provide support) excess amounts 
with respect to prior post-separation years will be subject to 
recapture.
    (e) Effective dates.
    Q-26 When does section 71, as amended by the Tax Reform Act of 1984, 
become effective?
    A-26 Generally, section 71, as amended, is effective with respect to 
divorce or separation instruments (as defined in section 71(b)(2)) 
executed after December 31, 1984. If a decree of divorce or separate 
maintenance executed after December 31, 1984, incorporates or adopts 
without change the terms of the alimony or separate maintenance payments 
under a divorce or separation instrument executed before January 1, 
1985, such decree will be treated as executed before January 1, 1985. A 
change in the amount of alimony or separate maintenance payments or the 
time period over which such payments are to continue, or the addition or 
deletion of any contingencies or conditions relating to such payments is 
a change in the terms of the alimony or separate maintenance payments. 
For example, in November 1984, A and B executed a written separation 
agreement. In February 1985, a decree of divorce is entered in 
substitution for the written separation agreement. The decree of divorce 
does not change the terms of the alimony A pays to B. The decree of 
divorce will be treated as executed before January 1, 1985 and hence 
alimony payments under the decree will be subject to the rules of 
section 71 prior to amendment by the Tax Reform Act of 1984. If the 
amount or time period of the alimony or separate maintenance payments 
are not specified in the pre-1985 separation agreement or if the decree 
of divorce changes the amount or term of such payments, the decree of 
divorce will not be treated as executed before January 1, 1985, and 
alimony payments

[[Page 141]]

under the decree will be subject to the rules of section 71, as amended 
by the Tax Reform Act of 1984.
    Section 71, as amended, also applies to any divorce or separation 
instrument executed (or treated as executed) before January 1, 1985 that 
has been modified on or after January 1, 1985, if such modification 
expressly provides that section 71, as amended by the Tax Reform Act of 
1984, shall apply to the instrument as modified. In this case, section 
71, as amended, is effective with respect to payments made after the 
date the instrument is modified.

(Secs. 1041(d)(4) (98 Stat. 798, 26 U.S.C. 1041(d)(4), 152(e)(2)(A) (98 
Stat. 802, 26 U.S.C. 152(e)(2)(A), 215(c) (98 Stat. 800, 26 U.S.C. 
215(c)) and 7805 (68A Stat. 917, 26 U.S.C. 7805) of the Internal Revenue 
Code of 1954.

[T.D. 7973, 49 FR 34455, Aug. 31, 1984; 49 FR 36645, Sept. 19, 1984]



Sec. 1.71-2  Effective date; taxable years ending after March 31, 1954, 
subject to the Internal Revenue Code of 1939.

    Pursuant to section 7851(a)(1)(C), the regulations prescribed in 
Sec. 1.71-1, to the extent that they relate to payments under a written 
separation agreement executed after August 16, 1954, and to the extent 
that they relate to payments under a decree for support received after 
August 16, 1954, under a decree entered after March 1, 1954, shall also 
apply to taxable years beginning before January 1, 1954, and ending 
after August 16, 1954, although such years are subject to the Internal 
Revenue Code of 1939.



Sec. 1.72-1  Introduction.

    (a) General principle. Section 72 prescribes rules relating to the 
inclusion in gross income of amounts received under a life insurance, 
endowment, or annuity contract unless such amounts are specifically 
excluded from gross income under other provisions of Chapter 1 of the 
Code. In general, these rules provide that amounts subject to the 
provisions of section 72 are includible in the gross income of the 
recipient except to the extent that they are considered to represent a 
reduction or return of premiums or other consideration paid.
    (b) Amounts to be considered as a return of premiums. For the 
purpose of determining the extent to which amounts received represent a 
reduction or return of premiums or other consideration paid, the 
provisions of section 72 distinguish between ``amounts received as an 
annuity'' and ``amounts not received as an annuity''. In general, 
``amounts received as an annuity'' are amounts which are payable at 
regular intervals over a period of more than one full year from the date 
on which they are deemed to begin, provided the total of the amounts so 
payable or the period for which they are to be paid can be determined as 
of that date. See paragraph (b) (2) and (3) of Sec. 1.72-2. Any other 
amounts to which the provisions of section 72 apply are considered to be 
``amounts not received as an annuity''. See Sec. 1.72-11.
    (c) ``Amounts received as an annuity.'' (1) In the case of ``amounts 
received as an annuity'' (other than certain employees' annuities 
described in section 72(d) and in Sec. 1.72-13), a proportionate part 
of each amount so received is considered to represent a return of 
premiums or other consideration paid. The proportionate part of each 
annuity payment which is thus excludable from gross income is determined 
by the ratio which the investment in the contract as of the date on 
which the annuity is deemed to begin bears to the expected return under 
the contract as of that date. See Sec. 1.72-4.
    (2) In the case of employees' annuities of the type described in 
section 72(d), no amount received as an annuity in a taxable year to 
which the Internal Revenue Code of 1954 applies is includible in the 
gross income of a recipient until the aggregate of all amounts received 
thereunder and excluded from gross income under the applicable income 
tax law exceeds the consideration contributed (or deemed contributed) by 
the employee under Sec. 1.72-8. Thereafter, all amounts so received are 
includible in the gross income of the recipient. See Sec. 1.72-13.
    (d) ``Amounts not received as an annuity''. In the case of ``amounts 
not received as an annuity'', if such amounts are received after an 
annuity has begun and during its continuance, amounts so received are 
generally includible in the

[[Page 142]]

gross income of the recipient. Amounts not received as an annuity which 
are received at any other time are generally includible in the gross 
income of the recipient only to the extent that such amounts, when added 
to all amounts previously received under the contract which were 
excludable from the gross income of the recipient under the income tax 
law applicable at the time of receipt, exceed the premiums or other 
consideration paid (see Sec. 1.72-11). However, if the aggregate of 
premiums or other consideration paid for the contract includes amounts 
for which a deduction was allowed under section 404 as contributions on 
behalf of an owner-employee, the amounts received under the 
circumstances of the preceding sentence shall be includible in gross 
income until the amount so included equals the amount for which the 
deduction was so allowed. See paragraph (b) of Sec. 1.72-17.
    (e) Classification of recipients. For the purpose of the regulations 
under section 72, a recipient shall be considered an ``annuitant'' if he 
receives amounts under an annuity contract during the period that the 
annuity payments are to continue, whether for a term certain or during 
the continuing life or lives of the person or persons whose lives 
measure the duration of such annuity. However, a recipient shall be 
considered a ``beneficiary'' rather than an ``annuitant'' if the amounts 
he receives under a contract are received after the term of the annuity 
for a life or lives has expired and such amounts are paid by reason of 
the fact that the contract guarantees that payments of some minimum 
amount or for some minimum period shall be made. For special rules with 
respect to beneficiaries, see paragraphs (a)(1)(iii) and (c) of Sec. 
1.72-11.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6676, 28 FR 
10134, Sept. 17, 1963]



Sec. 1.72-2  Applicability of section.

    (a) Contracts. (1) The contracts under which amounts paid will be 
subject to the provisions of section 72 include contracts which are 
considered to be life insurance, endowment, and annuity contracts in 
accordance with the customary practice of life insurance companies. For 
the purposes of section 72, however, it is immaterial whether such 
contracts are entered into with an insurance company. The term 
``endowment contract'' also includes the ``face-amount certificates'' 
described in section 72(1).
    (2) If two or more annuity obligations or elements to which section 
72 applies are acquired for a single consideration, such as an 
obligation to pay an annuity to A for his life accompanied by an 
obligation to pay an annuity to B for his life, there being a single 
consideration paid for both obligations (whether paid by one or more 
persons in equal or different amounts, and whether paid in a single sum 
or otherwise), such annuity elements shall be considered to comprise a 
single contract for the purpose of the application of section 72 and the 
regulations thereunder. For rules relating to the allocation of 
investment in the contract in the case of annuity elements payable to 
two or more persons, see paragraph (b) of Sec. 1.72-6.
    (3)(i) Sections 402 and 403 provide that certain distributions by 
employees' trusts and certain payments under employee plans are taxable 
under section 72. For taxable years beginning before January 1, 1964, 
section 72(e)(3), as in effect before such date, does not apply to such 
distributions or payments. For purposes of applying section 72 to such 
distributions and payments (other than those described in subdivision 
(iii) of this subparagraph), each separate program of the employer 
consisting of interrelated contributions and benefits shall be 
considered a single contract. Therefore, all distributions or payments 
(other than those described in subdivision (iii) of this subparagraph) 
which are attributable to a separate program of interrelated 
contributions and benefits are considered as received under a single 
contract. A separate program of interrelated contributions and benefits 
may be financed by the purchase from an insurance company of one or more 
group contracts or one or more individual contracts, or may be financed 
partly by the purchase of contracts from an insurance company and partly 
through an investment fund, or may be financed completely through an 
investment fund. A program may be considered

[[Page 143]]

separate for purposes of section 72 although it is only a part of a plan 
which qualifies under section 401. There may be several trusts under one 
separate program, or several separate programs may make use of a single 
trust. See, however, subdivision (iii) of this subparagraph for rules 
relating to what constitutes a ``contract'' for purposes of applying 
section 72 to distributions commencing before October 20, 1960.
    (ii) The following types of benefits, and the contributions used to 
provide them, are examples of separate programs of interrelated 
contributions and benefits:
    (a) Definitely determinable retirement benefits.
    (b) Definitely determinable benefits payable prior to retirement in 
case of disability.
    (c) Life insurance.
    (d) Accident and health insurance.

However, retirement benefits and life insurance will be considered part 
of a single separate program of interrelated contributions and benefits 
to the extent they are provided under retirement income, endowment, or 
other contracts providing life insurance protection. See examples (6), 
(7), and (8) contained in subdivision (iv) of this subparagraph for 
illustrations of the principles of this subdivision. See, also, Sec. 
1.72-15 for rules relating to the taxation of amounts received under an 
employee plan which provides both retirement benefits and accident and 
health benefits.
    (iii) If any amount which is taxable under section 72 by reason of 
section 402 or 403 is actually distributed or made available to any 
person under an employees' trust or plan (other than the Civil Service 
Retirement Act, 5 U.S.C. ch. 14) before October 20, 1960, section 72 
shall, notwithstanding any other provisions in this subparagraph, be 
applied to all the distributions with respect to such person (or his 
beneficiaries) under such trust or plan (whether received before or 
after October 20, 1960) as though such distributions were provided under 
a single contract. For purposes of applying section 72 to distributions 
to which this subdivision applies, therefore, the term ``contract'' 
shall be considered to include the entire interest of an employee in 
each trust or plan described in sections 402 and 403 to the extent that 
distributions thereunder are subject to the provisions of section 72. 
Section 72 shall be applied to distributions received under the Civil 
Service Retirement Act in the manner prescribed in subdivision (i) of 
this subparagraph (see example (4) in subdivision (iv) of this 
subparagraph).
    (iv) The application of this subparagraph may be illustrated by the 
following examples:

    Example (1). On January 1, 1961, X Corporation established a 
noncontributory profit-sharing plan for its employees providing that the 
amount standing to the account of each participant will be paid to him 
at the time of his retirement and also established a contributory 
pension plan for its employees providing for the payment to each 
participant of a lifetime pension after retirement. The profit-sharing 
plan is designed to enable the employees to participate in the profits 
of X Corporation; the amount of the contributions to it are determined 
by reference to the profits of X Corporation; and the amount of any 
distribution is determined by reference to the amount of contributions 
made on behalf of any participant and the earnings thereon. On the other 
hand, the pension plan is designed to provide a lifetime pension for a 
retired employee; the amount of the pension is to be determined by a 
formula set forth in the plan; and the amount of contributions to the 
plan is the amount necessary to provide such pensions. In view of the 
fact that each of these plans constitutes a separate program of 
interrelated contributions and benefits, the distributions from each 
shall be treated as received under a separate contract. If these plans 
had been established before October 20, 1960, then, in the case of an 
employee who receives a distribution under the plans before October 20, 
1960, the determination as to whether that distribution and all 
subsequent distributions to such employee are received under a single 
contract or under more than one contract shall be made by applying the 
rules in subdivision (iii) of this subparagraph. On the other hand, in 
the case of an employee who does not receive any distribution under 
these plans before October 20, 1960, the determination as to whether 
distributions to him are received under a single contract or under more 
than one contract shall be made in accordance with the rules illustrated 
by this example.
    Example (2). On January 1, 1961, Z Corporation established a profit-
sharing plan for its employees providing that any employee may make 
contributions, not in excess of 6 percent of his compensation, to a 
trust and that

[[Page 144]]

the employer would make matching contributions out of profits. Under the 
plan, a participant may receive a periodic distribution of the amount 
standing in his account during any period that he is absent from work 
due to a personal injury or sickness. On separation from service, the 
participant is entitled to receive a distribution of the balance 
standing in his account in accordance with one of several options. One 
option provides for the immediate distribution of one-half of the 
account and for the periodic distribution of the remaining one-half of 
the account. In addition, any participant may, after the completion of 
five years of participation, withdraw any part of his account, but in 
the case of such a withdrawal, the participant forfeits his rights to 
participate in the plan for a period of two years. Thus, a participant 
may receive distributions before separation from service; he may receive 
a distribution of a lump sum upon separation from service; he may also 
receive periodic distributions upon separation from service. However, 
since it is the total amount received under all the options that is 
interrelated with the contributions to the plan and not the amount 
received under any one option, this profit-sharing plan consists of only 
one separate program of interrelated contributions and benefits and all 
distributions under the plan (regardless of the option under which 
received) are treated as received under one contract. However, if, 
instead of providing that the amount standing in an employee's account 
would be paid to him during any period that he is absent from work due 
to a personal injury or sickness, the plan provided that a portion of 
the amount in the employee's account would be used to purchase 
incidental accident and health insurance, this plan would consist of two 
separate programs of interrelated contributions and benefits. The 
accident and health insurance, and the contributions used to purchase 
it, would be considered as one separate program of interrelated 
contributions and benefits and, therefore, a separate contract; whereas, 
the remaining contributions and benefits would be considered another 
separate program of interrelated contributions and benefits and, 
consequently, another separate contract.
    Example (3). On January 1, 1961, N Corporation established a profit-
sharing plan for its employees providing that the employees may make 
contributions, not in excess of 6 percent of their compensation, to a 
trust and that N Corporation would make matching contributions out of 
its profits. Under the plan, the employee may elect each year to have 
his and the employer's contributions for such year placed in either a 
savings arrangement or a retirement arrangement. Such an election is 
irrevocable. Under the savings arrangement, contributions to such 
arrangement for any one year and the earnings thereon will be 
distributed five years later. The retirement arrangement provides that 
all contributions thereto and the earnings thereon will be distributed 
when the employee is separated from the service of N Corporation. Since 
the distributions under the retirement arrangement are attributable 
solely to the contributions made to such arrangement and are not 
affected in any manner by contributions or distributions under the 
savings arrangement or any other plan, such distributions are treated as 
received under a separate program of interrelated contributions and 
benefits. Similarly, since distributions during any year under the 
savings arrangement are attributable only to contributions to such 
arrangement made during the fifth preceding year and are not affected in 
any manner by any other contributions to or distributions from such 
arrangement or any other plan, the savings arrangement constitutes a 
series of separate programs of interrelated contributions and benefits. 
The contributions to the savings arrangement for any year and the 
distribution in a subsequent year based thereon constitute a separate 
contract for purposes of section 72.
    Example (4). The Civil Service Retirement Act (5 U.S.C. Ch. 14) 
which provides retirement benefits for participating employees, consists 
of a compulsory program and a voluntary program. Under the compulsory 
program, all participating employees are required to make certain 
contributions and, upon retirement, are provided retirement benefits 
computed on the basis of compensation and length of service. Under the 
voluntary program, such participating employees are permitted to make 
contributions in addition to those required under the compulsory program 
and, upon retirement, are provided additional retirement benefits 
computed on the basis of their voluntary contributions. Distributions 
received under the Act constitute distributions from two separate 
contracts for purposes of section 72. Distributions received under the 
compulsory program are considered as received under a separate program 
of interrelated contributions and benefits since they are computed 
solely under the compulsory program and are not affected by any 
contributions or distributions under the voluntary program or under any 
other plan. For similar reasons, distributions which are attributable to 
the voluntary contributions are considered as received under a separate 
program of interrelated contributions and benefits.
    Example (5). On January 1, 1961, M Corporation established a 
contributory pension plan for its employees and created a trust to which 
it makes contributions to fund such plan. The plan provides that each 
participant will receive after age 65 a pension of 1\1/2\ percent of his 
compensation for each year of

[[Page 145]]

service performed subsequent to the establishment of such plan. In order 
to fund part of the benefits under the plan, the trustee purchased a 
group annuity contract. The remaining part of the benefits are to be 
paid out of a separate investment fund. This pension plan constitutes a 
single program of interrelated contributions and benefits and, 
therefore, all distributions received by an employee under the plan are 
considered as received under a single contract for purposes of section 
72.
    Example (6). On January 1, 1961, Y Corporation established a 
noncontributory pension plan (including incidental death benefits) for 
its employees and created a trust to which it makes contributions to 
fund such plan. The plan provides that each participant will receive 
after age 65 a pension of 1\1/2\ percent of his compensation for each 
year of service performed subsequent to the establishment of such plan. 
In addition, such plan provides for the payment of a death benefit if 
the employee dies before age 65. The trustee funded the death benefits 
through the purchase of a group term insurance policy and funded the 
retirement benefits through the purchase of a group annuity contract. 
Because of a subsequent change in funding from the deferred annuity 
method to the deposit administration method, the trustee purchased a 
second group annuity contract to provide the retirement benefits under 
the plan accruing after the effective date of the change in method of 
funding. Thus, retirement benefits distributed to an employee whose 
service with Y Corporation commenced before the effective date of the 
change in method of funding will be attributable to both group annuity 
contracts. This pension plan includes two separate programs of 
interrelated contributions and benefits. The death benefits, and the 
contributions required to provide them, are considered as one separate 
program of interrelated contributions and benefits; whereas, the 
retirement benefits, and the contributions required to provide them, are 
considered as another separate program of interrelated contributions and 
benefits. Therefore, any retirement benefits received by an employee, 
whether attributable to one or both of the group annuity contracts, 
shall be considered as received under a single contract for purposes of 
section 72. In determining the tax treatment of any such retirement 
benefits under section 72, no amount of the premiums used to purchase 
the group term insurance policy shall be taken into account, since such 
premiums, and the death benefits which they purchased, constitute a 
separate program of interrelated contributions and benefits.
    Example (7). Assume the same facts as in example (6) except that, in 
lieu of funding the benefits in the manner described in that example, 
the trustee purchased individual retirement income contracts from an 
insurance company. Additional individual retirement income contracts are 
purchased in order to fund any increase in benefits resulting from 
increases in salary. Therefore, distributions to a particular employee 
may be attributable to a single retirement income contract or to more 
than one such contract. All distributions received by an employee under 
the pension plan, whether attributable to one or more retirement income 
contracts and whether made directly from the insurance company to the 
employee or made through the trustee, are considered as received under a 
single contract for purposes of section 72. For rules relating to the 
tax treatment of contributions and distributions under retirement 
income, endowment, or other life insurance contracts purchased by a 
trust described in section 401(a) and exempt under section 501(a), see 
paragraph (a) (2), (3), and (4) of Sec. 1.402(a)-1.
    Example (8). Assume the same facts as in example (6) except that, in 
lieu of funding the benefits in the manner described in that example, 
the trustee funded the death benefits and part of the retirement 
benefits by purchasing individual retirement income contracts from an 
insurance company. The remaining part of the retirement benefits (such 
as any increase in benefits resulting from increases in salary) are to 
be paid out of a separate investment fund. This pension plan includes, 
with respect to each participant, two separate contracts for purposes of 
section 72. The retirement income contract purchased by the trust for 
each participant is a separate program of interrelated contributions and 
benefits and all distributions attributable to such contract (whether 
made directly from the insurance company to the employee or made through 
the trustee) are considered as received under a single contract. For 
rules relating to the tax treatment of contributions and distributions 
under retirement income, endowment, or other life insurance contracts 
purchased by a trust described in section 401(a) and exempt under 
section 501(a), see paragraph (a) (2), (3), and (4) of Sec. 1.402(a)-1. 
The remaining distributions under the plan are considered as received 
under another separate program of interrelated contributions and 
benefits.

    (b) Amounts. (1)(i) In general, the amounts to which section 72 
applies are any amounts received under the contracts described in 
paragraph (a)(1) of this section. However, if such amounts are 
specifically excluded from gross income under other provisions of 
Chapter 1 of the Code, section 72 shall not apply for the purpose of 
including such amounts in gross income. For example, section 72 does not 
apply to amounts

[[Page 146]]

received under a life insurance contract if such amounts are paid by 
reason of the death of the insured and are excludable from gross income 
under section 101(a). See also sections 101(d), relating to proceeds of 
life insurance paid at a date later than death, and 104(a)(4), relating 
to compensation for injuries or sickness.
    (ii) Section 72 does not exclude from gross income any amounts 
received under an agreement to hold an amount and pay interest thereon. 
See paragraph (a) of Sec. 1.72-14. However, section 72 does apply to 
amounts received by a surviving annuitant under a joint and survivor 
annuity contract since such amounts are not considered to be paid by 
reason of the death of an insured. For a special deduction for the 
estate tax attributable to the inclusion of the value of the interest of 
a surviving annuitant under a joint and survivor annuity contract in the 
estate of the deceased primary annuitant, see section 691(d) and the 
regulations thereunder.
    (2) Amounts subject to section 72 in accordance with subparagraph 
(1) of this paragraph are considered ``amounts received as an annuity'' 
only in the event that all of the following tests are met:
    (i) They must be received on or after the ``annuity starting date'' 
as that term is defined in paragraph (b) of Sec. 1.72-4;
    (ii) They must be payable in periodic installments at regular 
intervals (whether annually, semiannually, quarterly, monthly, weekly, 
or otherwise) over a period of more than one full year from the annuity 
starting date; and
    (iii) Except as indicated in subparagraph (3) of this paragraph, the 
total of the amounts payable must be determinable at the annuity 
starting date either directly from the terms of the contract or 
indirectly by the use of either mortality tables or compound interest 
computations, or both, in conjunction with such terms and in accordance 
with sound actuarial theory.


For the purpose of determining whether amounts subject to section 72(d) 
and Sec. 1.72-13 are ``amounts received as an annuity'', however, the 
provisions of subdivision (i) of this subparagraph shall be disregarded. 
In addition, the term ``amounts received as an annuity'' does not 
include amounts received to which the provisions of paragraph (b) or (c) 
of Sec. 1.72-11 apply, relating to dividends and certain amounts 
received by a beneficiary in the nature of a refund. If an amount is to 
be paid periodically until a fund plus interest at a fixed rate is 
exhausted, but further payments may be made thereafter because of 
earnings at a higher interest rate, the requirements of subdivision 
(iii) of this subparagraph are met with respect to the payments 
determinable at the outset by means of computations involving the fixed 
interest rate, but any payments received after the expiration of the 
period determinable by such computations shall be taxable as dividends 
received after the annuity starting date in accordance with paragraph 
(b)(2) of Sec. 1.72-11.
    (3)(i) Notwithstanding the requirement of subparagraph (2)(iii) of 
this paragraph, if amounts are to be received for a definite or 
determinable time (whether for a period certain or for a life or lives) 
under a contract which provides:
    (a) That the amount of the periodic payments may vary in accordance 
with investment experience (as in certain profit-sharing plans), cost of 
living indices, or similar fluctuating criteria, or
    (b) For specified payments the value of which may vary for income 
tax purposes, such as in the case of any annuity payable in foreign 
currency,


each such payment received shall be considered as an amount received as 
an annuity only to the extent that it does not exceed the amount 
computed by dividing the investment in the contract, as adjusted for any 
refund feature, by the number of periodic payments anticipated during 
the time that the periodic payments are to be made. If payments are to 
be made more frequently than annually, the amount so computed shall be 
multiplied by the number of periodic payments to be made during the 
taxable year for the purpose of determining the total amount which may 
be considered received as an annuity during such year. To this extent, 
the payments received shall be considered to represent a return of 
premium or other consideration paid and shall

[[Page 147]]

be excludable from gross income in the taxable year in which received. 
See paragraph (d) (2) and (3) of Sec. 1.72-4. To the extent that the 
payments received under the contract during the taxable year exceed the 
total amount thus considered to be received as an annuity during such 
year, they shall be considered to be amounts not received as an annuity 
and shall be included in the gross income of the recipient. See section 
72(e) and paragraph (b)(2) of Sec. 1.72-11.
    (ii) For purposes of subdivision (i) of this subparagraph, the 
number of periodic payments anticipated during the time payments are to 
be made shall be determined by multiplying the number of payments to be 
made each year (a) by the number of years payments are to be made, or 
(b) if payments are to be made for a life or lives, by the multiple 
found by the use of the appropriate tables contained in Sec. 1.72-9, as 
adjusted in accordance with the table in paragraph (a)(2) of Sec. 1.72-
5.
    (iii) For an example of the computation to be made in accordance 
with this subparagraph and a special election which may be made in a 
taxable year subsequent to a taxable year in which the total payments 
received under a contract described in this subparagraph are less than 
the total of the amounts excludable from gross income in such year under 
subdivision (i) of this subparagraph, see paragraph (d)(3) of Sec. 
1.72-4.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6497, 25 FR 
10019, Oct. 20, 1960; T.D. 6885, 31 FR 7798, June 2, 1966]



Sec. 1.72-3  Excludable amounts not income.

    In general, amounts received under contracts described in paragraph 
(a)(1) of Sec. 1.72-2 are not to be included in the income of the 
recipient to the extent that such amounts are excludable from gross 
income as the result of the application of section 72 and the 
regulations thereunder.



Sec. 1.72-4  Exclusion ratio.

    (a) General rule. (1)(i) To determine the proportionate part of the 
total amount received each year as an annuity which is excludable from 
the gross income of a recipient in the taxable year of receipt (other 
than amounts received under (a) certain employee annuities described in 
section 72(d) and Sec. 1.72-13, or (b) certain annuities described in 
section 72(o) and Sec. 1.122-1), an exclusion ratio is to be determined 
for each contract. In general, this ratio is determined by dividing the 
investment in the contract as found under Sec. 1.72-6 by the expected 
return under such contract as found under Sec. 1.72-5. Where a single 
consideration is given for a particular contract which provides for two 
or more annuity elements, an exclusion ratio shall be determined for the 
contract as a whole by dividing the investment in such contract by the 
aggregate of the expected returns under all the annuity elements 
provided thereunder. However, where the provisions of paragraph (b)(3) 
of Sec. 1.72-2 apply to payments received under such a contract, see 
paragraph (b)(3) of Sec. 1.72-6. In the case of a contract to which 
Sec. 1.72-6(d) (relating to contracts in which amounts were invested 
both before July 1, 1986, and after June 30, 1986) applies, the 
exclusion ratio for purposes of this paragraph (a) is determined in 
accordance with Sec. 1.72-6(d) and, in particular, Sec. 1.72-
6(d)(5)(i).
    (ii) The exclusion ratio for the particular contract is then applied 
to the total amount received as an annuity during the taxable year by 
each recipient. See, however, paragraph (e)(3) of Sec. 1.72-5. Any 
excess of the total amount received as an annuity during the taxable 
year over the amount determined by the application of the exclusion 
ratio to such total amount shall be included in the gross income of the 
recipient for the taxable year of receipt.
    (2) The principles of subparagraph (1) may be illustrated by the 
following example:

    Example. Taxpayer A purchased an annuity contract providing for 
payments of $100 per month for a consideration of $12,650. Assuming that 
the expected return under this contract is $16,000 the exclusion ratio 
to be used by A is $12,650/16,000; or 79.1 percent (79.06 rounded to the 
nearest tenth). If 12 such monthly payments are received by A during his 
taxable year, the total amount he may exclude from his gross income in 
such year is $949.20 ($1,200x79.1 percent).The balance of $250.80 
($1,200 less $949.20) is the amount to be included in gross income. If A 
instead received only five such payments during the

[[Page 148]]

year, he should exclude $395.50 (500x79.1 percent) of the total amounts 
received.


For examples of the computation of the exclusion ratio in cases where 
two annuity elements are acquired for a single consideration, see 
paragraph (b)(1) of Sec. 1.72-6.
    (3) The exclusion ratio shall be applied only to amounts received as 
an annuity within the meaning of that term under paragraph (b) (2) and 
(3) of Sec. 1.72-2. Where the periodic payments increase in amount 
after the annuity starting date in a manner not provided by the terms of 
the contract at such date, the portion of such payments representing the 
increase is not an amount received as an annuity. For the treatment of 
amounts not received as an annuity, see section 72(e) and Sec. 1.72-11. 
For special rules where paragraph (b)(3) of Sec. 1.72-2 applies to 
amounts received, see paragraph (d)(3) of this section.
    (4) After an exclusion ratio has been determined for a particular 
contract, it shall be applied to any amounts received as an annuity 
thereunder unless or until one of the following occurs:
    (i) The contract is assigned or transferred for a valuable 
consideration (see section 72(g) and paragraph (a) of Sec. 1.72-10);
    (ii) The contract matures or is surrendered, redeemed, or discharged 
in accordance with the provisions of paragraph (c) or (d) of Sec. 1.72-
11;
    (iii) The contract is exchanged (or is considered to have been 
exchanged) in a manner described in paragraph (e) of Sec. 1.72-11.
    (b) Annuity starting date. (1) Except as provided in subparagraph 
(2) of this paragraph, the annuity starting date is the first day of the 
first period for which an amount is received as an annuity, except that 
if such date was before January 1, 1954, then the annuity starting date 
is January 1, 1954. The first day of the first period for which an 
amount is received as an annuity shall be whichever of the following is 
the later:
    (i) The date upon which the obligations under the contract became 
fixed, or
    (ii) The first day of the period (year, half-year, quarter, month, 
or otherwise, depending on whether payments are to be made annually, 
semiannually, quarterly, monthly, or otherwise) which ends on the date 
of the first annuity payment.
    (2) Notwithstanding the provisions of paragraph (b)(1) of this 
section, the annuity starting date shall be determined in accordance 
with whichever of the following provisions is appropriate:
    (i) In the case of a joint and survivor annuity contract described 
in section 72(i) and paragraph (b)(3) of Sec. 1.72-5, the annuity 
starting date is January 1, 1954, or the first day of the first period 
for which an amount is received as an annuity by the surviving 
annuitant, whichever is the later;
    (ii) In the case of the transfer of an annuity contract for a 
valuable consideration, as described in section 72(g) and paragraph (a) 
of Sec. 1.72-10, the annuity starting date shall be January 1, 1954, or 
the first day of the first period for which the transferee received an 
amount as an annuity, whichever is the later;
    (iii) If the provisions of paragraph (e) of Sec. 1.72-11 apply to 
an exchange of one contract for another, or to a transaction deemed to 
be such an exchange, the annuity starting date of the contract received 
(or deemed received) in exchange shall be January 1, 1954, or the first 
day of the first period for which an amount is received as an annuity 
under such contract, whichever is the later; and
    (iv) In the case of an employee who has retired from work because of 
personal injuries or sickness, and who is receiving amounts under a plan 
that is a wage continuation plan under section 105(d) and Sec. 1.105-4, 
the annuity starting date shall be the date the employee reaches 
mandatory retirement age, as defined in Sec. 1.105-4(a)(3)(i)(B). (See 
also Sec. Sec. 1.72-15 and 1.105-6 for transitional and other special 
rules.)
    (c) Fiscal year taxpayers. Fiscal year taxpayers receiving amounts 
as annuities in a taxable year to which the Internal Revenue Code of 
1954 applies shall determine the annuity starting date in accordance 
with section 72(c)(4) and this section. The annuity starting date for 
fiscal year taxpayers receiving amounts as an annuity in a taxable year 
to which the Internal Revenue Code of 1939 applies shall be January 1,

[[Page 149]]

1954, except where the first day of the first period for which an amount 
is received by such a taxpayer as an annuity is subsequent thereto and 
before the end of a fiscal year to which the Internal Revenue Code of 
1939 applied. In such case, the latter date shall be the annuity 
starting date. In all cases where a fiscal year taxpayer received an 
amount as an annuity in a taxable year to which the Internal Revenue 
Code of 1939 applied and subsequent to the annuity starting date 
determined in accordance with the provisions of this paragraph, such 
amount shall be disregarded for the purposes of section 72 and the 
regulations thereunder.
    (d) Exceptions to the general rule. (1) Where the provisions of 
section 72 would otherwise require an exclusion ratio to be determined, 
but the investment in the contract (determined under Sec. 1.72-6) is an 
amount of zero or less, no exclusion ratio shall be determined and all 
amounts received under such a contract shall be includible in the gross 
income of the recipient for the purposes of section 72.
    (2) Where the investment in the contract is equal to or greater than 
the total expected return under such contract found under Sec. 1.72-5, 
the exclusion ratio shall be considered to be 100 percent and all 
amounts received as an annuity under such contract shall be excludable 
from the recipient's gross income. See, for example, paragraph (f)(1) of 
Sec. 1.72-5. In the case of a contract to which Sec. 1.72-6(d) 
(relating to contracts in which amounts were invested both before July 
1, 1986, and after June 30, 1986) applies, this paragraph (d)(2) is 
applied in the manner prescribed in Sec. 1.72-6(d) and, in particular, 
Sec. 1.72-6(d)(5)(ii).
    (3)(i) If a contract provides for payments to be made to a taxpayer 
in the manner described in paragraph (b)(3) of Sec. 1.72-2, the 
investment in the contract shall be considered to be equal to the 
expected return under such contract and the resulting exclusion ratio 
(100%) shall be applied to all amounts received as an annuity under such 
contract. For any taxable year, payments received under such a contract 
shall be considered to be amounts received as an annuity only to the 
extent that they do not exceed the portion of the investment in the 
contract which is properly allocable to that year and hence excludable 
from gross income as a return of premiums or other consideration paid 
for the contract. The portion of the investment in the contract which is 
properly allocable to any taxable year shall be determined by dividing 
the investment in the contract (adjusted for any refund feature in the 
manner described in paragraph (d) of Sec. 1.72-7) by the applicable 
multiple (whether for a term certain, life, or lives) which would 
otherwise be used in determining the expected return for such a contract 
under Sec. 1.72-5. The multiple shall be adjusted in accordance with 
the provisions of the table in paragraph (a)(2) of Sec. 1.72-5, if any 
adjustment is necessary, before making the above computation. If 
payments are to be made more frequently than annually and the number of 
payments to be made in the taxable year in which the annuity begins are 
less than the number of payments to be made each year thereafter, the 
amounts considered received as an annuity (as otherwise determined under 
this subdivision) shall not exceed, for such taxable year (including a 
short taxable year), an amount which bears the same ratio to the portion 
of the investment in the contract considered allocable to each taxable 
year as the number of payments to be made in the first year bears to the 
number of payments to be made in each succeeding year. Thus, if payments 
are to be made monthly, only seven payments will be made in the first 
taxable year, and the portion of the investment in the contract 
allocable to a full year of payments is $600, the amounts considered 
received as an annuity in the first taxable year cannot exceed $350 
($600x\7/12\). See subdivision (iii) of this subparagraph for an example 
illustrating the determination of the portion of the investment in the 
contract allocable to one taxable year of the taxpayer.
    (ii) If subdivision (i) of this subparagraph applies to amounts 
received by a taxpayer and the total amount of payments he receives in a 
taxable year is less than the total amount excludable for such year 
under subdivision (i) of this subparagraph, the taxpayer may elect, in a 
succeeding taxable year in

[[Page 150]]

which he receives another payment, to redetermine the amounts to be 
received as an annuity during the current and succeeding taxable years. 
This shall be computed in accordance with the provisions of subdivision 
(i) of this subparagraph except that:
    (a) The difference between the portion of the investment in the 
contract allocable to a taxable year, as found in accordance with 
subdivision (i) of this subparagraph, and the total payments actually 
received in the taxable year prior to the election shall be divided by 
the applicable life expectancy of the annuitant (or annuitants), found 
in accordance with the appropriate table in Sec. 1.72-9 (and adjusted 
in accordance with paragraph (a)(2) of Sec. 1.72-5), or by the 
remaining term of a term certain annuity, computed as of the first day 
of the first period for which an amount is received as an annuity in the 
taxable year of the election; and
    (b) The amount determined under (a) of this subdivision shall be 
added to the portion of the investment in the contract allocable to each 
taxable year (as otherwise found). To the extent that the total periodic 
payments received under the contract in the taxable year of the election 
or any succeeding taxable year does not equal this total sum, such 
payments shall be excludable from the gross income of the recipient. To 
the extent such payments exceed the sum so found, they shall be fully 
includible in the recipient's gross income. See subdivision (iii) of 
this subparagraph for an example illustrating the redetermination of 
amounts to be received as an annuity and subdivision (iv) of this 
subparagraph for the method of making the election provided by this 
subdivision.
    (iii) The application of the principles of paragraph (d)(3) (i) and 
(ii) of this section may be illustrated by the following example:

    Example. Taxpayer A, a 64 year old male, files his return on a 
calendar year basis and has a life expectancy of 15.6 years on June 30, 
1954, the annuity starting date of a contract to which Sec. 1.72-
2(b)(3) applies and which he purchased for $20,000. The contract 
provides for variable annual payments for his life. He receives a 
payment of $1,000 on June 30, 1955, but receives no other payment until 
June 30, 1957. He excludes the $1,000 payment from his gross income for 
the year 1955 since this amount is less than $1,324.50, the amount 
determined by dividing his investment in the contract ($20,000) by his 
life expectancy adjusted for annual payments, 15.1 (15.6-0.5), as of the 
original annuity starting date. Taxpayer A may elect, in his return for 
the taxable year 1957, to redetermine amounts to be received as an 
annuity under his contract as of June 30, 1956. For the purpose of 
determining the extent to which amounts received in 1957 or thereafter 
shall be considered amounts received as an annuity (to which a 100 
percent exclusion ratio shall apply) he shall add $118.63 to the 
$1,324.50 originally determined to be receivable as an annuity under the 
contract, making a total of $1,443.13. This is determined by dividing 
the difference between what was excludable in 1955 and 1956, $2,649 
(2x$1,324.50) and what he actually received in those years ($1,000) by 
his life expectancy adjusted for annual payments, 13.9 (14.4-0.5), as of 
his age at his nearest birthday (66) on the first day of the first 
period for which he received an amount as an annuity in the taxable year 
of election (June 30, 1956). The result, $1,443.13, is excludable in 
that year and each year thereafter as an amount received as an annuity 
to which the 100% exclusion ratio applies. It will be noted that in this 
example the taxpayer received amounts less than the excludable amounts 
in two successive years and deferred making his election until the third 
year, and thus was able to accumulate the portion of the investment in 
the contract allocable to each taxable year to the extent he failed to 
receive such portion in both years. Assuming that he received $1,500 in 
the taxable year of his election, he would include $56.87 in his gross 
income and exclude $1,443.13 therefrom for that year.

    (iv) If the taxpayer chooses to make the election described in 
subdivision (ii) of this subparagraph, he shall file with his return a 
statement that he elects to make a redetermination of the amounts 
excludable from gross income under his annuity contract in accordance 
with the provisions of paragraph (d)(3) of Sec. 1.72-4. This statement 
shall also contain the following information:
    (a) The original annuity starting date and his age on that date,
    (b) The date of the first day of the first period for which he 
received an amount in the current taxable year,
    (c) The investment in the contract originally determined (as 
adjusted for any refund feature), and
    (d) The aggregate of all amounts received under the contract between 
the date indicated in (a) of this subdivision

[[Page 151]]

and the day after the date indicated in (b) of this subdivision to the 
extent such amounts were excludable from gross income.

He shall include in gross income any amounts received during the taxable 
year for which the return is made in accordance with the redetermination 
made under this subparagraph.
    (v) In the case of a contract to which Sec. 1.72-6(d) (relating to 
contracts in which amounts were invested both before July 1, 1986, and 
after June 30, 1986) applies, this paragraph (d)(3) is applied in the 
manner prescribed in Sec. 1.72-6(d) and, in particular, Sec. 1.72-
6(d)(5)(iii). This application may be illustrated by the following 
example:

    Example. B, a male calendar year taxpayer, purchases a contract 
which provides for variable annual payments for life and to which Sec. 
1.72-2(b)(3) applies. The annuity starting date of the contract is June 
30, 1990, when B is 64 years old. B receives a payment of $1,000 on June 
30, 1991, but receives no other payment until June 30, 1993. B's total 
investment in the contract is $25,000. B's pre-July 1986 investment in 
the contract is $12,000. If B makes the election described in Sec. 
1.72-6(d)(6), separate computations are required to determine the 
amounts received as an annuity and excludable from gross income with 
respect to the pre-July 1986 investment in the contract and the post-
June 1986 investment in the contract. In the separate computations, B 
first determines the applicable portions of the total payment received 
which are allocable to the pre-July 1986 investment in the contract and 
the post-June 1986 investment in the contract. The portion of the 
payment received allocable to the pre-July 1986 investment in the 
contract is $480 ($12,000/$25,000 x $1,000). The portion of the payment 
received allocable to the post-June 1986 investment in the contract is 
$520 ($13,000/$25,000 x $1,000).
    Second, B determines the pre-July 1986 investment in the contract 
and the post-June 1986 investment in the contract allocable to the 
taxable year by dividing the pre-July 1986 and post-June 1986 
investments in the contract by the applicable life expectancy multiple. 
The life expectancy multiple applicable to pre-July 1986 investment in 
the contract is B's life expectancy as of the original annuity starting 
date adjusted for annual payments and is determined under Table I of 
Sec. 1.72-9 [15.1 (15.6-0.5)]. The life expectancy multiple applicable 
to post-June 1986 investment in the contract is determined under Table V 
of Sec. 1.72-9 (20.3 (20.8-0.5)). Thus, the pre-July 1986 investment in 
the contract allocable to each taxable year is $794.70 ($12,000/15.1), 
and the post-June 1986 investment in the contract so allocable is 
$640.39 ($13,000/20.3). Because the applicable portions of the total 
payment received in 1991 under the contract ($480 allocable to the pre-
July 1986 investment in the contract and $520 allocable to the post-June 
1986 investment in the contract) are treated as amounts received as an 
annuity and are excludable from gross income to the extent they do not 
exceed the portion of the corresponding investment in the contract 
allocable to 1991 ($794.70 pre-July 1986 investment in the contract and 
$640.39 post-June 1986 investment in the contract), the entire amount of 
each applicable portion of the total payment is excludable from gross 
income. B may elect, in the return filed for taxable year 1993, to 
redetermine amounts to be received as an annuity under the contract as 
of June 30, 1992. The extent to which the amounts received in 1993 or 
thereafter shall be considered amounts received as an annuity is 
determined as follows:

Pre-July 1986 investment in the contract allocable to          $1,589.40
 taxable years 1991 and 1992 ($794.70 x 2).................
Less: Portion of total payments allocable to pre-July 1986        480.00
 investment in the contract actually received as an annuity
 in taxable years 1991 and 1992............................
                                                            ------------
                                                                1,109.40
Divided by: Life expectancy multiple applicable to pre-July         13.9
 1986 investment in the contract for B, age 66 (14.4--0.5).
                                                            ------------
                                                                   79.81
Plus: Amount originally determined with respect to pre-July       794.70
 1986 investment in the contract...........................
                                                            ------------
Pre-July 1986 amount.......................................       874.51
                                                            ============
Post-June 1986 investment in the contract allocable to         $1,280.78
 taxable years 1991 and 1992 ($640.39 x 2).................
Less: Portion of total payments allocable to post-June 1986       520.00
 investment in the contract actually received as an annuity
 in taxable years 1991 and 1992............................
                                                            ------------
                                                                  760.78
Divided by: Life expectancy multiple applicable to post-            18.7
 June 1986 investment in the contract for B, age 66 (19.2-
 0.5)......................................................
                                                            ------------
                                                                   40.68
Plus: Amount originally determined with respect to post-          640.39
 June 1986 investment in the contract......................
                                                            ------------
Post-June 1986 amount......................................       681.07
 

    (vi) The method of making an election to perform the separate 
computations illustrated in paragraph (d)(3)(v) of this section is 
described in Sec. 1.72-6(d)(6).
    (e) Exclusion ratio in the case of two or more annuity elements 
acquired for a single consideration. (1)(i) Where two or

[[Page 152]]

more annuity elements are provided under a contract described in 
paragraph (a)(2) of Sec. 1.72-2, an exclusion ratio shall be determined 
for the contract as a whole and applied to all amounts received as an 
annuity under any of the annuity elements. To obtain this ratio, the 
investment in the contract determined in accordance with Sec. 1.72-6 
shall be divided by the aggregate of the expected returns found with 
respect to each of the annuity elements in accordance with Sec. 1.72-5. 
For this purpose, it is immaterial that payments under one or more of 
the annuity elements involved have not commenced at the time when an 
amount is first received as an annuity under one or more of the other 
annuity elements.
    (ii) The exclusion ratio found under subdivision (i) of this 
subparagraph does not apply to:
    (a) An annuity element payable to a surviving annuitant under a 
joint and survivor annuity contract to which section 72(i) and 
paragraphs (b)(3) and (e)(3) of Sec. 1.72-5 apply, or to
    (b) A contract under which one or more of the constituent annuity 
elements provides for payments described in paragraph (b)(3) of Sec. 
1.72-2.

For rules with respect to a contract providing for annuity elements 
described in (b) of this subdivision, see subparagraph (2) of this 
paragraph.
    (2) If one or more of the annuity elements under a contract 
described in paragraph (a)(2) of Sec. 1.72-2 provides for payments to 
which paragraph (b)(3) of Sec. 1.72-2 applies:
    (i) With respect to the annuity elements to which paragraph (b)(3) 
of Sec. 1.72-2 does not apply, an exclusion ratio shall be determined 
by dividing the portion of the investment in the entire contract which 
is properly allocable to all such elements (in the manner provided in 
paragraph (b)(3)(ii) of Sec. 1.72-6) by the aggregate of the expected 
returns thereunder and such ratio shall be applied in the manner 
described in subdivision (i) of subparagraph (1); and
    (ii) With respect to the annuity elements to which paragraph (b)(3) 
of Sec. 1.72-2 does apply, the investment in the entire contract shall 
be reduced by the portion thereof found in subdivision (i) of this 
subparagraph and the resulting amount shall be used to determine the 
extent to which the aggregate of the payments received during the 
taxable year under all such elements is excludable from gross income. 
The amount so excludable shall be allocated to each recipient under such 
elements in the same ratio that the total of payments he receives each 
year bears to the total of the payments received by all such recipients 
during the year. The exclusion ratio with respect to the amounts so 
allocated shall be 100 percent. See paragraph (f)(2) of Sec. 1.72-5 and 
paragraph (b)(3) of Sec. 1.72-6.
    (iii) In the case of a contract to which Sec. 1.72-6(d) (relating 
to contracts in which amounts were invested both before July 1, 1986, 
and after June 30, 1986) applies, this paragraph (e) is applied in the 
manner prescribed in Sec. 1.72-6(d) and, in particular, Sec. 1.72-
6(d)(5)(iv).

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 7352, 40 FR 
16663, Apr. 14, 1975; T.D. 8115, 51 FR 45691, Dec. 19, 1986; 52 FR 
10223, Mar. 31, 1987]



Sec. 1.72-5  Expected return.

    (a) Expected return for but one life. (1) If a contract to which 
section 72 applies provides that one annuitant is to receive a fixed 
monthly income for life, the expected return is determined by 
multiplying the total of the annuity payments to be received annually by 
the multiple shown in Table I or V (whichever is applicable) of Sec. 
1.72-9 under the age (as of the annuity starting date) and, if 
applicable, sex of the measuring life (usually the annuitant's). Thus, 
where a male purchases a contract before July 1, 1986, providing for an 
immediate annuity of $100 per month for his life and, as of the annuity 
starting date (in this case the date of purchase), the annuitant's age 
at his nearest birthday is 66, the expected return is computed as 
follows:

Monthly payment of $100x12 months equals annual payment of....    $1,200
Multiple shown in Table I, male, age 66.......................      14.4
                                                               ---------
Expected return (1,200x14.4)..................................    17,280
 


If, however, the taxpayer had purchased the contract after June 30, 
1986, the expected return would be $23,040, determined by multiplying 
19.2 (multiple shown in Table V, age 66) by $1,200.

[[Page 153]]

    (2)(i) If payments are to be made quarterly, semiannually, or 
annually, an adjustment of the applicable multiple shown in Table I or V 
(whichever is applicable) may be required. A further adjustment may be 
required where the interval between the annuity starting date and the 
date of the first payment is less than the interval between future 
payments. Neither adjustment shall be made, however, if the payments are 
to be made more frequently than quarterly. The amount of the adjustment, 
if any, is to be found in accordance with the following table:

--------------------------------------------------------------------------------------------------------------------------------------------------------
 If the number of whole months from the annuity starting
           date to the first payment date is--             0-1     2      3      4      5      6       7        8        9        10       11       12
--------------------------------------------------------------------------------------------------------------------------------------------------------
And the payments under the contract are to be made:
    Annually............................................   +0.5   +0.4   +0.3   +0.2   +0.1      0        0     -0.1     -0.2     -0.3     -0.4     -0.5
                                                         -----------------------------------------------------------------------------------------------
    Semiannually........................................    +.2    +.1      0      0    -.1    -.2
                                                         -----------------------------------------------------------------------------------------------
    Quarterly...........................................    +.1      0    -.1  .....  .....  .....  .......  .......  .......  .......  .......  .......
--------------------------------------------------------------------------------------------------------------------------------------------------------


Thus, for a male, age 66, the multiple found in Table I, adjusted for 
quarterly payments the first of which is to be made one full month after 
the annuity starting date, is 14.5 (14.4+0.1); for semiannual payments 
the first of which is to be made six full months from the annuity 
starting date, the adjusted multiple is 14.2 (14.4-0.2); for annual 
payments the first of which is to be made one full month from the 
annuity starting date, the adjusted multiple is 14.9 (14.4+0.5). If the 
annuitant in the example shown in subparagraph (1) of this paragraph 
were to receive an annual payment of $1,200 commencing 12 full months 
after his annuity starting date, the amount of the expected return would 
be $16,680 ($1,200x13.9 [14.4-0.5]). Similarly, for an annuitant, age 
50, the multiple found in Table V, adjusted for quarterly payments the 
first of which is to be made one full month after the annuity starting 
date, is 33.2 (33.1+0.1); for semiannual payments the first of which is 
to be made six full months from the annuity starting date, the adjusted 
multiple is 32.9 (33.1-0.2); for annual payments the first of which is 
to be made one full month from the annuity starting date, the adjusted 
multiple is 33.6 (33.1+0.5).
    (ii) Notwithstanding the table in subdivision (i) of this 
subparagraph, adjustments of multiples for early or other than monthly 
payments determined prior to February 19, 1956, under the table 
prescribed in paragraph 1(b)(4) of T.D. 6118 (19 FR 9897, C.B. 1955-1, 
699), approved December 30, 1954, need not be redetermined.
    (3) If the contract provides for fixed payments to be made to an 
annuitant until death or until the expiration of a specified limited 
period, whichever occurs earlier, the expected return of such temporary 
life annuity is determined by multiplying the total of the annuity 
payments to be received annually by the multiple shown in Table IV or 
VIII (whichever is applicable) of Sec. 1.72-9 for the age (as of the 
annuity starting date) and, if applicable, sex of the annuitant and the 
nearest whole number of years in the specified period. For example, if a 
male annuitant, age 60 (at his nearest birthday), is to receive $60 per 
month for five years or until he dies, whichever is earlier, and there 
is no post-June 1986, investment in the contract, the expected return 
under such a contract is $3,456, computed as follows:

Monthly payments of $60x12 months equals annual payment of....      $720
Multiple shown in Table IV for male, age 60, for term of 5           4.8
 years........................................................
                                                               ---------
Expected return for 5 year temporary life annuity of $720 per     $3,456
 year ($720x4.8)..............................................
 


If the annuitant purchased the same contract after June 30, 1986, the 
expected return under the contract would be $3,528, computed as follows:

Monthly payments of $60x12 months equals annual payment          $720.00
 of....................................................

[[Page 154]]

 
Multiple shown in Table VIII for annuitant, age 60, for              4.9
 term of 5 years.......................................
                                                        ----------------
Expected return for 5-year temporary life annuity of           $3,528.00
 $720 per year ($720x4.9)..............................
 


The adjustment provided by subparagraph (2) of this paragraph shall not 
be made with respect to the multiple found in Table IV or VIII 
(whichever is applicable).
    (4) If the contract provides for payments to be made to an annuitant 
for the annuitant's lifetime, but the amount of the annual payments is 
to be decreased after the expiration of a specified limited period, the 
expected return is computed by considering the contract as a combination 
of a whole life annuity for the smaller amount plus a temporary life 
annuity for an amount equal to the difference between the larger and the 
smaller amount. For example, if a male annuitant, age 60, is to receive 
$150 per month for five years or until his earlier death, and is to 
receive $90 per month for the remainder of his lifetime after such five 
years, the expected return is computed as if the annuitant's contract 
consisted of a whole life annuity for $90 per month plus a five year 
temporary life annuity of $60 per month. In such circumstances, the 
expected return if there is no post-June 1986 investment in the contract 
is computed as follows:

Monthly payments of $90x12 months equals annual payment           $1,080
 of....................................................
Multiple shown in Table I for male, age 60.............             18.2
                                                        ----------------
Expected return for whole life annuity of $1,080 per             $19,656
 year..................................................
Expected return for 5-year temporary life annuity of              $3,456
 $720 per year (as found in subparagraph (3) of this
 paragraph (a))........................................
                                                        ----------------
    Total expected return..............................          $23,112
 


If the annuitant purchased the same contract after June 30, 1986, the 
expected return would be $29,664, computed as follows:

Monthly payments of $90x12 months equals annual payment           $1,080
 of....................................................
Multiple shown in Table V for annuitant, age 60........             24.2
                                                        ----------------
Expected return for whole life annuity of $1,080 per             $26,136
 year..................................................
Plus: Expected return for 5-year temporary life annuity           $3,528
 of $720 per year (as found in subparagraph (3) of this
 paragraph (a))........................................
                                                        ----------------
    Total expected return..............................          $29,664
 


If payments are to be made quarterly, semiannually, or annually, an 
appropriate adjustment of the multiple found in Table I or V (whichever 
is applicable) for the whole life annuity should be made in accordance 
with subparagraph (2) of this paragraph.
    (5) If the contract described in subparagraph (4) of this paragraph 
provided that the amount of the annual payments to the annuitant were to 
be increased (instead of decreased) after the expiration of a specified 
limited period, the expected return would be computed as if the 
annuitant's contract consisted of a whole life annuity for the larger 
amount minus a temporary life annuity for an amount equal to the 
difference between the larger and smaller amount. Thus, if the annuitant 
described in subparagraph (4) of this paragraph were to receive $90 per 
month for five years or until his earlier death, and to receive $150 per 
month for the remainder of his lifetime after such five years, the 
expected return would be computed by subtracting the expected return 
under a five year temporary life annuity of $60 per month from the 
expected return under a whole life annuity of $150 per month. In such 
circumstances, the expected return if there is no post-June 1986 
investment in the contract is computed as follows:

Monthly payments of $150x12 months equals annual                  $1,800
 payment of............................................
Multiple shown in Table 1 (male, age 60)...............             18.2
                                                        ----------------
Expected return for annuity for whole life of $1,800             $32,760
 per year..............................................
Less expected return for 5-year temporary life annuity            $3,456
 of $720 per year (as found in subparagraph (3)).......
                                                        ----------------
    Net expected return................................          $29,304
 


If the annuitant purchased the same contract after June 30, 1986, the 
expected return would be $40,032, computed as follows:

Monthly payments of $150x12 months equals annual                  $1,800
 payments of...........................................
Multiple shown in Table V (age 60).....................             24.2
                                                        ----------------
Expected return for annuity for whole life of $1,800             $43,560
 per year..............................................
Less expected return for 5-year temporary life annuity            $3,528
 of $720 per year (as found in subparagraph (3) of this
 paragraph (a))........................................
                                                        ----------------
    Net expected return................................          $40,032
 


[[Page 155]]


If payments are to be made quarterly, semiannually, or annually, an 
appropriate adjustment of the multiple found in Table I or V (whichever 
is applicable) for the whole life annuity should be made in accordance 
with subparagraph (2) of this paragraph.
    (b) Expected return under joint and survivor and joint annuities. 
(1) In the case of a joint and survivor annuity contract involving two 
annuitants which provides the first annuitant with a fixed monthly 
income for life and, after the death of the first annuitant, provides an 
identical monthly income for life to a second annuitant, the expected 
return shall be determined by multiplying the total amount of the 
payments to be received annually by the multiple obtained from Table II 
or VI (whichever is applicable) of Sec. 1.72-9 under the ages (as of 
the annuity starting date) and, if applicable, sexes of the living 
annuitants. For example, a husband purchases a joint and survivor 
annuity contract providing for payments of $100 per month for life and, 
after his death, for the same amount to his wife for the remainder of 
her life. As of the annuity starting date his age at his nearest 
birthday is 70 and that of his wife at her nearest birthday is 67. If 
there is no post-June 1986 investment in the contract, the expected 
return is computed as follows:

Monthly payments of $100x12 months equals annual                  $1,200
 payment of............................................
Multiple shown in Table II (male, age 70, female, age               19.7
 67)...................................................
                                                        ----------------
Expected return ($1,200x19.7)..........................          $23,640
 


If the annuitants purchased the same contract after June 30, 1986, the 
expected return would be $26,400, computed as follows:

Monthly payments of $100x12 months equals annual                  $1,200
 payment of............................................
Multiple shown in Table VI (ages 70, 67)...............             22.0
                                                        ----------------
Expected return ($1,200x22.0)..........................          $26,400
 


If payments are to be made quarterly, semiannually, or annually, an 
appropriate adjustment of the multiple found in Table II or VI 
(whichever is applicable) should be made in accordance with paragraph 
(a)(2) of this section.
    (2) If a contract of the type described in subparagraph (1) of this 
paragraph provides that a different (rather than an identical) monthly 
income is payable to the second annuitant, the expected return is 
computed in the following manner. The applicable multiple in Table II or 
VI (whichever is applicable) is first found as in the example in 
subparagraph (1) of this paragraph. The multiple applicable to the first 
annuitant is then found in Table I or V (whichever is applicable) as 
though the contract were for a single life annuity. The multiple from 
Table I or V is then subtracted from the multiple obtained from Table II 
or VI and the resulting multiple is applied to the total payments to be 
received annually under the contract by the second annuitant. The result 
is the expected return with respect to the second annuitant. The portion 
of the expected return with respect to payments to be made during the 
first annuitant's life is then computed by applying the multiple found 
in Table I or V to the total annual payments to be received by such 
annuitant under the contract. The expected returns with respect to each 
of the annuitants separately are then aggregated to obtain the expected 
return under the entire contract.

    Example (1). A husband purchases a joint and survivor annuity 
providing for payments of $100 per month for his life and, after his 
death, payments to his wife of $50 per month for her life. As of the 
annuity starting date his age at his nearest birthday is 70 and that of 
his wife at her nearest birthday is 67. There is no post-June 1986 
investment in the contract.

Multiple from Table II (male, age 70, female, age 67)..             19.7
Multiple from Table I (male, age 70)...................             12.1
                                                        ----------------
Difference (multiple applicable to second annuitant)...              7.6
                                                        ================
Portion of expected return, second annuitant ($600x7.6)           $4,560
Portion of expected return, first annuitant                      $14,520
 ($1,200x12.1).........................................
                                                        ----------------
    Expected return under the contract.................          $19,080
 


The expected return thus found, $19,080, is to be used in computing the 
amount to be excluded from gross income. Thus, if the investment in the 
contract in this example is $14,310, the exclusion ratio is $14,310/
$19,080; or 75 percent. The amount excludable from each monthly payment 
made to the husband is 75 percent of $100, or $75, and the remaining $25 
of each payment received by him shall be included in his gross income. 
After the husband's death, the amount excludable

[[Page 156]]

by the second annuitant (the surviving wife) would be 75 percent of each 
monthly payment of $50, or $37.50, and the remaining $12.50 of each 
payment shall be included in her gross income.
    Example (2). If the same contract were purchased after June 30, 
1986, the expected return would be $22,800, computed as follows:

Multiple from Table VI (ages 70, 67)...................             22.0
Multiple from Table V (age 70).........................             16.0
                                                        ----------------
Difference (multiple applicable to second annuitant)...              6.0
                                                        ================
Portion of expected return, second annuitant ($600x6.0)           $3,600
Plus: Portion of expected return, first annuitant                $19,200
 ($1,200x16.0).........................................
                                                        ----------------
Expected return under the contract.....................          $22,800
 


If the investment in the contract is $14,310, the exclusion ratio is 
$14,310/$22,800, or 62.8 percent. Thus, the husband would exclude $62.80 
of each $100 payment received by him. After his death, his wife would 
exclude 62.8 percent, or $31.40, of each $50 monthly payment.
    Example (3). If amounts were invested in the same contract both 
before July 1, 1986, and after June 30, 1986, and the election described 
in Sec. 1.72-6(d)(6) were made, two exclusion ratios would be 
determined pursuant to Sec. 1.72-6(d). Assume that the husband's total 
investment in the contract is $14,310 and that $7,310 is the pre-July 
1986 investment in the contract. The pre-July 1986 exclusion ratio would 
be $7,310/$19,080, or 38.3 percent. The post-June 1986 exclusion ratio 
would be $7,000/$22,800, or 30.7 percent. The husband would exclude 
$69.00 ($38.30+$30.70) of the $100 monthly payment received by him. The 
remaining $31.00 would be included in his gross income. After the 
husband's death, the amount excludable by his wife would be $34.50 (38.3 
percent of $50 plus 30.7 percent of $50). The remaining $15.50 would be 
included in gross income.


The same method is used if the payments are to be increased after the 
death of the first annuitant. Thus, if the payments to be made until the 
husband's death were $50 per month and his widow were to receive $100 
per month thereafter until her death, the 7.6 multiple in example (1) 
above would be applied to the $100 payments, yielding an expected return 
with respect to this portion of the annuity contract of $9,120 
($1,200x7.6). An expected return of $7,260 ($600x12.1) would be obtained 
with respect to the payments to be made to the husband, yielding a total 
expected return under the contract of $16,380 ($9,120 plus $7,260). If 
payments are to be made quarterly, semiannually, or annually, an 
appropriate adjustment of the multiples found in Tables I and II or 
Tables V and VI (whichever are applicable) should be made in accordance 
with paragraph (a)(2) of this section.
    (3) In the case of a joint and survivor annuity contract in respect 
of which the first annuitant died in 1951, 1952, or 1953, and the basis 
of the surviving annuitant's interest in the contract was determinable 
under section 113(a)(5) of the Internal Revenue Code of 1939, such basis 
shall be considered the ``aggregate of premiums or other consideration 
paid'' by the surviving annuitant for the contract. (For rules governing 
this determination, see 26 CFR (1939) 39.22(b)(2)-2 and 39.113(a)(5)-1 
(Regulations 118).) In determining such an annuitant's investment in the 
contract, such aggregate shall be reduced by any amounts received under 
the contract by the surviving annuitant before the annuity starting 
date, to the extent such amounts were excludable from his gross income 
at the time of receipt. The expected return of the surviving annuitant 
in such cases shall be determined in the manner prescribed in paragraph 
(a) of this section, as though the surviving annuitant alone were 
involved. For this purpose, the appropriate multiple for the survivor 
shall be obtained from Table I as of the annuity starting date 
determined in accordance with paragraph (b)(2)(i) of Sec. 1.72-4.
    (4) If a contract involving two annuitants provides for fixed 
monthly payments to be made as a joint life annuity until the death of 
the first annuitant to die (in other words, only as long as both remain 
alive), the expected return under such contract shall be determined by 
multiplying the total of the annuity payments to be received annually 
under the contract by the multiple obtained from Table IIA or VIA 
(whichever is applicable) of Sec. 1.72-9 under the ages (as of the 
annuity starting date) and, if applicable, sexes of the annuitants. If, 
however, payments are to be made under the contract quarterly, 
semiannually, or annually, an appropriate adjustment of the multiple 
found in Table IIA or VIA shall be made in accordance with paragraph 
(a)(2) of this section.

[[Page 157]]

    (5) If a joint and survivor annuity contract involving two 
annuitants provides that a specified amount shall be paid during their 
joint lives and a different specified amount shall be paid to the 
survivor upon the death of whichever of the annuitants is the first to 
die, the following preliminary computation shall be made in all cases 
preparatory to determining the expected return under the contract:
    (i) From Table II or VI (whichever is applicable), obtain the 
multiple under both of the annuitants' ages (as of the annuity starting 
date) and, if applicable, their appropriate sexes;
    (ii) From Table IIA or VIA (whichever is applicable), obtain the 
multiple applicable to both annuitants' ages (as of the annuity starting 
date) and, if applicable, their appropriate sexes;
    (iii) Apply the multiple found in subdivision (i) of this 
subparagraph to the total of the amounts to be received annually after 
the death of the first to die; and
    (iv) Apply the multiple found in subdivision (ii) of this 
subparagraph to the difference between the total of the amounts to be 
received annually before and the total of the amounts to be received 
annually after the death of the first to die.


If the original annual payment is in excess of the annual payment to be 
made after the death of the first to die, the expected return is the sum 
of the amounts determined under subdivisions (iii) and (iv) of this 
subparagraph. This may be illustrated by the following examples:

    Example (1). A husband purchases a joint and survivor annuity 
providing for payments of $100 a month for as long as both he and his 
wife live, and, after the death of the first to die, payments to the 
survivor of $75 a month for life. As of the annuity starting date, his 
age at his nearest birthday is 70 and that of his wife at her nearest 
birthday is 67. If there is no post-June 1986 investment in the 
contract, the expected return under the contract is computed as follows:

Multiple from Table II (male age 70, female age 67)....             19.7
Multiple from Table IIA (male age 70, female age 67)...              9.3
                                                        ================
Portion of expected return ($900x19.7--sum per year              $17,730
 after first death)....................................
Plus: Portion of expected return ($300x9.3--amount of             $2,790
 change in sum at first death).........................
    Expected return under the contract.................          $20,520
 


The total expected return in this example, $20,520, is to be used in 
computing the amount to be excluded from gross income. Thus, if the 
investment in the contract is $17,887, the exclusion ratio is $17,887/
$20,520, or 87.2 percent. The amount excludable from each monthly 
payment made while both are alive is 87.2 percent of $100, or $87.20, 
and the remaining $12.80 of each payment shall be included in gross 
income. After the death of the first to die, the amount excludable by 
the survivor shall be 87.2 percent of each monthly payment of $75, or 
$65.40, and the remaining $9.60 of each payment shall be included in 
gross income.
    Example (2). Assume the same facts as in example (1), except that 
the contract is purchased after June 30, 1986.
    The expected return under the contract is computed as follows:

Multiple from Table VI (ages 70, 67)...................             22.0
Multiple from Table VIA (ages 70, 67)..................             12.4
                                                        ================
Portion of expected return ($900x22.0--sum per year              $19,800
 after first death)....................................
Plus: Portion of expected return ($300x12.4--amount of            $3,720
 change in sum at first death).........................
                                                        ----------------
    Expected return under the contract.................          $23,520
 


Thus, if the investment in the contract is $17,887, the exclusion ratio 
is $17,887/$23,520, or 76.1 percent. The amount excludable from each 
monthly payment made while both are alive would be 76.1 percent of $100, 
or $76.10, and the remaining $23.90 of each payment would be included in 
gross income. After the death of the first to die, the amount excludable 
by the survivor would be 76.1 percent of each monthly payment of $75, or 
$57.08, and the remaining $17.92 of each payment would be included in 
gross income.
    Example (3). Assume the same facts as in examples (1) and (2), 
except that the total investment in the contract is $17,887, and that 
the pre-July 1986 investment in the contract is $8,000. Assume also that 
one of the annuitants makes the election described in Sec. 1.72-
6(d)(6). Separate computations shall be performed pursuant to Sec. 
1.72-6(d) to determine the amount excludable from gross income. The pre-
July 1986 exclusion ratio would be $8,000/$20,520, or 39 percent. The 
post-June 1986 exclusion ratio would be $9,887/$23,520, or 42 percent. 
The amount excludable from each monthly payment made while both are 
alive would be $81 ((.39x100)+(.42x100)), and the remaining $19 would be 
included in gross income. After the death of the first to die, the 
amount excludable by the survivor would be $60.75 ((.39x75)+(.42x75)), 
and the remaining $14.25 would be included in gross income.


If the original annual payment is less than the annual payment to be 
made

[[Page 158]]

after the death of the first to die, the expected return is the 
difference between the amounts determined under subdivisions (iii) and 
(iv) of this subparagraph. If, however, payments are to be made 
quarterly, semiannually, or annually under the contract, the multiples 
obtained from both Tables II and IIA or Tables VI and VIA (whichever are 
applicable) shall first be adjusted in a manner prescribed in paragraph 
(a)(2) of this section.
    (6) If a contract provides for the payment of life annuities to two 
persons during their respective lives and, after the death of one 
(without regard to which one dies first), provides that the survivor 
shall receive for life both his own annuity payments and the payments 
made formerly to the deceased person, the expected return shall be 
determined in accordance with paragraph (e)(4) of this section.
    (7) If paragraph (b)(3) of Sec. 1.72-2 applies to payments provided 
under a contract and this paragraph applies to such payments, the 
principles of this paragraph shall be used in making the computations 
described in paragraph (d)(3) of Sec. 1.72-4. This may be illustrated 
by the following examples, examples (1) through (3) of which assume that 
there is no post-June 1986 investment in the contract:

    Example (1). Taxpayer A, a male age 63, pays $24,000 for a contract 
which provides that the proceeds (both income and return of capital) 
from eight units of an investment fund shall be paid monthly to him for 
his life and that after his death the proceeds from six such units shall 
be paid monthly to B, a female age 55, for her life. The portion of the 
investment in the contract allocable to each taxable year of A is 
$955.20 and that allocable to each taxable year of B is $716.40. This is 
determined in the following manner:

Multiple from Table II (male, age 63, and female, age               28.1
 55)...................................................
Number of units to be paid, in effect, as a joint and                 x6
 survivor annuity......................................
                                                        ----------------
Number of total annual unit payments anticipatable with            168.6
 respect to the joint and survivor annuity element.....
                                                        ----------------
Multiple from Table I (male, age 63)...................             16.2
Number of units to be paid, in effect, as a single life               x2
 annuity...............................................
                                                        ----------------
Number of total annual unit payments anticipatable with             32.4
 respect to A alone....................................
                                                        ----------------
Total number of unit payments anticipatable............              201
                                                        ================
Portion of investment in the contract allocable to unit          $119.40
 payments ($24,000/201) on an annual basis.............
Number of units payable to A while he continues to live               x8
                                                        ----------------
Portion of the investment in the contract allocable to           $955.20
 each taxable year of A................................
                                                        ----------------
Portion of investment in the contract allocable to unit          $119.40
 payments ($24,000/201) on an annual basis.............
Number of units payable to B for her life after A's                   x6
 death.................................................
                                                        ----------------
Portion of the investment in the contract allocable to           $716.40
 each taxable year of B................................
 


For the purpose of the above computation it is immaterial whether or not 
A lives to or beyond the life expectancy shown for him in Table I.
    Example (2). Assume that Taxpayer A in example (1) receives payments 
for five years which are at least as large as the portion of the 
investment in the contract allocable to such years, but in the sixth 
year he receives a total of only $626.40 rather than the $955.20 
allocable to such year. A is 69 and B is 61 at the beginning of the 
first monthly period for which an amount is payable in the seventh 
taxable year. A makes the election in that year provided under paragraph 
(d)(3) of Sec. 1.72-4. The difference between the portion of the 
investment in the contract allocable to the sixth year and the amount 
actually received in that year is $328.80 ($955.20 less $626.40). In 
this case, 139.2 unit payments are anticipatable (on an annual basis), 
since the appropriate multiple from Table II of Sec. 1.72-9, 23.2, 
multiplied by the number of units payable, in effect, as a joint and 
survivor annuity yields this result (6x23.2). A's appropriate multiple 
from Table I of Sec. 1.72-9 for the two units which will cease to be 
paid at his death is 12.6, and the total number of unit payments 
anticipatable (on an annual basis) is, therefore, 164.4 (2x12.6 plus 
139.2). Dividing the difference previously found ($328.80) by the total 
number of unit payments thus determined (164.4) indicates that A will 
have an additional allocation of the investment in the contract of $16 
to the seventh and every succeeding full taxable year (8 unitsx$2), and 
B will have an additional allocation of the investment in the contract 
of $12 (6 unitsx$2) to each taxable year in which she receives 12 
monthly payments subsequent to the death of A. The total allocable to 
each taxable year of A is, therefore, $971.20, and that allocable to 
each taxable year of B will be $728.40.
    Example (3). If, in example (2), A had died at the end of the fifth 
year, in the sixth year B would have received a payment of $469.80 (that 
portion of the $626.40 that A would have received which is in the same 
ratio that 6

[[Page 159]]

units bear to 8 units) and would thus have received $246.60 less than 
the portion of the investment in the contract originally determined to 
be allocable to each of her taxable years. In these circumstances, B 
would be entitled to elect to redetermine the portion of the investment 
in the contract allocable to the taxable year of election and all 
subsequent years. The new amount allocable thereto would be found by 
dividing the $246.60 difference by her life expectancy as of the first 
day of the first period for which she received an amount as an annuity 
in the seventh year of the annuity contract, and adding the result to 
her originally determined allocation of $716.40.
    Example (4). On July 1, 1986, Taxpayer C, age 60, pays $28,000 for a 
contract which provides that the proceeds (both income and return of 
capital) from 10 units of an investment fund shall be paid monthly to C 
for C's life and that after C's death the proceeds from 4 such units 
shall be paid monthly to D, age 57, for D's life. The portion of the 
investment in the contract allocable to each taxable year of C is 
$1,037.00 and that allocable to each taxable year of D is $414.80. This 
is determined as follows:

Multiple from Table VI (ages 60, 57)...................             31.2
Number of units to be paid, in effect, as a joint and                 x4
 survivor annuity......................................
                                                        ----------------
Number of total annual unit payments anticipatable with            124.8
 respect to the joint and survivor annuity element.....
                                                        ================
Multiple from Table V (age 60).........................             24.2
Number of units to be paid, in effect, as a single life               x6
 annuity...............................................
                                                        ----------------
Number of total annual unit payments anticipatable with            145.2
 respect to C alone....................................
                                                        ----------------
Total number of unit payments anticipatable............              270
                                                        ================
Portion of investment in the contract allocable to unit           103.70
 payments ($28,000/270) on an annual basis.............
Number of units payable to C while C continues to live.              x10
                                                        ----------------
Portion of the investment in the contract allocable to         $1,037.00
 each taxable year of C................................
                                                        ----------------
Portion of investment in the contract allocable to unit          $103.70
 payments ($28,000/270) on an annual basis.............
Number of units payable to D for D's life after C's                   x4
 death.................................................
                                                        ----------------
Portion of the investment in the contract allocable to           $414.80
 each taxable year of D................................
 



For purposes of the above computation it is immaterial whether or not C 
lives to or beyond the life expectancy shown in Table V.
    Example (5). Assume the same facts as in example (4), except that 
C's total investment in the contract is $28,000, and C's pre-July 1986 
investment in the contract is $16,000. If C makes the election described 
in Sec. 1.72-6(d)(6), separate computations are required to determine 
the amount excludable from gross income with respect to the pre-July 
1986 investment in the contract and the post-June 1986 investment in the 
contract. The annuitant shall apply the appropriate pre-July 1986 and 
post-June 1986 life expectancy multiples to the applicable portions of 
the units to be paid as a joint and survivor annuity, and as a single 
life annuity.
    Pre-July 1986 Computation (all references to unit payments are to 
the pre-July 1986 applicable portion of such payments):

Multiple from Table II (male, age 60, female, age 57)..             27.6
Number of units to be paid, in effect, as a joint and                 x4
 survivor annuity......................................
                                                        ----------------
Number of total annual unit payments anticipatable with           110.40
 respect to the joint and survivor annuity element.....
                                                        ================
Multiple from Table I (male, age 60)...................             18.2
Number of units to be paid, in effect, as a single life               x6
 annuity...............................................
                                                        ----------------
Number of total annual unit payments anticipatable with           109.20
 respect to C alone....................................
                                                        ================
Total number of unit payments anticipatable............            219.6
                                                        ================
Portion of pre-July 1986 investment in the contract               $72.86
 allocable to unit payments ($16,000/219.60) on an
 annual basis..........................................
                                                        ----------------
Number of units payable to C while C continues to live.              x10
                                                        ----------------
Portion of pre-July 1986 investment in the contract               728.60
 allocable to each taxable year of C...................
                                                        ----------------
Portion of pre-July 1986 investment in the contract                72.86
 allocable to unit payments ($16,000/219.60) on an
 annual basis..........................................
Number of units payable to D for D's life after C's                   x4
 death.................................................
                                                        ----------------
Portion of pre-July 1986 investment in the contract              $291.44
 allocable to each taxable year of D...................
 

    Post-June 1986 Computation (all references to unit payments are to 
the post-June 1986 applicable portion of such payments):

Multiple from Table VI (ages 60, 57)...................             31.2
Number of units to be paid, in effect, as a joint and                 x4
 survivor annuity......................................
                                                        ----------------
Number of total annual unit payments anticipatable with           124.80
 respect to the joint and survivor annuity element.....
                                                        ================
Multiple from Table V (age 60).........................             24.2
Number of units to be paid, in effect, as a single life               x6
 annuity...............................................
                                                        ----------------
Number of total annual unit payments anticipatable with           145.20
 respect to C alone....................................
                                                        ----------------
Total number of unit payments anticipatable............              270
                                                        ================

[[Page 160]]

 
Portion of post-June 1986 investment in the contract              $44.44
 allocable to unit payments ($12,000/270) on an annual
 basis.................................................
Number of units payable to C while C continues to live.              x10
                                                        ----------------
Portion of post-June 1986 investment in the contract             $444.40
 allocable to each taxable year of C...................
                                                        ================
Portion of post-June 1986 investment in the contract               44.44
 allocable to unit payments ($12,000/270) on an annual
 basis.................................................
Number of units payable to D for D's life after C's                   x4
 death.................................................
                                                        ----------------
Portion of post-June 1986 investment in the contract             $177.78
 allocable to each taxable year of D...................
 
Total computation:
 
  Total portion of the investment in the contract              $1,173.00
   allocable to each taxable year of C
   ($728.60+$444.40)...................................
  Total portion of the investment in the contract                $469.22
   allocable to each taxable year of D
   ($291.44+$177.78)...................................
 

    Example (6). Assume that taxpayer C in example (4) receives payments 
for four years which are at least as large as the portion of the 
investment in the contract allocable to such years, but in the fifth 
year receives a total of only $600 rather than the $1,037 allocable to 
such year. C is 65 and D is 62 at the beginning of the first monthly 
period for which an amount is payable in the sixth taxable year. C makes 
the election in that year provided under paragraph (d)(3) of Sec. 1.72-
4. The difference between the portion of the investment in the contract 
allocable to the fifth year and the amount actually received in that 
year is $437 ($1,037-$600). In this case, 106 unit payments are 
anticipatable with respect to the joint and survivor annuity element, 
since the appropriate multiple from Table VI of Sec. 1.72-9, 26.5, 
multiplied by the number of units payable, in effect, as a joint and 
survivor annuity yields this result (4 x 26.0). C's appropriate multiple 
from Table V of Sec. 1.72-9 for the six units which will cease to be 
paid at C's death is 20.0, and the number of unit payments anticipatable 
with respect to C alone is 120 (6 x 20). The total number of unit 
payments anticipatable is, therefore, 226 (120 plus 106). Dividing the 
difference previously found ($437) by the total number of unit payments 
thus determined (226) indicates that C will have an additional 
allocation of the investment in the contract of $19.30 to the sixth and 
every succeeding full taxable year (10 units x $1.93), and D will have 
an additional allocation of the investment in the contract of $7.72 (4 
units x $1.93) to each taxable year in which D receives 12 monthly 
payments subsequent to the death of C. The total allocable to each 
taxable year of C is, therefore, $1,056.30, and that allocable to each 
taxable year of D will be $422.52.
    Example (7). If, in example (6), C had died at the end of the fourth 
year, in the fifth year D would have received a payment of $240 (that 
portion of the $600 that C would have received which is in the same 
ratio that 4 units bear to 10 units) and would thus have received 
$174.80 less than the portion of the investment in the contract 
allocable to each of D's taxable years. In these circumstances, D would 
be entitled to elect to redetermine the portion of the investment in the 
contract allocable to the taxable year of election and all subsequent 
years. The new amount allocable thereto would be found by dividing the 
$174.80 difference by D's life expectancy as of the first day of the 
first period for which D received an amount as an annuity in the sixth 
year of the annuity contract, and adding the result to D's originally 
determined allocation of $414.80.

    (c) Expected return for term certain. In the case of a contract 
providing for specific periodic payments which are to be paid for a term 
certain such as a fixed number of months or years, without regard to 
life expectancy, the expected return is determined by multiplying the 
fixed number of years or months for which payments are to be made on or 
after the annuity starting date by the amount of the payment provided in 
the contract for each such period.
    (d) Expected return with respect to amount certain. In the case of 
contracts involving no life or lives as a measurement of their duration, 
but under which a determinable total amount is to be paid in 
installments of lesser amounts paid at periodic intervals, the expected 
return shall be the total amount guaranteed. If an amount is to be paid 
periodically until a fund plus interest at a fixed rate is exhausted, 
but further payments may be made thereafter because of earnings at a 
higher interest rate, this paragraph shall apply to the total amount 
anticipatable as a result of the amount of the fund plus the fixed 
interest thereon. Any amount which may be paid as the result of earnings 
at a greater interest rate shall be disregarded in determining the 
expected return. If such an amount is later received, it shall be 
considered an amount not received as an annuity after the annuity 
starting date. See paragraph (b)(2) of Sec. 1.72-11.

[[Page 161]]

    (e) Expected return where two or more annuity elements providing for 
fixed payments are acquired for a single consideration. (1) In the case 
of a contract described in paragraph (a)(2) of Sec. 1.72-2, which 
provides for specified payments to be made under two or more annuity 
elements, the expected return shall be found for the contract as a whole 
by aggregating the expected returns found with respect to each annuity 
element. If individual life annuity elements are involved (including 
joint and survivor annuities where the primary annuitant died before 
January 1, 1954) the expected return for each of them shall be 
determined in the manner prescribed in paragraph (a) of this section. If 
joint and survivor annuity elements are involved, the expected return 
for such elements shall be determined under the appropriate subparagraph 
of paragraph (b) of this section. If terms certain or amounts certain 
are involved, the expected returns for such elements shall be determined 
under paragraph (c) or (d) of this section, respectively.
    (2) The aggregate expected return found in accordance with the rules 
set forth in subparagraph (1) of this paragraph shall constitute the 
expected return for the contract as a whole. The investment in the 
contract shall be divided by the amount thus determined to obtain the 
exclusion ratio for the contract as a whole, This exclusion ratio shall 
be applied to all amounts received as an annuity under the contract by 
any recipient (in accordance with the provisions of Sec. 1.72-4), 
except in the case of amounts received by a surviving annuitant under a 
joint and survivor annuity element to which the provisions of section 
72(i) and paragraph (b)(3) of this section would apply if it were a 
separate contract. See subparagraph (3) of this paragraph.
    (3) In the case of a contract providing two or more annuity 
elements, one of which is a joint and survivor annuity element of the 
type described in section 72(i) and paragraph (b)(3) of this section, 
the general exclusion ratio for the contract as a whole, for the purpose 
of computations with respect to all the other annuity elements shall be 
determined in accordance with the principles of subparagraphs (1) and 
(2) of this paragraph. A special exclusion ratio shall thereafter be 
determined for the surviving annuitant receiving payments under the 
annuity element described in section 72(i) and paragraph (b)(3) of this 
section by using the investment in the contract and the expected return 
determined in accordance with the provisions of paragraph (b)(3) of this 
section.
    (4) In the case of a contract providing for payments to be made to 
two persons in the manner described in paragraph (b)(6) of this section, 
the expected return is to be computed as though there were two joint and 
survivor annuities under the same contract, in the following manner. 
First, the multiple appropriate to the ages (as of the annuity starting 
date) and, if applicable, sexes of the annuitants involved shall be 
found in Table II or VI (whichever is applicable) of Sec. 1.72-9 and 
adjusted, if necessary, in the manner described in paragraph (a)(2) of 
this section. Second, the multiple so found shall be applied to the sum 
of the payments to be made each year to both annuitants. The result is 
the expected return for the contract as a whole.
    (5) For rules relating to expected return where two or more annuity 
elements are acquired for a single consideration and one or more of such 
elements does not specify a fixed payment for each period, see paragraph 
(f) of this section.
    (f) Expected return with respect to obligations providing for 
payments described in paragraph (b)(3) of Sec. 1.72-2. (1) If a 
contract to which section 72 applies provides only for payments to be 
made in a manner described in paragraph (b)(3) of Sec. 1.72-2, the 
expected return for such contract as a whole shall be an amount equal to 
the investment in the contract found in accordance with section 72(c)(1) 
and Sec. 1.72-6, as adjusted for any refund feature in accordance with 
Sec. 1.72-7.
    (2) If a contract to which section 72 applies provides for annuity 
elements, one or more of which (but not all) provide for payments to be 
made in a manner described in paragraph (b)(3) of Sec. 1.72-2:
    (i) With respect to the portion of the contract providing for 
annuity elements to which paragraph (b)(3) of

[[Page 162]]

Sec. 1.72-2 does not apply, the expected return shall be the aggregate 
of the expected returns found for each of such elements in accordance 
with the appropriate paragraph of this section; and
    (ii) With respect to all annuity elements to which paragraph (b)(3) 
of Sec. 1.72-2 does apply, the expected return for all such elements 
shall be an amount equal to the portion of the investment in the 
contract allocable to such elements in accordance with the provisions of 
paragraph (e)(2)(ii) of Sec. 1.72-4 and paragraph (b)(3)(ii)(b) of 
Sec. 1.72-6.
    (g) Expected return with respect to contracts subject to Sec. 1.72-
6(d). In the case of a contract to which Sec. 1.72-6(d) (relating to 
contracts in which amounts were invested both before July 1, 1986, and 
after June 30, 1986) applies, an expected return is computed using the 
multiples in Tables I through IV of Sec. 1.72-9 with respect to the 
pre-July 1986 investment in the contract and a second expected return is 
computed using the multiples in Tables V through VIII of Sec. 1.72-9 
with respect to the post-June 1986 investment in the contract.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as 
amended by T.D. 8115, 51 FR 45694, Dec. 19, 1986]



Sec. 1.72-6  Investment in the contract.

    (a) General rule. (1) For the purpose of computing the ``investment 
in the contract'', it is first necessary to determine the ``aggregate 
amount of premiums or other consideration paid'' for such contract. See 
section 72(c)(1). This determination is made as of the later of the 
annuity starting date of the contract or the date on which an amount is 
first received thereunder as an annuity. The amount so found is then 
reduced by the sum of the following amounts in order to find the 
investment in the contract:
    (i) The total amount of any return of premiums or dividends received 
(including unrepaid loans or dividends applied against the principal or 
interest on such loans) on or before the date on which the foregoing 
determination is made, and
    (ii) The total of any other amounts received with respect to the 
contract on or before such date which were excludable from the gross 
income of the recipient under the income tax law applicable at the time 
of receipt.

Amounts to which subdivision (ii) of this subparagraph applies shall 
include, for example, amounts considered to be return of premiums or 
other consideration paid under section 22(b)(2) of the Internal Revenue 
Code of 1939 and amounts considered to be an employer-provided death 
benefit under section 22(b)(1)(B) of such Code. For rules relating to 
the extent to which an employee or his beneficiary may include employer 
contributions in the aggregate amount of premiums or other consideration 
paid, see Sec. 1.72-8. If the aggregate amount of premiums or other 
consideration paid for the contract includes amounts for which 
deductions were allowed under section 404 as contributions on behalf of 
a self-employed individual, such amounts shall not be included in the 
investment in the contract.
    (2) For the purpose of subparagraph (1) of this paragraph, amounts 
received subsequent to the receipt of an amount as an annuity or 
subsequent to the annuity starting date, whichever is the later, shall 
be disregarded. See, however, Sec. 1.72-11.
    (3) The application of this paragraph may be illustrated by the 
following examples:

    Example (1). In 1950, B purchased an annuity contract for $10,000 
which was to provide him with an annuity of $1,000 per year for life. He 
received $1,000 in each of the years 1950, 1951, 1952, and 1953, prior 
to the annuity starting date (January 1, 1954). Under the Internal 
Revenue Code of 1939, $300 of each of these payments (3 percent of 
$10,000) was includible in his gross income, and the remaining $700 was 
excludable therefrom during each of the taxable years mentioned. In 
computing B's investment in the contract as of January 1, 1954, the 
total amount excludable from his gross income during the years 1950 
through 1953 ($2,800) must be subtracted from the consideration paid 
($10,000). Accordingly, B's investment in the contract as of January 1, 
1954, is $7,200 ($10,000 less $2,800).
    Example (2). In 1945, C contracted for an annuity to be paid to him 
beginning December 31, 1960. In 1945 and in each successive year until 
1960, he paid a premium of $5,000. Assuming he receives no payments of 
any kind under the contract until the date on which he receives the 
first annual payment as an annuity (December 31, 1960), his investment 
in the contract as of the annuity starting date (December 31, 1959) will 
be $75,000 ($5,000

[[Page 163]]

paid each year for the 15 years from 1945 to 1959, inclusive).
    Example (3). Assume the same facts as in example (2), except that 
prior to the annuity starting date C has already received from the 
insurer dividends of $1,000 each in 1949, 1954, and 1959, such dividends 
not being includible in his gross income in any of those years. C's 
investment in the contract, as of the annuity starting date, will then 
be $72,000 ($75,000-$3,000).

    (b) Allocation of the investment in the contract where two or more 
annuity elements are acquired for a single consideration. (1) In the 
case of a contract described in Sec. 1.72-2(a)(2) which provides for 
two or more annuity elements, the investment in the contract determined 
under paragraph (a) shall be allocated to each of the annuity elements 
in the ratio that the expected return under each annuity element bears 
to the aggregate of the expected returns under all the annuity elements. 
The exclusion ratio for the contract as a whole shall be determined by 
dividing the investment in the contract (after adjustment for the 
present value of any or all refund features) by the aggregate of the 
expected returns under all the annuity elements. This may be illustrated 
by the following examples:

    Example (1). If a contract provides for annuity payments of $1,000 
per year for life (with no refund feature) to both A and B, a male and 
female, respectively, each 70 years of age as of the annuity starting 
date, such contract is acquired for consideration of $19,575 (without 
regard to whether paid by A, B, or both), and there is no post-June 1986 
investment in the contract, the investment in the contract shall be 
allocated by determining the exclusion ratio for the contract as a whole 
in the following manner:

Expectancy of A under Table I and Sec.  1.72-5(a)(2), 11.6      $11,600
 (12.1-0.5), multiplied by $1,000.............................
Plus: Expectancy of B computed in a similar manner                14,500
 ($1,000x14.5 [15.0-0.5]).....................................
                                                               ---------
    Total expected return.....................................    26,100
 


The exclusion ratio for both A and B is then $19,575/$26,100, or 75 
percent. A and B shall each exclude from gross income three-fourths 
($750) of each $1,000 annual payment received and shall include the 
remaining one-fourth ($250) of each $1,000 annual payment received in 
gross income.
    Example (2). Assume the same facts as in example (1) except that of 
the total investment in the contract of $19,575, the pre-July 1986 
investment in the contract is $10,000. If the election described in 
Sec. 1.72-6(d)(6) is made with respect to the contract, the investment 
in the contract shall be allocated by determining an exclusion ratio for 
the contract as a whole based on separately computed exclusion ratios 
with respect to the pre-July 1986 investment in the contract and the 
post-June 1986 investment in the contract in the following manner:

Expectancy of A under Table I and Sec.  1.72-5(a)(2), 11.6      $11,600
 (12.1-0.5), multiplied by $1,000.............................
Plus: Expectancy of B under Table I and Sec.  1.72-5(a)(2),     $14,500
 14.5 (15.0-0.5), multiplied by $1,000........................
                                                               ---------
Pre-July 1986 expected return.................................   $26,100
Expectancy of A under Table V and Sec.  1.72-5(a)(2), 15.5      $15,500
 (16.0-0.5), multiplied by $1,000.............................
Plus: Expectancy of B under Table V and Sec.  1.72-5(a)(2),     $15,500
 15.5 (16.0-0.5), multiplied by $1,000........................
                                                               ---------
Post-June 1986 expected return................................   $31,000
                                                               =========
Pre-July 1986 exclusion ratio ($10,000/$26,100)...............      38.3
Post-June 1986 exclusion ratio ($9,575/31,000)................      30.9
 
A and B shall each exclude from gross income $692 (38.3
 percent of $1,000+30.9 percent of $1,000) of each $1,000
 payment and include the remaining $308 in gross income
 

    (2) In the case of a contract providing for specified annual annuity 
payments to be made to two persons during their joint lives and the 
payment of the aggregate of the two individual payments to the survivor 
for his life, the investment in the contract shall be allocated in 
accordance with the provisions of subparagraph (1) of this paragraph. 
For this purpose, the investment in the contract (without regard to the 
fact that differing amounts may have been contributed by the two 
annuitants) shall be divided by the expected return determined in 
accordance with paragraph (e)(4) of Sec. 1.72-5. The resulting 
exclusion ratio shall then be applied to any amounts received as an 
annuity by either annuitant.
    (3) In the case of a contract providing two or more annuity 
elements, one or more of which provides for payments to be made in a 
manner described in paragraph (b)(3) of Sec. 1.72-2, the investment in 
the contract shall be allocated to the various annuity elements in the 
following manner.
    (i) If all the annuity elements provide for payments to be made in 
the manner described in paragraph (b)(3) of Sec. 1.72-2, the investment 
in the contract shall be allocated on the basis of the amounts received 
by each recipient by apportioning the amount determined to be excludable 
under that section to each recipient in the same ratio as the total of 
the amounts received by him in the

[[Page 164]]

taxable year bears to the total of the amounts received by all 
recipients during the same period; and
    (ii) If one or more, but not all, of the annuity elements provide 
for payments to be made in a manner described in paragraph (b)(3) of 
Sec. 1.72-2:
    (a) With respect to all annuity elements to which that section does 
not apply, the investment in the contract for all such elements shall be 
the portion of the investment in the contract as a whole (found in 
accordance with the provisions of this section) which is properly 
allocable to all such elements; and
    (b) With respect to all annuity elements to which paragraph (b)(3) 
of Sec. 1.72-2 does apply, the investment in the contract for all such 
elements shall be the investment in the contract as a whole (found in 
accordance with the provisions of this section) as reduced by the 
portion thereof determined under (a) of this subdivision.

For the purpose of determining, pursuant to (a) of this subdivision, the 
portion of the investment in the contract as a whole properly allocable 
to a particular annuity element, reference shall be made to the present 
value of such annuity element determined in accordance with paragraph 
(e)(1)(iii) (b) of Sec. 1.101-2.
    (iii) In the case of a contract to which paragraph (d) of this 
section applies, this paragraph (b) is applied in the manner prescribed 
in paragraph (d) and, in particular, paragraph (d)(5)(v) of this 
section.
    (c) Special rules. (1) For the special rule for determining the 
investment in the contract for a surviving annuitant in cases where the 
prior annuitant of a joint and survivor annuity contract died in 1951, 
1952, or 1953, see paragraph (b)(3) of Sec. 1.72-5.
    (2) For special rules relating to the determination of the 
investment in the contract where employer contributions are involved, 
see Sec. 1.72-8. See also paragraph (b) of Sec. 1.72-16 for a special 
rule relating to the determination of the premiums or other 
consideration paid for a contract where an employee is taxable on the 
premiums paid for life insurance protection that is purchased by and 
considered to be a distribution from an exempt employees' trust.
    (3) For the determination of an adjustment in investment in the 
contract in cases where a contract contains a refund feature, see Sec. 
1.72-7.
    (4) In the case of ``face-amount certificates'' described in section 
72(1), the amount of consideration paid for purposes of computing the 
investment in the contract shall include any amount added to the 
holder's basis by reason of section 1232(a)(3)(E) (relating to basis 
adjustment for amount of original issue discount ratably included in 
gross income as interest under section 1232(a)(3)).
    (d) Pre-July 1986 and post-June 1986 investment in the contract. (1) 
This paragraph (d) applies to an annuity contract if:
    (i) The investment in the contract includes a pre-July 1986 
investment in the contract and a post-June 1986 investment in the 
contract (both as defined in Sec. 1.72-6(d)(3));
    (ii) The use of a multiple found in Tables I through VIII of Sec. 
1.72-9 is required to determine the expected return under the contract; 
and
    (iii) The election described in paragraph (d)(6) of this section is 
made with respect to the contract.
    (2) In the case of annuity contract to which this paragraph (d) 
applies--
    (i) All computations required to determine the amount excludable 
from gross income shall be performed separately with respect to the pre-
July 1986 investment in the contract and the post-June 1986 investment 
in the contract as if each such amount were the entire investment in the 
contract;
    (ii) The multiples in Tables I through IV shall be used for 
computations involving the pre-July 1986 investment in the contract and 
the multiples in Tables V through VIII shall be used for computations 
involving the post-June 1986 investment in the contract; and
    (iii) The amount excludable from gross income shall be the sum of 
the amounts determined under the separate computations required by 
paragraph (d)(2)(i) of this section.
    (3) For purposes of the regulations under section 72, the pre-July 
1986 investment in the contract and post-June 1986 investment in the 
contract are determined in accordance with the following rules:

[[Page 165]]

    (i)(A) Except as provided in Sec. 1.72-9, if the annuity starting 
date of the contract occurs before July 1, 1986, the pre-July 1986 
investment in the contract is the total investment in the contract as of 
the annuity starting date;
    (B) Except as provided in Sec. 1.72-9, if the annuity starting date 
of the contract occurs after June 30, 1986, and the contract does not 
provide for a disqualifying form of payment or settlement, the pre-July 
1986 investment in the contract is the investment in the contract 
computed as of June 30, 1986, as if June 30, 1986, had been the later of 
the annuity starting date of the contract or the date on which an amount 
is first received thereunder as an annuity;
    (C) If the annuity starting date of the contract occurs after June 
30, 1986, and the contract provides, at the option of the annuitant or 
of any other person (including, in the case of an employee's annuity, an 
option exercisable only by, or with the consent of, the employer), for a 
disqualifying form of payment or settlement, the pre-July 1986 
investment in the contract is zero (i.e., the total investment in the 
contract is post-June 1986 investment in the contract).
    (ii) The post-June 1986 investment in the contract is the amount by 
which the total investment in the contract as of the annuity starting 
date exceeds the pre-July 1986 investment in the contract.
    (iii) For purposes of paragraph (d)(3)(i) of this section, a 
disqualifying form of payment or settlement is any form of payment or 
settlement (whether or not selected) that permits the receipt of amounts 
under the contract in a form other than a life annuity. For example, 
each of the following options provides for a disqualifying form of 
payment or settlement:
    (A) An option to receive a lump sum in full discharge of the 
obligation under the contract.
    (B) An option to receive an amount under the contract after June 30, 
1986, and before the annuity starting date.
    (C) An option to receive an annuity for a period certain.
    (D) An option to receive payments under a refund feature (within the 
meaning of paragraphs (b) and (c) of Sec. 1.72-7) that is substantially 
equivalent to an annuity for a period certain.
    (E) An option to receive a temporary life annuity (within the 
meaning of Sec. 1.72-5 (a)(3)) that is substantially equivalent to an 
annuity for a period certain.

An option to receive alternative forms of life annuity is not a 
disqualifying option for purposes of paragraph (d)(3)(i) of this 
section. Thus, if the sole options provided under a contract are a 
single life annuity and a joint and survivor life annuity, paragraph 
(d)(3)(i) (C) of this section does not apply to such contract.
    (iv) For purposes of paragraph (d)(3)(iii) of this section, a refund 
feature is substantially equivalent to an annuity for a period certain 
if its value determined under Table VII of Sec. 1.72-9 exceeds 50 
percent. Similarly, a temporary life annuity is substantially equivalent 
to an annuity for a period certain if the multiple determined under 
Table VIII of Sec. 1.72-9 exceeds 50 percent of the maximum duration of 
the annuity.
    (4) In any separate computation under this paragraph (d), only the 
applicable portion of other amounts (such as the total expected return 
under the contract, or the total amount guaranteed under the contract as 
of the annuity starting date) shall be taken into account if the use of 
the entire amount in such computation is inconsistent with the use in 
the computation of only a portion of the investment in the contract. For 
example, such use is generally inconsistent if the computation requires 
a comparison of the investment in the contract and such other amount for 
the purpose of using the greater (or lesser) amount or the difference 
between the two. For purposes of the first sentence of this paragraph 
(d)(4), the applicable portion is the amount that bears the same ratio 
to the entire amount as the pre-July 1986, investment in the contract or 
the post-June 1986 investment in the contract, whichever is applicable, 
bears to the total investment in the contract as of the annuity starting 
date.
    (5) Application to particular computations. (i) In the case of a 
contract to which this paragraph (d) applies, the

[[Page 166]]

exclusion ratio for purposes of Sec. 1.72-4 (a) is the sum of the 
exclusion ratios separately computed in accordance with this paragraph 
(d). The exclusion ratio with respect to the pre-July 1986 investment in 
the contract is determined by dividing the pre-July 1986 investment in 
the contract by the expected return as found under Sec. 1.72-5 by 
applying the appropriate multiples of Tables I through IV of Sec. 1.72-
9. Similarly, the exclusion ratio with respect to the post-June 1986 
investment in the contract is determined by dividing the post-June 1986 
investment in the contract by the expected return as found under Sec. 
1.72-5 by applying the appropriate multiples in Tables V through VIII of 
Sec. 1.72-9.
    (ii) The applicability of Sec. 1.72-4(d)(2) to a contract to which 
this paragraph (d) applies shall be determined separately with respect 
to the post-June 1986 investment in the contract and the pre-July 1986 
investment in the contract and in each such determination only the 
applicable portion of the total expected return under the contract shall 
be taken into account. If Sec. 1.72-4(d)(2) applies with respect to 
either such investment in the contract, the separately computed 
exclusion ratio shall be considered to be the applicable portion of 100 
percent.
    (iii) If Sec. 1.72-4(d)(3) applies to a contract to which this 
paragraph (d) applies--
    (A) The applicable portions (as defined in paragraph (d)(4) of this 
section) of payments received under the contract for a taxable year 
shall be separately computed;
    (B) The pre-July 1986 investment in the contract and the post-June 
1986 investment in the contract shall be separately allocated to the 
taxable year; and
    (C) The separate applicable portions of the payments received under 
the contract for the taxable year shall be considered to be amounts 
received as an annuity (for which the exclusion ratio is 100 percent) 
only to the extent they do not exceed the portions of the corresponding 
investments in the contract which are properly allocable to that year.

See the example in Sec. 1.72-4(d)(3)(v).
    (iv) If Sec. 1.72-4(e) applies to a contract to which this 
paragraph (d) applies, the exclusion ratio shall be separately computed 
with respect to the pre-July 1986 investment in the contract and the 
post-June 1986 investment in the contract. For purposes of the separate 
computations under Sec. 1.72-4(e)(2)(ii), only the applicable portion 
of payments received shall be taken into account and the exclusion ratio 
(100%) shall be applied to the separately computed portion allocated to 
each participant.
    (v) If paragraph (b)(3) of this section applies to a contract to 
which this paragraph (d) applies, separate allocations are required with 
respect to the pre-July 1986 investment in the contract and the post-
June 1986 investment in the contract.

For purposes of the separate computations required to determine the 
portion of the investment in the contract properly allocable to a 
particular annuity element, only the applicable portion of the present 
value of the annuity element determined in accordance with Sec. 1.101-
2(e)(1)(iii)(b) is taken into account.
    (vi) If Sec. 1.72-7 applies to a contract to which this paragraph 
(d) applies, separate computations are required to determine the 
adjustment to the pre-July 1986 investment in the contract and the post-
June 1986 investment in the contract. For purposes of such separate 
computations, only the applicable portions of the amounts described in 
Sec. 1.72-7 (b)(3)(ii), (c)(1)(ii)(B), (c)(2)(vii)(B), and (d)(1)(ii) 
are taken into account. Similarly, in the case of computations with 
respect to the guarantee of a specified amount under Sec. 1.72-7(d)(1), 
only the applicable portion of such amount is taken into account.
    (6) This paragraph (d) applies to a contract only if the first 
taxpayer to receive an amount as an annuity under the contract elects to 
perform separate computations with respect to the pre-July 1986 
investment in the contract and the post-June 1986 investment in the 
contract as if each such amount were the entire investment in contract. 
If two or more annuitants receive an amount as an annuity under the 
contract at the same time (such as under a joint-and-last-survivorship 
annuity

[[Page 167]]

contract), an election by one of the annuitants is treated as an 
election by each of the annuitants. The election is made by attaching a 
statement to the first return filed by the taxpayer for the first 
taxable year in which an amount is received as an annuity under the 
contract. The statement must indicate that the taxpayer is electing to 
apply the provisions of paragraph (d) of Sec. 1.72-6, and must also 
contain the name, address, and taxpayer identification number of each 
annuitant under the contract, and the amount of the pre-July 1986 
investment in the contract.
    (7) If the investment in the contract includes a post-June 1986 
investment in the contract and the election described in paragraph 
(d)(6) of this section is not made--
    (i) The amount excludable from gross income shall be determined 
without regard to the separate computations described in this paragraph 
(d); and
    (ii) Only the multiples found in Tables V through VIII shall be used 
in determining the amount excludable from gross income.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6676, 28 FR 
10134, Sept. 17, 1963; T.D. 7311, 39 FR 11880, Apr. 1, 1974; T.D. 8115, 
51 FR 45700, Dec. 19, 1986; 52 FR 10223, Mar. 31, 1987]



Sec. 1.72-7  Adjustment in investment where a contract contains a refund 
feature.

    (a) Definition of a contract containing a refund feature. A contract 
to which section 72 applies, contains a refund feature if:
    (1) The total amount receivable as an annuity under such contract 
depends, in whole or in part, on the continuing life of one or more 
persons,
    (2) The contract provides for payments to be made to a beneficiary 
or the estate of an annuitant on or after the death of the annuitant if 
a specified amount or a stated number of payments has not been paid to 
the annuitant or annuitants prior to death, and
    (3) Such payments are in the nature of a refund of the consideration 
paid. See paragraph (c)(1) of Sec. 1.72-11.
    (b) Adjustment of investment for the refund feature in the case of a 
single life annuity. Where a single life annuity contract to which 
section 72 applies contains a refund feature and the special rule of 
paragraph (d) of this section does not apply, the investment in the 
contract shall be adjusted in the following manner:
    (1) Determine the number of years necessary for the guaranteed 
amount to be fully paid by dividing the maximum amount guaranteed as of 
the annuity starting date by the amount to be received annually under 
the contract to the extent such amount reduces the guaranteed amount. 
The number of years should be stated in terms of the nearest whole year, 
considering for this purpose a fraction of one-half or more as an 
additional whole year.
    (2) Consult Table III or VII (whichever is applicable) of Sec. 
1.72-9 for the appropriate percentage under the whole number of years 
found in subparagraph (1) of this paragraph and the age (as of the 
annuity starting date) and, if applicable, sex of the annuitant.
    (3) Multiply the percentage found in subparagraph (2) of this 
paragraph by whichever of the following is the smaller: (i) The 
investment in the contract found in accordance with Sec. 1.72-6 or (ii) 
the total amount guaranteed as of the annuity starting date.
    (4) Subtract the amount found in subparagraph (3) of this paragraph 
from the investment in the contract found in accordance with Sec. 1.72-
6.

The resulting amount is the investment in the contract adjusted for the 
present value of the refund feature without discount for interest and is 
to be used in determining the exclusion ratio to be applied to the 
payments received as an annuity. The percentage found in Tables III or 
VII shall not be adjusted in a manner described in paragraph (a)(2) of 
Sec. 1.72-5. These principles may be illustrated by the following 
examples:

    Example (1). On January 1, 1954, a husband, age 65, purchased for 
$21,053, an immediate installment refund annuity payable $100 per month 
for life. The contract provided that in the event the husband did not 
live long enough to recover the full purchase price, payments were to be 
made to his wife until the total payments under the contract equaled the 
purchase price. The investment in the contract adjusted for the purpose 
of

[[Page 168]]

determining the exclusion ratio is computed in the following manner:

Cost of the annuity contract (investment in the contract,        $21,053
 unadjusted)...............................................
Amount to be received annually.............................       $1,200
Number of years for which payment guaranteed ($21,053               17.5
 divided by $1,200)........................................
Rounded to nearest whole number of years...................           18
Percentage located in Table III for age 65 (age of the                30
 annuitant as of the annuity starting date) and 18 (the
 number of whole years) (percent)..........................
Subtract value of the refund feature to the nearest dollar        $6,316
 (30 percent of $21,053)...................................
                                                            ------------
Investment in the contract adjusted for the present value        $14,737
 of the refund feature without discount for interest.......
 

    Example (2). Assume the same facts as in example (1), except that 
the total investment in the contract was made after June 30, 1986. The 
investment in the contract adjusted for the purpose of determining the 
exclusion ratio is computed as follows:

Cost of the annuity contract (investment in the contract,        $21,053
 unadjusted)...............................................
Amount to be received annually.............................       $1,200
Number of years for which payment guaranteed ($21,053/              17.5
 $1,200)...................................................
Rounded to nearest whole number of years...................           18
Percentage in Table VII for age 65 and 18 years (percent)..           15
Subtract value of the refund feature to the nearest dollar        $3,158
 (15 percent of $21,053)...................................
                                                            ------------
Investment in the contract adjusted for the present value        $17,895
 of the refund feature without discount for interest.......
 

    Example (3). Assume the same facts as in example (1), except that 
the pre-July 1986 investment in the contract is $10,000 and the post-
June 1986 investment in the contract is $11,053. If the annuitant makes 
the election described in Sec. 1.72-6(d)(6), separate computations must 
be performed pursuant to Sec. 1.72-6(d) to determine the adjusted 
investment in the contract. The pre-July 1986 investment in the contract 
and the post-June 1986 investment in the contract adjusted for the 
purpose of determining the exclusion ratios are, respectively, $7,000 
and $9,395, determined as follows:

Pre-July 1986 investment in the contract (unadjusted)......      $10,000
Pre-July 1986 portion of the amount to be received annually      $570.00
 ($10,000/$21,053x$1,200)..................................
    Number of years for which payment guaranteed ($10,000/         17.50
     $570).................................................
    Rounded to nearest whole number of years...............           18
    Percentage in Table III for age 65 and 18 years                   30
     (percent).............................................
    Subtract value of the refund feature to the nearest           $3,000
     dollar (30 percent of $10,000)........................
Pre-July 1986 investment in the contract adjusted for the         $7,000
 present value of the refund feature without discount for
 interest..................................................
                                                            ============
Post-June 1986 investment in the contract (unadjusted).....      $11,053
Post-June 1986 portion of the amount to be received                 $630
 annually ($11,053/$21,053x$1,200).........................
Number of years for which payment guaranteed ($11,053/$630)        17.54
Rounded to nearest whole number of years...................           18
Percentage in Table VII for age 65 and 18 years (percent)..           15
Subtract value of the refund feature to the nearest dollar        $1,658
 (15 percent of $11,053)...................................
                                                            ------------
Post-June 1986 investment in the contract adjusted for the        $9,395
 present value of the refund feature without discount for
 interest..................................................
 


If, in the above examples, the guaranteed amount had exceeded the 
investment in the contract (or applicable portion thereof), the 
percentage found in Table III or VII (whichever is applicable) should 
have been applied to the lesser of these amounts since any excess of the 
guaranteed amount over the investment in the contract (as found under 
Sec. 1.72-6) would not have constituted a refund of premiums or other 
consideration paid. In such a case, however, a different multiple might 
have been obtained from Table III or VII (whichever is applicable) since 
the number of years for which payments were guaranteed would have been 
greater.
    (c) Adjustment of investment for the refund feature in the case of a 
joint and survivor annuity. (1) Except as provided in paragraph (c)(2) 
of this section, if a joint and survivor annuity contract described in 
paragraph (b) (1), (2) or (6) of Sec. 1.72-5 contains a refund feature 
and the special rule of paragraph (d) of this section does not apply, 
the investment in the contract shall be adjusted in the following 
manner:
    (i) Find the percentage determined under the following formula:
    [GRAPHIC] [TIFF OMITTED] TC05OC91.042
    

[[Page 169]]


In which:

V = The percentage, rounded to the nearest whole percent,
x = The age at the nearest birthday of the primary annuitant,
y = The age at the nearest birthday of the survivor annuitant,
N = The guaranteed amount divided by the annual annuity payable to the 
primary annuitant, rounded to the nearest integer,
P = The annual annuity continued to the survivor annuitant divided by 
the annual annuity payable to the primary annuitant,
[GRAPHIC] [TIFF OMITTED] TC05OC91.043

    (ii) Multiply the percentage found in paragraph (c)(1)(i) of this 
section by the lesser of (A) the investment in the contract found in 
accordance with Sec. 1.72-6, or (B) the total amount guaranteed as of 
the annuity starting date.
    (iii) Subtract the amount found in paragraph (c)(1)(ii) of this 
section from the investment in the contract found in accordance with 
Sec. 1.72-6.

In the case of a contract providing for payments to be made to two 
persons in the manner described in paragraph (b)(6) of Sec. 1.72-5, 
this paragraph (c)(1) is applied as though the older person were the 
primary annuitant and the younger person were the survivor annuitant. 
For purposes of this paragraph (c)(1), the number of survivors at 
agex (lx) is determined under the following table:

------------------------------------------------------------------------
                          x                                    lx
------------------------------------------------------------------------
5....................................................    1000000.
6....................................................     999729.
7....................................................     999493.
8....................................................     999284.
9....................................................     999069.
10...................................................     998849.
11...................................................     998620.
12...................................................     998382.
13...................................................     998135.
14...................................................     997876.
15...................................................     997606.
16...................................................     997322.
17...................................................     997025.
18...................................................     996714.
19...................................................     996387.
20...................................................     996044.
21...................................................     995684.
22...................................................     995304.
23...................................................     994905.
24...................................................     994484.
25...................................................     994041.
26...................................................     993573.
27...................................................     993080.
28...................................................     992563.
29...................................................     992024.
30...................................................     991461.
31...................................................     990876.
32...................................................     990269.
33...................................................     989638.
34...................................................     988984.
35...................................................     988303.
36...................................................     987593.
37...................................................     986846.
38...................................................     986055.
39...................................................     985210.
40...................................................     984298.
41...................................................     983310.
42...................................................     982230.
43...................................................     981046.
44...................................................     979742.
45...................................................     978302.
46...................................................     976709.
47...................................................     974945.
48...................................................     972992.
49...................................................     970832.
50...................................................     968447.
51...................................................     966000.
52...................................................     963313.
53...................................................     960375.
54...................................................     957175.
55...................................................     953705.
56...................................................     949954.
57...................................................     945912.
58...................................................     941568.
59...................................................     936908.
60...................................................     931903.
61...................................................     926451.
62...................................................     920540.
63...................................................     914090.

[[Page 170]]

 
64...................................................     907011.
65...................................................     899221.
66...................................................     890428.
67...................................................     880797.
68...................................................     870298.
69...................................................     858904.
70...................................................     846565.
71...................................................     832316.
72...................................................     816861.
73...................................................     800078.
74...................................................     781837.
75...................................................     762012.
76...................................................     740743.
77...................................................     717689.
78...................................................     692780.
79...................................................     665977.
80...................................................     637260.
81...................................................     607339.
82...................................................     575531.
83...................................................     541919.
84...................................................     506647.
85...................................................     469931.
86...................................................     432459.
87...................................................     394138.
88...................................................     355393.
89...................................................     316712.
90...................................................     278663.
91...................................................     242020.
92...................................................     207150.
93...................................................     174602.
94...................................................     144828.
95...................................................     118151.
96...................................................      94871.7
97...................................................      74863.6
98...................................................      58042.2
99...................................................      44176.1
100..................................................      32956.4
101..................................................      24044.8
102..................................................      17104.1
103..................................................      11815.5
104..................................................       7886.75
105..................................................       5054.94
106..................................................       3086.95
107..................................................       1778.82
108..................................................        955.465
109..................................................        470.955
110..................................................        208.668
111..................................................         80.7899
112..................................................         26.2340
113..................................................          6.69620
114..................................................          1.19385
115..................................................           .111460
------------------------------------------------------------------------

    (2) If the multiples in Tables I through IV of Sec. 1.72-9 are used 
to determine any portion of the expected return under a contract 
described in paragraph (c)(1) of this section, only the post-June 1986 
investment in the contract (if any) shall be adjusted in the manner 
described in paragraph (c)(1) of this section, and the pre-July 1986 
investment in the contract shall, in the case of a contract described in 
paragraph (b) (1) or (6) of Sec. 1.72-5, be adjusted in the following 
manner:
    (i) Determine the number of years necessary for the guaranteed 
amount to be fully paid by dividing the maximum amount guaranteed as of 
the annuity starting date by the amount to be received annually under 
the contract. The number of years should be stated in terms of the 
nearest whole year, considering for this purpose a fraction of one-half 
or more as an additional whole year.
    (ii) Consult Table III of Sec. 1.72-9 for the appropriate 
percentages under the whole number of years found in subdivision (i) of 
this subparagraph and the age (as of the annuity starting date) and sex 
of each annuitant. If the annuitants are not of the same sex, substitute 
for the female annuitant a male annuitant 5 years younger, or for the 
male annuitant a female annuitant 5 years older, so that Table III will 
be entered in both cases with the ages of annuitants of the same sex.
    (iii) Find the sum of the two percentages found in accordance with 
subdivision (ii) of this subparagraph.
    (iv) To the age of the elder of the two annuitants (as determined 
under subdivision (ii) of this subparagraph), add the number of years 
(indicated in the table below) opposite the number of years by which 
such annuitants' ages differ:

------------------------------------------------------------------------
                                                             Addition to
 Number of years difference in age (2 male annuitants or 2    older age
                     female annuitants)                        in years
------------------------------------------------------------------------
0 to 1, inclusive..........................................            9
2 to 3, inclusive..........................................            8
4 to 5, inclusive..........................................            7
6 to 8, inclusive..........................................            6
9 to 11, inclusive.........................................            5
12 to 15, inclusive........................................            4
16 to 20, inclusive........................................            3
21 to 27, inclusive........................................            2
28 to 42, inclusive........................................            1
Over 42....................................................            0
------------------------------------------------------------------------

    (v) Consult Table III for the appropriate percentage under the whole 
number of years found in subdivision (i) of this subparagraph and the 
age and sex of the elder annuitant as adjusted under subdivision (iv) of 
this subparagraph.
    (vi) Subtract the percentage obtained in subdivision (v) of this 
subparagraph from the sum of the percentages found under subdivision 
(iii) of this subparagraph. If the result is less than one, subdivisions 
(vii) and (viii) of this subparagraph shall be disregarded and no 
adjustment made to the investment in the contract.

[[Page 171]]

    (vii) Multiply the percentage found in subdivision (vi) of this 
subparagraph by whichever of the following is the smaller: (A) the 
investment in the contract found in accordance with Sec. 1.72-6 or (B) 
the total amount guaranteed as of the annuity starting date.
    (viii) Subtract the amount found in subdivision (vii) of this 
subparagraph from the investment in the contract found in accordance 
with Sec. 1.72-6.
    (3) The principles of this paragraph (c) may be illustrated by the 
following examples:

    Example (1). Prior to July 1, 1986, Taxpayer A, a 70-year-old male, 
purchases a joint and last survivor annuity for $33,050. The contract 
provides for payments of $100 a month to be paid first to himself for 
life and then to B, his 40-year-old daughter, if she survives him. The 
contract further provides that in the event both die before ten years' 
payments have been made, payments will be continued to C, a beneficiary, 
or to C's estate, until ten years' payments have been made. If there is 
no post-June 1986 investment in the contract, the investment in the 
contract adjusted for the purpose of determining the exclusion ratio is 
computed in the following manner:

Cost of the annuity contract (investment in the contract         $33,050
 unadjusted)...............................................
Guaranteed amount ($1,200x10)..............................      $12,000
                                                            ============
Percentage in Table III for male, age 70 (or female, age              21
 75) for duration of the guarantee (10)....................
Percentage in Table III for female, age 40 (or male, age               2
 35) for duration of the guarantee (10)....................
                                                            ------------
    Sum of percentages obtained............................           23
                                                            ============
Difference in years of age between two males, aged 70 and             35
 35 (or 2 females, aged 75 and 40).........................
Addition, in years, to older age...........................            1
Percentage in Table III for male one year older than A.....           22
Difference between percentages obtained (23 percent less 22            1
 percent)..................................................
Value of the refund feature to the nearest dollar (1                $120
 percent of $12,000).......................................
                                                            ------------
    Investment in the contract adjusted for present value        $32,930
     of the refund feature.................................
 

    Example (2). The facts are the same as in example (1), except that 
the total investment in the contract was made after June 30, 1986, A is 
73 years of age, and B is A's 70 year old spouse. The percentage 
determined under the formula in paragraph (c)(1)(i) of this section is 
two percent. Thus, the amount determined under paragraph (c)(1)(ii) of 
this section is $240 (2 percent of $12,000), and the investment in the 
contract adjusted for the present value of the refund feature is $32,810 
($33,050--$240).

    (4) If an annuity described in paragraph (b) of Sec. 1.72-5 
contains a refund feature and the manner of determining the adjustment 
to the investment in the contract (or to any part of such investment) is 
not prescribed or requires use of the formula in paragraph (c)(1)(i) of 
this section, the Commissioner will determine the amount of the 
adjustment upon request. The request must contain the date of birth of 
each annuitant, the guaranteed amount, the annual annuity payable to 
each annuitant, and the annuity starting date. Send the request to the 
Commissioner of Internal Revenue, Attention: OP:E:EP:GA, Washington, 
D.C. 20224.
    (d) Adjustment of investment in the contract where paragraph (b)(3) 
of Sec. 1.72-2 applies to payments. (1) If paragraph (b)(3) of Sec. 
1.72-2 applies to payments to be made under a contract and this section 
also applies because of the provision for a refund feature, an 
adjustment shall be made to the investment in the contract in accordance 
with this paragraph before making the computations required by paragraph 
(d)(3) of Sec. 1.72-4 and paragraph (d)(7) of Sec. 1.72-5. In the case 
of the guarantee of a specified amount, the adjustment shall be made by 
applying the appropriate multiple from Table III or VII (whichever is 
applicable), as otherwise determined under this section, to the 
investment in the contract or the guranteed amount, whichever is the 
lesser. The guarantee period shall be found by dividing the amount 
guaranteed by the amount determined by placing the payments received 
during the first taxable year (to guaranteed amount) on an annual basis. 
Thus, if monthly payments are first received by a taxpayer on a calendar 
year basis in August, his total payments (to the extent that they reduce 
the guaranteed amount) for the taxable year would be divided by 5 and 
multiplied by 12. The guaranteed amount would then be divided by the 
result of this computation to obtain the guarantee period. If the 
contract merely guarantees that proceeds from a unit or units of a fund 
shall be paid for a fixed number of years or the life (or lives) of an 
annuitant (or annuitants), whichever is the longer, the

[[Page 172]]

fixed number of years is the guarantee period. The appropriate 
percentage in Table III or VII shall be applied to whichever of the 
following is the smaller: (i) the investment in the contract; or (ii) 
the product of the payments received in the first taxable year, placed 
on an annual basis, multiplied by the number of years for which payment 
of the proceeds of a unit or units is guaranteed.
    (2) The principles of this paragraph may be illustrated by the 
following examples:

    Example (1). Taxpayer A, a 50-year-old male purchases for $25,000 a 
contract which provides for variable monthly payments to be paid to him 
for his life. The contract also provides that if he should die before 
receiving payments for fifteen years, payments shall continue according 
to the original formula to his estate or beneficiary until payments have 
been made for that period. Beginning with the month of September, A 
receives payments which total $450 for the first taxable year of 
receipt. This amount, placed on an annual basis, is $1,350 ($450 divided 
by 4, or $112.50; $112.50 multiplied by 12, or $1,350). If there is no 
post-June 1986 investment in the contract, the guaranteed amount is 
considered to be $20,250 ($1,350x15), and the multiple from Table III 
(found in the same manner as in paragraph (b) of this section), 9 
percent, applied to $20,250 (since this amount is less than the 
investment in the contract), results in a refund adjustment of 
$1,822,50. The latter amount, subtracted from the investment in the 
contract of $25,000, results in an adjusted investment in the contract 
of $23,177.50. If A dies before receiving payments for 15 years and the 
remaining payments are made to B, his beneficiary, B shall exclude the 
entire amount of such payments from his gross income until the amounts 
so received by B, together with the amount received by A and excludable 
from A's gross income, equal or exceed $25,000. Any excess and any 
payments thereafter received by B shall be fully includible in gross 
income.
    Example (2). Assume the same facts as in example (1), except that 
the total investment in the contract was made after June 30, 1986. The 
applicable multiple found in Table VII is 3 percent. When this is 
applied to the guaranteed amount of $20,250, it results in a refund 
adjustment of $607.50. The adjusted investment in the contract in 
$24,392.50 ($25,000--$607.50).

    (e) Adjustment of the investment in the contract where more than one 
annuity element is provided for a single consideration. In the case of 
contracts to which paragraph (b) of Sec. 1.72-6 applies for the purpose 
of allocating the investment in the contract to two or more annuity 
elements which are provided for a single consideration, if one or more 
of such elements involves a refund feature, the portion of the 
investment in the contract properly allocable to each such element shall 
be adjusted for the refund feature before aggregating all the 
investments in order to obtain the exclusion ratio which is to apply to 
the contract as a whole.

    Example (1). If taxpayer A, an insured 70 years of age, upon 
maturity of an endowment policy which cost him a net amount of $86,000, 
elected a dual settlement consisting of (1) monthly payments for his 
life aggregating $4,146 per year with 10 years' payments certain, and 
(2) monthly payments for his 60-year-old brother, B, aggregating $2,820 
per year with 20 years' payments certain, the exclusion ratio to be used 
by both A and B if there is no post-June 1986 investment in the contract 
would be determined in the following manner:

A's expected return (A's payments per year of $4,146          $50,166.60
 multiplied by his life expectancy from Table 1 of
 12.1)...............................................
B's expected return (B's payments per year of $2,820          $51,324.00
 multiplied by his life expectancy from Table 1 of
 18.2)...............................................
                                                      ------------------
    Sum of expected returns to be used in determining        $101,490.60
     exclusion ratio.................................
                                                      ==================
Percentage of total expected return attributable to                 49.4
 A's expectancy of life ($50,166.60/$101,490.60).....
Percentage of total expected return attributable to                 50.6
 B's expectancy of life ($51,324/$101,490.60)........
Portion of investment in the contract allocable to            $42,484.00
 A's annuity (49.4 percent of $86,000)...............
Portion of investment in the contract allocable to            $43,516.00
 B's annuity (50.6 percent of $86,000)...............
Value of the refund feature with respect to A's                $8,707.00
 annuity (percentage from Table III for male, age 70,
 and duration 10, or 21 percent, multiplied by lesser
 of guaranteed amount and allocable portion of
 investment in the contract, $41,460)................
A's allocable portion of the investment in the                $33,777.00
 contract adjusted for refund feature ($42,484 less
 $8,707.00)..........................................
Value of the refund feature with respect to B's               $10,879.00
 annuity (percentage from Table III for male, age 60,
 and duration 20, or 25 percent, multiplied by lesser
 of guaranteed amount and allocable portion of
 investment in the contract, $43,516)................
B's allocable portion of the investment in the                $32,637.00
 contract adjusted for refund feature ($43,516 less
 $10,879.00).........................................

[[Page 173]]

 
Sum of A's and B's allocable portions of the                  $66,414.00
 investment in the contract after adjustment for the
 refund feature......................................
Exclusion ratio for the contract as a whole (total                  65.4
 adjusted investment in the contract, $66,414,
 divided by the total expected return from above,
 $101,490.60) (percent)..............................
 

    Example (2). Assume the same facts as in example (1) except that the 
total investment in the contract was made after June 30, 1986. The 
exclusion ratio to be used by both A and B would be 56.9 percent, 
determined as follows:

A's expected return (A's payments per year of $4,146          $66,336.00
 multiplied by his life expectancy from Table V of
 16.0)...............................................
B's expected return (B's payments per year of $2,820          $68,244.00
 multiplied by his life expectancy from Table V of
 24.2)...............................................
                                                      ------------------
Sum of expected returns to be used in determining            $134,580.00
 exclusion ratio.....................................
                                                      ==================
Percentage of total expected return attributable to                 49.3
 A's expectancy of life ($66,336.00/$134,580.00).....
Percentage of total expected return attributable to                 50.7
 B's expectancy of life ($68,244.00/$134,580.00).....
Portion of investment in the contract allocable to            $42,398.00
 A's annuity (49.3 percent of $86,000)...............
Portion of investment in the contract allocable to            $43,602.00
 B's annuity (50.7 percent of $86,000)...............
Value of the refund feature with respect to A's                $4,560.60
 annuity (percentage from Table VII for age 70 and
 duration 10, or 11 percent, multiplied by lesser of
 the guaranteed amount and allocable portion of
 investment in the contract, $41,460)................
A's allocable portion of the investment in the                $37,837.40
 contract adjusted for refund feature ($42,398 less
 $4,560.60)..........................................
Value of the refund feature with respect to B's                $4,796.22
 annuity (percentage from Table VII for age 60 and
 duration 20, or 11 percent, multiplied by lesser of
 guaranteed amount and allocable portion of
 investment in the contract, $43,602)................
B's allocable portion of the investment in the                $38,805.78
 contract adjusted for refund feature ($43,602 less
 $4,796.22)..........................................
                                                      ------------------
Sum of A's and B's allocable portions of the                  $76,643.18
 investment in the contract after adjustment for the
 refund feature......................................
Exclusion ratio for the contract as a whole (total                  56.9
 adjusted investment in the contract, $76,643.18,
 divided by the total expected return from above,
 $134,580.00) (percent)..............................
 

    (f) Adjustment of investment in the contract with respect to 
contracts subject to Sec. 1.72-6(d). In the case of a contract to which 
Sec. 1.72-6(d) (relating to contracts in which amounts were invested 
both before July 1, 1986, and after June 30, 1986) applies, this section 
is applied in the manner prescribed in Sec. 1.72-6(d) and, in 
particular, Sec. 1.72-6(d)(5)(vi).

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as 
amended by T.D. 8115, 51 FR 45702, Dec. 19, 1986]



Sec. 1.72-8  Effect of certain employer contributions with respect to 
premiums or other consideration paid or contributed by an employee.

    (a) Contributions in the nature of compensation--(1) Amounts 
includible in gross income of employee under subtitle A of the Code or 
prior income tax laws. Section 72(f) provides that for the purposes of 
section 72 (c), (d), and (e), amounts contributed by an employer for the 
benefit of an employee or his beneficiaries shall constitute 
consideration paid or contributed by the employee to the extent that 
such amounts were includible in the gross income of the employee under 
subtitle A of the Code or prior income tax laws. Amounts to which this 
paragraph applies include, for example, contributions made by an 
employer to or under a trust or plan which fails to qualify under the 
provisions of section 401(a), provided that the employee's rights to 
such contributions are nonforfeitable at the time the contributions are 
made. See sections 402(b) and 403(c) and the regulations thereunder. 
This subparagraph also applies to premiums paid by an employer (other 
than premiums paid on behalf of an owner-employee) for life insurance 
protection for an employee if such premiums are includible in the gross 
income of the employee when paid. See Sec. 1.72-16. However, such 
premiums shall only be considered as premiums and other consideration 
paid by the employee with respect to any benefits attributable to the 
contract providing the life insurance protection. See Sec. 1.72-16.
    (2) Amounts not includible in gross income of employee at time 
contributed if paid directly to employee at that time. Except as 
provided in subparagraph (3) of this paragraph, section 72(f) provides 
that for the purposes of section 72 (c), (d), and (e), amounts 
contributed by an employer for the benefit of an employee or his 
beneficiaries shall constitute consideration paid or contributed by the 
employee to the extent that such amounts would not have been

[[Page 174]]

includible in the gross income of the employee at the time contributed 
had they been paid directly to the employee at that time. Amounts to 
which this subparagraph applies include, for example, contributions made 
by an employer after December 31, 1950, and before January 1, 1963, if 
made on account of foreign services rendered by an employee during a 
period in which the employee qualified as a bona fide resident of a 
foreign country under section 911(a) of the Internal Revenue Code of 
1954, or under section 116(a) of the Internal Revenue Code of 1939. In 
such a case, it would be immaterial whether such contributions were made 
under a qualified plan or otherwise. See subparagraph (4) of this 
paragraph for rules governing the determination of the amount of 
employer foreign service contributions to which this subparagraph 
applies. On the other hand, if contributions are made by an employer to 
a qualified plan at a time when compensation paid directly to the 
employee concerned with respect to the same services rendered would have 
been includible in the gross income of the employee, such as in the case 
of an employee of a State government where contributions are made in 
1955 with respect to services rendered by the employee prior to the year 
1939, this subparagraph does not apply to such contributions.
    (3) Limitation--(i) In general. Except as provided in subdivision 
(ii) of this subparagraph, the provisions of subparagraph (2) of this 
paragraph shall not apply to amounts which were contributed by the 
employer after December 31, 1962, and which would not have been 
includible in the gross income of the employee by reason of the 
application of section 911, if such amounts had been paid directly to 
the employee at the time of contribution. Employer contributions 
attributable to foreign services performed by the employee after 
December 31, 1962, do not constitute, for purposes of section 72 (c), 
(d), and (e), consideration paid or contributed by the employee.
    (ii) Exception. The provisions of subdivision (i) of this 
subparagraph shall not apply to amounts which were contributed by the 
employer to provide pension or annuity credits (determined in accordance 
with the provisions of subparagraph (4) of this paragraph) to the extent 
such credits are--
    (a) Attributable to foreign services performed before January 1, 
1963, with respect to which the employee qualified for the benefits of 
section 911(a) (or corresponding provisions of prior revenue laws), and
    (b) Provided pursuant to pension or annuity plan provisions in 
existence on March 12, 1962, and on that date applicable to such 
services.

Amounts described in this subdivision constitute, for purposes of 
section 72 (c), (d), and (e), consideration paid or contributed by the 
employee even though such amounts are contributed by the employer after 
December 31, 1962.
    (4) Determination of employer foreign service contributions which 
constitute consideration paid or contributed by employee. For purposes 
of subparagraphs (2) and (3)(ii) of this paragraph, employer foreign 
service contributions which constitute, for purposes of section 72 (c), 
(d), and (e), consideration paid or contributed by the employee shall be 
determined as follows:
    (i) Treatment of identifiable contributions. If, under the terms of 
the pension or annuity plan under which employer contributions were 
made, such contributions may be identified as--
    (a) Attributable to foreign services performed before January 1, 
1963, with respect to which the employee qualified for the benefits of 
section 911(a) (or corresponding provisions of prior revenue laws), and
    (b) Made under pension or annuity plan provisions in existence on 
March 12, 1962, which were applicable to the services referred to in (a) 
of this subdivision on that date,

the amount of employer contributions so identified shall be considered 
paid or contributed by the employee.
    (ii) Alternative rule for unidentifiable contributions. If employer 
contributions may not be identified in the manner described in 
subdivision (i) of this subparagraph, the amount of employer 
contributions attributable to foreign services performed before January 
1,

[[Page 175]]

1963, and considered paid or contributed by the employee shall be 
determined on the basis of an estimated allocation which is reasonable 
and consistent with the circumstances and the provisions of the pension 
or annuity plan under which such contributions are made. For example, if 
an employee's benefits under a pension or annuity plan, which is 
unchanged after March 12, 1962, are determined with respect to his basic 
compensation during his entire period of credited service, the amount of 
employer contributions considered paid or contributed by the employee 
shall be an amount which bears the same ratio to total employer 
contributions for such employee under the pension or annuity plan as his 
basic compensation attributable to foreign services performed before 
January 1, 1963, with respect to which he qualified for the benefits of 
section 911(a) (or corresponding provisions of prior revenue laws) bears 
to his total basic compensation. On the other hand, if an employee's 
benefits under a pension or annuity plan, which is unchanged after March 
12, 1962, are determined with respect to his basic compensation during 
his final five years of credited service, the amount of employer 
contributions considered paid or contributed by the employee shall be an 
amount which bears the same ratio to total employer contributions for 
such employee as his number of years of credited service before January 
1, 1963, with respect to which he qualified for the benefits of section 
911(a) (or corresponding provisions of prior revenue laws) bears to his 
total number of years of credited service.
    (5) Amounts not includible in gross income of employee under 
subtitle A of the Code or prior income tax laws. Amounts contributed by 
an employer which were not includible in the gross income of the 
employee under Subtitle A of the Code or prior income tax laws, but 
which would have been includible therein had they been paid directly to 
the employee, do not constitute consideration paid or contributed by the 
employee for the purposes of section 72. For example, contributions made 
by an employer under a qualified employees' trust or plan, which 
contributions would have been includible in the gross income of the 
employee had such contributions been paid to him directly as 
compensation, do not constitute consideration paid or contributed by the 
employee. Accordingly, the aggregate amount of premiums or other 
consideration paid or contributed by an employee, insofar as 
compensatory employer contributions are concerned, consists solely of 
the (i) sum of all amounts actually contributed by the employee, plus 
(ii) contributions in the nature of compensation which are deemed to be 
paid or contributed by the employee under this paragraph.
    (b) Contributions in the nature of death benefits. In the case of an 
employee's beneficiary, the aggregate amount of premiums or other 
consideration paid or deemed to be paid or contributed by the employee 
shall also include:
    (1) Amounts (other than amounts paid as an annuity) to the extent 
such amounts are excludable from the beneficiary's gross income as a 
death benefit under section 101(b), and
    (2) Any amount or amounts of death benefits which are treated as 
additional consideration contributed by the employee under section 
101(b)(2)(D) and the regulations thereunder, or which were excludable 
from the beneficiary's gross income as a death benefit under section 
22(b)(1)(B) of the Internal Revenue Code of 1939 and the regulations 
thereunder.

Accordingly, in the case of an employee's beneficiary, any such amount 
shall be added to any amount or amounts deemed paid or contributed by 
the employee under paragraph (a)(1) of this section and to any amounts 
actually contributed by the employee for the purpose of finding the 
aggregate amount of premiums or other consideration paid or contributed 
by the employee.
    (c) Amounts ``made available'' to an employee or his beneficiary. 
Any amount which, although not actually paid, is made available to and 
includable in the gross income of an employee or his beneficiary under 
the rules of sections 402 and 403 and the regulations thereunder, shall 
be considered an amount contributed by the employee and shall be 
aggregated with amounts, if any, to which paragraphs (a) and (b) of this

[[Page 176]]

section apply for the purpose of determining the aggregate amount of 
premiums or other consideration paid by the employee.
    (d) Amounts includable in gross income of employee when his rights 
under annuity contract change to nonforfeitable rights. Any amount 
which, by reason of section 403(d) and after the application of 
paragraph (b) of Sec. 1.403 (b)-1, is required to be included in an 
employee's gross income for the year when his rights under an annuity 
contract change from forfeitable to nonforfeitable rights shall be 
considered an amount contributed by the employee and shall be aggregated 
with amounts, if any, to which paragraphs (a), (b), and (c) of this 
section apply for the purpose of determining the aggregate amount of 
premiums or other consideration paid or contributed by the employee for 
such annuity contract. In other words, if, under section 403(d), an 
employee of an organization exempt from tax under section 501(a) or 
521(a) is required to include an amount in gross income by reason of his 
rights under an annuity contract changing from forfeitable to 
nonforfeitable rights, such amount, to the extent it is not excludable 
from gross income under paragraph (b) of Sec. 1.403 (b)-1, shall be 
considered an amount contributed by such employee for the annuity 
contract.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6665, 28 FR 
7245, July 16, 1963; T.D. 6783, 29 FR 18356, Dec. 24, 1964]



Sec. 1.72-9  Tables.

    The following tables are to be used in connection with computations 
under section 72 and the regulations thereunder. Tables I, II, IIA, III, 
and IV are to be used if the investment in the contract does not include 
a post-June 1986 investment in the contract (as defined in Sec. 1.72-
6(d)(3)). Tables V, VI, VIA, VII, and VIII are to be used if the 
investment in the contract includes a post-June 1986 investment in the 
contract (as defined in Sec. 1.72-6(d)(3)).
    In the case of a contract under which amounts are received as an 
annuity after June 30, 1986, a taxpayer receiving such amounts may elect 
to treat the entire investment in the contract as post-June 1986 
investment in the contract and thus apply Tables V through VIII. A 
taxpayer may make the election for any taxable year in which such 
amounts are received by attaching to the taxpayer's return for such 
taxable year a statement that the taxpayer is electing under Sec. 1.72-
9 to treat the entire investment in the contract as post-June 1986 
investment in the contract. The statement must contain the taxpayer's 
name, address, and taxpayer identification number. The election is 
irrevocable and applies with respect to all amounts that the taxpayer 
receives as an annuity under the contract in the taxable year for which 
the election is made or in any subsequent taxable year. (Note that for 
purposes of the examples in Sec. Sec. 1.72-4 through 1.72-11 the 
election described in this section is disregarded (i.e., it assumed that 
the taxpayer does not make an election under this section).) See also 
Sec. 1.72-6(d)(3) for rules treating the entire investment in a 
contract as post-June 1986 investment in a contract if the annuity 
starting date of the contract is after June 30, 1986, and the contract 
provides for a disqualifying form of payment or settlement, such as an 
option to receive a lump sum in full discharge of the obligation under 
the contract. In addition, see Sec. 1.72-6(d) for special rules 
concerning the tables to be used and the separate computations required 
if the investment in the contract includes both a pre-July 1986 
investment in the contract and a post-June 1986 investment in the 
contract and the election described in Sec. 1.72-6(d)(6) is made with 
respect to the contract.

  Table I--Ordinary Life Annuities--One Life--Expected Return Multiples
------------------------------------------------------------------------
                            Ages
-------------------------------------------------------------  Multiples
                      Male                          Female
------------------------------------------------------------------------
6...............................................     11          65.0
7...............................................     12          64.1
8...............................................     13          63.2
9...............................................     14          62.3
10..............................................     15          61.4
 
11..............................................     16          60.4
12..............................................     17          59.5
13..............................................     18          58.6
14..............................................     19          57.7
15..............................................     20          56.7
 
16..............................................     21          55.8
17..............................................     22          54.9
18..............................................     23          53.9
19..............................................     24          53.0
20..............................................     25          52.1

[[Page 177]]

 
 
21..............................................     26          51.1
22..............................................     27          50.2
23..............................................     28          49.3
24..............................................     29          48.3
25..............................................     30          47.4
 
26..............................................     31          46.5
27..............................................     32          45.6
28..............................................     33          44.6
29..............................................     34          43.7
30..............................................     35          42.8
 
31..............................................     36          41.9
32..............................................     37          41.0
33..............................................     38          40.0
34..............................................     39          39.1
35..............................................     40          38.2
 
36..............................................     41          37.3
37..............................................     42          36.5
38..............................................     43          35.6
39..............................................     44          34.7
40..............................................     45          33.8
 
41..............................................     46          33.0
42..............................................     47          32.1
43..............................................     48          31.2
44..............................................     49          30.4
45..............................................     50          29.6
 
46..............................................     51          28.7
47..............................................     52          27.9
48..............................................     53          27.1
49..............................................     54          26.3
50..............................................     55          25.5
 
51..............................................     56          24.7
52..............................................     57          24.0
53..............................................     58          23.2
54..............................................     59          22.4
55..............................................     60          21.7
 
56..............................................     61          21.0
57..............................................     62          20.3
58..............................................     63          19.6
59..............................................     64          18.9
60..............................................     65          18.2
 
61..............................................     66          17.5
62..............................................     67          16.9
63..............................................     68          16.2
64..............................................     69          15.6
65..............................................     70          15.0
 
66..............................................     71          14.4
67..............................................     72          13.8
68..............................................     73          13.2
69..............................................     74          12.6
70..............................................     75          12.1
 
71..............................................     76          11.6
72..............................................     77          11.0
73..............................................     78          10.5
74..............................................     79          10.1
75..............................................     80           9.6
 
76..............................................     81           9.1
77..............................................     82           8.7
78..............................................     83           8.3
79..............................................     84           7.8
80..............................................     85           7.5
 
81..............................................     86           7.1
82..............................................     87           6.7
83..............................................     88           6.3
84..............................................     89           6.0
85..............................................     90           5.7
 
86..............................................     91           5.4
87..............................................     92           5.1
88..............................................     93           4.8
89..............................................     94           4.5
90..............................................     95           4.2
 
91..............................................     96           4.0
92..............................................     97           3.7
93..............................................     98           3.5
94..............................................     99           3.3
95..............................................    100           3.1
 
96..............................................    101           2.9
97..............................................    102           2.7
98..............................................    103           2.5
99..............................................    104           2.3
100.............................................    105           2.1
 
101.............................................    106           1.9
102.............................................    107           1.7
103.............................................    108           1.5
104.............................................    109           1.3
105.............................................    110           1.2
 
106.............................................    111           1.0
107.............................................    112            .8
108.............................................    113            .7
109.............................................    114            .6
110.............................................    115            .5
111.............................................    116           0
------------------------------------------------------------------------


[[Page 178]]


                                                 Table II--Ordinary Joint Life and Last Survivor Annuities--Two Lives--Expected Return Multiples
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                         Ages
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
              Male                      Female           Male 6        7        8        9        10       11       12       13       14       15       16       17       18       19       20
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
                                                        Female 11      12       13       14       15       16       17       18       19       20       21       22       23       24       25
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6...............................  11................          73.5     73.0     72.6     72.2     71.8     71.4     71.0     70.7     70.4     70.0     69.7     69.5     69.2     68.9     68.7
7...............................  12................          73.0     72.6     72.1     71.7     71.3     70.9     70.5     70.1     69.8     69.4     69.1     68.8     68.5     68.3     68.0
8...............................  13................          72.6     72.1     71.6     71.2     70.8     70.4     70.0     69.6     69.2     68.9     68.5     68.2     67.9     67.6     67.3
9...............................  14................          72.2     71.7     71.2     70.7     70.3     69.9     69.4     69.0     68.7     68.3     67.9     67.6     67.3     67.0     66.7
10..............................  15................          71.8     71.3     70.8     70.3     69.8     69.4     68.9     68.5     68.1     67.7     67.4     67.0     66.7     66.4     66.1
 
11..............................  16................          71.4     70.9     70.4     69.9     69.4     68.9     68.5     68.0     67.6     67.2     66.8     66.5     66.1     65.8     65.4
12..............................  17................          71.0     70.5     70.0     69.4     68.9     68.5     68.0     67.5     67.1     66.7     66.3     65.9     65.5     65.2     64.8
13..............................  18................          70.7     70.1     69.6     69.0     68.5     68.0     67.5     67.1     66.6     66.2     65.8     65.4     65.0     64.6     64.2
14..............................  19................          70.4     69.8     69.2     68.7     68.1     67.6     67.1     66.6     66.1     65.7     65.3     64.8     64.4     64.0     63.7
15..............................  20................          70.0     69.4     68.9     68.3     67.7     67.2     66.7     66.2     65.7     65.2     64.8     64.3     63.9     63.5     63.1
 
16..............................  21................          69.7     69.1     68.5     67.9     67.4     66.8     66.3     65.8     65.3     64.8     64.3     63.8     63.4     63.0     62.6
17..............................  22................          69.5     68.8     68.2     67.6     67.0     66.5     65.9     65.4     64.8     64.3     63.8     63.4     62.9     62.5     62.0
18..............................  23................          69.2     68.5     67.9     67.3     66.7     66.1     65.5     65.0     64.4     63.9     63.4     62.9     62.4     62.0     61.5
19..............................  24................          68.9     68.3     67.6     67.0     66.4     65.8     65.2     64.6     64.0     63.5     63.0     62.5     62.0     61.5     61.0
20..............................  25................          68.7     68.0     67.3     66.7     66.1     65.4     64.8     64.2     63.7     63.1     62.6     62.0     61.5     61.0     60.6
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                              Ages
                                                              ----------------------------------------------------------------------------------------------------------------------------------
                Male                           Female             Male 21       22       23       24       25       26       27       28       29       30       31       32       33       34
                                                              ----------------------------------------------------------------------------------------------------------------------------------
                                                                 Female 26      27       28       29       30       31       32       33       34       35       36       37       38       39
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6...................................  11.....................          68.4     68.2     68.0     67.8     67.6     67.5     67.3     67.1     67.0     66.8     66.7     66.6     66.5     66.4
7...................................  12.....................          67.8     67.5     67.3     67.1     66.9     66.7     66.5     66.4     66.2     66.1     65.9     65.8     65.7     65.6
8...................................  13.....................          67.1     66.8     66.6     66.4     66.2     66.0     65.8     65.6     65.4     65.3     65.1     65.0     64.9     64.7
9...................................  14.....................          66.4     66.2     65.9     65.7     65.4     65.2     65.0     64.8     64.7     64.5     64.3     64.2     64.1     63.9
10..................................  15.....................          65.8     65.5     65.2     65.0     64.7     64.5     64.3     64.1     63.9     63.7     63.6     63.4     63.3     63.1
 
11..................................  16.....................          65.1     64.8     64.6     64.3     64.1     63.8     63.6     63.4     63.2     63.0     62.8     62.6     62.5     62.3
12..................................  17.....................          64.5     64.2     63.9     63.6     63.4     63.1     62.9     62.7     62.4     62.2     62.0     61.9     61.7     61.5
13..................................  18.....................          63.9     63.6     63.3     63.0     62.7     62.4     62.2     61.9     61.7     61.5     61.3     61.1     60.9     60.8
14..................................  19.....................          63.3     63.0     62.7     62.3     62.0     61.8     61.5     61.2     61.0     60.8     60.6     60.4     60.2     60.0
15..................................  20.....................          62.7     62.4     62.0     61.7     61.4     61.1     60.8     60.6     60.3     60.1     59.8     59.6     59.4     59.2
 
16..................................  21.....................          62.2     61.8     61.4     61.1     60.8     60.5     60.2     59.9     59.6     59.4     59.1     58.9     58.7     58.5
17..................................  22.....................          61.6     61.2     60.9     60.5     60.2     59.8     59.5     59.2     58.9     58.7     58.4     58.2     57.9     57.7
18..................................  23.....................          61.1     60.7     60.3     59.9     59.6     59.2     58.9     58.6     58.3     58.0     57.7     57.5     57.2     57.0
19..................................  24.....................          60.6     60.2     59.7     59.4     59.0     58.6     58.3     57.9     57.6     57.3     57.0     56.8     56.5     56.3
20..................................  25.....................          60.1     59.6     59.2     58.8     58.4     58.0     57.7     57.3     57.0     56.7     56.4     56.1     55.8     55.6
 
21..................................  26.....................          59.6     59.1     58.7     58.3     57.9     57.5     57.1     56.7     56.4     56.0     55.7     55.4     55.1     54.9

[[Page 179]]

 
22..................................  27.....................          59.1     58.7     58.2     57.7     57.3     56.9     56.5     56.1     55.8     55.4     55.1     54.8     54.5     54.2
23..................................  28.....................          58.7     58.2     57.7     57.2     56.8     56.4     55.9     55.5     55.2     54.8     54.4     54.1     53.8     53.5
24..................................  29.....................          58.3     57.7     57.2     56.8     56.3     55.8     55.4     55.0     54.6     54.2     53.8     53.5     53.2     52.8
25..................................  30.....................          57.9     57.3     56.8     56.3     55.8     55.3     54.9     54.4     54.0     53.6     53.2     52.9     52.5     52.2
 
26..................................  31.....................          57.5     56.9     56.4     55.8     55.3     54.8     54.4     53.9     53.5     53.1     52.7     52.3     51.9     51.6
27..................................  32.....................          57.1     56.5     55.9     55.4     54.9     54.4     53.9     53.4     53.0     52.5     52.1     51.7     51.3     50.9
28..................................  33.....................          56.7     56.1     55.5     55.0     54.4     53.9     53.4     52.9     52.4     52.0     51.6     51.1     50.7     50.3
29..................................  34.....................          56.4     55.8     55.2     54.6     54.0     53.5     53.0     52.4     52.0     51.5     51.0     50.6     50.2     49.3
30..................................  35.....................          56.0     55.4     54.8     54.2     53.6     53.1     52.5     52.0     51.5     51.0     50.5     50.1     49.6     49.2
 
31..................................  36.....................          55.7     55.1     54.4     53.8     53.2     52.7     52.1     51.6     51.0     50.5     50.0     49.5     49.1     48.7
32..................................  37.....................          55.4     54.8     54.1     53.5     52.9     52.3     51.7     51.1     50.6     50.1     49.5     49.1     48.6     48.1
33..................................  38.....................          55.1     54.5     53.8     53.2     52.5     51.9     51.3     50.7     50.2     49.6     49.1     48.6     48.1     47.6
34..................................  39.....................          54.9     54.2     53.5     52.8     52.2     51.6     50.9     50.3     49.8     49.2     48.7     48.1     47.6     47.1
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                         Ages
                                                    --------------------------------------------------------------------------------------------------------------------------------------------
              Male                     Female          Male 35       36       37       38       39       40       41       42       43       44       45       46       47       48        49
                                                    --------------------------------------------------------------------------------------------------------------------------------------------
                                                      Female 40      41       42       43       44       45       46       47       48       49       50       51       52       53        54
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6..............................  11................         66.3     66.2     66.1     66.0     65.9     65.9     65.8     65.7     65.7     65.6     65.6     65.5     65.5     65.5       65.4
7..............................  12................         65.4     65.3     65.3     65.2     65.1     65.0     64.9     64.9     64.8     64.8     64.7     64.7     64.6     64.6       64.5
8..............................  13................         64.6     64.5     64.4     64.3     64.2     64.2     64.1     64.0     64.0     63.9     63.8     63.8     63.7     63.7       63.7
9..............................  14................         63.8     63.7     63.6     63.5     63.4     63.3     63.2     63.2     63.1     63.0     63.0     62.9     62.9     62.8       62.8
10.............................  15................         63.0     62.9     62.8     62.7     62.6     62.5     62.4     62.3     62.2     62.2     62.1     62.0     62.0     61.9       61.9
 
11.............................  16................         62.2     62.1     61.9     61.8     61.7     61.6     61.5     61.4     61.4     61.3     61.2     61.2     61.1     61.0       61.0
12.............................  17................         61.4     61.3     61.1     61.0     60.9     60.8     60.7     60.6     60.5     60.4     60.4     60.3     60.2     60.2       60.1
13.............................  18................         60.6     60.5     60.3     60.2     60.1     60.0     59.9     59.8     59.7     59.6     59.5     59.4     59.4     59.3       59.2
14.............................  19................         59.8     59.7     59.5     59.4     59.3     59.1     59.0     58.9     58.8     58.7     58.6     58.6     58.5     58.4       58.4
15.............................  20................         59.0     58.9     58.7     58.6     58.4     58.3     58.2     58.1     58.0     57.9     57.8     57.7     57.6     57.6       57.5
 
16.............................  21................         58.3     58.1     57.9     57.8     57.6     57.5     57.4     57.2     57.1     57.0     56.9     56.8     56.8     56.7       56.6
17.............................  22................         57.5     57.3     57.2     57.0     56.8     56.7     56.6     56.4     56.3     56.2     56.1     56.0     55.9     55.8       55.7
18.............................  23................         56.8     56.6     56.4     56.2     56.0     55.9     55.7     55.6     55.5     55.4     55.2     55.1     55.1     55.0       54.9
19.............................  24................         56.0     55.8     55.6     55.4     55.3     55.1     54.9     54.8     54.7     54.5     54.4     54.3     54.2     54.1       54.0
20.............................  25................         55.3     55.1     54.9     54.7     54.5     54.3     54.1     54.0     53.8     53.7     53.6     53.5     53.4     53.3       53.2
 
21.............................  26................         54.6     54.4     54.1     53.9     53.7     53.5     53.4     53.2     53.0     52.9     52.8     52.6     52.5     52.4       52.3
22.............................  27................         53.9     53.6     53.4     53.2     53.0     52.8     52.6     52.4     52.2     52.1     51.9     51.8     51.7     51.6       51.5
23.............................  28................         53.2     52.9     52.7     52.5     52.2     52.0     51.8     51.6     51.5     51.3     51.1     51.0     50.9     50.7       50.6
24.............................  29................         52.5     52.3     52.0     51.7     51.5     51.3     51.1     50.9     50.7     50.5     50.3     50.2     50.0     49.9       49.8
25.............................  30................         51.9     51.6     51.3     51.0     50.8     50.5     50.3     50.1     49.9     49.7     49.6     49.4     49.2     49.1       49.0
 
26.............................  31................         51.2     50.9     50.6     50.3     50.1     49.8     49.6     49.4     49.2     49.0     48.8     48.6     48.4     48.3       48.1
27.............................  32................         50.6     50.3     50.0     49.7     49.4     49.1     48.9     48.6     48.4     48.2     48.0     47.8     47.6     47.5       47.3
28.............................  33................         50.0     49.6     49.3     49.0     48.7     48.4     48.2     47.9     47.7     47.5     47.2     47.1     46.9     46.7       46.5
29.............................  34................         49.4     49.0     48.7     48.3     48.0     47.7     47.5     47.2     47.0     46.7     46.5     46.3     46.1     45.9       45.7

[[Page 180]]

 
30.............................  35................         48.8     48.4     48.1     47.7     47.4     47.1     46.8     46.5     46.2     46.0     45.8     45.5     45.3     45.2       45.0
 
31.............................  36................         48.2     47.8     47.5     47.1     46.8     46.4     46.1     45.8     45.6     45.3     45.0     44.8     44.6     44.4       44.2
32.............................  37................         47.7     47.3     46.9     46.5     46.1     45.8     45.5     45.2     44.9     44.6     44.3     44.1     43.9     43.7       43.4
33.............................  38................         47.2     46.7     46.3     45.9     45.5     45.2     44.8     44.5     44.2     43.9     43.7     43.4     43.2     42.9       42.7
34.............................  39................         46.7     46.2     45.8     45.4     45.0     44.6     44.2     43.9     43.6     43.3     43.0     42.7     42.5     42.2       42.0
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                             Ages
                                                             -----------------------------------------------------------------------------------------------------------------------------------
                Male                          Female            Male 50       51       52       53       54       55       56       57       58       59       60       61       62        63
                                                             -----------------------------------------------------------------------------------------------------------------------------------
                                                               Female 55      56       57       58       59       60       61       62       63       64       65       66       67        68
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6...................................  11....................         65.4     65.4     65.3     65.3     65.3     65.3     65.3     65.2     65.2     65.2     65.2     65.2     65.2       65.2
7...................................  12....................         64.5     64.5     64.4     64.4     64.4     64.4     64.3     64.3     64.3     64.3     64.3     64.3     64.3       64.2
8...................................  13....................         63.6     63.6     63.5     63.5     63.5     63.5     63.4     63.4     63.4     63.4     63.4     63.4     63.3       63.3
9...................................  14....................         62.7     62.7     62.7     62.6     62.6     62.6     62.5     62.5     62.5     62.5     62.5     62.4     62.4       62.4
10..................................  15....................         61.8     61.8     61.8     61.7     61.7     61.7     61.6     61.6     61.6     61.6     61.6     61.5     61.5       61.5
 
11..................................  16....................         61.0     60.9     60.9     60.8     60.8     60.8     60.7     60.7     60.7     60.7     60.6     60.6     60.6       60.6
12..................................  17....................         60.1     60.0     60.0     59.9     59.9     59.9     59.8     59.8     59.8     59.8     59.7     59.7     59.7       59.7
13..................................  18....................         59.2     59.1     59.1     59.0     59.0     59.0     58.9     58.9     58.9     58.9     58.8     58.8     58.8       58.8
14..................................  19....................         58.3     58.2     58.2     58.2     58.1     58.1     58.0     58.0     58.0     57.9     57.9     57.9     57.9       57.9
15..................................  20....................         57.4     57.4     57.3     57.3     57.2     57.2     57.1     57.1     57.1     57.0     57.0     57.0     57.0       56.9
 
16..................................  21....................         56.5     56.5     56.4     56.4     56.3     56.3     56.2     56.2     56.2     56.1     56.1     56.1     56.1       56.0
17..................................  22....................         55.7     55.6     55.5     55.5     55.4     55.4     55.3     55.3     55.3     55.2     55.2     55.2     55.1       55.1
18..................................  23....................         54.8     54.7     54.7     54.6     54.6     54.5     54.5     54.4     54.4     54.3     54.3     54.3     54.2       54.2
19..................................  24....................         53.9     53.9     53.8     53.7     53.7     53.6     53.6     53.5     53.5     53.4     53.4     53.4     53.3       53.3
20..................................  25....................         53.1     53.0     52.9     52.8     52.8     52.7     52.7     52.6     52.6     52.5     52.5     52.4     52.4       52.4
 
21..................................  26....................         52.2     52.1     52.0     52.0     51.9     51.8     51.8     51.7     51.7     51.6     51.6     51.5     51.5       51.5
22..................................  27....................         51.4     51.3     51.2     51.1     51.0     51.0     50.9     50.8     50.8     50.7     50.7     50.6     50.6       50.6
23..................................  28....................         50.5     50.4     50.3     50.2     50.2     50.1     50.0     50.0     49.9     49.8     49.8     49.7     49.7       49.7
24..................................  29....................         49.7     49.6     49.5     49.4     49.3     49.2     49.1     49.1     49.0     49.0     48.9     48.9     48.8       48.8
25..................................  30....................         48.8     48.7     48.6     48.5     48.4     48.3     48.3     48.2     48.1     48.1     48.0     48.0     47.9       47.9
 
26..................................  31....................         48.0     47.9     47.8     47.7     47.6     47.5     47.4     47.3     47.3     47.2     47.1     47.1     47.0       47.0
27..................................  32....................         47.2     47.1     46.9     46.8     46.7     46.6     46.5     46.5     46.4     46.3     46.2     46.2     46.1       46.1
28..................................  33....................         46.4     46.3     46.1     46.0     45.9     45.8     45.7     45.6     45.5     45.4     45.4     45.3     45.2       45.2
29..................................  34....................         45.6     45.4     45.3     45.2     45.1     44.9     44.8     44.7     44.7     44.6     44.5     44.4     44.4       44.3
30..................................  35....................         44.8     44.6     44.5     44.4     44.2     44.1     44.0     43.9     43.8     43.7     43.6     43.6     43.5       43.4
 
31..................................  36....................         44.0     43.9     43.7     43.6     43.4     43.3     43.2     43.1     43.0     42.9     42.8     42.7     42.6       42.0
32..................................  37....................         43.3     43.1     42.9     42.8     42.6     42.5     42.4     42.2     42.1     42.0     41.9     41.9     41.8       41.7

[[Page 181]]

 
33..................................  38....................         42.5     42.3     42.1     42.0     41.8     41.7     41.5     41.4     41.3     41.2     41.1     41.0     40.9       40.8
34..................................  39....................         41.8     41.6     41.4     41.2     41.0     40.9     40.7     40.6     40.5     40.4     40.3     40.2     40.1       40.0
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                         Ages
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
              Male                      Female           Male 64       65       66       67       68       69       70       71       72       73       74       75       76       77       78
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
                                                        Female 69      70       71       72       73       74       75       76       77       78       79       80       81       82       83
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6...............................  11................          65.1     65.1     65.1     65.1     65.1     65.1     65.1     65.1     65.1     65.1     65.1     65.1     65.1     65.1     65.1
7...............................  12................          64.2     64.2     64.2     64.2     64.2     64.2     64.2     64.2     64.2     64.2     64.2     64.2     64.2     64.1     64.1
8...............................  13................          63.3     63.3     63.3     63.3     63.3     63.3     63.3     63.3     63.3     63.2     63.2     63.2     63.2     63.2     63.2
9...............................  14................          62.4     62.4     62.4     62.4     62.4     62.4     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3
10..............................  15................          61.5     61.5     61.5     61.5     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4
 
11..............................  16................          60.6     60.6     60.6     60.5     60.5     60.5     60.5     60.5     60.5     60.5     60.5     60.5     60.5     60.5     60.5
12..............................  17................          59.7     59.6     59.6     59.6     59.6     59.6     59.6     59.6     59.6     59.6     59.6     59.6     59.6     59.5     59.5
13..............................  18................          58.8     58.7     58.7     58.7     58.7     58.7     58.7     58.7     58.7     58.7     58.6     58.6     58.6     58.6     58.6
14..............................  19................          57.8     57.8     57.8     57.8     57.8     57.8     57.8     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7
15..............................  20................          56.9     56.9     56.9     56.9     56.9     56.8     56.8     56.8     56.8     56.8     56.8     56.8     56.8     56.8     56.8
 
16..............................  21................          56.0     56.0     56.0     56.0     55.9     55.9     55.9     55.9     55.9     55.9     55.9     55.9     55.9     55.9     55.8
17..............................  22................          55.1     55.1     55.1     55.0     55.0     55.0     55.0     55.0     55.0     55.0     55.0     54.9     54.9     54.9     54.9
18..............................  23................          54.2     54.2     54.1     54.1     54.1     54.1     54.1     54.1     54.0     54.0     54.0     54.0     54.0     54.0     54.0
19..............................  24................          53.3     53.2     53.2     53.2     53.2     53.2     53.2     53.1     53.1     53.1     53.1     53.1     53.1     53.1     53.1
20..............................  25................          52.4     52.3     52.3     52.3     52.3     52.2     52.2     52.2     52.2     52.2     52.2     52.2     52.2     52.1     52.1
 
21..............................  26................          51.4     51.4     51.4     51.4     51.3     51.3     51.3     51.3     51.3     51.3     51.3     51.2     51.2     51.2     51.2
22..............................  27................          50.5     50.5     50.5     50.5     50.4     50.4     50.4     50.4     50.4     50.3     50.3     50.3     50.3     50.3     50.3
23..............................  28................          49.6     49.6     49.6     49.5     49.5     49.5     49.5     49.5     49.4     49.4     49.4     49.4     49.4     49.4     49.4
24..............................  29................          48.7     48.7     48.7     48.6     48.6     48.6     48.6     48.5     48.5     48.5     48.5     48.5     48.5     48.4     48.4
25..............................  30................          47.8     47.8     47.8     47.7     47.7     47.7     47.6     47.6     47.6     47.6     47.6     47.5     47.5     47.5     47.5
 
26..............................  31................          46.9     46.9     46.8     46.8     46.8     46.8     46.7     46.7     46.7     46.7     46.6     46.6     46.6     46.6     46.6
27..............................  32................          46.0     46.0     45.9     45.9     45.9     45.8     45.8     45.8     45.8     45.7     45.7     45.7     45.7     45.7     45.7
28..............................  33................          45.1     45.1     45.1     45.0     45.0     44.9     44.9     44.9     44.9     44.8     44.8     44.8     44.8     44.8     44.8
29..............................  34................          44.3     44.2     44.2     44.1     44.1     44.0     44.0     44.0     44.0     43.9     43.9     43.9     43.9     43.9     43.8
30..............................  35................          43.4     43.3     43.3     43.2     43.2     43.1     43.1     43.1     43.1     43.0     43.0     43.0     43.0     42.9     42.9
 
31..............................  36................          42.5     42.4     42.4     42.3     42.3     42.3     42.2     42.2     42.2     42.1     42.1     42.1     42.1     42.0     42.0
32..............................  37................          41.6     41.6     41.5     41.5     41.4     41.4     41.3     41.3     41.3     41.2     41.2     41.2     41.2     41.1     41.1
33..............................  38................          40.8     40.7     40.7     40.6     40.5     40.5     40.5     40.4     40.4     40.3     40.3     40.3     40.3     40.2     40.2
34..............................  39................          39.9     39.9     39.8     39.7     39.7     39.6     39.6     39.5     39.5     39.5     39.4     39.4     39.4     39.3     39.3
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 182]]


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                              Ages
                                                              ----------------------------------------------------------------------------------------------------------------------------------
                Male                           Female             Male 79       80       81       82       83       84       85       86       87       88       89       90       91       92
                                                              ----------------------------------------------------------------------------------------------------------------------------------
                                                                 Female 84      85       86       87       88       89       90       91       92       93       94       95       96       97
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6...................................  11.....................          65.1     65.1     65.1     65.1     65.1     65.1     65.1     65.1     65.1     65.0     65.0     65.0     65.0     65.0
7...................................  12.....................          64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1
8...................................  13.....................          63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2
9...................................  14.....................          62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3
10..................................  15.....................          61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4
 
11..................................  16.....................          60.5     60.5     60.5     60.5     60.5     60.5     60.4     60.4     60.4     60.4     60.4     60.4     60.4     60.4
12..................................  17.....................          59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5
13..................................  18.....................          58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6
14..................................  19.....................          57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7
15..................................  20.....................          56.8     56.8     56.8     56.8     56.8     56.8     56.7     56.7     56.7     56.7     56.7     56.7     56.7     56.7
 
16..................................  21.....................          55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8
17..................................  22.....................          54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9
18..................................  23.....................          54.0     54.0     54.0     54.0     54.0     54.0     54.0     54.0     54.0     54.0     54.0     54.0     54.0     53.9
19..................................  24.....................          53.1     53.1     53.1     53.0     53.0     53.0     53.0     53.0     53.0     53.0     53.0     53.0     53.0     53.0
20..................................  25.....................          52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1
 
21..................................  26.....................          51.2     51.2     51.2     51.2     51.2     51.2     51.2     51.2     51.2     51.2     51.2     51.2     51.2     51.2
22..................................  27.....................          50.3     50.3     50.3     50.3     50.3     50.2     50.2     50.2     50.2     50.2     50.2     50.2     50.2     50.2
23..................................  28.....................          49.4     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3
24..................................  29.....................          48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4
25..................................  30.....................          47.5     47.5     47.5     47.5     47.5     47.5     47.5     47.5     47.4     47.4     47.4     47.4     47.4     47.4
 
26..................................  31.....................          46.6     46.6     46.6     46.6     46.5     46.5     46.5     46.5     46.5     46.5     46.5     46.5     46.5     46.5
27..................................  32.....................          45.7     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6
28..................................  33.....................          44.7     44.7     44.7     44.7     44.7     44.7     44.7     44.7     44.7     44.7     44.7     44.7     44.7     44.7
29..................................  34.....................          43.8     43.8     43.8     43.8     43.8     43.8     43.8     43.8     43.8     43.7     43.7     43.7     43.7     43.7
30..................................  35.....................          42.9     42.9     42.9     42.9     42.9     42.9     42.8     42.8     42.8     42.8     42.8     42.8     42.8     42.8
 
31..................................  36.....................          42.0     42.0     42.0     42.0     42.0     41.9     41.9     41.9     41.9     41.9     41.9     41.9     41.9     41.9
32..................................  37.....................          41.1     41.1     41.1     41.1     41.0     41.0     41.0     41.0     41.0     41.0     41.0     41.0     41.0     41.0
33..................................  38.....................          40.2     40.2     40.2     40.2     40.1     40.1     40.1     40.1     40.1     40.1     40.1     40.1     40.1     40.1
34..................................  39.....................          39.3     39.3     39.3     39.3     39.2     39.2     39.2     39.2     39.2     39.2     39.2     39.2     39.2     39.2
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                                             Ages
                                                                                    ----------------------------------------------------------------------------------------------------------------------------------------------------
                      Male                                     Female                   Male 93       94       95       96       97       98       99      100      101      102      103      104      105      106      107      108
                                                                                    ----------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                       Female 98      99      100      101      102      103      104      105      106      107      108      109      110      111      112      113
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6..............................................  11................................          65.0     65.0     65.0     65.0     65.0     65.0     65.0     65.0     65.0     65.0     65.0     65.0     65.0     65.0     65.0     65.0
7..............................................  12................................          64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1     64.1
8..............................................  13................................          63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2     63.2
9..............................................  14................................          62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3     62.3

[[Page 183]]

 
10.............................................  15................................          61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4     61.4
 
11.............................................  16................................          60.4     60.4     60.4     60.4     60.4     60.4     60.4     60.4     60.4     60.4     60.4     60.4     60.4     60.4     60.4     60.4
12.............................................  17................................          59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5     59.5
13.............................................  18................................          58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6     58.6
14.............................................  19................................          57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7     57.7
15.............................................  20................................          56.7     56.7     56.7     56.7     56.7     56.7     56.7     56.7     56.7     56.7     56.7     56.7     56.7     56.7     56.7     56.7
 
16.............................................  21................................          55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8     55.8
17.............................................  22................................          54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9     54.9
18.............................................  23................................          53.9     53.9     53.9     53.9     53.9     53.9     53.9     53.9     53.9     53.9     53.9     53.9     53.9     53.9     53.9     53.9
19.............................................  24................................          53.0     53.0     53.0     53.0     53.0     53.0     53.0     53.0     53.0     53.0     53.0     53.0     53.0     53.0     53.0     53.0
20.............................................  25................................          52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1     52.1
 
21.............................................  26................................          51.2     51.2     51.2     51.2     51.2     51.2     51.1     51.1     51.1     51.1     51.1     51.1     51.1     51.1     51.1     51.1
22.............................................  27................................          50.2     50.2     50.2     50.2     50.2     50.2     50.2     50.2     50.2     50.2     50.2     50.2     50.2     50.2     50.2     50.2
23.............................................  28................................          49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3     49.3
24.............................................  29................................          48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.4     48.3     48.3
25.............................................  30................................          47.4     47.4     47.4     47.4     47.4     47.4     47.4     47.4     47.4     47.4     47.4     47.4     47.4     47.4     47.4     47.4
 
26.............................................  31................................          46.5     46.5     46.5     46.5     46.5     46.5     46.5     46.5     46.5     46.5     46.5     46.5     46.5     46.5     46.5     46.5
27.............................................  32................................          45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6     45.6
28.............................................  33................................          44.7     44.6     44.6     44.6     44.6     44.6     44.6     44.6     44.6     44.6     44.6     44.6     44.6     44.6     44.6     44.6
29.............................................  34................................          43.7     43.7     43.7     43.7     43.7     43.7     43.7     43.7     43.7     43.7     43.7     43.7     43.7     43.7     43.7     43.7
30.............................................  35................................          42.8     42.8     42.8     42.8     42.8     42.8     42.8     42.8     42.8     42.8     42.8     42.8     42.8     42.8     42.8     42.8
 
31.............................................  36................................          41.9     41.9     41.9     41.9     41.9     41.9     41.9     41.9     41.9     41.9     41.9     41.9     41.9     41.9     41.9     41.9
32.............................................  37................................          41.0     41.0     41.0     41.0     41.0     41.0     41.0     41.0     41.0     41.0     41.0     41.0     41.0     41.0     41.0     41.0
33.............................................  38................................          40.1     40.1     40.1     40.1     40.1     40.1     40.1     40.1     40.1     40.1     40.1     40.1     40.1     40.1     40.1     40.0
34.............................................  39................................          39.2     39.2     39.2     39.2     39.2     39.2     39.2     39.2     39.2     39.2     39.2     39.1     39.1     39.1     39.1     39.1
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                  Ages
                                                                       -------------------------------------------------------------------------------------------------------------------------
                   Male                               Female               Male 35       36       37       38       39       40       41       42       43       44       45       46       47
                                                                       -------------------------------------------------------------------------------------------------------------------------
                                                                          Female 40      41       42       43       44       45       46       47       48       49       50       51       52
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
35.......................................  40.........................          46.2     45.7     45.3     44.8     44.4     44.0     43.6     43.3     43.0     42.6     42.3     42.0     41.8
36.......................................  41.........................          45.7     45.2     44.8     44.3     43.9     43.5     43.1     42.7     42.3     42.0     41.7     41.4     41.1
37.......................................  42.........................          45.3     44.8     44.3     43.8     43.4     42.9     42.5     42.1     41.8     41.4     41.1     40.7     40.4
38.......................................  43.........................          44.8     44.3     43.8     43.3     42.9     42.4     42.0     41.6     41.2     40.8     40.5     40.1     39.8
39.......................................  44.........................          44.4     43.9     43.4     42.9     42.4     41.9     41.5     41.0     40.6     40.2     39.9     39.5     39.2
40.......................................  45.........................          44.0     43.5     42.9     42.4     41.9     41.4     41.0     40.5     40.1     39.7     39.3     38.9     38.6
 
41.......................................  46.........................          43.6     43.1     42.5     42.0     41.5     41.0     40.5     40.0     39.6     39.2     38.8     38.4     38.0
42.......................................  47.........................          43.3     42.7     42.1     41.6     41.0     40.5     40.0     39.6     39.1     38.7     38.2     37.8     37.5
43.......................................  48.........................          43.0     42.3     41.8     41.2     40.6     40.1     39.6     39.1     38.6     38.2     37.7     37.3     36.9
44.......................................  49.........................          42.6     42.0     41.4     40.8     40.2     39.7     39.2     38.7     38.2     37.7     37.2     36.8     36.4
45.......................................  50.........................          42.3     41.7     41.1     40.5     39.9     39.3     38.8     38.2     37.7     37.2     36.8     36.3     35.9
 

[[Page 184]]

 
46.......................................  51.........................          42.0     41.4     40.7     40.1     39.5     38.9     38.4     37.8     37.3     36.8     36.3     35.9     35.4
47.......................................  52.........................          41.8     41.1     40.4     39.8     39.2     38.6     38.0     37.5     36.9     36.4     35.9     35.4     35.0
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                  Ages
                                                                       -------------------------------------------------------------------------------------------------------------------------
                   Male                               Female               Male 48       49       50       51       52       53       54       55       56       57       58       59       60
                                                                       -------------------------------------------------------------------------------------------------------------------------
                                                                          Female 53      54       55       56       57       58       59       60       61       62       63       64       65
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
35.......................................  40.........................          41.5     41.3     41.0     40.8     40.6     40.4     40.3     40.1     40.0     39.8     39.7     39.6     39.5
36.......................................  41.........................          40.8     40.6     40.3     40.1     39.9     39.7     39.5     39.3     39.2     39.0     38.9     38.8     38.6
37.......................................  42.........................          40.2     39.9     39.6     39.4     39.2     39.0     38.8     38.6     38.4     38.3     38.1     38.0     37.9
38.......................................  43.........................          39.5     39.2     39.0     38.7     38.5     38.3     38.1     37.9     37.7     37.5     37.3     37.2     37.1
39.......................................  44.........................          38.9     38.6     38.3     38.0     37.8     37.6     37.3     37.1     36.9     36.8     36.6     36.4     36.3
40.......................................  45.........................          38.3     38.0     37.7     37.4     37.1     36.9     36.6     36.4     36.2     36.0     35.9     35.7     35.5
 
41.......................................  46.........................          37.7     37.3     37.0     36.7     36.5     36.2     36.0     35.7     35.5     35.3     35.1     35.0     34.8
42.......................................  47.........................          37.1     36.8     36.4     36.1     35.8     35.6     35.3     35.1     34.8     34.6     34.4     34.2     34.1
43.......................................  48.........................          36.5     36.2     35.8     35.5     35.2     34.9     34.7     34.4     34.2     33.9     33.7     33.5     33.3
44.......................................  49.........................          36.0     35.6     35.3     34.9     34.6     34.3     34.0     33.8     33.5     33.3     33.0     32.8     32.6
45.......................................  50.........................          35.5     35.1     34.7     34.4     34.0     33.7     33.4     33.1     32.9     32.6     32.4     32.2     31.9
 
46.......................................  51.........................          35.0     34.6     34.2     33.8     33.5     33.1     32.8     32.5     32.2     32.0     31.7     31.5     31.3
47.......................................  52.........................          34.5     34.1     33.7     33.3     32.9     32.6     32.2     31.9     31.6     31.4     31.1     30.9     30.6
48.......................................  53.........................          34.0     33.6     33.2     32.8     32.4     32.0     31.7     31.4     31.1     30.8     30.5     30.2     30.0
49.......................................  54.........................          33.6     33.1     32.7     32.3     31.9     31.5     31.2     30.8     30.5     30.2     29.9     29.6     29.4
50.......................................  55.........................          33.2     32.7     32.3     31.8     31.4     31.0     30.6     30.3     29.9     29.6     29.3     29.0     28.8
 
51.......................................  56.........................          32.8     32.3     31.8     31.4     30.9     30.5     30.1     29.8     29.4     29.1     28.8     28.5     28.2
52.......................................  57.........................          32.4     31.9     31.4     30.9     30.5     30.1     29.7     29.3     28.9     28.6     28.2     27.9     27.6
53.......................................  58.........................          32.0     31.5     31.0     30.5     30.1     29.6     29.2     28.8     28.4     28.1     27.7     27.4     27.1
54.......................................  59.........................          31.7     31.2     30.6     30.1     29.7     29.2     28.8     28.3     27.9     27.6     27.2     26.9     26.5
55.......................................  60.........................          31.4     30.8     30.3     29.8     29.3     28.8     28.3     27.9     27.5     27.1     26.7     26.4     26.0
 
56.......................................  61.........................          31.1     30.5     29.9     29.4     28.9     28.4     27.9     27.5     27.1     26.7     26.3     25.9     25.5
57.......................................  62.........................          30.8     30.2     29.6     29.1     28.6     28.1     27.6     27.1     26.7     26.2     25.8     25.4     25.1
58.......................................  63.........................          30.5     29.9     29.3     28.8     28.2     27.7     27.2     26.7     26.3     25.8     25.4     25.0     24.6
59.......................................  64.........................          30.2     29.6     29.0     28.5     27.9     27.4     26.9     26.4     25.9     25.4     25.0     24.6     24.2
60.......................................  65.........................          30.0     29.4     28.8     28.2     27.6     27.1     26.5     26.0     25.5     25.1     24.6     24.2     23.8
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 185]]


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                  Ages
                                                                       -------------------------------------------------------------------------------------------------------------------------
                   Male                               Female               Male 61       62       63       64       65       66       67       68       69       70       71       72       73
                                                                       -------------------------------------------------------------------------------------------------------------------------
                                                                          Female 66      67       68       69       70       71       72       73       74       75       76       77       78
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
35.......................................  40.........................          39.4     39.3     39.2     39.1     39.0     38.9     38.9     38.8     38.8     38.7     38.7     38.6     38.6
36.......................................  41.........................          38.5     38.4     38.3     38.2     38.2     38.1     38.0     38.0     37.9     37.9     37.8     37.8     37.7
37.......................................  42.........................          37.7     37.6     37.5     37.4     37.3     37.3     37.2     37.1     37.1     37.0     36.9     36.9     36.9
38.......................................  43.........................          36.9     36.8     36.7     36.6     36.5     36.4     36.4     36.3     36.2     36.2     36.1     36.0     36.0
39.......................................  44.........................          36.2     36.0     35.9     35.8     35.7     35.6     35.5     35.5     35.4     35.3     35.3     35.2     35.2
40.......................................  45.........................          35.4     35.3     35.1     35.0     34.9     34.8     34.7     34.6     34.6     34.5     34.4     34.4     34.3
 
41.......................................  46.........................          34.6     34.5     34.4     34.2     34.1     34.0     33.9     33.8     33.8     33.7     33.6     33.5     33.5
42.......................................  47.........................          33.9     33.7     33.6     33.5     33.4     33.2     33.1     33.0     33.0     32.9     32.8     32.7     32.7
43.......................................  48.........................          33.2     33.0     32.9     32.7     32.6     32.5     32.4     32.3     32.2     32.1     32.0     31.9     31.9
44.......................................  49.........................          32.5     32.3     32.1     32.0     31.8     31.7     31.6     31.5     31.4     31.3     31.2     31.1     31.1
45.......................................  50.........................          31.8     31.6     31.4     31.3     31.1     31.0     30.8     30.7     30.6     30.5     30.4     30.4     30.3
 
46.......................................  51.........................          31.1     30.9     30.7     30.5     30.4     30.2     30.1     30.0     29.9     29.8     29.7     29.6     29.5
47.......................................  52.........................          30.4     30.2     30.0     29.8     29.7     29.5     29.4     29.3     29.1     29.0     28.9     28.8     28.7
48.......................................  53.........................          29.8     29.5     29.3     29.2     29.0     28.8     28.7     28.5     28.4     28.3     28.2     28.1     28.0
49.......................................  54.........................          29.1     28.9     28.7     28.5     28.3     28.1     28.0     27.8     27.7     27.6     27.5     27.4     27.3
50.......................................  55.........................          28.5     28.3     28.1     27.8     27.6     27.5     27.3     27.1     27.0     26.9     26.7     26.6     26.5
 
51.......................................  56.........................          27.9     27.7     27.4     27.2     27.0     26.8     26.6     26.5     26.3     26.2     26.0     25.9     25.8
52.......................................  57.........................          27.3     27.1     26.8     26.6     26.4     26.2     26.0     25.8     25.7     25.5     25.4     25.2     25.1
53.......................................  58.........................          26.8     26.5     26.2     26.0     25.8     25.6     25.4     25.2     25.0     24.8     24.7     24.6     24.4
54.......................................  59.........................          26.2     25.9     25.7     25.4     25.2     25.0     24.7     24.6     24.4     24.2     24.0     23.9     23.8
55.......................................  60.........................          25.7     25.4     25.1     24.9     24.6     24.4     24.1     23.9     23.8     23.6     23.4     23.3     23.1
 
56.......................................  61.........................          25.2     24.9     24.6     24.3     24.1     23.8     23.6     23.4     23.2     23.0     22.8     22.6     22.5
57.......................................  62.........................          24.7     24.4     24.1     23.8     23.5     23.3     23.0     22.8     22.6     22.4     22.2     22.0     21.9
58.......................................  63.........................          24.3     23.9     23.6     23.3     23.0     22.7     22.5     22.2     22.0     21.8     21.6     21.4     21.3
59.......................................  64.........................          23.8     23.5     23.1     22.8     22.5     22.2     21.9     21.7     21.5     21.2     21.0     20.9     20.7
60.......................................  65.........................          23.4     23.0     22.7     22.3     22.0     21.7     21.4     21.2     20.9     20.7     20.5     20.3     20.1
 
61.......................................  66.........................          23.0     22.6     22.2     21.9     21.6     21.3     21.0     20.7     20.4     20.2     20.0     19.8     19.6
62.......................................  67.........................          22.6     22.2     21.8     21.5     21.1     20.8     20.5     20.2     19.9     19.7     19.5     19.2     19.0
63.......................................  68.........................          22.2     21.8     21.4     21.1     20.7     20.4     20.1     19.8     19.5     19.2     19.0     18.7     18.5
64.......................................  69.........................          21.9     21.5     21.1     20.7     20.3     20.0     19.6     19.3     19.0     18.7     18.5     18.2     18.0
65.......................................  70.........................          21.6     21.1     20.7     20.3     19.9     19.6     19.2     18.9     18.6     18.3     18.0     17.8     17.5
 
66.......................................  71.........................          21.3     20.8     20.4     20.0     19.6     19.2     18.8     18.5     18.2     17.9     17.6     17.3     17.1
67.......................................  72.........................          21.0     20.5     20.1     19.6     19.2     18.8     18.5     18.1     17.8     17.5     17.2     16.9     16.7
68.......................................  73.........................          20.7     20.2     19.8     19.3     18.9     18.5     18.1     17.8     17.4     17.1     16.8     16.5     16.2
69.......................................  74.........................          20.4     19.9     19.5     19.0     18.6     18.2     17.8     17.4     17.1     16.7     16.4     16.1     15.8
70.......................................  75.........................          20.2     19.7     19.2     18.7     18.3     17.9     17.5     17.1     16.7     16.4     16.1     15.8     15.5
 
71.......................................  76.........................          20.0     19.5     19.0     18.5     18.0     17.6     17.2     16.8     16.4     16.1     15.7     15.4     15.1
72.......................................  77.........................          19.8     19.2     18.7     18.2     17.8     17.3     16.9     16.5     16.1     15.8     15.4     15.1     14.8

[[Page 186]]

 
73.......................................  78.........................          19.6     19.0     18.5     18.0     17.5     17.1     16.7     16.2     15.8     15.5     15.1     14.8     14.4
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                       Ages
                                                                                ----------------------------------------------------------------------------------------------------------------
                     Male                                   Female                  Male 74       75       76       77       78       79       80       81       82       83       84       85
                                                                                ----------------------------------------------------------------------------------------------------------------
                                                                                   Female 79      80       81       82       83       84       85       86       87       88       89       90
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
35...........................................  40..............................          38.6     38.5     38.5     38.5     38.4     38.4     38.4     38.4     38.4     38.4     38.3     38.3
36...........................................  41..............................          37.7     37.6     37.6     37.6     37.6     27.5     37.5     37.5     37.5     37.5     37.5     37.4
37...........................................  42..............................          36.8     36.8     36.7     36.7     36.7     36.7     36.6     36.6     36.6     36.6     36.6     36.6
38...........................................  43..............................          36.0     35.9     35.9     35.9     35.8     35.8     35.8     35.8     35.7     35.7     35.7     35.7
39...........................................  44..............................          35.1     35.1     35.0     35.0     35.0     34.9     34.9     34.9     34.9     34.8     34.8     34.8
40...........................................  45..............................          34.3     34.2     34.2     34.1     34.1     34.1     34.1     34.0     34.0     34.0     34.0     34.0
 
41...........................................  46..............................          33.4     33.4     33.3     33.3     33.3     33.2     33.2     33.2     33.2     33.1     33.1     33.1
42...........................................  47..............................          32.6     32.6     32.5     32.5     32.4     32.4     32.4     32.3     32.3     32.3     32.3     32.3
43...........................................  48..............................          31.8     31.8     31.7     31.7     31.6     31.6     31.5     31.5     31.5     31.5     31.4     31.4
44...........................................  49..............................          31.0     30.9     30.9     30.8     30.8     30.8     30.7     30.7     30.7     30.6     30.6     30.6
45...........................................  50..............................          30.2     30.1     30.1     30.0     30.0     29.9     29.9     29.9     29.8     29.8     29.8     29.8
 
46...........................................  51..............................          29.4     29.4     29.3     29.2     29.2     29.2     29.1     29.1     29.0     29.0     29.0     28.9
47...........................................  52..............................          28.7     28.6     28.5     28.5     28.4     28.4     28.3     28.3     28.2     28.2     28.2     28.1
48...........................................  53..............................          27.9     27.8     27.8     27.7     27.6     27.6     27.5     27.5     27.5     27.4     27.4     27.4
49...........................................  54..............................          27.2     27.1     27.0     26.9     26.9     26.8     26.8     26.7     26.7     26.6     26.6     26.6
50...........................................  55..............................          26.4     26.3     26.3     26.2     26.1     26.1     26.0     26.0     25.9     25.9     25.8     25.8
 
51...........................................  56..............................          25.7     25.6     25.5     25.5     25.4     25.3     25.3     25.2     25.2     25.1     25.1     25.0
52...........................................  57..............................          25.0     24.9     24.8     24.7     24.7     24.6     24.5     24.5     24.4     24.4     24.3     24.3
53...........................................  58..............................          24.3     24.2     24.1     24.0     23.9     23.9     23.8     23.7     23.7     23.6     23.6     23.5
54...........................................  59..............................          23.6     23.5     23.4     23.3     23.2     23.2     23.1     23.0     23.0     22.9     22.9     22.8
55...........................................  60..............................          23.0     22.9     22.8     22.7     22.6     22.5     22.4     22.3     22.3     22.2     22.2     22.1
 
56...........................................  61..............................          22.3     22.2     22.1     22.0     21.9     21.8     21.7     21.6     21.6     21.5     21.5     21.4
57...........................................  62..............................          21.7     21.6     21.5     21.3     21.2     21.1     21.1     21.0     20.9     20.8     20.8     20.7
58...........................................  63..............................          21.1     21.0     20.8     20.7     20.6     20.5     20.4     20.3     20.2     20.2     20.1     20.0
59...........................................  64..............................          20.5     20.4     20.2     20.1     20.0     19.9     19.8     19.7     19.6     19.5     19.4     19.4
60...........................................  65..............................          19.9     19.8     19.6     19.5     19.4     19.3     19.1     19.0     19.0     18.9     18.8     18.7
 
61...........................................  66..............................          19.4     19.2     19.1     18.9     18.8     18.7     18.5     18.4     18.3     18.3     18.2     18.1
62...........................................  67..............................          18.8     18.7     18.5     18.3     18.2     18.1     18.0     17.8     17.7     17.7     17.6     17.5
63...........................................  68..............................          18.3     18.1     18.0     17.8     17.6     17.5     17.4     17.3     17.2     17.1     17.0     16.9
64...........................................  69..............................          17.8     17.6     17.4     17.3     17.1     17.0     16.8     16.7     16.6     16.5     16.4     16.3
65...........................................  70..............................          17.3     17.1     16.9     16.7     16.6     16.4     16.3     16.2     16.0     15.9     15.8     15.8
 

[[Page 187]]

 
66...........................................  71..............................          16.9     16.6     16.4     16.3     16.1     15.9     15.8     15.6     15.5     15.4     15.3     15.2
67...........................................  72..............................          16.4     16.2     16.0     15.8     15.6     15.4     15.3     15.1     15.0     14.9     14.8     14.7
68...........................................  73..............................          16.0     15.7     15.5     15.3     15.1     15.0     14.8     14.6     14.5     14.4     14.3     14.2
69...........................................  74..............................          15.6     15.3     15.1     14.9     14.7     14.5     14.3     14.2     14.0     13.9     13.8     13.7
70...........................................  75..............................          15.2     14.9     14.7     14.5     14.3     14.1     13.9     13.7     13.6     13.4     13.3     13.2
 
71...........................................  76..............................          14.8     14.5     14.3     14.1     13.8     13.6     13.5     13.3     13.1     13.0     12.8     12.7
72...........................................  77..............................          14.5     14.2     13.9     13.7     13.5     13.2     13.0     12.9     12.7     12.5     12.4     12.3
73...........................................  78..............................          14.1     13.8     13.6     13.3     13.1     12.9     12.7     12.5     12.3     12.1     12.0     11.8
74...........................................  79..............................          13.8     13.5     13.2     13.0     12.7     12.5     12.3     12.1     11.9     11.7     11.6     11.4
75...........................................  80..............................          13.5     13.2     12.9     12.6     12.4     12.2     11.9     11.7     11.5     11.4     11.2     11.0
 
76...........................................  81..............................          13.2     12.9     12.6     12.3     12.1     11.8     11.6     11.4     11.2     11.0     10.8     10.7
77...........................................  82..............................          13.0     12.6     12.3     12.1     11.8     11.5     11.3     11.1     10.8     10.7     10.5     10.3
78...........................................  83..............................          12.7     12.4     12.1     11.8     11.5     11.2     11.0     10.7     10.5     10.3     10.1     10.0
79...........................................  84..............................          12.5     12.2     11.8     11.5     11.2     11.0     10.7     10.5     10.2     10.0      9.8      9.6
80...........................................  85..............................          12.3     11.9     11.6     11.3     11.0     10.7     10.4     10.2     10.0      9.7      9.5      9.3
 
81...........................................  86..............................          12.1     11.7     11.4     11.1     10.7     10.5     10.2      9.9      9.7      9.5      9.3      9.1
82...........................................  87..............................          11.9     11.5     11.2     10.8     10.5     10.2     10.0      9.7      9.4      9.2      9.0      8.8
83...........................................  88..............................          11.7     11.4     11.0     10.7     10.3     10.0      9.7      9.5      9.2      9.0      8.7      8.5
84...........................................  89..............................          11.6     11.2     10.8     10.5     10.1      9.8      9.5      9.3      9.0      8.7      8.5      8.3
85...........................................  90..............................          11.4     11.0     10.7     10.3     10.0      9.6      9.3      9.1      8.8      8.5      8.3      8.1
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                       Ages
                                                                                ----------------------------------------------------------------------------------------------------------------
                     Male                                   Female                  Male 86       87       88       89       90       91       92       93       94       95       96       97
                                                                                ----------------------------------------------------------------------------------------------------------------
                                                                                   Female 91      92       93       94       95       96       97       98       99      100      101      102
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
35...........................................  40..............................          38.3     38.3     38.3     38.3     38.3     38.3     38.3     38.3     38.3     38.3     38.3     38.3
36...........................................  41..............................          37.4     37.4     37.4     37.4     37.4     37.4     37.4     37.4     37.4     37.4     37.4     37.4
37...........................................  42..............................          36.5     36.5     36.5     36.5     36.5     36.5     36.5     36.5     36.5     36.5     36.5     36.5
38...........................................  43..............................          35.7     35.7     35.6     35.6     35.6     35.6     35.6     35.6     35.6     35.6     35.6     35.6
39...........................................  44..............................          34.8     34.8     34.8     34.8     34.8     34.8     34.7     34.7     34.7     34.7     34.7     34.7
40...........................................  45..............................          33.9     33.9     33.9     33.9     33.9     33.9     33.9     33.9     33.9     33.9     33.9     33.9
 
41...........................................  46..............................          33.1     33.1     33.1     33.0     33.0     33.0     33.0     33.0     33.0     33.0     33.0     33.0
42...........................................  47..............................          32.2     32.2     32.2     32.2     32.2     32.2     32.2     32.2     32.2     32.1     32.1     32.1
43...........................................  48..............................          31.4     31.4     31.4     31.3     31.3     31.3     31.3     31.3     31.3     31.3     31.3     31.3
44...........................................  49..............................          30.6     30.5     30.5     30.5     30.5     30.5     30.5     30.5     30.5     30.5     30.5     30.4
45...........................................  50..............................          29.7     29.7     29.7     29.7     29.7     29.7     29.7     29.6     29.6     29.6     29.6     29.6
 
46...........................................  51..............................          28.9     28.9     28.9     28.9     28.9     28.8     28.8     28.8     28.8     28.8     28.8     28.8
47...........................................  52..............................          28.1     28.1     28.1     28.1     28.0     28.0     28.0     28.0     28.0     28.0     28.0     28.0
48...........................................  53..............................          27.3     27.3     27.3     27.3     27.2     27.2     27.2     27.2     27.2     27.2     27.2     27.2
49...........................................  54..............................          26.5     26.5     26.5     26.5     26.5     26.4     26.4     26.4     26.4     26.4     26.4     26.4
50...........................................  55..............................          25.8     25.7     25.7     25.7     25.7     25.7     25.6     25.6     25.6     25.6     25.6     25.6
 
51...........................................  56..............................          25.0     25.0     24.9     24.9     24.9     24.9     24.9     24.9     24.8     24.8     24.8     24.8

[[Page 188]]

 
52...........................................  57..............................          24.3     24.2     24.2     24.2     24.1     24.1     24.1     24.1     24.1     24.1     24.1     24.0
53...........................................  58..............................          23.5     23.5     23.4     23.4     23.4     23.4     23.4     23.3     23.3     23.3     23.3     23.3
54...........................................  59..............................          22.8     22.7     22.7     22.7     22.7     22.6     22.6     22.6     22.6     22.6     22.6     22.5
55...........................................  60..............................          22.1     22.0     22.0     22.0     21.9     21.9     21.9     21.9     21.8     21.8     21.8     21.8
 
56...........................................  61..............................          21.4     21.3     21.3     21.3     21.2     21.2     21.2     21.1     21.1     21.1     21.1     21.1
57...........................................  62..............................          20.7     20.6     20.6     20.6     20.5     20.5     20.5     20.4     20.4     20.4     20.4     20.4
58...........................................  63..............................          20.0     19.9     19.9     19.9     19.8     19.8     19.8     19.8     19.7     19.7     19.7     19.7
59...........................................  64..............................          19.3     19.3     19.2     19.2     19.2     19.1     19.1     19.1     19.0     19.0     19.0     19.0
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 189]]


--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                   Ages
                                                 -------------------------------------------------------------------------------------------------------
             Male                    Female          Male 98       99      100      101      102      103      104      105      106      107      108
                                                 -------------------------------------------------------------------------------------------------------
                                                   Female 103     104      105      106      107      108      109      110      111      112      113
--------------------------------------------------------------------------------------------------------------------------------------------------------
35............................  40..............          38.3     38.3     38.3     38.3     38.3     38.3     38.2     38.2     38.2     38.2     38.2
36............................  41..............          37.4     37.4     37.4     37.4     37.4     37.4     37.4     37.4     37.4     37.4     37.3
37............................  42..............          36.5     36.5     36.5     36.5     36.5     36.5     36.5     36.5     36.5     36.5     36.5
38............................  43..............          35.6     35.6     35.6     35.6     35.6     35.6     35.6     35.6     35.6     35.6     35.6
39............................  44..............          34.7     34.7     34.7     34.7     34.7     34.7     34.7     34.7     34.7     34.7     34.7
 
40............................  45..............          33.9     33.8     33.8     33.8     33.8     33.8     33.8     33.8     33.8     33.8     33.8
41............................  46..............          33.0     33.0     33.0     33.0     33.0     33.0     33.0     33.0     33.0     33.0     33.0
42............................  47..............          32.1     32.1     32.1     32.1     32.1     32.1     32.1     32.1     32.1     32.1     32.1
43............................  48..............          31.3     31.3     31.3     31.3     31.3     31.3     31.3     31.3     31.3     31.3     31.3
44............................  49..............          30.4     30.4     30.4     30.4     30.4     30.4     30.4     30.4     30.4     30.4     30.4
45............................  50..............          29.6     29.6     29.6     29.6     29.6     29.6     29.6     29.6     29.6     29.6     29.6
 
46............................  51..............          28.8     28.8     28.8     28.8     28.8     28.8     28.8     28.8     28.8     28.8     28.7
47............................  52..............          28.0     28.0     28.0     28.0     28.0     28.0     28.0     27.9     27.9     27.9     27.9
48............................  53..............          27.2     27.2     27.2     27.2     27.2     27.1     27.1     27.1     27.1     27.1     27.1
49............................  54..............          26.4     26.4     26.4     26.4     26.4     26.3     26.3     26.3     26.3     26.3     26.3
50............................  55..............          25.6     25.6     25.6     25.6     25.6     25.6     25.6     25.6     25.5     25.5     25.5
 
51............................  56..............          24.8     24.8     24.8     24.8     24.8     24.8     24.8     24.8     24.8     24.8     24.7
52............................  57..............          24.0     24.0     24.0     24.0     24.0     24.0     24.0     24.0     24.0     24.0     24.0
53............................  58..............          23.3     23.3     23.3     23.3     23.3     23.3     23.2     23.2     23.2     23.2     23.2
54............................  59..............          22.5     22.5     22.5     22.5     22.5     22.5     22.5     22.5     22.5     22.5     22.5
55............................  60..............          21.8     21.8     21.8     21.8     21.8     21.8     21.8     21.8     21.8     21.7     21.7
 
56............................  61..............          21.1     21.1     21.1     21.1     21.1     21.0     21.0     21.0     21.0     21.0     21.0
57............................  62..............          20.4     20.4     20.4     20.3     20.3     20.3     20.3     20.3     20.3     20.3     20.3
58............................  63..............          19.7     19.7     19.7     19.6     19.6     19.6     19.6     19.6     19.6     19.6     19.6
59............................  64..............          19.0     19.0     19.0     19.0     19.0     18.9     18.9     18.9     18.9     18.9     18.9
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 190]]


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                       Ages
                                                                                ----------------------------------------------------------------------------------------------------------------
                     Male                                   Female                  Male 86       87       88       89       90       91       92       93       94       95       96       97
                                                                                ----------------------------------------------------------------------------------------------------------------
                                                                                   Female 91      92       93       94       95       96       97       98       99      100      101      102
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
60...........................................  65..............................          18.7     18.6     18.6     18.5     18.5     18.5     18.4     18.4     18.4     18.4     18.3     18.3
61...........................................  66..............................          18.1     18.0     17.9     17.9     17.9     17.8     17.8     17.8     17.7     17.7     17.7     17.7
62...........................................  67..............................          17.4     17.4     17.3     17.3     17.2     17.2     17.1     17.1     17.1     17.1     17.0     17.0
63...........................................  68..............................          16.8     16.8     16.7     16.7     16.6     16.6     16.5     16.5     16.5     16.4     16.4     16.4
64...........................................  69..............................          16.2     16.2     16.1     16.1     16.0     16.0     15.9     15.9     15.9     15.8     15.8     15.8
65...........................................  70..............................          15.7     15.6     15.5     15.5     15.4     15.4     15.3     15.3     15.3     15.2     15.2     15.2
 
66...........................................  71..............................          15.1     15.0     15.0     14.9     14.8     14.8     14.7     14.7     14.7     14.6     14.6     14.6
67...........................................  72..............................          14.6     14.5     14.4     14.4     14.3     14.2     14.2     14.1     14.1     14.1     14.1     14.0
68...........................................  73..............................          14.1     14.0     13.9     13.8     13.8     13.7     13.6     13.6     13.6     13.5     13.5     13.5
69...........................................  74..............................          13.6     13.5     13.4     13.3     13.2     13.2     13.1     13.1     13.0     13.0     13.0     12.9
70...........................................  75..............................          13.1     13.0     12.9     12.8     12.7     12.7     12.6     12.5     12.5     12.5     12.4     12.4
 
71...........................................  76..............................          12.6     12.5     12.4     12.3     12.2     12.2     12.1     12.1     12.0     12.0     11.9     11.9
72...........................................  77..............................          12.1     12.0     11.9     11.8     11.8     11.7     11.6     11.6     11.5     11.5     11.4     11.4
73...........................................  78..............................          11.7     11.6     11.5     11.4     11.3     11.2     11.2     11.1     11.0     11.0     11.0     10.9
74...........................................  79..............................          11.3     11.2     11.1     11.0     10.9     10.8     10.7     10.7     10.6     10.6     10.5     10.5
75...........................................  80..............................          10.9     10.8     10.7     10.5     10.5     10.4     10.3     10.2     10.2     10.1     10.1     10.0
 
76...........................................  81..............................          10.5     10.4     10.3     10.2     10.1     10.0      9.9      9.8      9.7      9.7      9.7      9.6
77...........................................  82..............................          10.2     10.0      9.9      9.8      9.7      9.6      9.5      9.4      9.3      9.3      9.2      9.2
78...........................................  83..............................           9.8      9.7      9.5      9.4      9.3      9.2      9.1      9.0      9.0      8.9      8.9      8.8
79...........................................  84..............................           9.5      9.3      9.2      9.2      8.9      8.8      8.8      8.7      8.6      8.5      8.5      8.4
80...........................................  85..............................           9.2      9.0      8.9      8.7      8.6      8.5      8.4      8.3      8.3      8.2      8.1      8.1
 
81...........................................  86..............................           8.9      8.7      8.6      8.4      8.3      8.2      8.1      8.0      7.9      7.9      7.8      7.7
82...........................................  87..............................           8.6      8.4      8.3      8.1      8.0      7.9      7.8      7.7      7.6      7.5      7.5      7.4
83...........................................  88..............................           8.3      8.2      8.0      7.9      7.7      7.6      7.5      7.4      7.3      7.2      7.2      7.1
84...........................................  89..............................           8.1      7.9      7.8      7.6      7.5      7.3      7.2      7.1      7.0      7.0      6.9      6.8
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 191]]


--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                   Ages
                                                 -------------------------------------------------------------------------------------------------------
             Male                    Female          Male 98       99      100      101      102      103      104      105      106      107      108
                                                 -------------------------------------------------------------------------------------------------------
                                                   Female 103     104      105      106      107      108      109      110      111      112      113
--------------------------------------------------------------------------------------------------------------------------------------------------------
60............................  65..............          18.3     18.3     18.3     18.3     18.3     18.3     18.3     18.2     18.2     18.2     18.2
61............................  66..............          17.7     17.7     17.6     17.6     17.6     17.6     17.6     17.6     17.6     17.6     17.5
62............................  67..............          17.0     17.0     17.0     17.0     17.0     17.0     16.9     16.9     16.9     16.9     16.9
63............................  68..............          16.4     16.4     16.4     16.3     16.3     16.3     16.3     16.3     16.3     16.3     16.2
64............................  69..............          15.8     15.8     15.7     15.7     15.7     15.7     15.7     15.7     15.7     15.7     15.6
65............................  70..............          15.2     15.2     15.1     15.1     15.1     15.1     15.1     15.1     15.1     15.0     15.0
 
66............................  71..............          14.6     14.6     14.5     14.5     14.5     14.5     14.5     14.5     14.5     14.4     14.4
67............................  72..............          14.0     14.0     14.0     14.0     13.9     13.9     13.9     13.9     13.9     13.9     13.8
68............................  73..............          13.5     13.4     13.4     13.4     13.4     13.4     13.3     13.3     13.3     13.3     13.2
69............................  74..............          12.9     12.9     12.9     12.8     12.8     12.8     12.8     12.8     12.8     12.7     12.7
70............................  75..............          12.4     12.4     12.3     12.3     12.3     12.3     12.3     12.2     12.2     12.2     12.1
 
71............................  76..............          11.9     11.9     11.8     11.8     11.8     11.8     11.7     11.7     11.7     11.7     11.6
72............................  77..............          11.4     11.4     11.3     11.3     11.3     11.3     11.2     11.2     11.2     11.2     11.1
73............................  78..............          10.9     10.9     10.9     10.8     10.8     10.8     10.7     10.7     10.7     10.7     10.6
74............................  79..............          10.5     10.4     10.4     10.4     10.3     10.3     10.3     10.3     10.2     10.2     10.1
75............................  80..............          10.0     10.0      9.9      9.9      9.9      9.8      9.8      9.8      9.8      9.7
 
76............................  81..............           9.6      9.5      9.5      9.5      9.4      9.4      9.4      9.4      9.3      9.3
77............................  82..............           9.2      9.1      9.1      9.1      9.0      9.0      9.0      8.9      8.9      8.9
78............................  83..............           8.8      8.7      8.7      8.7      8.6      8.6      8.5      8.5      8.5      8.4
79............................  84..............           8.4      8.4      8.3      8.3      8.2      8.2      8.2      8.1      8.1      8.0
80............................  85..............           8.0      8.0      7.9      7.9      7.9      7.8      7.8      7.7      7.7      7.6
 
81............................  86..............           7.7      7.6      7.6      7.6      7.5      7.5      7.4      7.4      7.3      7.3
82............................  87..............           7.4      7.3      7.3      7.2      7.2      7.1      7.1      7.0      7.0      6.9
83............................  88..............           7.1      7.0      6.9      6.9      6.8      6.8      6.7      6.7      6.7      6.6
84............................  89..............           6.8      6.7      6.6      6.6      6.5      6.5      6.4      6.4      6.3  .......  .......
--------------------------------------------------------------------------------------------------------------------------------------------------------


--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                   Ages
                                                 -------------------------------------------------------------------------------------------------------
             Male                    Female          Male 86       87       88       89       90       91       92       93       94       95       96
                                                 -------------------------------------------------------------------------------------------------------
                                                    Female 91      92       93       94       95       96       97       98       99      100      101
--------------------------------------------------------------------------------------------------------------------------------------------------------
85............................  90..............           7.9      7.7      7.5      7.4      7.2      7.1      7.0      6.9      6.8      6.7      6.6
86............................  91..............           7.7      7.5      7.3      7.1      7.0      6.8      6.7      6.6      6.5      6.4      6.4
87............................  92..............           7.5      7.3      7.1      6.9      6.8      6.6      6.5      6.4      6.3      6.2      6.1
88............................  93..............           7.3      7.1      6.9      6.7      6.6      6.4      6.3      6.2      6.1      6.0      5.9
89............................  94..............           7.1      6.9      6.7      6.5      6.4      6.2      6.1      6.0      5.9      5.8      5.7
90............................  95..............           7.0      6.8      6.6      6.4      6.2      6.1      5.9      5.8      5.7      5.6      5.5
 
91............................  96..............           6.8      6.6      6.4      6.2      6.1      5.9      5.8      5.7      5.5      5.4      5.3
92............................  97..............           6.7      6.5      6.3      6.1      5.9      5.8      5.6      5.5      5.4      5.3      5.2
93............................  98..............           6.6      6.4      6.2      6.0      5.8      5.7      5.5      5.4      5.2      5.1      5.0
94............................  99..............           6.5      6.3      6.1      5.9      5.7      5.5      5.4      5.2      5.1      5.0      4.9
95............................  100.............           6.4      6.2      6.0      5.8      5.6      5.4      5.3      5.1      5.0      4.9      4.7
 
96............................  101.............           6.4      6.1      5.9      5.7      5.5      5.3      5.2      5.0      4.9      4.7      4.6
97............................  102.............           6.3      6.1      5.8      5.6      5.4      5.2      5.1      4.9      4.8      4.6      4.5
98............................  103.............           6.2      6.0      5.8      5.5      5.3      5.1      5.0      4.8      4.7      4.5      4.4
99............................  104.............           6.2      5.9      5.7      5.5      5.2      5.1      4.9      4.7      4.6      4.4      4.3
--------------------------------------------------------------------------------------------------------------------------------------------------------


--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                        Ages
                                                          ----------------------------------------------------------------------------------------------
               Male                         Female            Male 97       98       99      100      101      102      103      104      105      106
                                                          ----------------------------------------------------------------------------------------------
                                                            Female 102     103      104      105      106      107      108      109      110      111
--------------------------------------------------------------------------------------------------------------------------------------------------------
85................................  90...................           6.6      6.5      6.4      6.4      6.3      6.2      6.2      6.1      6.1      6.0
86................................  91...................           6.3      6.2      6.2      6.1      6.0      6.0      5.9      5.9      5.8      5.7
87................................  92...................           6.1      6.0      5.9      5.8      5.8      5.7      5.6      5.6      5.5      5.4
88................................  93...................           5.8      5.8      5.7      5.6      5.5      5.5      5.4      5.3      5.3      5.1
89................................  94...................           5.6      5.5      5.5      5.4      5.3      5.2      5.2      5.1      5.0
 
90................................  95...................           5.4      5.3      5.2      5.2      5.1      5.0      4.9      4.9      4.8
91................................  96...................           5.2      5.1      5.1      5.0      4.9      4.8      4.7      4.6      4.5
92................................  97...................           5.1      5.0      4.9      4.8      4.7      4.6      4.5      4.4
93................................  98...................           4.9      4.8      4.7      4.6      4.5      4.4      4.3      4.2
94................................  99...................           4.8      4.7      4.6      4.5      4.4      4.3      4.1

[[Page 192]]

 
 
95................................  100..................           4.6      4.5      4.4      4.3      4.2      4.1      4.0
96................................  101..................           4.5      4.4      4.3      4.2      4.1      3.9
97................................  102..................           4.4      4.3      4.1      4.0      3.9      3.7
98................................  103..................           4.3      4.1      4.0      3.9      3.7
99................................  104..................           4.1      4.0      3.9      3.7  .......  .......  .......  .......  .......  .......
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 193]]


                                                         Table IIa--Annuities for Joint Life Only--Two Lives--Expected Return Multiples
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                         Ages
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
              Male                      Female           Male 6        7        8        9        10       11       12       13       14       15       16       17       18       19       20
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
                                                        Female 11      12       13       14       15       16       17       18       19       20       21       22       23       24       25
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6...............................  11................          56.6     56.1     55.7     55.1     54.6     54.1     53.5     52.9     52.3     51.7     51.1     50.5     49.8     49.1     48.4
7...............................  12................          56.1     55.7     55.2     54.7     54.2     53.7     53.1     52.6     52.0     51.4     50.8     50.2     49.5     48.9     48.2
8...............................  13................          55.7     55.2     54.8     54.3     53.8     53.3     52.8     52.2     51.6     51.1     50.5     49.9     49.2     48.6     47.9
9...............................  14................          55.1     54.7     54.3     53.8     53.3     52.9     52.3     51.8     51.3     50.7     50.1     49.5     48.9     48.3     47.7
10..............................  15................          54.6     54.2     53.8     53.3     52.9     52.4     51.9     51.4     50.9     50.3     49.8     49.2     48.6     48.0     47.4
 
11..............................  16................          54.1     53.7     53.3     52.9     52.4     52.0     51.5     51.0     50.5     50.0     49.4     48.8     48.3     47.7     47.1
12..............................  17................          53.5     53.1     52.8     52.3     51.9     51.5     51.0     50.6     50.1     49.6     49.0     48.5     47.9     47.3     46.7
13..............................  18................          52.9     52.6     52.2     51.8     51.4     51.0     50.6     50.1     49.6     49.1     48.6     48.1     47.5     47.0     46.4
14..............................  19................          52.3     52.0     51.6     51.3     50.9     50.5     50.1     49.6     49.2     48.7     48.2     47.7     47.2     46.6     46.1
 
15..............................  20................          51.7     51.4     51.1     50.7     50.3     50.0     49.6     49.1     48.7     48.2     47.8     47.3     46.8     46.2     45.7
16..............................  21................          51.1     50.8     50.5     50.1     49.8     49.4     49.0     48.6     48.2     47.8     47.3     46.8     46.3     45.8     45.3
17..............................  22................          50.5     50.2     49.9     49.5     49.2     48.8     48.5     48.1     47.7     47.3     46.8     46.4     45.9     45.4     44.9
18..............................  23................          49.8     49.5     49.2     48.9     48.6     48.3     47.9     47.5     47.2     46.8     46.3     45.9     45.4     45.0     44.5
19..............................  24................          49.1     48.9     48.6     48.3     48.0     47.7     47.3     47.0     46.6     46.2     45.8     45.4     45.0     44.5     44.0
20..............................  25................          48.4     48.2     47.9     47.7     47.4     47.1     46.7     46.4     46.1     45.7     45.3     44.9     44.5     44.0     43.6
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                              Ages
                                                              ----------------------------------------------------------------------------------------------------------------------------------
                Male                           Female             Male 21       22       23       24       25       26       27       28       29       30       31       32       33       34
                                                              ----------------------------------------------------------------------------------------------------------------------------------
                                                                 Female 26      27       28       29       30       31       32       33       34       35       36       37       38       39
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6...................................  11.....................          47.7     47.0     46.3     45.6     44.8     44.1     43.3     42.5     41.8     41.0     40.2     39.4     38.6     37.8
7...................................  12.....................          47.5     46.8     46.1     45.4     44.6     43.9     43.2     42.4     41.6     40.9     40.1     39.3     38.5     37.7
8...................................  13.....................          47.3     46.6     45.9     45.2     44.5     43.7     43.0     42.2     41.5     40.7     39.9     39.2     38.4     37.6
9...................................  14.....................          47.0     46.3     45.6     45.0     44.2     43.5     42.8     42.1     41.3     40.6     39.8     39.0     38.3     37.5
10..................................  15.....................          46.7     46.1     45.4     44.7     44.0     43.3     42.6     41.9     41.1     40.4     39.7     38.9     38.1     37.4
 
11..................................  16.....................          46.4     45.8     45.1     44.5     43.8     43.1     42.4     41.7     41.0     40.2     39.5     38.8     38.0     37.2
12..................................  17.....................          46.1     45.5     44.9     44.2     43.6     42.9     42.2     41.5     40.8     40.1     39.3     38.6     37.9     37.1
13..................................  18.....................          45.8     45.2     44.6     43.9     43.3     42.6     42.0     41.3     40.6     39.9     39.2     38.4     37.7     37.0
14..................................  19.....................          45.5     44.9     44.3     43.7     43.0     42.4     41.7     41.0     40.4     39.7     39.0     38.3     37.5     36.8
15..................................  20.....................          45.1     44.6     44.0     43.4     42.7     42.1     41.5     40.8     40.1     39.5     38.8     38.1     37.4     36.6
 
16..................................  21.....................          44.8     44.2     43.6     43.0     42.4     41.8     41.2     40.5     39.9     39.2     38.6     37.9     37.2     36.5
17..................................  22.....................          44.4     43.8     43.3     42.7     42.1     41.5     40.9     40.3     39.6     39.0     38.3     37.7     37.0     36.3
18..................................  23.....................          44.0     43.5     42.9     42.4     41.8     41.2     40.6     40.0     39.4     38.7     38.1     37.4     36.8     36.1
19..................................  24.....................          43.6     43.1     42.5     42.0     41.4     40.9     40.3     39.7     39.1     38.5     37.8     37.2     36.5     35.9
20..................................  25.....................          43.1     42.6     42.1     41.6     41.1     40.5     40.0     39.4     38.8     38.2     37.6     36.9     36.3     35.7
 
21..................................  26.....................          42.7     42.2     41.7     41.2     40.7     40.2     39.6     39.1     38.5     37.9     37.3     36.7     36.1     35.4

[[Page 194]]

 
22..................................  27.....................          42.2     41.8     41.3     40.8     40.3     39.8     39.3     38.7     38.2     37.6     37.0     36.4     35.8     35.2
23..................................  28.....................          41.7     41.3     40.8     40.4     39.9     39.4     38.9     38.4     37.8     37.3     36.7     36.1     35.5     34.9
24..................................  29.....................          41.2     40.8     40.4     39.9     39.5     39.0     38.5     38.0     37.5     36.9     36.4     35.8     35.2     34.6
25..................................  30.....................          40.7     40.3     39.9     39.5     39.0     38.6     38.1     37.6     37.1     36.6     36.0     35.5     34.9     34.4
 
26..................................  31.....................          40.2     39.8     39.4     39.0     38.6     38.1     37.7     37.2     36.7     36.2     35.7     35.2     34.6     34.1
27..................................  32.....................          39.6     39.3     38.9     38.5     38.1     37.7     37.2     36.8     36.3     35.8     35.3     34.8     34.3     33.7
28..................................  33.....................          39.1     38.7     38.4     38.0     37.6     37.2     36.8     36.3     35.9     35.4     34.9     34.5     33.9     33.4
29..................................  34.....................          38.5     38.2     37.8     37.5     37.1     36.7     36.3     35.9     35.5     35.0     34.6     34.1     33.6     33.1
30..................................  35.....................          37.9     37.6     37.3     36.9     36.6     36.2     35.8     35.4     35.0     34.6     34.1     33.7     33.2     32.7
 
31..................................  36.....................          37.3     37.0     36.7     36.4     36.0     35.7     35.3     34.9     34.6     34.1     33.7     33.3     32.8     32.3
32..................................  37.....................          36.7     36.4     36.1     35.8     35.5     35.2     34.8     34.5     34.1     33.7     33.3     32.9     32.4     32.0
33..................................  38.....................          36.1     35.8     35.5     35.2     34.9     34.6     34.3     33.9     33.6     33.2     32.8     32.4     32.0     31.6
34..................................  39.....................          35.4     35.2     34.9     34.6     34.4     34.1     33.7     33.4     33.1     32.7     32.3     32.0     31.6     31.1
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                         Ages
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
              Male                      Female           Male 35       36       37       38       39       40       41       42       43       44       45       46       47       48       49
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
                                                        Female 40      41       42       43       44       45       46       47       48       49       50       51       52       53       54
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6...............................  11................          37.0     36.2     35.4     34.6     33.8     33.0     32.2     31.4     30.6     29.8     29.0     28.2     27.5     26.7     25.9
7...............................  12................          36.9     36.1     35.3     34.5     33.7     32.9     32.1     31.3     30.5     29.8     29.0     28.2     27.4     26.7     25.9
8...............................  13................          36.8     36.0     35.2     34.4     33.7     32.9     32.1     31.3     30.5     29.7     28.9     28.2     27.4     26.6     25.9
9...............................  14................          36.7     35.9     35.1     34.4     33.6     32.8     32.0     31.2     30.4     29.7     28.9     28.1     27.3     26.6     25.8
10..............................  15................          36.6     35.8     35.1     34.3     33.5     32.7     31.9     31.2     30.4     29.6     28.8     28.1     27.3     26.5     25.8
 
11..............................  16................          36.5     35.7     34.9     34.2     33.4     32.6     31.9     31.1     30.3     29.5     28.8     28.0     27.3     26.5     25.7
12..............................  17................          36.4     35.6     34.8     34.1     33.3     32.5     31.8     31.0     30.2     29.5     28.7     28.0     27.2     26.4     25.7
13..............................  18................          36.2     35.5     34.7     34.0     33.2     32.4     31.7     30.9     30.2     29.4     28.7     27.9     27.1     26.4     25.7
14..............................  19................          36.1     35.3     34.6     33.8     33.1     32.3     31.6     30.8     30.1     29.3     28.6     27.8     27.1     26.3     25.6
15..............................  20................          35.9     35.2     34.5     33.7     33.0     32.2     31.5     30.7     30.0     29.3     28.5     27.8     27.0     26.3     25.6
 
16..............................  21................          35.8     35.0     34.3     33.6     32.9     32.1     31.4     30.6     29.9     29.2     28.4     27.7     27.0     26.2     25.5
17..............................  22................          35.6     34.9     34.2     33.4     32.7     32.0     31.3     30.5     29.8     29.1     28.3     27.6     26.9     26.2     25.4
18..............................  23................          35.4     34.7     34.0     33.3     32.6     31.9     31.2     30.4     29.7     29.0     28.3     27.5     26.8     26.1     25.4
19..............................  24................          35.2     34.5     33.8     33.1     32.4     31.7     31.0     30.3     29.6     28.9     28.2     27.4     26.7     26.0     25.3
20..............................  25................          35.0     34.3     33.7     33.0     32.3     31.6     30.9     30.2     29.5     28.8     28.1     27.3     26.6     25.9     25.2
 
21..............................  26................          34.8     34.1     33.5     32.8     32.1     31.4     30.7     30.0     29.3     28.6     27.9     27.2     26.5     25.8     25.1
22..............................  27................          34.5     33.9     33.3     32.6     31.9     31.3     30.6     29.9     29.2     28.5     27.8     27.1     26.4     25.7     25.1
23..............................  28................          34.3     33.7     33.0     32.4     31.7     31.1     30.4     29.7     29.1     28.4     27.7     27.0     26.3     25.6     25.0
24..............................  29................          34.0     33.4     32.8     32.2     31.5     30.9     30.2     29.6     28.9     28.2     27.6     26.9     26.2     25.5     24.9
25..............................  30................          33.8     33.2     32.6     32.0     31.3     30.7     30.1     29.4     28.8     28.1     27.4     26.8     26.1     25.4     24.8

[[Page 195]]

 
 
26..............................  31................          33.5     32.9     32.3     31.7     31.1     30.5     29.9     29.2     28.6     27.9     27.3     26.6     26.0     25.3     24.6
27..............................  32................          33.2     32.6     32.1     31.5     30.9     30.3     29.6     29.0     28.4     27.8     27.1     26.5     25.8     25.2     24.5
28..............................  33................          32.9     32.3     31.8     31.2     30.6     30.0     29.4     28.8     28.2     27.6     27.0     26.3     25.7     25.0     24.4
29..............................  34................          32.6     32.0     31.5     30.9     30.4     29.8     29.2     28.6     28.0     27.4     26.8     26.2     25.5     24.9     24.3
30..............................  35................          32.2     31.7     31.2     30.6     30.1     29.5     29.0     28.4     27.8     27.2     26.6     26.0     25.4     24.7     24.1
 
31..............................  36................          31.9     31.4     30.9     30.3     29.8     29.3     28.7     28.1     27.6     27.0     26.4     25.8     25.2     24.6     24.0
32..............................  37................          31.5     31.0     30.5     30.0     29.5     29.0     28.4     27.9     27.3     26.8     26.2     25.6     25.0     24.4     23.8
33..............................  38................          31.1     30.7     30.2     29.7     29.2     28.7     28.2     27.6     27.1     26.5     26.0     25.4     24.8     24.2     23.6
34..............................  39................          30.7     30.3     29.8     29.3     28.9     28.4     27.9     27.3     26.8     26.3     25.7     25.2     24.6     24.0     23.5
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                              Ages
                                                              ----------------------------------------------------------------------------------------------------------------------------------
                Male                           Female             Male 50       51       52       53       54       55       56       57       58       59       60       61       62       63
                                                              ----------------------------------------------------------------------------------------------------------------------------------
                                                                 Female 55      56       57       58       59       60       61       62       63       64       65       66       67       68
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6...................................  11.....................          25.2     24.4     23.7     22.9     22.2     21.5     20.8     20.1     19.4     18.7     18.0     17.4     16.7     16.1
7...................................  12.....................          25.1     24.4     23.6     22.9     22.2     21.5     20.8     20.1     19.4     18.7     18.0     17.4     16.7     16.1
8...................................  13.....................          25.1     24.4     23.6     22.9     22.2     21.4     20.7     20.0     19.4     18.7     18.0     17.4     16.7     16.1
9...................................  14.....................          25.1     24.3     23.6     22.9     22.1     21.4     20.7     20.0     19.3     18.7     18.0     17.3     16.7     16.1
10..................................  15.....................          25.0     24.3     23.6     22.8     22.1     21.4     20.7     20.0     19.3     18.6     18.0     17.3     16.7     16.1
 
11..................................  16.....................          25.0     24.3     23.5     22.8     22.1     21.4     20.7     20.0     19.3     18.6     18.0     17.3     16.7     16.1
12..................................  17.....................          25.0     24.2     23.5     22.8     22.1     21.4     20.7     20.0     19.3     18.6     18.0     17.3     16.7     16.0
13..................................  18.....................          24.9     24.2     23.5     22.7     22.0     21.3     20.6     19.9     19.3     18.6     17.9     17.3     16.7     16.0
14..................................  19.....................          24.9     24.1     23.4     22.7     22.0     21.3     20.6     19.9     19.2     18.6     17.9     17.3     16.6     16.0
15..................................  20.....................          24.8     24.1     23.4     22.7     22.0     21.3     20.6     19.9     19.2     18.5     17.9     17.3     16.6     16.0
 
16..................................  21.....................          24.8     24.0     23.3     22.6     21.9     21.2     20.5     19.9     19.2     18.5     17.9     17.2     16.6     16.0
17..................................  22.....................          24.7     24.0     23.3     22.6     21.9     21.2     20.5     19.8     19.2     18.5     17.8     17.2     16.6     16.0
18..................................  23.....................          24.7     23.9     23.2     22.5     21.8     21.1     20.5     19.8     19.1     18.5     17.8     17.2     16.6     15.9
19..................................  24.....................          24.6     23.9     23.2     22.5     21.8     21.1     20.4     19.8     19.1     18.4     17.8     17.2     16.5     15.9
20..................................  25.....................          24.5     23.8     23.1     22.4     21.7     21.1     20.4     19.7     19.1     18.4     17.8     17.1     16.5     15.9
 
21..................................  26.....................          24.4     23.7     23.1     22.4     21.7     21.0     20.3     19.7     19.0     18.4     17.7     17.1     16.5     15.9
22..................................  27.....................          24.4     23.7     23.0     22.3     21.6     21.0     20.3     19.6     19.0     18.3     17.7     17.1     16.5     15.9
23..................................  28.....................          24.3     23.6     22.9     22.2     21.6     20.9     20.2     19.6     18.9     18.3     17.7     17.0     16.4     15.8
24..................................  29.....................          24.2     23.5     22.8     22.2     21.5     20.8     20.2     19.5     18.9     18.3     17.6     17.0     16.4     15.8
25..................................  30.....................          24.1     23.4     22.8     22.1     21.4     20.8     20.1     19.5     18.8     18.2     17.6     17.0     16.4     15.8
 
26..................................  31.....................          24.0     23.3     22.7     22.0     21.4     20.7     20.1     19.4     18.8     18.2     17.5     16.9     16.3     15.7
27..................................  32.....................          23.9     23.2     22.6     21.9     21.3     20.6     20.0     19.4     18.7     18.1     17.5     16.9     16.3     15.7
28..................................  33.....................          23.8     23.1     22.5     21.8     21.2     20.6     19.9     19.3     18.7     18.1     17.4     16.8     16.2     15.6
29..................................  34.....................          23.6     23.0     22.4     21.7     21.1     20.5     19.8     19.2     18.6     18.0     17.4     16.8     16.2     15.6
30..................................  35.....................          23.5     22.9     22.3     21.6     21.0     20.4     19.8     19.1     18.5     17.9     17.3     16.7     16.1     15.6
 
31..................................  36.....................          23.4     22.7     22.1     21.5     20.9     20.3     19.7     19.1     18.5     17.9     17.3     16.7     16.1     15.5
32..................................  37.....................          23.2     22.6     22.0     21.4     20.8     20.2     19.6     19.0     18.4     17.8     17.2     16.6     16.0     15.5

[[Page 196]]

 
33..................................  38.....................          23.1     22.5     21.9     21.3     20.7     20.1     19.5     18.9     18.3     17.7     17.1     16.5     16.0     15.4
34..................................  39.....................          22.9     22.3     21.7     21.1     20.5     20.0     19.4     18.8     18.2     17.6     17.0     16.5     15.9     15.3
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                         Ages
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
              Male                      Female           Male 64       65       66       67       68       69       70       71       72       73       74       75       76       77       78
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
                                                        Female 69      70       71       72       73       74       75       76       77       78       79       80       81       82       83
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6...............................  11................          15.5     14.9     14.3     13.7     13.1     12.6     12.0     11.5     11.0     10.5     10.0      9.6      9.1      8.7      8.2
7...............................  12................          15.5     14.9     14.3     13.7     13.1     12.6     12.0     11.5     11.0     10.5     10.0      9.6      9.1      8.7      8.2
8...............................  13................          15.5     14.9     14.3     13.7     13.1     12.6     12.0     11.5     11.0     10.5     10.0      9.6      9.1      8.7      8.2
9...............................  14................          15.5     14.9     14.3     13.7     13.1     12.6     12.0     11.5     11.0     10.5     10.0      9.5      9.1      8.7      8.2
10..............................  15................          15.4     14.8     14.3     13.7     13.1     12.6     12.0     11.5     11.0     10.5     10.0      9.5      9.1      8.7      8.2
 
11..............................  16................          15.4     14.8     14.2     13.7     13.1     12.6     12.0     11.5     11.0     10.5     10.0      9.5      9.1      8.7      8.2
12..............................  17................          15.4     14.8     14.2     13.7     13.1     12.5     12.0     11.5     11.0     10.5     10.0      9.5      9.1      8.6      8.2
13..............................  18................          15.4     14.8     14.2     13.6     13.1     12.5     12.0     11.5     11.0     10.5     10.0      9.5      9.1      8.6      8.2
14..............................  19................          15.4     14.8     14.2     13.6     13.1     12.5     12.0     11.5     11.0     10.5     10.0      9.5      9.1      8.6      8.2
15..............................  20................          15.4     14.8     14.2     13.6     13.1     12.5     12.0     11.5     11.0     10.5     10.0      9.5      9.1      8.6      8.2
 
16..............................  21................          15.4     14.8     14.2     13.6     13.1     12.5     12.0     11.5     11.0     10.5     10.0      9.5      9.1      8.6      8.2
17..............................  22................          15.4     14.8     14.2     13.6     13.0     12.5     12.0     11.5     10.9     10.5     10.0      9.5      9.1      8.6      8.2
18..............................  23................          15.3     14.7     14.2     13.6     13.0     12.5     12.0     11.4     10.9     10.4     10.0      9.5      9.1      8.6      8.2
19..............................  24................          15.3     14.7     14.1     13.6     13.0     12.5     12.0     11.4     10.9     10.4     10.0      9.5      9.1      8.6      8.2
20..............................  25................          15.3     14.7     14.1     13.6     13.0     12.5     11.9     11.4     10.9     10.4     10.0      9.5      9.0      8.6      8.2
 
21..............................  26................          15.3     14.7     14.1     13.5     13.0     12.5     11.9     11.4     10.9     10.4      9.9      9.5      9.0      8.6      8.2
22..............................  27................          15.3     14.7     14.1     13.5     13.0     12.4     11.9     11.4     10.9     10.4      9.9      9.5      9.0      8.6      8.2
23..............................  28................          15.2     14.6     14.1     13.5     13.0     12.4     11.9     11.4     10.9     10.4      9.9      9.5      9.0      8.6      8.2
24..............................  29................          15.2     14.6     14.0     13.5     12.9     12.4     11.9     11.4     10.9     10.4      9.9      9.5      9.0      8.6      8.2
25..............................  30................          15.2     14.6     14.0     13.5     12.9     12.4     11.9     11.4     10.9     10.4      9.9      9.5      9.0      8.6      8.2
 
26..............................  31................          15.1     14.6     14.0     13.4     12.9     12.4     11.9     11.3     10.8     10.4      9.9      9.4      9.0      8.6      8.2
27..............................  32................          15.1     14.5     14.0     13.4     12.9     12.4     11.8     11.3     10.8     10.4      9.9      9.4      9.0      8.6      8.2
28..............................  33................          15.1     14.5     13.9     13.4     12.9     12.3     11.8     11.3     10.8     10.3      9.9      9.4      9.0      8.6      8.1
29..............................  34................          15.0     14.5     13.9     13.4     12.8     12.3     11.8     11.3     10.8     10.3      9.9      9.4      9.0      8.5      8.1
30..............................  35................          15.0     14.4     13.9     13.3     12.8     12.3     11.8     11.3     10.8     10.3      9.8      9.4      9.0      8.5      8.1
 
31..............................  36................          14.9     14.4     13.8     13.3     12.8     12.2     11.7     11.2     10.8     10.3      9.8      9.4      8.9      8.5      8.1
32..............................  37................          14.9     14.3     13.8     13.3     12.7     12.2     11.7     11.2     10.7     10.3      9.8      9.4      8.9      8.5      8.1
33..............................  38................          14.8     14.3     13.8     13.2     12.7     12.2     11.7     11.2     10.7     10.2      9.8      9.3      8.9      8.5      8.1
34..............................  39................          14.8     14.2     13.7     13.2     12.7     12.2     11.7     11.2     10.7     10.2      9.8      9.3      8.9      8.5      8.1
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 197]]


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                         Ages
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
              Male                      Female           Male 79       80       81       82       83       84       85       86       87       88       89       90       91       92       93
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
                                                        Female 84      85       86       87       88       89       90       91       92       93       94       95       96       97       98
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6...............................  11................           7.8      7.4      7.1      6.7      6.3      6.0      5.7      5.4      5.1      4.8      4.5      4.2      4.0      3.7      3.5
7...............................  12................           7.8      7.4      7.1      6.7      6.3      6.0      5.7      5.4      5.1      4.8      4.5      4.2      4.0      3.7      3.5
8...............................  13................           7.8      7.4      7.0      6.7      6.3      6.0      5.7      5.4      5.1      4.8      4.5      4.2      4.0      3.7      3.5
9...............................  14................           7.8      7.4      7.0      6.7      6.3      6.0      5.7      5.4      5.1      4.8      4.5      4.2      4.0      3.7      3.5
10..............................  15................           7.8      7.4      7.0      6.7      6.3      6.0      5.7      5.4      5.1      4.8      4.5      4.2      4.0      3.7      3.5
 
11..............................  16................           7.8      7.4      7.0      6.7      6.3      6.0      5.7      5.4      5.1      4.8      4.5      4.2      4.0      3.7      3.5
12..............................  17................           7.8      7.4      7.0      6.7      6.3      6.0      5.7      5.4      5.1      4.8      4.5      4.2      4.0      3.7      3.5
13..............................  18................           7.8      7.4      7.0      6.7      6.3      6.0      5.7      5.3      5.1      4.8      4.5      4.2      4.0      3.7      3.5
14..............................  19................           7.8      7.4      7.0      6.7      6.3      6.0      5.7      5.3      5.0      4.8      4.5      4.2      4.0      3.7      3.5
15..............................  20................           7.8      7.4      7.0      6.7      6.3      6.0      5.7      5.3      5.0      4.8      4.5      4.2      4.0      3.7      3.5
 
16..............................  21................           7.8      7.4      7.0      6.7      6.3      6.0      5.7      5.3      5.0      4.8      4.5      4.2      4.0      3.7      3.5
17..............................  22................           7.8      7.4      7.0      6.7      6.3      6.0      5.7      5.3      5.0      4.8      4.5      4.2      4.0      3.7      3.5
18..............................  23................           7.8      7.4      7.0      6.7      6.3      6.0      5.7      5.3      5.0      4.8      4.5      4.2      4.0      3.7      3.5
19..............................  24................           7.8      7.4      7.0      6.7      6.3      6.0      5.7      5.3      5.0      4.8      4.5      4.2      4.0      3.7      3.5
20..............................  25................           7.8      7.4      7.0      6.7      6.3      6.0      5.6      5.3      5.0      4.8      4.5      4.2      4.0      3.7      3.5
 
21..............................  26................           7.8      7.4      7.0      6.7      6.3      6.0      5.6      5.3      5.0      4.8      4.5      4.2      4.0      3.7      3.5
22..............................  27................           7.8      7.4      7.0      6.7      6.3      6.0      5.6      5.3      5.0      4.8      4.5      4.2      4.0      3.7      3.5
23..............................  28................           7.8      7.4      7.0      6.6      6.3      6.0      5.6      5.3      5.0      4.8      4.5      4.2      4.0      3.7      3.5
24..............................  29................           7.8      7.4      7.0      6.6      6.3      6.0      5.6      5.3      5.0      4.7      4.5      4.2      4.0      3.7      3.5
25..............................  30................           7.8      7.4      7.0      6.6      6.3      6.0      5.6      5.3      5.0      4.7      4.5      4.2      4.0      3.7      3.5
 
26..............................  31................           7.8      7.4      7.0      6.6      6.3      6.0      5.6      5.3      5.0      4.7      4.5      4.2      4.0      3.7      3.5
27..............................  32................           7.7      7.4      7.0      6.6      6.3      5.9      5.6      5.3      5.0      4.7      4.5      4.2      4.0      3.7      3.5
28..............................  33................           7.7      7.4      7.0      6.6      6.3      5.9      5.6      5.3      5.0      4.7      4.5      4.2      4.0      3.7      3.5
29..............................  34................           7.7      7.3      7.0      6.6      6.3      5.9      5.6      5.3      5.0      4.7      4.5      4.2      4.0      3.7      3.5
30..............................  35................           7.7      7.3      7.0      6.6      6.3      5.9      5.6      5.3      5.0      4.7      4.5      4.2      4.0      3.7      3.5
 
31..............................  36................           7.7      7.3      7.0      6.6      6.3      5.9      5.6      5.3      5.0      4.7      4.5      4.2      4.0      3.7      3.5
32..............................  37................           7.7      7.3      7.0      6.6      6.3      5.9      5.6      5.3      5.0      4.7      4.5      4.2      4.0      3.7      3.5
33..............................  38................           7.7      7.3      6.9      6.6      6.2      5.9      5.6      5.3      5.0      4.7      4.5      4.2      3.9      3.7      3.5
34..............................  39................           7.7      7.3      6.9      6.6      6.2      5.9      5.6      5.3      5.0      4.7      4.4      4.2      3.9      3.7      3.5
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                         Ages
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
              Male                      Female           Male 94       95       96       97       98       99      100      101      102      103      104      105      106      107      108
                                                     -------------------------------------------------------------------------------------------------------------------------------------------
                                                        Female 99     100      101      102      103      104      105      106      107      108      109      110      111      112      113
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6...............................  11................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
7...............................  12................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
8...............................  13................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
9...............................  14................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7

[[Page 198]]

 
10..............................  15................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
 
11..............................  16................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
12..............................  17................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
13..............................  18................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
14..............................  19................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
15..............................  20................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
 
16..............................  21................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
17..............................  22................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
18..............................  23................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
19..............................  24................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
20..............................  25................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
 
21..............................  26................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
22..............................  27................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
23..............................  28................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
24..............................  29................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
25..............................  30................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
 
26..............................  31................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
27..............................  32................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
28..............................  33................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
29..............................  34................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
30..............................  35................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
 
31..............................  36................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
32..............................  37................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
33..............................  38................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
34..............................  39................           3.3      3.1      2.9      2.7      2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                  Ages
                                                                       -------------------------------------------------------------------------------------------------------------------------
                   Male                               Female               Male 35       36       37       38       39       40       41       42       43       44       45       46       47
                                                                       -------------------------------------------------------------------------------------------------------------------------
                                                                          Female 40      41       42       43       44       45       46       47       48       49       50       51       52
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
35.......................................  40.........................          30.3     29.9     29.4     29.0     28.5     28.0     27.5     27.0     26.5     26.0     25.5     24.9     24.4
36.......................................  41.........................          29.9     29.5     29.0     28.6     28.2     27.7     27.2     26.7     26.2     25.7     25.2     24.7     24.2
37.......................................  42.........................          29.4     29.0     28.6     28.2     27.8     27.3     26.9     26.4     25.9     25.5     25.0     24.4     23.9
38.......................................  43.........................          29.0     28.6     28.2     27.8     27.4     27.0     26.5     26.1     25.6     25.2     24.7     24.2     23.7
39.......................................  44.........................          28.5     28.2     27.8     27.4     27.0     26.6     26.2     25.8     25.3     24.8     24.4     23.9     23.4
40.......................................  45.........................          28.0     27.7     27.3     27.0     26.6     26.2     25.8     25.4     25.0     24.5     24.1     23.6     23.1
 
41.......................................  46.........................          27.5     27.2     26.9     26.5     26.2     25.8     25.4     25.0     24.6     24.2     23.8     23.3     22.9

[[Page 199]]

 
42.......................................  47.........................          27.0     26.7     26.4     26.1     25.8     25.4     25.0     24.6     24.2     23.8     23.4     23.0     22.6
43.......................................  48.........................          26.5     26.2     25.9     25.6     25.3     25.0     24.6     24.2     23.9     23.5     23.1     22.7     22.2
44.......................................  49.........................          26.0     25.7     25.5     25.2     24.8     24.5     24.2     23.8     23.5     23.1     22.7     22.3     21.9
45.......................................  50.........................          25.5     25.2     25.0     24.7     24.4     24.1     23.8     23.4     23.1     22.7     22.4     22.0     21.6
 
46.......................................  51.........................          24.9     24.7     24.4     24.2     23.9     23.6     23.3     23.0     22.7     22.3     22.0     21.6     21.2
47.......................................  52.........................          24.4     24.2     23.9     23.7     23.4     23.1     22.9     22.6     22.2     21.9     21.6     21.2     20.9
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                  Ages
                                                                       -------------------------------------------------------------------------------------------------------------------------
                   Male                               Female               Male 48       49       50       51       52       53       54       55       56       57       58       59       60
                                                                       -------------------------------------------------------------------------------------------------------------------------
                                                                          Female 53      54       55       56       57       58       59       60       61       62       63       64       65
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
35.......................................  40.........................          23.8     23.3     22.7     22.1     21.6     21.0     20.4     19.8     19.3     18.7     18.1     17.5     17.0
36.......................................  41.........................          23.6     23.1     22.5     22.0     21.4     20.8     20.3     19.7     19.1     18.6     18.0     17.4     16.9
37.......................................  42.........................          23.4     22.9     22.3     21.8     21.2     20.7     20.1     19.6     19.0     18.4     17.9     17.3     16.8
38.......................................  43.........................          23.2     22.6     22.1     21.6     21.1     20.5     20.0     19.4     18.9     18.3     17.8     17.2     16.7
39.......................................  44.........................          22.9     22.4     21.9     21.4     20.9     20.3     19.8     19.3     18.7     18.2     17.7     17.1     16.6
40.......................................  45.........................          22.7     22.2     21.7     21.2     20.7     20.1     19.6     19.1     18.6     18.0     17.5     17.0     16.5
 
41.......................................  46.........................          22.4     21.9     21.4     20.9     20.4     19.9     19.4     18.9     18.4     17.9     17.4     16.9     16.3
42.......................................  47.........................          22.1     21.6     21.2     20.7     20.2     19.7     19.2     18.7     18.2     17.7     17.2     16.7     16.2
43.......................................  48.........................          21.8     21.4     20.9     20.5     20.0     19.5     19.0     18.6     18.1     17.6     17.1     16.6     16.1
44.......................................  49.........................          21.5     21.1     20.6     20.2     19.8     19.3     18.8     18.4     17.9     17.4     16.9     16.4     15.9
45.......................................  50.........................          21.2     20.8     20.4     19.9     19.5     19.1     18.6     18.1     17.7     17.2     16.7     16.3     15.8
 
46.......................................  51.........................          20.9     20.5     20.1     19.7     19.2     18.8     18.4     17.9     17.5     17.0     16.6     16.1     15.6
47.......................................  52.........................          20.5     20.1     19.8     19.4     19.0     18.5     18.1     17.7     17.3     16.8     16.4     15.9     15.5
48.......................................  53.........................          20.2     19.8     19.4     19.1     18.7     18.3     17.9     17.5     17.0     16.6     16.2     15.7     15.3
49.......................................  54.........................          19.8     19.5     19.1     18.8     18.4     18.0     17.6     17.2     16.8     16.4     16.0     15.5     15.1
50.......................................  55.........................          19.4     19.1     18.8     18.4     18.1     17.7     17.3     16.9     16.6     16.2     15.8     15.3     14.9
 
51.......................................  56.........................          19.1     18.8     18.4     18.1     17.8     17.4     17.0     16.7     16.3     15.9     15.5     15.1     14.7
52.......................................  57.........................          18.7     18.4     18.1     17.8     17.4     17.1     16.8     16.4     16.0     15.7     15.3     14.9     14.5
53.......................................  58.........................          18.3     18.0     17.7     17.4     17.1     16.8     16.4     16.1     15.8     15.4     15.1     14.7     14.3
54.......................................  59.........................          17.9     17.6     17.3     17.0     16.8     16.4     16.1     15.8     15.5     15.1     14.8     14.4     14.1
55.......................................  60.........................          17.5     17.2     16.9     16.7     16.4     16.1     15.8     15.5     15.2     14.9     14.5     14.2     13.9
 
56.......................................  61.........................          17.0     16.8     16.6     16.3     16.0     15.8     15.5     15.2     14.9     14.6     14.3     13.9     13.6
57.......................................  62.........................          16.6     16.4     16.2     15.9     15.7     15.4     15.1     14.9     14.6     14.3     14.0     13.7     13.4
58.......................................  63.........................          16.2     16.0     15.8     15.5     15.3     15.1     14.8     14.5     14.3     14.0     13.7     13.4     13.1
59.......................................  64.........................          15.7     15.5     15.3     15.1     14.9     14.7     14.4     14.2     13.9     13.7     13.4     13.1     12.8
60.......................................  65.........................          15.3     15.1     14.9     14.7     14.5     14.3     14.1     13.9     13.6     13.4     13.1     12.8     12.6
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 200]]


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                  Ages
                                                                       -------------------------------------------------------------------------------------------------------------------------
                   Male                               Female               Male 61       62       63       64       65       66       67       68       69       70       71       72       73
                                                                       -------------------------------------------------------------------------------------------------------------------------
                                                                          Female 66      67       68       69       70       71       72       73       74       74       76       77       78
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
35.......................................  40.........................          16.4     15.8     15.3     14.7     14.2     13.7     13.1     12.6     12.1     11.6     11.1     10.7     10.2
36.......................................  41.........................          16.3     15.8     15.2     14.7     14.1     13.6     13.1     12.6     12.1     11.6     11.1     10.6     10.2
37.......................................  42.........................          16.2     15.7     15.1     14.6     14.1     13.6     13.0     12.5     12.0     11.5     11.1     10.6     10.1
38.......................................  43.........................          16.1     15.6     15.1     14.5     14.0     13.5     13.0     12.5     12.0     11.5     11.0     10.6     10.1
39.......................................  44.........................          16.0     15.5     15.0     14.5     13.9     13.4     12.9     12.4     11.9     11.5     11.0     10.5     10.1
40.......................................  45.........................          15.9     15.4     14.9     14.4     13.9     13.4     12.9     12.4     11.9     11.4     11.0     10.5     10.0
 
41.......................................  46.........................          15.8     15.3     14.8     14.3     13.8     13.3     12.8     12.3     11.8     11.4     10.9     10.5     10.0
42.......................................  47.........................          15.7     15.2     14.7     14.2     13.7     13.2     12.7     12.3     11.8     11.3     10.9     10.4     10.0
43.......................................  48.........................          15.6     15.1     14.6     14.1     13.6     13.1     12.7     12.2     11.7     11.3     10.8     10.4      9.9
44.......................................  49.........................          15.5     15.0     14.5     14.0     13.5     13.1     12.6     12.1     11.7     11.2     10.8     10.3      9.9
45.......................................  50.........................          15.3     14.8     14.4     13.9     13.4     13.0     12.5     12.0     11.6     11.1     10.7     10.3      9.8
 
46.......................................  51.........................          15.2     14.7     14.2     13.8     13.3     12.9     12.4     12.0     11.5     11.1     10.6     10.2      9.8
47.......................................  52.........................          15.0     14.6     14.1     13.7     13.2     12.8     12.3     11.9     11.4     11.0     10.6     10.1      9.7
48.......................................  53.........................          14.9     14.4     14.0     13.5     13.1     12.6     12.2     11.8     11.3     10.9     10.5     10.1      9.7
49.......................................  54.........................          14.7     14.3     13.8     13.4     13.0     12.5     12.1     11.7     11.3     10.8     10.4     10.0      9.6
50.......................................  55.........................          14.5     14.1     13.7     13.3     12.8     12.4     12.0     11.6     11.2     10.7     10.3      9.9      9.5
 
51.......................................  56.........................          14.3     13.9     13.5     13.1     12.7     12.3     11.9     11.5     11.1     10.7     10.3      9.9      9.5
52.......................................  57.........................          14.1     13.7     13.3     12.9     12.5     12.1     11.7     11.3     10.9     10.6     10.2      9.8      9.4
53.......................................  58.........................          13.9     13.6     13.2     12.8     12.4     12.0     11.6     11.2     10.8     10.5     10.1      9.7      9.3
54.......................................  59.........................          13.7     13.4     13.0     12.6     12.2     11.9     11.5     11.1     10.7     10.3     10.0      9.6      9.2
55.......................................  60.........................          13.5     13.2     12.8     12.4     12.1     11.7     11.3     11.0     10.6     10.2      9.9      9.5      9.1
 
56.......................................  61.........................          13.3     12.9     12.6     12.2     11.9     11.5     11.2     10.8     10.5     10.1      9.8      9.4      9.0
57.......................................  62.........................          13.0     12.7     12.4     12.1     11.7     11.4     11.0     10.7     10.3     10.0      9.6      9.3      8.9
58.......................................  63.........................          12.8     12.5     12.2     11.8     11.5     11.2     10.9     10.5     10.2      9.8      9.5      9.2      8.8
59.......................................  64.........................          12.6     12.3     11.9     11.6     11.3     11.0     10.7     10.4     10.0      9.7      9.4      9.1      8.7
60.......................................  65.........................          12.3     12.0     11.7     11.4     11.1     10.8     10.5     10.2      9.9      9.6      9.3      8.9      8.6
 
61.......................................  66.........................          12.0     11.8     11.5     11.2     10.9     10.6     10.3     10.0      9.7      9.4      9.1      8.8      8.5
62.......................................  67.........................          11.8     11.5     11.2     11.0     10.7     10.4     10.1      9.8      9.6      9.3      9.0      8.7      8.4
63.......................................  68.........................          11.5     11.2     11.0     10.7     10.5     10.2      9.9      9.7      9.4      9.1      8.8      8.5      8.2
64.......................................  69.........................          11.2     11.0     10.7     10.5     10.2     10.0      9.7      9.5      9.2      8.9      8.7      8.4      8.1
65.......................................  70.........................          10.9     10.7     10.5     10.2     10.0      9.8      9.5      9.3      9.0      8.8      8.5      8.2      8.0
 
66.......................................  71.........................          10.6     10.4     10.2     10.0      9.8      9.5      9.3      9.1      8.8      8.6      8.3      8.1      7.8
67.......................................  72.........................          10.3     10.1      9.9      9.7      9.5      9.3      9.1      8.9      8.6      8.4      8.1      7.9      7.7
68.......................................  73.........................          10.0      9.8      9.7      9.5      9.3      9.1      8.9      8.6      8.4      8.2      8.0      7.7      7.5
69.......................................  74.........................           9.7      9.6      9.4      9.2      9.0      8.8      8.6      8.4      8.2      8.0      7.8      7.6      7.3
70.......................................  75.........................           9.4      9.3      9.1      8.9      8.8      8.6      8.4      8.2      8.0      7.8      7.6      7.4      7.2
71.......................................  76.........................           9.1      9.0      8.8      8.7      8.5      8.3      8.1      8.0      7.8      7.6      7.4      7.2      7.0
72.......................................  77.........................           8.8      8.7      8.5      8.4      8.2      8.1      7.9      7.7      7.6      7.4      7.2      7.0      6.8

[[Page 201]]

 
73.......................................  78.........................           8.5      8.4      8.2      8.1      8.0      7.8      7.7      7.5      7.3      7.2      7.0      6.8      6.7
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                  Ages
                                                                       -------------------------------------------------------------------------------------------------------------------------
                   Male                               Female               Male 74       75       76       77       78       79       80       81       82       83       84       85       86
                                                                       -------------------------------------------------------------------------------------------------------------------------
                                                                          Female 79      80       81       82       83       84       85       86       87       88       89       90       91
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
35.......................................  40.........................           9.7      9.3      8.9      8.5      8.1      7.7      7.3      6.9      6.6      6.2      5.9      5.6      5.3
36.......................................  41.........................           9.7      9.3      8.9      8.4      8.0      7.7      7.3      6.9      6.6      6.2      5.9      5.6      5.3
37.......................................  42.........................           9.7      9.3      8.8      8.4      8.0      7.6      7.3      6.9      6.5      6.2      5.9      5.6      5.3
38.......................................  43.........................           9.7      9.2      8.8      8.4      8.0      7.6      7.2      6.9      6.5      6.2      5.9      5.6      5.3
39.......................................  44.........................           9.6      9.2      8.8      8.4      8.0      7.6      7.2      6.9      6.5      6.2      5.9      5.6      5.3
40.......................................  45.........................           9.6      9.2      8.8      8.4      8.0      7.6      7.2      6.9      6.5      6.2      5.9      5.5      5.2
 
41.......................................  46.........................           9.6      9.2      8.7      8.3      7.9      7.6      7.2      6.8      6.5      6.2      5.8      5.5      5.2
42.......................................  47.........................           9.5      9.1      8.7      8.3      7.9      7.5      7.2      6.8      6.5      6.2      5.8      5.5      5.2
43.......................................  48.........................           9.5      9.1      8.7      8.3      7.9      7.5      7.2      6.8      6.5      6.1      5.8      5.5      5.2
44.......................................  49.........................           9.5      9.0      8.6      8.2      7.9      7.5      7.1      6.8      6.4      6.1      5.8      5.5      5.2
45.......................................  50.........................           9.4      9.0      8.6      8.2      7.8      7.5      7.1      6.8      6.4      6.1      5.8      5.5      5.2
 
46.......................................  51.........................           9.4      9.0      8.6      8.2      7.8      7.4      7.1      6.7      6.4      6.1      5.8      5.5      5.2
47.......................................  52.........................           9.3      8.9      8.5      8.1      7.8      7.4      7.1      6.7      6.4      6.1      5.8      5.5      5.2
48.......................................  53.........................           9.3      8.9      8.5      8.1      7.7      7.4      7.0      6.7      6.4      6.0      5.7      5.4      5.1
49.......................................  54.........................           9.2      8.8      8.4      8.1      7.7      7.3      7.0      6.7      6.3      6.0      5.7      5.4      5.1
50.......................................  55.........................           9.1      8.8      8.4      8.0      7.7      7.3      7.0      6.6      6.3      6.0      5.7      5.4      5.1
 
51.......................................  56.........................           9.1      8.7      8.3      8.0      7.6      7.3      6.9      6.6      6.3      6.0      5.7      5.4      5.1
52.......................................  57.........................           9.0      8.6      8.3      7.9      7.6      7.2      6.9      6.6      6.2      5.9      5.6      5.4      5.1
53.......................................  58.........................           8.9      8.6      8.2      7.9      7.5      7.2      6.9      6.5      6.2      5.9      5.6      5.3      5.1
54.......................................  59.........................           8.9      8.5      8.2      7.8      7.5      7.1      6.8      6.5      6.2      5.9      5.6      5.3      5.0
55.......................................  60.........................           8.8      8.4      8.1      7.7      7.4      7.1      6.8      6.4      6.1      5.8      5.6      5.3      5.0
 
56.......................................  61.........................           8.7      8.4      8.0      7.7      7.3      7.0      6.7      6.4      6.1      5.8      5.5      5.3      5.0
57.......................................  62.........................           8.6      8.3      7.9      7.6      7.3      7.0      6.7      6.4      6.1      5.8      5.5      5.2      5.0
58.......................................  63.........................           8.5      8.2      7.9      7.5      7.2      6.9      6.6      6.3      6.0      5.7      5.5      5.2      4.9
59.......................................  64.........................           8.4      8.1      7.8      7.5      7.1      6.8      6.5      6.3      6.0      5.7      5.4      5.2      4.9
60.......................................  65.........................           8.3      8.0      7.7      7.4      7.1      6.8      6.5      6.2      5.9      5.6      5.4      5.1      4.9
 
61.......................................  66.........................           8.2      7.9      7.6      7.3      7.0      6.7      6.4      6.1      5.9      5.6      5.3      5.1      4.8
62.......................................  67.........................           8.1      7.8      7.5      7.2      6.9      6.6      6.4      6.1      5.8      5.5      5.3      5.0      4.8
63.......................................  68.........................           8.0      7.7      7.4      7.1      6.8      6.6      6.3      6.0      5.7      5.5      5.2      5.0      4.7
64.......................................  69.........................           7.8      7.6      7.3      7.0      6.7      6.5      6.2      5.9      5.7      5.4      5.2      4.9      4.7
65.......................................  70.........................           7.7      7.4      7.2      6.9      6.6      6.4      6.1      5.9      5.6      5.4      5.1      4.9      4.7
 
66.......................................  71.........................           7.6      7.3      7.1      6.8      6.5      6.3      6.0      5.8      5.5      5.3      5.1      4.8      4.6
67.......................................  72.........................           7.4      7.2      6.9      6.7      6.4      6.2      6.0      5.7      5.5      5.2      5.0      4.8      4.6
68.......................................  73.........................           7.3      7.0      6.8      6.6      6.3      6.1      5.9      5.6      5.4      5.2      4.9      4.7      4.5
69.......................................  74.........................           7.1      6.9      6.7      6.4      6.2      6.0      5.8      5.5      5.3      5.1      4.9      4.7      4.5
70.......................................  75.........................           7.0      6.8      6.5      6.3      6.1      5.9      5.7      5.4      5.2      5.0      4.8      4.6      4.4

[[Page 202]]

 
 
71.......................................  76.........................           6.8      6.6      6.4      6.2      6.0      5.8      5.6      5.3      5.1      4.9      4.7      4.5      4.3
72.......................................  77.........................           6.6      6.4      6.3      6.1      5.9      5.7      5.5      5.3      5.0      4.9      4.7      4.5      4.3
73.......................................  78.........................           6.5      6.3      6.1      5.9      5.7      5.5      5.3      5.1      5.0      4.8      4.6      4.4      4.2
74.......................................  79.........................           6.3      6.1      6.0      5.8      5.6      5.4      5.2      5.0      4.9      4.7      4.5      4.3      4.1
75.......................................  80.........................           6.1      6.0      5.8      5.6      5.5      5.3      5.1      4.9      4.8      4.6      4.4      4.2      4.1
 
76.......................................  81.........................           6.0      5.8      5.6      5.5      5.3      5.2      5.0      4.8      4.7      4.5      4.3      4.1      4.0
77.......................................  82.........................           5.8      5.6      5.5      5.3      5.2      5.0      4.9      4.7      4.5      4.4      4.2      4.1      3.9
78.......................................  83.........................           5.6      5.5      5.3      5.2      5.0      4.9      4.7      4.6      4.4      4.3      4.1      4.0      3.8
79.......................................  84.........................           5.4      5.3      5.2      5.0      4.9      4.7      4.6      4.5      4.3      4.2      4.0      3.9      3.7
80.......................................  85.........................           5.2      5.1      5.0      4.9      4.7      4.6      4.5      4.3      4.2      4.1      3.9      3.8      3.6
 
81.......................................  86.........................           5.0      4.9      4.8      4.7      4.6      4.5      4.3      4.2      4.1      3.9      3.8      3.7      3.6
82.......................................  87.........................           4.9      4.8      4.7      4.5      4.4      4.3      4.2      4.1      4.0      3.8      3.7      3.6      3.5
83.......................................  88.........................           4.7      4.6      4.5      4.4      4.3      4.2      4.1      3.9      3.8      3.7      3.6      3.5      3.4
84.......................................  89.........................           4.5      4.4      4.3      4.2      4.1      4.0      3.9      3.8      3.7      3.6      3.5      3.4      3.3
85.......................................  90.........................           4.3      4.2      4.1      4.1      4.0      3.9      3.8      3.7      3.6      3.5      3.4      3.3      3.2
86.......................................  91.........................           4.1      4.1      4.0      3.9      3.8      3.7      3.6      3.6      3.5      3.4      3.3      3.2      3.1
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 203]]


--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                   Ages
                                                 -------------------------------------------------------------------------------------------------------
             Male                    Female          Male 87       88       89       90       91       92       93       94       95       96       97
                                                 -------------------------------------------------------------------------------------------------------
                                                    Female 92      93       94       95       96       97       98       99      100      101      102
--------------------------------------------------------------------------------------------------------------------------------------------------------
35............................  40..............           5.0      4.7      4.4      4.2      3.9      3.7      3.5      3.3      3.1      2.9      2.7
36............................  41..............           5.0      4.7      4.4      4.2      3.9      3.7      3.5      3.3      3.1      2.9      2.7
37............................  42..............           5.0      4.7      4.4      4.2      3.9      3.7      3.5      3.3      3.1      2.9      2.7
38............................  43..............           5.0      4.7      4.4      4.2      3.9      3.7      3.5      3.3      3.1      2.8      2.6
39............................  44..............           5.0      4.7      4.4      4.2      3.9      3.7      3.5      3.3      3.0      2.8      2.6
40............................  45..............           5.0      4.7      4.4      4.2      3.9      3.7      3.5      3.3      3.0      2.8      2.6
 
41............................  46..............           5.0      4.7      4.4      4.2      3.9      3.7      3.5      3.2      3.0      2.8      2.6
42............................  47..............           4.9      4.7      4.4      4.2      3.9      3.7      3.5      3.2      3.0      2.8      2.6
43............................  48..............           4.9      4.7      4.4      4.1      3.9      3.7      3.5      3.2      3.0      2.8      2.6
44............................  49..............           4.9      4.7      4.4      4.1      3.9      3.7      3.4      3.2      3.0      2.8      2.6
45............................  50..............           4.9      4.6      4.4      4.1      3.9      3.7      3.4      3.2      3.0      2.8      2.6
 
46............................  51..............           4.9      4.6      4.4      4.1      3.9      3.7      3.4      3.2      3.0      2.8      2.6
47............................  52..............           4.9      4.6      4.4      4.1      3.9      3.7      3.4      3.2      3.0      2.8      2.6
48............................  53..............           4.9      4.6      4.4      4.1      3.9      3.6      3.4      3.2      3.0      2.8      2.6
49............................  54..............           4.9      4.6      4.3      4.1      3.9      3.6      3.4      3.2      3.0      2.8      2.6
50............................  55..............           4.8      4.6      4.3      4.1      3.9      3.6      3.4      3.2      3.0      2.8      2.6
 
51............................  56..............           4.8      4.6      4.3      4.1      3.8      3.6      3.4      3.2      3.0      2.8      2.6
52............................  57..............           4.8      4.5      4.3      4.1      3.8      3.6      3.4      3.2      3.0      2.8      2.6
53............................  58..............           4.8      4.5      4.3      4.0      3.8      3.6      3.4      3.2      3.0      2.8      2.6
54............................  59..............           4.8      4.5      4.3      4.0      3.8      3.6      3.4      3.2      3.0      2.8      2.6
55............................  60..............           4.7      4.5      4.3      4.0      3.8      3.6      3.4      3.2      3.0      2.8      2.6
 
56............................  61..............           4.7      4.5      4.2      4.0      3.8      3.6      3.3      3.1      2.9      2.8      2.6
57............................  62..............           4.7      4.5      4.2      4.0      3.8      3.5      3.3      3.1      2.9      2.7      2.6
58............................  63..............           4.7      4.4      4.2      4.0      3.7      3.5      3.3      3.1      2.9      2.7      2.5
59............................  64..............           4.6      4.4      4.2      3.9      3.7      3.5      3.3      3.1      2.9      2.7      2.5
--------------------------------------------------------------------------------------------------------------------------------------------------------


--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                   Ages
                                                 -------------------------------------------------------------------------------------------------------
             Male                    Female          Male 98       99      100      101      102      103      104      105      106      107      108
                                                 -------------------------------------------------------------------------------------------------------
                                                   Female 103     104      105      106      107      108      109      110      111      112      113
--------------------------------------------------------------------------------------------------------------------------------------------------------
35............................  40..............           2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
36............................  41..............           2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.2      1.0      0.8      0.7
37............................  42..............           2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.1      1.0      0.8      0.7
38............................  43..............           2.5      2.3      2.1      1.9      1.7      1.5      1.3      1.1      1.0      0.8      0.7
39............................  44..............           2.4      2.3      2.1      1.9      1.7      1.5      1.3      1.1      1.0      0.8      0.7
 
40............................  45..............           2.4      2.2      2.1      1.9      1.7      1.5      1.3      1.1      1.0      0.8      0.7
41............................  46..............           2.4      2.2      2.1      1.9      1.7      1.5      1.3      1.1      1.0      0.8      0.7
42............................  47..............           2.4      2.2      2.0      1.9      1.7      1.5      1.3      1.1      1.0      0.8      0.7
43............................  48..............           2.4      2.2      2.0      1.9      1.7      1.5      1.3      1.1      1.0      0.8      0.7
44............................  49..............           2.4      2.2      2.0      1.9      1.7      1.5      1.3      1.1      1.0      0.8      0.7
 
45............................  50..............           2.4      2.2      2.0      1.8      1.7      1.5      1.3      1.1      1.0      0.8      0.7
46............................  51..............           2.4      2.2      2.0      1.8      1.7      1.5      1.3      1.1      1.0      0.8      0.7
47............................  52..............           2.4      2.2      2.0      1.8      1.7      1.5      1.3      1.1      1.0      0.8      0.7
48............................  53..............           2.4      2.2      2.0      1.8      1.7      1.5      1.3      1.1      1.0      0.8      0.7
49............................  54..............           2.4      2.2      2.0      1.8      1.7      1.5      1.3      1.1      1.0      0.8      0.7
 
50............................  55..............           2.4      2.2      2.0      1.8      1.6      1.5      1.3      1.1      1.0      0.8      0.7
51............................  56..............           2.4      2.2      2.0      1.8      1.6      1.5      1.3      1.1      1.0      0.8      0.7
52............................  57..............           2.4      2.2      2.0      1.8      1.6      1.5      1.3      1.1      1.0      0.8      0.7
53............................  58..............           2.4      2.2      2.0      1.8      1.6      1.5      1.3      1.1      1.0      0.8      0.7
54............................  59..............           2.4      2.2      2.0      1.8      1.6      1.5      1.3      1.1      1.0      0.8      0.7
 
55............................  60..............           2.4      2.2      2.0      1.8      1.6      1.4      1.3      1.1      1.0      0.8      0.7
56............................  61..............           2.4      2.2      2.0      1.8      1.6      1.4      1.3      1.1      1.0      0.8      0.7
57............................  62..............           2.4      2.2      2.0      1.8      1.6      1.4      1.3      1.1      0.9      0.8      0.7
58............................  63..............           2.4      2.2      2.0      1.8      1.6      1.4      1.3      1.1      0.9      0.8      0.7
59............................  64..............           2.3      2.2      2.0      1.8      1.6      1.4      1.3      1.1      0.9      0.8      0.7
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[[Page 204]]


--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                   Ages
                                                 -------------------------------------------------------------------------------------------------------
             Male                    Female          Male 87       88       89       90       91       92       93       94       95       96       97
                                                 -------------------------------------------------------------------------------------------------------
                                                    Female 92      93       94       95       96       97       98       99      100      101      102
--------------------------------------------------------------------------------------------------------------------------------------------------------
60............................  65..............           4.6      4.4      4.1      3.9      3.7      3.5      3.3      3.1      2.9      2.7      2.5
61............................  66..............           4.6      4.3      4.1      3.9      3.7      3.5      3.3      3.1      2.9      2.7      2.5
62............................  67..............           4.5      4.3      4.1      3.9      3.7      3.5      3.3      3.1      2.9      2.7      2.5
63............................  68..............           4.5      4.3      4.1      3.8      3.6      3.4      3.2      3.0      2.9      2.7      2.5
64............................  69..............           4.5      4.2      4.0      3.8      3.6      3.4      3.2      3.0      2.8      2.7      2.5
 
65............................  70..............           4.4      4.2      4.0      3.8      3.6      3.4      3.2      3.0      2.8      2.6      2.5
66............................  71..............           4.4      4.2      4.0      3.8      3.6      3.4      3.2      3.0      2.8      2.6      2.4
67............................  72..............           4.3      4.1      3.9      3.7      3.5      3.3      3.1      3.0      2.8      2.6      2.4
68............................  73..............           4.3      4.1      3.9      3.7      3.5      3.3      3.1      2.9      2.8      2.6      2.4
69............................  74..............           4.2      4.0      3.8      3.6      3.5      3.3      3.1      2.9      2.7      2.6      2.4
 
70............................  75..............           4.2      4.0      3.8      3.6      3.4      3.2      3.1      2.9      2.7      2.5      2.4
71............................  76..............           4.1      3.9      3.8      3.6      3.4      3.2      3.0      2.9      2.7      2.5      2.3
72............................  77..............           4.1      3.9      3.7      3.5      3.3      3.2      3.0      2.8      2.7      2.5      2.3
73............................  78..............           4.0      3.8      3.7      3.5      3.3      3.1      3.0      2.8      2.6      2.5      2.3
74............................  79..............           3.9      3.8      3.6      3.4      3.3      3.1      2.9      2.8      2.6      2.4      2.3
 
75............................  80..............           3.9      3.7      3.5      3.4      3.2      3.0      2.9      2.7      2.6      2.4      2.2
76............................  81..............           3.8      3.6      3.5      3.3      3.2      3.0      2.8      2.7      2.5      2.4      2.2
77............................  82..............           3.7      3.6      3.4      3.3      3.1      3.0      2.8      2.6      2.5      2.3      2.2
78............................  83..............           3.7      3.5      3.4      3.2      3.1      2.9      2.7      2.6      2.4      2.3      2.1
79............................  84..............           3.6      3.4      3.3      3.1      3.0      2.8      2.7      2.5      2.4      2.2      2.1
 
80............................  85..............           3.5      3.4      3.2      3.1      2.9      2.8      2.6      2.5      2.3      2.2      2.0
81............................  86..............           3.4      3.3      3.1      3.0      2.9      2.7      2.6      2.4      2.3      2.1      2.0
82............................  87..............           3.3      3.2      3.1      2.9      2.8      2.7      2.5      2.4      2.2      2.1      2.0
83............................  88..............           3.2      3.1      3.0      2.9      2.7      2.6      2.5      2.3      2.2      2.0      1.9
84............................  89..............           3.1      3.0      2.9      2.8      2.7      2.5      2.4      2.3      2.1      2.0      1.9
--------------------------------------------------------------------------------------------------------------------------------------------------------


--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                   Ages
                                                 -------------------------------------------------------------------------------------------------------
             Male                    Female          Male 98       99      100      101      102      103      104      105      106      107      108
                                                 -------------------------------------------------------------------------------------------------------
                                                   Female 103     104      105      106      107      108      109      110      111      112      113
--------------------------------------------------------------------------------------------------------------------------------------------------------
60............................  65..............           2.3      2.1      2.0      1.8      1.6      1.4      1.3      1.1      0.9      0.8      0.7
61............................  66..............           2.3      2.1      2.0      1.8      1.6      1.4      1.2      1.1      0.9      0.8      0.7
62............................  67..............           2.3      2.1      1.9      1.8      1.6      1.4      1.2      1.1      0.9      0.8      0.7
63............................  68..............           2.3      2.1      1.9      1.7      1.6      1.4      1.2      1.1      0.9      0.8      0.7
64............................  69..............           2.3      2.1      1.9      1.7      1.6      1.4      1.2      1.1      0.9      0.8      0.7
65............................  70..............           2.3      2.1      1.9      1.7      1.6      1.4      1.2      1.1      0.9      0.8      0.7
 
66............................  71..............           2.3      2.1      1.9      1.7      1.5      1.4      1.2      1.1      0.9      0.8      0.7
67............................  72..............           2.2      2.1      1.9      1.7      1.5      1.4      1.2      1.0      0.9      0.7      0.7
68............................  73..............           2.2      2.0      1.9      1.7      1.5      1.4      1.2      1.0      0.9      0.7      0.7
69............................  74..............           2.2      2.0      1.8      1.7      1.5      1.3      1.2      1.0      0.9      0.7      0.6
70............................  75..............           2.2      2.0      1.8      1.7      1.5      1.3      1.2      1.0      0.9      0.7      0.6
 
71............................  76..............           2.2      2.0      1.8      1.6      1.5      1.3      1.2      1.0      0.9      0.7      0.6
72............................  77..............           2.1      2.0      1.8      1.6      1.5      1.3      1.1      1.0      0.8      0.7      0.6
73............................  78..............           2.1      1.9      1.8      1.6      1.4      1.3      1.1      1.0      0.8      0.7      0.6
74............................  79..............           2.1      1.9      1.7      1.6      1.4      1.3      1.1      1.0      0.8      0.7      0.6
75............................  80..............           2.1      1.9      1.7      1.6      1.4      1.3      1.1      1.0      0.8      0.7
 
76............................  81..............           2.0      1.9      1.7      1.5      1.4      1.2      1.1      0.9      0.8      0.7
77............................  82..............           2.0      1.8      1.7      1.5      1.4      1.2      1.1      0.9      0.8      0.7
78............................  83..............           2.0      1.8      1.6      1.5      1.3      1.2      1.0      0.9      0.8      0.7
79............................  84..............           1.9      1.8      1.6      1.5      1.3      1.2      1.0      0.9      0.8      0.7
80............................  85..............           1.9      1.7      1.6      1.4      1.3      1.1      1.0      0.9      0.7      0.7
 
81............................  86..............           1.8      1.7      1.5      1.4      1.3      1.1      1.0      0.8      0.7      0.6
82............................  87..............           1.8      1.7      1.5      1.4      1.2      1.1      1.0      0.8      0.7      0.6
83............................  88..............           1.8      1.6      1.5      1.3      1.2      1.1      0.9      0.8      0.7      0.6
84............................  89..............           1.7      1.6      1.4      1.3      1.2      1.0      0.9      0.8      0.7  .......  .......
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 205]]


--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                        Ages
                                                          ----------------------------------------------------------------------------------------------
               Male                         Female            Male 87       88       89       90       91       92       93       94       95       96
                                                          ----------------------------------------------------------------------------------------------
                                                             Female 92      93       94       95       96       97       98       99      100      101
--------------------------------------------------------------------------------------------------------------------------------------------------------
85................................  90...................           3.1      2.9      2.8      2.7      2.6      2.5      2.3      2.2      2.1      1.9
86................................  91...................           3.0      2.8      2.7      2.6      2.5      2.4      2.3      2.1      2.0      1.9
87................................  92...................           2.9      2.8      2.6      2.5      2.4      2.3      2.2      2.1      1.9      1.8
88................................  93...................           2.8      2.7      2.6      2.4      2.3      2.2      2.1      2.0      1.9      1.7
89................................  94...................           2.6      2.6      2.5      2.4      2.2      2.1      2.0      1.9      1.8      1.7
90................................  95...................           2.5      2.4      2.4      2.3      2.2      2.0      1.9      1.8      1.7      1.6
 
91................................  96...................           2.4      2.3      2.2      2.2      2.1      2.0      1.9      1.7      1.6      1.5
92................................  97...................           2.3      2.2      2.1      2.0      2.0      1.9      1.8      1.7      1.6      1.5
93................................  98...................           2.2      2.1      2.0      1.9      1.9      1.8      1.7      1.6      1.5      1.4
94................................  99...................           2.1      2.0      1.9      1.8      1.7      1.7      1.6      1.5      1.4      1.3
95................................  100..................           1.9      1.9      1.8      1.7      1.6      1.6      1.5      1.4      1.3      1.2
 
96................................  101..................           1.8      1.7      1.7      1.6      1.5      1.5      1.4      1.3      1.2      1.1
97................................  102..................           1.7      1.6      1.6      1.5      1.4      1.4      1.3      1.2      1.1      1.1
98................................  103..................           1.6      1.5      1.4      1.4      1.3      1.3      1.2      1.1      1.0      1.0
99................................  104..................           1.4      1.4      1.3      1.3      1.2      1.1      1.1      1.0      1.0      0.9
--------------------------------------------------------------------------------------------------------------------------------------------------------


--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                        Ages
                                                          ----------------------------------------------------------------------------------------------
               Male                         Female            Male 97       98       99      100      101      102      103      104      105      106
                                                          ----------------------------------------------------------------------------------------------
                                                            Female 102     103      104      105      106      107      108      109      110      111
--------------------------------------------------------------------------------------------------------------------------------------------------------
85................................  90...................           1.8      1.7      1.5      1.4      1.3      1.1      1.0      0.9      0.8      0.7
86................................  91...................           1.7      1.6      1.5      1.3      1.2      1.1      1.0      0.8      0.7      0.7
87................................  92...................           1.7      1.6      1.4      1.3      1.2      1.1      0.9      0.8      0.7      0.6
88................................  93...................           1.6      1.5      1.4      1.3      1.1      1.0      0.9      0.8      0.7      0.6
89................................  94...................           1.6      1.4      1.3      1.2      1.1      1.0      0.9      0.7      0.7
90................................  95...................           1.5      1.4      1.3      1.2      1.0      0.9      0.8      0.7      0.6
 
91................................  96...................           1.4      1.3      1.2      1.1      1.0      0.9      0.8      0.7      0.6
92................................  97...................           1.4      1.3      1.1      1.0      0.9      0.8      0.7      0.7
93................................  98...................           1.3      1.2      1.1      1.0      0.9      0.8      0.7      0.6
94................................  99...................           1.2      1.1      1.0      0.9      0.8      0.7      0.7
95................................  100..................           1.1      1.0      1.0      0.9      0.8      0.7      0.6
 
96................................  101..................           1.1      1.0      0.9      0.8      0.7      0.7
97................................  102..................           1.0      0.9      0.8      0.7      0.7      0.6
98................................  103..................           0.9      0.8      0.7      0.7      0.6
99................................  104..................           0.8      0.7      0.7      0.6  .......  .......  .......  .......  .......  .......
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 206]]


                                                                           Table III--Percent Value of Refund Feature
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                    Ages                                                                            Duration of guaranteed amount--[Years]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                    Male                                 Female                 1        2        3        4        5        6        7        8        9        10       11       12       13
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6..........................................  11............................  .......  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1
7..........................................  12............................  .......  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1
8..........................................  13............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
9..........................................  14............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
10.........................................  15............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
 
11.........................................  16............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
12.........................................  17............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
13.........................................  18............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
14.........................................  19............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
15.........................................  20............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
 
16.........................................  21............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
17.........................................  22............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
18.........................................  23............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
19.........................................  24............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
20.........................................  25............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
 
21.........................................  26............................  .......  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1
22.........................................  27............................  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1        1
23.........................................  28............................  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1        1
24.........................................  29............................  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1        1
25.........................................  30............................  .......  .......  .......  .......  .......  .......        1        1        1        1        1        1        1
 
26.........................................  31............................  .......  .......  .......  .......  .......        1        1        1        1        1        1        1        1
27.........................................  32............................  .......  .......  .......  .......  .......        1        1        1        1        1        1        1        1
28.........................................  33............................  .......  .......  .......  .......  .......        1        1        1        1        1        1        1        1
29.........................................  34............................  .......  .......  .......  .......  .......        1        1        1        1        1        1        1        2
30.........................................  35............................  .......  .......  .......  .......        1        1        1        1        1        1        1        2        2
 
31.........................................  36............................  .......  .......  .......  .......        1        1        1        1        1        1        1        2        2
32.........................................  37............................  .......  .......  .......  .......        1        1        1        1        1        1        2        2        2
33.........................................  38............................  .......  .......  .......        1        1        1        1        1        1        1        2        2        2
34.........................................  39............................  .......  .......  .......        1        1        1        1        1        1        2        2        2        2
35.........................................  40............................  .......  .......  .......        1        1        1        1        1        2        2        2        2        2
 
36.........................................  41............................  .......  .......  .......        1        1        1        1        1        2        2        2        2        3
37.........................................  42............................  .......  .......        1        1        1        1        1        2        2        2        2        3        3
38.........................................  43............................  .......  .......        1        1        1        1        1        2        2        2        2        3        3
39.........................................  44............................  .......  .......        1        1        1        1        2        2        2        2        3        3        3
40.........................................  45............................  .......  .......        1        1        1        1        2        2        2        3        3        3        4
 
41.........................................  46............................  .......  .......        1        1        1        1        2        2        2        3        3        3        4
42.........................................  47............................  .......  .......        1        1        1        2        2        2        3        3        3        4        4

[[Page 207]]

 
43.........................................  48............................  .......        1        1        1        1        2        2        2        3        3        4        4        4
44.........................................  49............................  .......        1        1        1        1        2        2        3        3        3        4        4        5
45.........................................  50............................  .......        1        1        1        2        2        2        3        3        4        4        5        5
 
46.........................................  51............................  .......        1        1        1        2        2        3        3        3        4        4        5        5
47.........................................  52............................  .......        1        1        1        2        2        3        3        4        4        5        5        6
48.........................................  53............................  .......        1        1        2        2        2        3        3        4        5        5        6        6
49.........................................  54............................  .......        1        1        2        2        3        3        4        4        5        5        6        7
50.........................................  55............................  .......        1        1        2        2        3        3        4        5        5        6        7        7
 
51.........................................  56............................  .......        1        1        2        3        3        4        4        5        6        6        7        8
52.........................................  57............................        1        1        2        2        3        3        4        5        5        6        7        8        8
53.........................................  58............................        1        1        2        2        3        4        4        5        6        7        7        8        9
54.........................................  59............................        1        1        2        2        3        4        5        5        6        7        8        9       10
55.........................................  60............................        1        1        2        3        3        4        5        6        7        8        8        9       10
 
56.........................................  61............................        1        1        2        3        4        4        5        6        7        8        9       10       11
57.........................................  62............................        1        1        2        3        4        5        6        7        8        9       10       11       12
58.........................................  63............................        1        2        2        3        4        5        6        7        8        9       10       12       13
59.........................................  64............................        1        2        3        4        5        6        7        8        9       10       11       12       14
60.........................................  65............................        1        2        3        4        5        6        7        8       10       11       12       13       15
 
61.........................................  66............................        1        2        3        4        5        6        8        9       10       12       13       14       16
62.........................................  67............................        1        2        3        4        6        7        8       10       11       12       14       15       17
63.........................................  68............................        1        2        4        5        6        7        9       10       12       13       15       16       18
64.........................................  69............................        1        3        4        5        7        8        9       11       13       14       16       17       19
65.........................................  70............................        1        3        4        6        7        9       10       12       13       15       17       19       20
 
66.........................................  71............................        1        3        4        6        8        9       11       13       14       16       18       20       22
67.........................................  72............................        2        3        5        6        8       10       12       14       15       17       19       21       23
68.........................................  73............................        2        3        5        7        9       11       13       14       16       18       21       23       25
69.........................................  74............................        2        4        6        7        9       11       13       16       18       20       22       24       26
70.........................................  75............................        2        4        6        8       10       12       14       17       19       21       23       26       28
 
71.........................................  76............................        2        4        6        9       11       13       15       18       20       22       25       27       29
72.........................................  77............................        2        5        7        9       12       14       16       19       21       24       26       29       31
73.........................................  78............................        2        5        7       10       12       15       18       20       23       25       28       30       33
74.........................................  79............................        3        5        8       11       13       16       19       22       24       27       30       32       35
75.........................................  80............................        3        6        8       11       14       17       20       23       26       29       31       34       37
 
76.........................................  81............................        3        6        9       12       15       18       21       24       27       30       33       36       39
77.........................................  82............................        3        7       10       13       16       20       23       26       29       32       35       38       41
78.........................................  83............................        4        7       11       14       17       21       24       28       31       34       37       40       43
79.........................................  84............................        4        8       11       15       19       22       26       29       33       36       39       42       45
80.........................................  85............................        4        8       12       16       20       24       27       31       34       38       41       44       47
 
81.........................................  86............................        4        9       13       17       21       25       29       33       36       40       43       46       49
82.........................................  87............................        5        9       14       18       23       27       31       35       38       42       45       48       51
83.........................................  88............................        5       10       15       19       24       28       33       37       40       44       47       50       53
84.........................................  89............................        5       11       16       21       26       30       34       38       42       46       49       52       55

[[Page 208]]

 
85.........................................  90............................        6       11       17       22       27       32       36       41       44       48       51       55       57
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                    Ages                                                                            Duration of guaranteed amount--[Years]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                    Male                                 Female                 14       15       16       17       18       19       20       21       22       23       24       25       26
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
6..........................................  11............................        1        1        1        1        1        1        1        1        1        1        2        2        2
7..........................................  12............................        1        1        1        1        1        1        1        1        1        1        2        2        2
8..........................................  13............................        1        1        1        1        1        1        1        1        1        1        2        2        2
9..........................................  14............................        1        1        1        1        1        1        1        1        1        1        2        2        2
10.........................................  15............................        1        1        1        1        1        1        1        1        1        2        2        2        2
 
11.........................................  16............................        1        1        1        1        1        1        1        1        1        2        2        2        2
12.........................................  17............................        1        1        1        1        1        1        1        1        1        2        2        2        2
13.........................................  18............................        1        1        1        1        1        1        1        1        2        2        2        2        2
14.........................................  19............................        1        1        1        1        1        1        1        1        2        2        2        2        2
15.........................................  20............................        1        1        1        1        1        1        1        1        2        2        2        2        2
 
16.........................................  21............................        1        1        1        1        1        1        1        2        2        2        2        2        2
17.........................................  22............................        1        1        1        1        1        1        1        2        2        2        2        2        2
18.........................................  23............................        1        1        1        1        1        1        2        2        2        2        2        2        2
19.........................................  24............................        1        1        1        1        1        2        2        2        2        2        2        2        2
20.........................................  25............................        1        1        1        1        1        2        2        2        2        2        2        2        3
 
21.........................................  26............................        1        1        1        1        2        2        2        2        2        2        2        3        3
22.........................................  27............................        1        1        1        1        2        2        2        2        2        2        3        3        3
23.........................................  28............................        1        1        1        2        2        2        2        2        2        2        3        3        3
24.........................................  29............................        1        1        2        2        2        2        2        2        2        3        3        3        3
25.........................................  30............................        1        1        2        2        2        2        2        2        3        3        3        3        3
 
26.........................................  31............................        1        2        2        2        2        2        2        3        3        3        3        3        4
27.........................................  32............................        2        2        2        2        2        2        3        3        3        3        3        4        4
28.........................................  33............................        2        2        2        2        2        3        3        3        3        3        4        4        4
29.........................................  34............................        2        2        2        2        2        3        3        3        3        4        4        4        5
30.........................................  35............................        2        2        2        2        3        3        3        3        4        4        4        5        5
 
31.........................................  36............................        2        2        2        3        3        3        3        4        4        4        5        5        5
32.........................................  37............................        2        2        3        3        3        3        4        4        4        5        5        5        6
33.........................................  38............................        2        3        3        3        3        4        4        4        5        5        5        6        6
34.........................................  39............................        3        3        3        3        4        4        4        5        5        5        6        6        7
35.........................................  40............................        3        3        3        4        4        4        5        5        5        6        6        7        7
 
36.........................................  41............................        3        3        4        4        4        5        5        5        6        6        7        7        8
37.........................................  42............................        3        3        4        4        4        5        5        6        6        7        7        8        8

[[Page 209]]

 
38.........................................  43............................        3        4        4        4        5        5        6        6        7        7        8        8        9
39.........................................  44............................        4        4        4        5        5        6        6        7        7        8        8        9        9
40.........................................  45............................        4        4        5        5        6        6        7        7        8        8        9        9       10
 
41.........................................  46............................        4        5        5        6        6        7        7        8        8        9        9       10       11
42.........................................  47............................        5        5        5        6        6        7        8        8        9        9       10       11       12
43.........................................  48............................  .......        5        6        6        7        8        8        9        9       10       11       12       12
44.........................................  49............................        5        6        6        7        7        8        9        9       10       11       12       12       13
45.........................................  50............................        6        6        7        7        8        9        9       10       11       12       12       13       14
46.........................................  51............................        6        7        7        8        9        9       10       11       12       12       13       14       15
47.........................................  52............................        7        7        8        9        9       10       11       12       12       13       14       15       16
48.........................................  53............................        7        8        8        9       10       11       12       12       13       14       15       16       17
49.........................................  54............................        8        8        9       10       11       11       12       13       14       15       16       17       18
50.........................................  55............................        8        9       10       11       11       12       13       14       15       16       17       18       20
 
51.........................................  56............................        9       10       10       11       12       13       14       15       16       17       18       20       21
52.........................................  57............................        9       10       11       12       13       14       15       16       17       18       20       21       22
53.........................................  58............................       10       11       12       13       14       15       16       17       19       20       21       22       24
54.........................................  59............................       11       12       13       14       15       16       17       18       20       21       22       24       25
55.........................................  60............................       11       13       14       15       16       17       18       20       21       22       24       25       26
 
56.........................................  61............................       12       13       15       16       17       18       20       21       22       24       25       27       28
57.........................................  62............................       13       14       16       17       18       20       21       22       24       25       27       28       30
58.........................................  63............................       14       15       17       18       19       21       22       24       25       27       28       30       31
59.........................................  64............................       15       16       18       19       21       22       24       25       27       28       30       31       33
60.........................................  65............................       16       18       19       20       22       24       25       27       28       30       32       33       35
 
61.........................................  66............................       17       19       20       22       23       25       27       28       30       32       33       35       37
62.........................................  67............................       18       20       22       23       25       27       28       30       32       33       35       37       38
63.........................................  68............................       20       21       23       25       26       28       30       32       33       35       37       39       40
64.........................................  69............................       21       23       24       26       28       30       32       33       35       37       39       41       42
65.........................................  70............................       22       24       26       28       30       32       33       35       37       39       41       42       44
 
66.........................................  71............................       24       26       28       29       31       33       35       37       39       41       43       44       46
67.........................................  72............................       25       27       29       31       33       35       37       39       41       43       45       46       48
68.........................................  73............................       27       29       31       33       35       37       39       41       43       45       47       48       50
69.........................................  74............................       28       30       33       35       37       39       41       43       45       47       48       50       52
70.........................................  75............................       30       32       34       37       39       41       43       45       47       49       50       52       54
 
71.........................................  76............................       32       34       36       39       41       43       45       47       49       51       52       54       56
72.........................................  77............................       34       36       38       41       43       45       47       49       51       53       54       56       58
73.........................................  78............................       35       38       40       43       45       47       49       51       53       55       56       58       59
74.........................................  79............................       37       40       42       45       47       49       51       53       55       57       58       60       61
75.........................................  80............................       39       42       44       47       49       51       53       55       57       58       60       62       63
 
76.........................................  81............................       41       44       46       49       51       53       55       57       59       60       62       63       65
77.........................................  82............................       43       46       48       51       53       55       57       59       61       62       64       65       66
78.........................................  83............................       45       48       50       53       55       57       59       61       62       64       65       67       68
79.........................................  84............................       48       50       53       55       57       59       61       63       64       66       67       68       70
80.........................................  85............................       50       52       55       57       59       61       63       64       66       67       69       70       71

[[Page 210]]

 
 
81.........................................  86............................       52       54       57       59       61       63       65       66       68       69       70       72       73
82.........................................  87............................       54       56       59       61       63       65       66       68       69       71       72       73       74
83.........................................  88............................       56       58       61       63       65       66       68       70       71       72       73       74       75
84.........................................  89............................       58       60       63       65       67       68       70       71       73       74       75       76       77
85.........................................  90............................       60       62       65       67       68       70       71       73       74       75       76       77  .......
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


--------------------------------------------------------------------------------------------------------------------------------------------------------
                         Ages                                                        Duration of guaranteed amount--[Years]
--------------------------------------------------------------------------------------------------------------------------------------------------------
              Male                       Female            27         28         29         30         31         32         33         34         35
--------------------------------------------------------------------------------------------------------------------------------------------------------
6...............................  11.................          2          2          2          2          2          2          2          2          2
7...............................  12.................          2          2          2          2          2          2          2          2          3
8...............................  13.................          2          2          2          2          2          2          2          2          3
9...............................  14.................          2          2          2          2          2          2          2          3          3
10..............................  15.................          2          2          2          2          2          2          3          3          3
 
11..............................  16.................          2          2          2          2          2          2          3          3          3
12..............................  17.................          2          2          2          2          2          3          3          3          3
13..............................  18.................          2          2          2          2          2          3          3          3          3
14..............................  19.................          2          2          2          2          3          3          3          3          3
15..............................  20.................          2          2          2          3          3          3          3          3          3
 
16..............................  21.................          2          2          3          3          3          3          3          3          4
17..............................  22.................          2          2          3          3          3          3          3          4          4
18..............................  23.................          2          3          3          3          3          3          4          4          4
19..............................  24.................          3          3          3          3          3          4          4          4          4
20..............................  25.................          3          3          3          3          4          4          4          4          5
 
21..............................  26.................          3          3          3          4          4          4          4          5          5
22..............................  27.................          3          3          4          4          4          4          5          5          5
23..............................  28.................          3          3          4          4          4          5          5          5          5
24..............................  29.................          3          4          4          4          5          5          5          5          6
25..............................  30.................          4          4          4          5          5          5          6          6          6
 
26..............................  31.................          4          4          5          5          5          6          6          6          7
27..............................  32.................          4          5          5          5          6          6          6          7          7
28..............................  33.................          5          5          5          6          6          6          7          7          8
29..............................  34.................          5          5          6          6          6          7          7          8          8
30..............................  35.................          5          6          6          6          7          7          8          8          9
 
31..............................  36.................          6          6          6          7          7          8          8          9          9
32..............................  37.................          6          7          7          7          8          8          9         10         10
33..............................  38.................          7          7          7          8          8          9         10         10         11
34..............................  39.................          7          8          8          9          9         10         10         11         12
35..............................  40.................          8          8          9          9         10         10         11         12         12

[[Page 211]]

 
 
36..............................  41.................          8          9          9         10         10         11         12         13         13
37..............................  42.................          9          9         10         11         11         12         13         13         14
38..............................  43.................          9         10         11         11         12         13         13         14         15
39..............................  44.................         10         11         11         12         13         14         14         15         16
40..............................  45.................         11         11         12         13         14         15         15         16         17
 
41..............................  46.................         11         12         13         14         15         16         16         17         18
42..............................  47.................         12         13         14         15         16         17         18         18         19
43..............................  48.................         13         14         15         16         17         18         19         20         21
44..............................  49.................         14         15         16         17         18         19         20         21         22
45..............................  50.................         15         16         17         18         19         20         21         22         23
 
46..............................  51.................         16         17         18         19         20         21         22         24         25
47..............................  52.................         17         18         19         20         21         23         24         25         26
48..............................  53.................         18         19         20         22         23         24         25         26         28
49..............................  54.................         19         21         22         23         24         25         27         28         29
50..............................  55.................         21         22         23         24         26         27         28         29         31
 
51..............................  56.................         22         23         25         26         27         28         30         31         32
52..............................  57.................         23         25         26         27         29         30         31         33         34
53..............................  58.................         25         26         28         29         30         32         33         34         36
54..............................  59.................         26         28         29         31         32         33         35         36         38
55..............................  60.................         28         29         31         32         34         35         36         38         39
 
56..............................  61.................         29         31         32         34         35         37         38         40         41
57..............................  62.................         31         33         34         36         37         39         40         41         43
58..............................  63.................         33         34         36         37         39         40         42         43         45
59..............................  64.................         35         36         38         39         41         42         44         45         47
60..............................  65.................         36         38         40         41         43         44         46         47         48
 
61..............................  66.................         38         40         41         43         44         46         47         49         50
62..............................  67.................         40         42         43         45         46         48         49         51         52
63..............................  68.................         42         44         45         47         48         50         51         52         54
64..............................  69.................         44         46         47         49         50         52         53         54         55
65..............................  70.................         46         47         49         50         52         53         55         56         57
 
66..............................  71.................         48         49         51         52         54         55         56         58         59
67..............................  72.................         50         51         53         54         56         57         58         59         61
68..............................  73.................         52         53         55         56         57         59         60         61         62
69..............................  74.................         53         55         56         58         59         60         62         63         64
70..............................  75.................         55         57         58         60         61         62         62         64         65
 
71..............................  76.................         57         59         60         61         63         64         65         66         67
72..............................  77.................         59         60         62         63         64         65         66         67         68
73..............................  78.................         61         62         64         65         66         67         68         69         70
74..............................  79.................         63         64         65         66         67         68         69         70         71
75..............................  80.................         64         66         67         68         69         70         71         72         72
 
76..............................  81.................         66         67         68         69         70         71         72         73

[[Page 212]]

 
77..............................  82.................         68         69         70         71         72         73         74
78..............................  83.................         69         70         71         72         73         74
79..............................  84.................         71         72         73         74         75
80..............................  85.................         72         73         74         75
 
81..............................  86.................         74         75         75
82..............................  87.................         75         76
83..............................  88.................         76
84..............................  89.................
85..............................  90.................  .........  .........  .........  .........  .........  .........  .........  .........  .........
--------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                               Ages                                                                            Duration of guaranteed amount--[Years]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                  Male                             Female              1        2        3        4        5        6        7        8        9        10       11       12       13       14
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
86.....................................  91.......................        6       12       18       24       29       34       38       43       47       50       54       57       59       62
87.....................................  92.......................        7       13       19       25       31       36       40       45       49       52       56       59       61       64
88.....................................  93.......................        7       14       21       27       32       38       42       47       51       55       58       61       63       66
89.....................................  94.......................        8       15       22       28       34       40       45       49       53       57       60       63       65       68
90.....................................  95.......................        8       16       23       30       36       42       47       51       55       59       62       65       67       70
 
91.....................................  96.......................        9       17       25       32       38       44       49       53       57       61       64       67       69       71
92.....................................  97.......................        9       18       26       34       40       46       51       55       59       63       66       69       71       73
93.....................................  98.......................       10       20       28       36       42       48       53       58       62       65       68       70       73       75
94.....................................  99.......................       11       21       30       37       44       50       55       60       64       67       70       72       74       76
95.....................................  100......................       12       22       31       39       46       52       58       62       66       69       72       74       76       78
 
96.....................................  101......................       12       24       33       42       49       55       60       64       68       71       73       76       78       79
97.....................................  102......................       13       25       35       44       51       57       62       66       70       73       75       77       79
98.....................................  103......................       14       27       37       46       54       60       65       69       72       75       77       79
99.....................................  104......................       15       29       40       49       56       62       67       71       74       77       79
100....................................  105......................       17       31       43       52       59       65       70       74       76       79
 
101....................................  106......................       18       33       46       55       63       68       73       76       79
102....................................  107......................       20       36       49       59       66       71       75       78
103....................................  108......................       22       40       53       62       69       74       78
104....................................  109......................       24       43       57       66       73       77
105....................................  110......................       27       48       61       70       76
 
106....................................  111......................  .......       53       66       74
107....................................  112......................       35       53       71
108....................................  113......................       40       64  .......  .......  .......  .......  .......  .......  .......  .......  .......  .......  .......  .......
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 213]]


--------------------------------------------------------------------------------------------------------------------------------------------------------
                         Ages                                                        Duration of guaranteed amount--[Years]
--------------------------------------------------------------------------------------------------------------------------------------------------------
              Male                       Female           15       16       17       18       19       20       21       22       23       24       25
--------------------------------------------------------------------------------------------------------------------------------------------------------
86..............................  91.................       64       66       68       70       72       73       74       75       76       77
87..............................  92.................       66       68       70       72       73       74       76       77       78
88..............................  93.................       68       70       72       73       75       76       77       78
89..............................  94.................       70       72       73       75       76       77       78
90..............................  95.................       72       73       75       76       77       79
 
91..............................  96.................       73       75       76       78       79
92..............................  97.................       75       76       78       79
93..............................  98.................       76       78       79
94..............................  99.................       78       79
95..............................  100................       79  .......  .......  .......  .......  .......  .......  .......  .......  .......  .......
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                                           Table IV--Temporary Life Annuities \1\--One Life--Expected Return Multiples
                                                                                 [See footnote at end of table]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                       Ages                                                                    Temporary period--maximum duration of annuity--[Years]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                      Male                                     Female                   1          2          3          4          5          6          7          8          9          10
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
0 to 8.........................................  0 to 13..........................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
9..............................................  14...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
10.............................................  15...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
 
11.............................................  16...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
12.............................................  17...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
13.............................................  18...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
14.............................................  19...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
15.............................................  20...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
 
16.............................................  21...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
17.............................................  22...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
18.............................................  23...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
19.............................................  24...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
20.............................................  25...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
 
21.............................................  26...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
22.............................................  27...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
23.............................................  28...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        8.0        8.9        9.9
24.............................................  29...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        7.9        8.9        9.9
25.............................................  30...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        7.9        8.9        9.9
 
26.............................................  31...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        7.9        8.9        9.9
27.............................................  32...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        7.9        8.9        9.9
28.............................................  33...............................        1.0        2.0        3.0        4.0        5.0        6.0        7.0        7.9        8.9        9.9
29.............................................  34...............................        1.0        2.0        3.0        4.0        5.0        6.0        6.9        7.9        8.9        9.9
30.............................................  35...............................        1.0        2.0        3.0        4.0        5.0        6.0        6.9        7.9        8.9        9.9

[[Page 214]]

 
 
31.............................................  36...............................        1.0        2.0        3.0        4.0        5.0        6.0        6.9        7.9        8.9        9.9
32.............................................  37...............................        1.0        2.0        3.0        4.0        5.0        6.0        6.9        7.9        8.9        9.9
33.............................................  38...............................        1.0        2.0        3.0        4.0        5.0        6.0        6.9        7.9        8.9        9.9
34.............................................  39...............................        1.0        2.0        3.0        4.0        5.0        5.9        6.9        7.9        8.9        9.8
35.............................................  40...............................        1.0        2.0        3.0        4.0        5.0        5.9        6.9        7.9        8.9        9.8
 
36.............................................  41...............................        1.0        2.0        3.0        4.0        5.0        5.9        6.9        7.9        8.9        9.8
37.............................................  42...............................        1.0        2.0        3.0        4.0        5.0        5.9        6.9        7.9        8.8        9.8
38.............................................  43...............................        1.0        2.0        3.0        4.0        5.0        5.9        6.9        7.9        8.8        9.8
39.............................................  44...............................        1.0        2.0        3.0        4.0        4.9        5.9        6.9        7.9        8.8        9.8
40.............................................  45...............................        1.0        2.0        3.0        4.0        4.9        5.9        6.9        7.8        8.8        9.7
 
41.............................................  46...............................        1.0        2.0        3.0        4.0        4.9        5.9        6.9        7.8        8.8        9.7
42.............................................  47...............................        1.0        2.0        3.0        4.0        4.9        5.9        6.9        7.8        8.8        9.7
43.............................................  48...............................        1.0        2.0        3.0        4.0        4.9        5.9        6.9        7.8        8.8        9.7
44.............................................  49...............................        1.0        2.0        3.0        4.0        4.9        5.9        6.8        7.8        8.7        9.7
45.............................................  50...............................        1.0        2.0        3.0        3.9        4.9        5.9        6.8        7.8        8.7        9.6
 
46.............................................  51...............................        1.0        2.0        3.0        3.9        4.9        5.9        6.8        7.8        8.7        9.6
47.............................................  52...............................        1.0        2.0        3.0        3.9        4.9        5.9        6.8        7.7        8.7        9.6
48.............................................  53...............................        1.0        2.0        3.0        3.9        4.9        5.9        6.8        7.7        8.6        9.5
49.............................................  54...............................        1.0        2.0        3.0        3.9        4.9        5.8        6.8        7.7        8.6        9.5
50.............................................  55...............................        1.0        2.0        3.0        3.9        4.9        5.8        6.8        7.7        8.6        9.5
 
51.............................................  56...............................        1.0        2.0        3.0        3.9        4.9        5.8        6.7        7.7        8.6        9.4
52.............................................  57...............................        1.0        2.0        3.0        3.9        4.9        5.8        6.7        7.6        8.5        9.4
53.............................................  58...............................        1.0        2.0        2.9        3.9        4.9        5.8        6.7        7.6        8.5        9.3
54.............................................  59...............................        1.0        2.0        2.9        3.9        4.8        5.8        6.7        7.6        8.4        9.3
55.............................................  60...............................        1.0        2.0        2.9        3.9        4.8        5.8        6.7        7.5        8.4        9.2
 
56.............................................  61...............................        1.0        2.0        2.9        3.9        4.8        5.7        6.6        7.5        8.4        9.2
57.............................................  62...............................        1.0        2.0        2.9        3.9        4.8        5.7        6.6        7.5        8.3        9.1
58.............................................  63...............................        1.0        2.0        2.9        3.9        4.8        5.7        6.6        7.4        8.3        9.1
59.............................................  64...............................        1.0        2.0        2.9        3.9        4.8        5.7        6.5        7.4        8.2        9.0
60.............................................  65...............................        1.0        2.0        2.9        3.8        4.8        5.6        6.5        7.3        8.1        8.9
 
61.............................................  66...............................        1.0        2.0        2.9        3.8        4.7        5.6        6.5        7.3        8.1        8.8
62.............................................  67...............................        1.0        2.0        2.9        3.8        4.7        5.6        6.4        7.2        8.0        8.8
63.............................................  68...............................        1.0        2.0        2.9        3.8        4.7        5.6        6.4        7.2        7.9        8.7
64.............................................  69...............................        1.0        1.9        2.9        3.8        4.7        5.5        6.3        7.1        7.9        8.6
65.............................................  70...............................        1.0        1.9        2.9        3.8        4.6        5.5        6.3        7.1        7.8        8.5
 

[[Page 215]]

 
66.............................................  71...............................        1.0        1.9        2.9        3.8        4.6        5.4        6.2        7.0        7.7        8.4
67.............................................  72...............................        1.0        1.9        2.9        3.7        4.6        5.4        6.2        6.9        7.6        8.3
68.............................................  73...............................        1.0        1.9        2.8        3.7        4.6        5.4        6.1        6.8        7.5        8.2
69.............................................  74...............................        1.0        1.9        2.8        3.7        4.5        5.3        6.1        6.8        7.4        8.0
70.............................................  75...............................        1.0        1.9        2.8        3.7        4.5        5.3        6.0        6.7        7.3        7.9
 
71.............................................  76...............................        1.0        1.9        2.8        3.7        4.5        5.2        5.9        6.6        7.2        7.8
72.............................................  77...............................        1.0        1.9        2.8        3.6        4.4        5.2        5.8        6.5        7.1        7.6
73.............................................  78...............................        1.0        1.9        2.8        3.6        4.4        5.1        5.8        6.4        7.0        7.5
74.............................................  79...............................        1.0        1.9        2.8        3.6        4.3        5.0        5.7        6.3        6.8        7.3
75.............................................  80...............................        1.0        1.9        2.7        3.5        4.3        5.0        5.6        6.2        6.7        7.1
 
76.............................................  81...............................        1.0        1.9        2.7        3.5        4.2        4.9        5.5        6.1        6.5        7.0
77.............................................  82...............................        1.0        1.9        2.7        3.5        4.2        4.8        5.4        5.9        6.4        6.8
78.............................................  83...............................        1.0        1.9        2.7        3.4        4.1        4.7        5.3        5.8        6.2        6.6
79.............................................  84...............................        1.0        1.8        2.7        3.4        4.1        4.7        5.2        5.7        6.1        6.4
80.............................................  85...............................        1.0        1.8        2.6        3.4        4.0        4.6        5.1        5.5        5.9        6.2
 
81.............................................  86...............................        1.0        1.8        2.6        3.3        3.9        4.5        5.0        5.4        5.7        6.0
82.............................................  87...............................        1.0        1.8        2.6        3.3        3.9        4.4        4.8        5.2        5.6        5.8
83.............................................  88...............................         .9        1.8        2.6        3.2        3.8        4.3        4.7        5.1        5.4        5.6
84.............................................  89...............................         .9        1.8        2.5        3.2        3.7        4.2        4.6        4.9        5.2        5.4
85.............................................  90...............................         .9        1.8        2.5        3.1        3.6        4.1        4.5        4.8        5.0        5.2
86.............................................  91...............................         .9        1.8        2.5        3.1        3.6        4.0        4.3        4.6        4.8        5.0
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                       Ages                                                                    Temporary period--maximum duration of annuity--[Years]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                      Male                                     Female                   11         12         13         14         15         16         17         18         19         20
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
0 to 8.........................................  0 to 13..........................       10.9       11.9       12.9       13.9       14.9       15.8       16.8       17.8       18.8       19.7
9..............................................  14...............................       10.9       11.9       12.9       13.9       14.9       15.8       16.8       17.8       18.8       19.7
10.............................................  15...............................       10.9       11.9       12.9       13.9       14.9       15.8       16.8       17.8       18.8       19.7
 
11.............................................  16...............................       10.9       11.9       12.9       13.9       14.9       15.8       16.8       17.8       18.8       19.7
12.............................................  17...............................       10.9       11.9       12.9       13.9       14.9       15.8       16.8       17.8       18.8       19.7
13.............................................  18...............................       10.9       11.9       12.9       13.9       14.9       15.8       16.8       17.8       18.8       19.7
14.............................................  19...............................       10.9       11.9       12.9       13.9       14.9       15.8       16.8       17.8       18.8       19.7
15.............................................  20...............................       10.9       11.9       12.9       13.9       14.9       15.8       16.8       17.8       18.7       19.7
 
16.............................................  21...............................       10.9       11.9       12.9       13.9       14.8       15.8       16.8       17.8       18.7       19.7
17.............................................  22...............................       10.9       11.9       12.9       13.9       14.8       15.8       16.8       17.8       18.7       19.7
18.............................................  23...............................       10.9       11.9       12.9       13.9       14.8       15.8       16.8       17.8       18.7       19.7
19.............................................  24...............................       10.9       11.9       12.9       13.9       14.8       15.8       16.8       17.7       18.7       19.7
20.............................................  25...............................       10.9       11.9       12.9       13.9       14.8       15.8       16.8       17.7       18.7       19.7
 
21.............................................  26...............................       10.9       11.9       12.9       13.8       14.8       15.8       16.8       17.7       18.7       19.6
22.............................................  27...............................       10.9       11.9       12.9       13.8       14.8       15.8       16.7       17.7       18.7       19.6
23.............................................  28...............................       10.9       11.9       12.9       13.8       14.8       15.8       16.7       17.7       18.7       19.6
24.............................................  29...............................       10.9       11.9       12.9       13.8       14.8       15.8       16.7       17.7       18.6       19.6
25.............................................  30...............................       10.9       11.9       12.8       13.8       14.8       15.7       16.7       17.7       18.6       19.6

[[Page 216]]

 
 
26.............................................  31...............................       10.9       11.9       12.8       13.8       14.8       15.7       16.7       17.6       18.6       19.5
27.............................................  32...............................       10.9       11.9       12.8       13.8       14.8       15.7       16.7       17.6       18.6       19.5
28.............................................  33...............................       10.9       11.8       12.8       13.8       14.7       15.7       16.6       17.6       18.5       19.5
29.............................................  34...............................       10.9       11.8       12.8       13.8       14.7       15.7       16.6       17.6       18.5       19.4
30.............................................  35...............................       10.9       11.8       12.8       13.7       14.7       15.6       16.6       17.5       18.4       19.4
 
31.............................................  36...............................       10.8       11.8       12.8       13.7       14.7       15.6       16.5       17.5       18.4       19.3
32.............................................  37...............................       10.8       11.8       12.7       13.7       14.6       15.6       16.5       17.4       18.4       19.3
33.............................................  38...............................       10.8       11.8       12.7       13.7       14.6       15.6       16.5       17.4       18.3       19.2
34.............................................  39...............................       10.8       11.8       12.7       13.6       14.6       15.5       16.4       17.4       18.3       19.2
35.............................................  40...............................       10.8       11.7       12.7       13.6       14.6       15.5       16.4       17.3       18.2       19.1
 
36.............................................  41...............................       10.8       11.7       12.7       13.6       14.5       15.4       16.3       17.2       18.1       19.0
37.............................................  42...............................       10.8       11.7       12.6       13.6       14.5       15.4       16.3       17.2       18.1       18.9
38.............................................  43...............................       10.7       11.7       12.6       13.5       14.4       15.3       16.2       17.1       18.0       18.9
39.............................................  44...............................       10.7       11.6       12.6       13.5       14.4       15.3       16.2       17.1       17.9       18.8
40.............................................  45...............................       10.7       11.6       12.5       13.5       14.4       15.2       16.1       17.0       17.8       18.7
 
41.............................................  46...............................       10.7       11.6       12.5       13.4       14.3       15.2       16.1       16.9       17.8       18.6
42.............................................  47...............................       10.6       11.6       12.5       13.4       14.3       15.1       16.0       16.8       17.7       18.5
43.............................................  48...............................       10.6       11.5       12.4       13.3       14.2       15.1       15.9       16.7       17.6       18.4
44.............................................  49...............................       10.6       11.5       12.4       13.3       14.1       15.0       15.8       16.7       17.5       18.3
45.............................................  50...............................       10.5       11.4       12.3       13.2       14.1       14.9       15.7       16.6       17.4       18.1
 
46.............................................  51...............................       10.5       11.4       12.3       13.2       14.0       14.8       15.7       16.5       17.2       18.0
47.............................................  52...............................       10.5       11.4       12.2       13.1       13.9       14.7       15.6       16.3       17.1       17.8
48.............................................  53...............................       10.4       11.3       12.2       13.0       13.8       14.7       15.4       16.2       17.0       17.7
49.............................................  54...............................       10.4       11.3       12.1       12.9       13.8       14.6       15.3       16.1       16.8       17.5
50.............................................  55...............................       10.3       11.2       12.0       12.9       13.7       14.5       15.2       16.0       16.7       17.4
 
51.............................................  56...............................       10.3       11.1       12.0       12.8       13.6       14.3       15.1       15.8       16.5       17.2
52.............................................  57...............................       10.2       11.1       11.9       12.7       13.5       14.2       14.9       15.6       16.3       17.0
53.............................................  58...............................       10.2       11.0       11.8       12.6       13.4       14.1       14.8       15.5       16.1       16.8
54.............................................  59...............................       10.1       10.9       11.7       12.5       13.2       14.0       14.6       15.3       15.9       16.5
55.............................................  60...............................       10.1       10.9       11.6       12.4       13.1       13.8       14.5       15.1       15.7       16.3
 
56.............................................  61...............................       10.0       10.8       11.5       12.3       13.0       13.7       14.3       14.9       15.5       16.1
57.............................................  62...............................        9.9       10.7       11.4       12.2       12.8       13.5       14.1       14.7       15.3       15.8
58.............................................  63...............................        9.8       10.6       11.3       12.0       12.7       13.3       13.9       14.5       15.0       15.5
59.............................................  64...............................        9.8       10.5       11.2       11.9       12.5       13.2       13.7       14.3       14.8       15.3
60.............................................  65...............................        9.7       10.4       11.1       11.7       12.4       13.0       13.5       14.0       14.5       15.0
 
61.............................................  66...............................        9.6       10.3       11.0       11.6       12.2       12.8       13.3       13.8       14.2       14.7
62.............................................  67...............................        9.5       10.2       10.8       11.4       12.0       12.5       13.1       13.5       14.0       14.3
63.............................................  68...............................        9.4       10.0       10.7       11.3       11.8       12.3       12.8       13.2       13.7       14.0

[[Page 217]]

 
64.............................................  69...............................        9.3        9.9       10.5       11.1       11.6       12.1       12.5       13.0       13.3       13.7
65.............................................  70...............................        9.1        9.8       10.3       10.9       11.4       11.9       12.3       12.7       13.0       13.3
 
66.............................................  71...............................        9.0        9.6       10.2       10.7       11.2       11.6       12.0       12.4       12.7       13.0
67.............................................  72...............................        8.9        9.5       10.0       10.5       10.9       11.3       11.7       12.0       12.3       12.6
68.............................................  73...............................        8.7        9.3        9.8       10.3       10.7       11.1       11.4       11.7       12.0       12.2
69.............................................  74...............................        8.6        9.1        9.6       10.0       10.4       10.8       11.1       11.4       11.6       11.8
70.............................................  75...............................        8.4        8.9        9.4        9.8       10.2       10.5       10.8       11.0       11.2       11.4
 
71.............................................  76...............................        8.3        8.7        9.2        9.6        9.9       10.2       10.4       10.7       10.9       11.0
72.............................................  77...............................        8.1        8.6        8.9        9.3        9.6        9.9       10.1       10.3       10.5       10.6
73.............................................  78...............................        7.9        8.3        8.7        9.0        9.3        9.6        9.8        9.9       10.1       10.2
74.............................................  79...............................        7.7        8.1        8.5        8.8        9.0        9.2        9.4        9.6        9.7        9.8
75.............................................  80...............................        7.6        7.9        8.2        8.5        8.7        8.9        9.1        9.2        9.3        9.4
 
76.............................................  81...............................        7.4        7.7        8.0        8.2        8.4        8.6        8.7        8.8        8.9        9.0
77.............................................  82...............................        7.1        7.5        7.7        7.9        8.1        8.3        8.4        8.5        8.5        8.6
78.............................................  83...............................        6.9        7.2        7.4        7.6        7.8        7.9        8.0        8.1        8.2        8.2
79.............................................  84...............................        6.7        7.0        7.2        7.3        7.5        7.6        7.7        7.7        7.8        7.8
80.............................................  85...............................        6.5        6.7        6.9        7.1        7.2        7.3        7.3        7.4        7.4        7.4
 
81.............................................  86...............................        6.3        6.5        6.6        6.8        6.9        6.9        7.0        7.0        7.1
82.............................................  87...............................        6.0        6.2        6.4        6.5        6.5        6.6        6.7        6.7
83.............................................  88...............................        5.8        6.0        6.1        6.2        6.2        6.3        6.3
84.............................................  89...............................        5.6        5.7        5.8        5.9        5.9        6.0
85.............................................  90...............................        5.3        5.5        5.5        5.6        5.6
86.............................................  91...............................        5.1        5.2        5.3        5.3  .........  .........  .........  .........  .........  .........
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                       Ages                                                                    Temporary period--maximum duration of annuity--[Years]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                      Male                                     Female                   21         22         23         24         25         26         27         28         29         30
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
0 to 8.........................................  0 to 13..........................       20.7       21.7       22.7       23.6       24.6       25.6       26.5       27.5       28.4       29.4
9..............................................  14...............................       20.7       21.7       22.7       23.6       24.6       25.5       26.5       27.5       28.4       29.4
10.............................................  15...............................       20.7       21.7       22.7       23.6       24.6       25.5       26.5       27.5       28.4       29.4
 
11.............................................  16...............................       20.7       21.7       22.6       23.6       24.6       25.5       26.5       27.4       28.4       29.3
12.............................................  17...............................       20.7       21.7       22.6       23.6       24.6       25.5       26.5       27.4       28.4       29.3
13.............................................  18...............................       20.7       21.7       22.6       23.6       24.6       25.5       26.5       27.4       28.4       29.3
14.............................................  19...............................       20.7       21.7       22.6       23.6       24.5       25.5       26.4       27.4       28.3       29.3
15.............................................  20...............................       20.7       21.6       22.6       23.6       24.5       25.5       26.4       27.4       28.3       29.2
 
16.............................................  21...............................       20.7       21.6       22.6       23.6       24.5       25.5       26.4       27.3       28.3       29.2
17.............................................  22...............................       20.7       21.6       22.6       23.5       24.5       25.4       26.4       27.3       28.2       29.2
18.............................................  23...............................       20.7       21.6       22.6       23.5       24.5       25.4       26.3       27.3       28.2       29.1
19.............................................  24...............................       20.6       21.6       22.5       23.5       24.4       25.4       26.3       27.2       28.1       29.1
20.............................................  25...............................       20.6       21.6       22.5       23.5       24.4       25.3       26.3       27.2       28.1       29.0
 
21.............................................  26...............................       20.6       21.5       22.5       23.4       24.4       25.3       26.2       27.1       28.0       28.9
22.............................................  27...............................       20.6       21.5       22.5       23.4       24.3       25.3       26.2       27.1       28.0       28.9

[[Page 218]]

 
23.............................................  28...............................       20.6       21.5       22.4       23.4       24.3       25.2       26.1       27.0       27.9       28.8
24.............................................  29...............................       20.5       21.5       22.4       23.3       24.2       25.2       26.1       27.0       27.8       28.7
25.............................................  30...............................       20.5       21.4       22.4       23.3       24.2       25.1       26.0       26.9       27.8       28.6
 
26.............................................  31...............................       20.5       21.4       22.3       23.2       24.1       25.0       25.9       26.8       27.7       28.5
27.............................................  32...............................       20.4       21.3       22.3       23.2       24.1       25.0       25.8       26.7       27.6       28.4
28.............................................  33...............................       20.4       21.3       22.2       23.1       24.0       24.9       25.8       26.6       27.5       28.3
29.............................................  34...............................       20.3       21.2       22.1       23.0       23.9       24.8       25.7       26.5       27.4       28.2
30.............................................  35...............................       20.3       21.2       22.1       23.0       23.8       24.7       25.6       26.4       27.2       28.1
 
31.............................................  36...............................       20.2       21.1       22.0       22.9       23.8       24.6       25.5       26.3       27.1       27.9
32.............................................  37...............................       20.2       21.1       21.9       22.8       23.7       24.5       25.4       26.2       27.0       27.8
33.............................................  38...............................       20.1       21.0       21.9       22.7       23.6       24.4       25.2       26.0       26.8       27.6
34.............................................  39...............................       20.0       20.9       21.8       22.6       23.5       24.3       25.1       25.9       26.7       27.4
35.............................................  40...............................       20.0       20.8       21.7       22.5       23.3       24.2       25.0       25.7       26.5       27.2
 
36.............................................  41...............................       19.9       20.7       21.6       22.4       23.2       24.0       24.8       25.6       26.3       27.0
37.............................................  42...............................       19.8       20.6       21.5       22.3       23.1       23.9       24.6       25.4       26.1       26.8
38.............................................  43...............................       19.7       20.5       21.4       22.2       23.0       23.7       24.5       25.2       25.9       26.6
39.............................................  44...............................       19.6       20.4       21.2       22.0       22.8       23.6       24.3       25.0       25.7       26.4
40.............................................  45...............................       19.5       20.3       21.1       21.9       22.6       23.4       24.1       24.8       25.5       26.1
 
41.............................................  46...............................       19.4       20.2       21.0       21.7       22.5       23.2       23.9       24.6       25.2       25.9
42.............................................  47...............................       19.3       20.1       20.8       21.6       22.3       23.0       23.7       24.3       25.0       25.6
43.............................................  48...............................       19.2       19.9       20.7       21.4       22.1       22.8       23.4       24.1       24.7       25.3
44.............................................  49...............................       19.0       19.8       20.5       21.2       21.9       22.6       23.2       23.8       24.4       25.0
45.............................................  50...............................       18.9       19.6       20.3       21.0       21.7       22.3       22.9       23.5       24.1       24.6
 
46.............................................  51...............................       18.7       19.4       20.1       20.8       21.5       22.1       22.7       23.2       23.8       24.3
47.............................................  52...............................       18.6       19.3       19.9       20.6       21.2       21.8       22.4       22.9       23.4       23.9
48.............................................  53...............................       18.4       19.1       19.7       20.4       21.0       21.5       22.1       22.6       23.1       23.5
49.............................................  54...............................       18.2       18.9       19.5       20.1       20.7       21.2       21.7       22.2       22.7       23.1
50.............................................  55...............................       18.0       18.7       19.3       19.8       20.4       20.9       21.4       21.9       22.3       22.7
 
51.............................................  56...............................       17.8       18.4       19.0       19.6       20.1       20.6       21.1       21.5       21.9       22.3
52.............................................  57...............................       17.6       18.2       18.7       19.3       19.8       20.2       20.7       21.1       21.5       21.8
53.............................................  58...............................       17.4       17.9       18.5       19.0       19.4       19.9       20.3       20.7       21.0       21.3
54.............................................  59...............................       17.1       17.7       18.2       18.7       19.1       19.5       19.9       20.2       20.6       20.8
55.............................................  60...............................       16.9       17.4       17.9       18.3       18.7       19.1       19.5       19.8       20.1       20.3
 
56.............................................  61...............................       16.6       17.1       17.5       18.0       18.4       18.7       19.0       19.3       19.6       19.8
57.............................................  62...............................       16.3       16.8       17.2       17.6       18.0       18.3       18.6       18.9       19.1       19.3
58.............................................  63...............................       16.0       16.5       16.9       17.2       17.6       17.9       18.1       18.4       18.6       18.8
59.............................................  64...............................       15.7       16.1       16.5       16.8       17.1       17.4       17.7       17.9       18.1       18.2
60.............................................  65...............................       15.4       15.8       16.1       16.4       16.7       17.0       17.2       17.4       17.5       17.7
 

[[Page 219]]

 
61.............................................  66...............................       15.1       15.4       15.7       16.0       16.3       16.5       16.7       16.9       17.0       17.1
62.............................................  67...............................       14.7       15.0       15.3       15.6       15.8       16.0       16.2       16.3       16.4       16.5
63.............................................  68...............................       14.4       14.6       14.9       15.1       15.3       15.5       15.7       15.8       15.9       16.0
64.............................................  69...............................       14.0       14.3       14.5       14.7       14.9       15.0       15.2       15.3       15.3       15.4
65.............................................  70...............................       13.6       13.8       14.1       14.2       14.4       14.5       14.6       14.7       14.8       14.9
 
66.............................................  71...............................       13.2       13.4       13.6       13.8       13.9       14.0       14.1       14.2       14.2       14.3
67.............................................  72...............................       12.8       13.0       13.2       13.3       13.4       13.5       13.6       13.7       13.7       13.7
68.............................................  73...............................       12.4       12.6       12.7       12.8       12.9       13.0       13.1       13.1       13.2       13.2
69.............................................  74...............................       12.0       12.1       12.3       12.4       12.4       12.5       12.6       12.6       12.6       12.6
70.............................................  75...............................       11.6       11.7       11.8       11.9       12.0       12.0       12.0       12.1       12.1       12.1
 
71.............................................  76...............................       11.2       11.3       11.3       11.4       11.5       11.5       11.5       11.6       11.6
72.............................................  77...............................       10.7       10.8       10.9       10.9       11.0       11.0       11.0       11.0
73.............................................  78...............................       10.3       10.4       10.4       10.5       10.5       10.5       10.5
74.............................................  79...............................        9.9        9.9       10.0       10.0       10.1       10.1
75.............................................  80...............................        9.5        9.5        9.6        9.6        9.6
 
76.............................................  81...............................        9.1        9.1        9.1        9.1
77.............................................  82...............................        8.6        8.7        8.7
78.............................................  83...............................        8.2        8.3
79.............................................  84...............................        7.8
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Footnote to Table IV:
\1\ The multiples in this table are not applicable to annuities for a term certain; for such cases see paragraph (c) of Sec.  1.72-5.


[[Page 220]]


  Table V--Ordinary Life Annuities One Life--Expected Return Multiples
------------------------------------------------------------------------
                          Age                                Multiple
------------------------------------------------------------------------
5......................................................             76.6
6......................................................             75.6
7......................................................             74.7
8......................................................             73.7
9......................................................             72.7
10.....................................................             71.7
11.....................................................             70.7
12.....................................................             69.7
13.....................................................             68.8
14.....................................................             67.8
15.....................................................             66.8
16.....................................................             65.8
17.....................................................             64.8
18.....................................................             63.9
19.....................................................             62.9
20.....................................................             61.9
21.....................................................             60.9
22.....................................................             59.9
23.....................................................             59.0
24.....................................................             58.0
25.....................................................             57.0
26.....................................................             56.0
27.....................................................             55.1
28.....................................................             54.1
29.....................................................             53.1
30.....................................................             52.2
31.....................................................             51.2
32.....................................................             50.2
33.....................................................             49.3
34.....................................................             48.3
35.....................................................             47.3
36.....................................................             46.4
37.....................................................             45.4
38.....................................................             44.4
39.....................................................             43.5
40.....................................................             42.5
41.....................................................             41.5
42.....................................................             40.6
43.....................................................             39.6
44.....................................................             38.7
45.....................................................             37.7
46.....................................................             36.8
47.....................................................             35.9
48.....................................................             34.9
49.....................................................             34.0
50.....................................................             33.1
51.....................................................             32.2
52.....................................................             31.3
53.....................................................             30.4
54.....................................................             29.5
55.....................................................             28.6
56.....................................................             27.7
57.....................................................             26.8
58.....................................................             25.9
59.....................................................             25.0
60.....................................................             24.2
61.....................................................             23.3
62.....................................................             22.5
63.....................................................             21.6
64.....................................................             20.8
65.....................................................             20.0
66.....................................................             19.2
67.....................................................             18.4
68.....................................................             17.6
69.....................................................             16.8
70.....................................................             16.0
71.....................................................             15.3
72.....................................................             14.6
73.....................................................             13.9
74.....................................................             13.2
75.....................................................             12.5
76.....................................................             11.9
77.....................................................             11.2
78.....................................................             10.6
79.....................................................             10.0
80.....................................................              9.5
81.....................................................              8.9
82.....................................................              8.4
83.....................................................              7.9
84.....................................................              7.4
85.....................................................              6.9
86.....................................................              6.5
87.....................................................              6.1
88.....................................................              5.7
89.....................................................              5.3
90.....................................................              5.0
91.....................................................              4.7
92.....................................................              4.4
93.....................................................              4.1
94.....................................................              3.9
95.....................................................              3.7
96.....................................................              3.4
97.....................................................              3.2
98.....................................................              3.0
99.....................................................              2.8
100....................................................              2.7
101....................................................              2.5
102....................................................              2.3
103....................................................              2.1
104....................................................              1.9
105....................................................              1.8
106....................................................              1.6
107....................................................              1.4
108....................................................              1.3
109....................................................              1.1
110....................................................              1.0
111....................................................               .9
112....................................................               .8
113....................................................               .7
114....................................................               .6
115....................................................               .5
------------------------------------------------------------------------


                             Table VI--Ordinary Joint Life and Last Survivor Annuities; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                              5         6         7         8         9        10        11        12        13        14
--------------------------------------------------------------------------------------------------------------------------------------------------------
5...................................................      83.8      83.3      82.8      82.4      82.0      81.6      81.2      80.9      80.6      80.3
6...................................................      83.3      82.8      82.3      81.8      81.4      81.0      80.6      80.3      79.9      79.6
7...................................................      82.8      82.3      81.8      81.3      80.9      80.4      80.0      79.6      79.3      78.9
8...................................................      82.4      81.8      81.3      80.8      80.3      79.9      79.4      79.0      78.6      78.3
9...................................................      82.0      81.4      80.9      80.3      79.8      79.3      78.9      78.4      78.0      77.6
10..................................................      81.6      81.0      80.4      79.9      79.3      78.8      78.3      77.9      77.4      77.0
11..................................................      81.2      80.6      80.0      79.4      78.9      78.3      77.8      77.3      76.9      76.4
12..................................................      80.9      80.3      79.6      79.0      78.4      77.9      77.3      76.8      76.3      75.9

[[Page 221]]

 
13..................................................      80.6      79.9      79.3      78.6      78.0      77.4      76.9      76.3      75.8      75.3
14..................................................      80.3      79.6      78.9      78.3      77.6      77.0      76.4      75.9      75.3      74.8
15..................................................      80.0      79.3      78.6      77.9      77.3      76.6      76.0      75.4      74.9      74.3
16..................................................      79.8      79.0      78.3      77.6      76.9      76.3      75.6      75.0      74.4      73.9
17..................................................      79.5      78.8      78.0      77.3      76.6      75.9      75.3      74.6      74.0      73.4
18..................................................      79.3      78.5      77.8      77.0      76.3      75.6      74.9      74.3      73.6      73.0
19..................................................      79.1      78.3      77.5      76.8      76.0      75.3      74.6      73.9      73.3      72.6
20..................................................      78.9      78.1      77.3      76.5      75.8      75.0      74.3      73.6      72.9      72.3
21..................................................      78.7      77.9      77.1      76.3      75.5      74.8      74.0      73.3      72.6      71.9
22..................................................      78.6      77.7      76.9      76.1      75.3      74.5      73.8      73.0      72.3      71.6
23..................................................      78.4      77.6      76.7      75.9      75.1      74.3      73.5      72.8      72.0      71.3
24..................................................      78.3      77.4      76.6      75.7      74.9      74.1      73.3      72.6      71.8      71.1
25..................................................      78.2      77.3      76.4      75.6      74.8      73.9      73.1      72.3      71.6      70.8
26..................................................      78.0      77.2      76.3      75.4      74.6      73.8      72.9      72.1      71.3      70.6
27..................................................      77.9      77.1      76.2      75.3      74.4      73.6      72.8      71.9      71.1      70.3
28..................................................      77.8      76.9      76.1      75.2      74.3      73.4      72.6      71.8      70.9      70.1
29..................................................      77.7      76.8      76.0      75.1      74.2      73.3      72.5      71.6      70.8      70.0
30..................................................      77.7      76.8      75.9      75.0      74.1      73.2      72.3      71.5      70.6      69.8
31..................................................      77.6      76.7      75.8      74.9      74.0      73.1      72.2      71.3      70.5      69.6
32..................................................      77.5      76.6      75.7      74.8      73.9      73.0      72.1      71.2      70.3      69.5
33..................................................      77.5      76.5      75.6      74.7      73.8      72.9      72.0      71.1      70.2      69.3
34..................................................      77.4      76.5      75.5      74.6      73.7      72.8      71.9      71.0      70.1      69.2
35..................................................      77.3      76.4      75.5      74.5      73.6      72.7      71.8      70.9      70.0      69.1
36..................................................      77.3      76.3      75.4      74.5      73.5      72.6      71.7      70.8      69.9      69.0
37..................................................      77.2      76.3      75.4      74.4      73.5      72.6      71.6      70.7      69.8      68.9
38..................................................      77.2      76.2      75.3      74.4      73.4      72.5      71.6      70.6      69.7      68.8
39..................................................      77.2      76.2      75.3      74.3      73.4      72.4      71.5      70.6      69.6      68.7
40..................................................      77.1      76.2      75.2      74.3      73.3      72.4      71.4      70.5      69.6      68.6
41..................................................      77.1      76.1      75.2      74.2      73.3      72.3      71.4      70.4      69.5      68.6
42..................................................      77.0      76.1      75.1      74.2      73.2      72.3      71.3      70.4      69.4      68.5
43..................................................      77.0      76.1      75.1      74.1      73.2      72.2      71.3      70.3      69.4      68.5
44..................................................      77.0      76.0      75.1      74.1      73.1      72.2      71.2      70.3      69.3      68.4
45..................................................      77.0      76.0      75.0      74.1      73.1      72.2      71.2      70.2      69.3      68.4
46..................................................      76.9      76.0      75.0      74.0      73.1      72.1      71.2      70.2      69.3      68.3
47..................................................      76.9      75.9      75.0      74.0      73.1      72.1      71.1      70.2      69.2      68.3
48..................................................      76.9      75.9      75.0      74.0      73.0      72.1      71.1      70.1      69.2      68.2
49..................................................      76.9      75.9      74.9      74.0      73.0      72.0      71.1      70.1      69.1      68.2
50..................................................      76.9      75.9      74.9      73.9      73.0      72.0      71.0      70.1      69.1      68.2
51..................................................      76.8      75.9      74.9      73.9      73.0      72.0      71.0      70.1      69.1      68.1
52..................................................      76.8      75.9      74.9      73.9      72.9      72.0      71.0      70.0      69.1      68.1
53..................................................      76.8      75.8      74.9      73.9      72.9      71.9      71.0      70.0      69.0      68.1
54..................................................      76.8      75.8      74.8      73.9      72.9      71.9      71.0      70.0      69.0      68.1
55..................................................      76.8      75.8      74.8      73.9      72.9      71.9      70.9      70.0      69.0      68.0
56..................................................      76.8      75.8      74.8      73.8      72.9      71.9      70.9      69.9      69.0      68.0
57..................................................      76.8      75.8      74.8      73.8      72.9      71.9      70.9      69.9      69.0      68.0
58..................................................      76.8      75.8      74.8      73.8      72.8      71.9      70.9      69.9      68.9      68.0
59..................................................      76.7      75.8      74.8      73.8      72.8      71.9      70.9      69.9      68.9      68.0
60..................................................      76.7      75.8      74.8      73.8      72.8      71.8      70.9      69.9      68.9      67.9
61..................................................      76.7      75.7      74.8      73.8      72.8      71.8      70.9      69.9      68.9      67.9
62..................................................      76.7      75.7      74.8      73.8      72.8      71.8      70.8      69.9      68.9      67.9
63..................................................      76.7      75.7      74.8      73.8      72.8      71.8      70.8      69.9      68.9      67.9
64..................................................      76.7      75.7      74.7      73.8      72.8      71.8      70.8      69.8      68.9      67.9
65..................................................      76.7      75.7      74.7      73.8      72.8      71.8      70.8      69.8      68.9      67.9
66..................................................      76.7      75.7      74.7      73.7      72.8      71.8      70.8      69.8      68.9      67.9
67..................................................      76.7      75.7      74.7      73.7      72.8      71.8      70.8      69.8      68.8      67.9
68..................................................      76.7      75.7      74.7      73.7      72.8      71.8      70.8      69.8      68.8      67.9
69..................................................      76.7      75.7      74.7      73.7      72.7      71.8      70.8      69.8      68.8      67.8
70..................................................      76.7      75.7      74.7      73.7      72.7      71.8      70.8      69.8      68.8      67.8
71..................................................      76.7      75.7      74.7      73.7      72.7      71.8      70.8      69.8      68.8      67.8
72..................................................      76.7      75.7      74.7      73.7      72.7      71.8      70.8      69.8      68.8      67.8
73..................................................      76.7      75.7      74.7      73.7      72.7      71.7      70.8      69.8      68.8      67.8
74..................................................      76.7      75.7      74.7      73.7      72.7      71.7      70.8      69.8      68.8      67.8
75..................................................      76.7      75.7      74.7      73.7      72.7      71.7      70.8      69.8      68.8      67.8
76..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.8      69.8      68.8      67.8
77..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.8      69.8      68.8      67.8
78..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.7      69.8      68.8      67.8
79..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.7      69.8      68.8      67.8
80..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.7      69.8      68.8      67.8
81..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.7      69.8      68.8      67.8
82..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.7      69.8      68.8      67.8
83..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.7      69.8      68.8      67.8

[[Page 222]]

 
84..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.7      69.8      68.8      67.8
85..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.7      69.8      68.8      67.8
86..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.7      69.8      68.8      67.8
87..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.7      69.8      68.8      67.8
88..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.7      69.8      68.8      67.8
89..................................................      76.6      75.7      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
90..................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
91..................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
92..................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
93..................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
94..................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
95..................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
96..................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
97..................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
98..................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
99..................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
100.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
101.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
102.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
103.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
104.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
105.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
106.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
107.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
108.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
109.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
110.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
111.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
112.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
113.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
114.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
115.................................................      76.6      75.6      74.7      73.7      72.7      71.7      70.7      69.7      68.8      67.8
--------------------------------------------------------------------------------------------------------------------------------------------------------


                             Table VI--Ordinary Joint Life and Last Survivor Annuities; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             15        16        17        18        19        20        21        22        23        24
--------------------------------------------------------------------------------------------------------------------------------------------------------
15..................................................      73.8      73.3      72.9      72.4      72.0      71.6      71.3      70.9      70.6      70.3
16..................................................      73.3      72.8      72.3      71.9      71.4      71.0      70.7      70.3      70.0      69.6
17..................................................      72.9      72.3      71.8      71.3      70.9      70.5      70.0      69.7      69.3      69.0
18..................................................      72.4      71.9      71.3      70.8      70.4      69.0      69.5      69.9      68.7      68.3
19..................................................      72.0      71.4      70.9      70.4      69.8      69.4      68.9      68.5      68.1      67.7
20..................................................      71.6      71.0      70.5      69.9      69.4      68.8      68.4      67.9      67.5      67.1
21..................................................      71.3      70.7      70.0      69.5      68.9      68.4      67.9      67.4      66.9      66.5
22..................................................      70.9      70.3      69.7      69.0      68.5      67.9      67.4      66.9      66.4      65.9
23..................................................      70.6      70.0      69.3      68.7      68.1      67.5      66.9      66.4      65.9      65.4
24..................................................      70.3      69.6      69.0      68.3      67.7      67.1      66.5      65.9      65.4      64.9
25..................................................      70.1      69.3      68.6      68.0      67.3      66.7      66.1      65.5      64.9      64.4
26..................................................      69.8      69.1      68.3      67.6      67.0      66.3      65.7      65.1      64.5      63.9
27..................................................      69.6      68.8      68.1      67.3      66.7      66.0      65.3      64.7      64.1      63.5
28..................................................      69.3      68.6      67.8      67.1      66.4      65.7      65.0      64.3      63.7      63.1
29..................................................      69.1      68.4      67.6      66.8      66.1      65.4      64.7      64.0      63.3      62.7
30..................................................      69.0      68.2      67.4      66.6      65.8      65.1      64.4      63.7      63.0      62.3
31..................................................      68.8      68.0      67.2      66.4      65.6      64.8      64.1      63.4      62.7      62.0
32..................................................      68.6      67.8      67.0      66.2      65.4      64.6      63.8      63.1      62.4      61.7
33..................................................      68.5      67.6      66.8      66.0      65.2      64.4      63.6      62.8      62.1      61.4
34..................................................      68.3      67.5      66.6      65.8      65.0      64.2      63.4      62.6      61.9      61.1
35..................................................      68.2      67.4      66.5      65.6      64.8      64.0      63.2      62.4      61.6      60.9
36..................................................      68.1      67.2      66.4      65.5      64.7      63.8      63.0      62.2      61.4      60.6
37..................................................      68.0      67.1      66.2      65.4      64.5      63.7      62.8      62.0      61.2      60.4
38..................................................      67.9      67.0      66.1      65.2      64.4      63.5      62.7      61.8      61.0      60.2
39..................................................      67.8      66.9      66.0      65.1      64.2      63.4      62.5      61.7      60.8      60.0
40..................................................      67.7      66.8      65.9      65.0      64.1      63.3      62.4      61.5      60.7      59.9
41..................................................      67.7      66.7      65.8      64.9      64.0      63.1      62.3      61.4      60.5      59.7
42..................................................      67.6      66.7      65.7      64.8      63.9      63.0      62.2      61.3      60.4      59.6
43..................................................      67.5      66.6      65.7      64.8      63.8      62.9      62.1      61.2      60.3      59.4
44..................................................      67.5      66.5      65.6      64.7      63.8      62.9      62.0      61.1      60.2      59.3
45..................................................      67.4      66.5      65.5      64.6      63.7      62.8      61.9      61.0      60.1      59.2
46..................................................      67.4      66.4      65.4      64.6      63.6      62.7      61.8      60.9      60.0      59.1

[[Page 223]]

 
47..................................................      67.3      66.4      65.4      64.5      63.6      62.6      61.7      60.8      59.9      59.0
48..................................................      67.3      66.3      65.4      64.4      63.5      62.6      61.6      60.7      59.8      58.9
49..................................................      67.2      66.3      65.3      64.4      63.5      62.5      61.6      60.7      59.7      58.8
50..................................................      67.2      66.2      65.3      64.3      63.4      62.5      61.5      60.6      59.7      58.8
51..................................................      67.2      66.2      65.3      64.3      63.4      62.4      61.5      60.5      59.6      58.7
52..................................................      67.1      66.2      65.2      64.3      63.3      62.4      61.4      60.5      59.6      58.6
53..................................................      67.1      66.2      65.2      64.2      63.3      62.3      61.4      60.4      59.5      58.6
54..................................................      67.1      66.1      65.2      64.2      63.2      62.3      61.3      60.4      59.5      58.5
55..................................................      67.1      66.1      65.1      64.2      63.2      62.3      61.3      60.4      59.4      58.5
56..................................................      67.0      66.1      65.1      64.1      63.2      62.2      61.3      60.3      59.4      58.4
57..................................................      67.0      66.1      65.1      64.1      63.2      62.2      61.2      60.3      59.3      58.4
58..................................................      67.0      66.0      65.1      64.1      63.1      62.2      61.2      60.3      59.3      58.4
59..................................................      67.0      66.0      65.0      64.1      63.1      62.1      61.2      60.2      59.3      58.3
60..................................................      67.0      66.0      65.0      64.1      63.1      62.1      61.2      60.2      59.2      58.3
61..................................................      67.0      66.0      65.0      64.0      63.1      62.1      61.1      60.2      59.2      58.3
62..................................................      66.9      66.0      65.0      64.0      63.1      62.1      61.1      60.2      59.2      58.2
63..................................................      66.9      66.0      65.0      64.0      63.0      62.1      61.1      60.1      59.2      58.2
64..................................................      66.9      65.9      65.0      64.0      63.0      62.1      61.1      60.1      59.2      58.2
65..................................................      66.9      65.9      65.0      64.0      63.0      62.0      61.1      60.1      59.1      58.2
66..................................................      66.9      65.9      64.9      64.0      63.0      62.0      61.1      60.1      59.1      58.2
67..................................................      66.9      65.9      64.9      64.0      63.0      62.0      61.1      60.1      59.1      58.1
68..................................................      66.9      65.9      64.9      64.0      63.0      62.0      61.0      60.1      59.1      58.1
69..................................................      66.9      65.9      64.9      63.9      63.0      62.0      61.0      60.0      59.1      58.1
70..................................................      66.9      65.9      64.9      63.9      63.0      62.0      61.0      60.0      59.1      58.1
71..................................................      66.9      65.9      64.9      63.9      62.9      62.0      61.0      60.0      59.1      58.1
72..................................................      66.9      65.9      64.9      63.9      62.9      62.0      61.0      60.0      59.0      58.1
73..................................................      66.8      65.9      64.9      63.9      62.9      62.0      61.0      60.0      59.0      58.1
74..................................................      66.8      65.9      64.9      63.9      62.9      62.0      61.0      60.0      59.0      58.1
75..................................................      66.8      65.9      64.9      63.9      62.9      61.9      61.0      60.0      59.0      58.1
76..................................................      66.8      65.9      64.9      63.9      62.9      61.9      61.0      60.0      59.0      58.0
76..................................................      66.8      65.9      64.9      63.9      62.9      61.9      61.0      60.0      59.0      58.0
77..................................................      66.8      65.9      64.9      63.9      63.9      62.9      61.0      60.0      59.0      58.0
78..................................................      66.8      65.8      64.9      63.9      62.9      61.9      61.0      60.0      59.0      58.0
79..................................................      66.8      65.8      64.9      63.9      62.9      61.9      61.0      60.0      59.0      58.0
80..................................................      66.8      65.9      64.9      63.9      62.9      61.9      60.9      60.0      59.0      58.0
81..................................................      66.8      65.8      64.9      63.9      62.9      61.9      60.9      60.0      59.0      58.0
82..................................................      66.8      65.8      64.9      63.9      62.9      61.9      60.9      60.0      59.0      58.0
83..................................................      66.8      65.8      64.9      63.9      62.9      61.9      60.9      60.0      59.0      58.0
84..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      60.0      59.0      58.0
85..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      60.0      59.0      58.0
86..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      60.0      59.0      58.0
87..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      60.0      59.0      58.0
88..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      60.0      59.0      58.0
89..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      60.0      59.0      58.0
90..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      60.0      59.0      58.0
91..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      60.0      59.0      58.0
92..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
93..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
94..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
95..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
96..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
97..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
98..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
99..................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
100.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
101.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
102.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
103.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
104.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
105.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
106.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
107.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
108.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
109.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
110.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
111.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
112.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
113.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
114.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
115.................................................      66.8      65.8      64.8      63.9      62.9      61.9      60.9      59.9      59.0      58.0
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 224]]


                             Table VI--Ordinary Joint Life and Last Survivor Annuities; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             25        26        27        28        29        30        31        32        33        34
--------------------------------------------------------------------------------------------------------------------------------------------------------
25..................................................      63.9      63.4      62.9      62.5      62.1      61.7      61.3      61.0      60.7      60.4
26..................................................      63.4      62.9      62.4      61.9      61.5      61.1      60.7      60.4      60.0      59.7
27..................................................      62.9      62.4      61.9      61.4      60.9      60.5      60.1      59.7      59.4      59.0
28..................................................      62.5      61.9      61.4      60.9      60.4      60.0      59.5      59.1      58.7      58.4
29..................................................      62.1      61.5      60.9      60.4      59.9      59.4      59.0      58.5      58.1      57.7
30..................................................      61.7      61.1      60.5      60.0      59.4      58.9      58.4      58.0      57.5      57.1
31..................................................      61.3      60.7      60.1      59.5      59.0      58.4      57.9      57.4      57.0      56.5
32..................................................      61.0      60.4      59.7      59.1      58.5      58.0      57.4      56.9      56.4      56.0
33..................................................      60.7      60.0      59.4      58.7      58.1      57.5      57.0      56.4      55.9      55.5
34..................................................      60.4      59.7      59.0      58.4      57.7      57.1      56.5      56.0      55.5      54.9
35..................................................      60.1      59.4      58.7      58.0      57.4      56.7      56.1      55.6      55.0      54.5
36..................................................      59.9      59.1      58.4      57.7      57.0      56.4      55.8      55.1      54.6      54.0
37..................................................      59.6      58.9      58.1      57.4      56.7      56.0      55.4      54.8      54.2      53.6
38..................................................      59.4      58.6      57.9      57.9      56.4      55.7      55.1      54.4      53.8      53.2
39..................................................      59.2      58.4      57.7      56.9      56.2      55.4      54.7      54.1      53.4      52.8
40..................................................      59.0      58.2      57.4      56.7      55.9      55.2      54.5      53.8      53.1      52.4
41..................................................      58.9      58.0      57.2      56.4      55.7      54.9      54.2      53.5      52.8      52.1
42..................................................      58.7      57.9      57.1      56.2      55.5      54.7      53.9      53.2      52.5      51.8
43..................................................      58.6      57.7      56.9      56.1      55.3      54.5      53.7      52.9      52.2      51.5
44..................................................      58.4      57.6      56.7      55.9      55.1      54.3      53.5      52.7      52.0      51.2
45..................................................      58.3      57.4      56.6      55.7      54.9      54.1      53.3      52.5      51.7      51.0
46..................................................      58.2      57.3      56.5      55.6      54.8      53.9      53.1      52.3      51.5      50.7
47..................................................      58.1      57.2      56.3      55.5      54.6      53.8      52.9      52.1      51.3      50.5
48..................................................      58.0      57.1      56.2      55.3      54.5      53.6      52.8      51.9      51.1      50.3
49..................................................      57.9      57.0      56.1      55.2      54.4      53.5      52.6      51.8      51.0      50.1
50..................................................      57.8      56.9      56.0      55.1      54.2      53.4      52.5      51.7      50.8      50.0
51..................................................      57.8      56.9      55.9      55.0      54.1      53.3      52.4      51.5      50.7      49.8
52..................................................      57.7      56.8      55.9      55.0      54.1      53.2      52.3      51.4      50.5      49.7
53..................................................      57.6      56.7      55.8      54.9      54.0      53.1      52.2      51.3      50.4      49.6
54..................................................      57.6      56.7      55.7      54.8      53.9      53.0      52.1      51.2      50.3      49.4
55..................................................      57.5      56.6      55.7      54.7      53.8      52.9      52.0      51.1      40.2      49.3
56..................................................      57.5      56.5      55.6      54.7      53.8      52.8      51.9      51.0      50.1      49.2
57..................................................      57.4      56.5      55.6      54.6      53.7      52.8      51.9      50.9      50.0      49.1
58..................................................      57.4      56.5      55.5      54.6      53.6      52.7      51.8      50.9      50.0      49.1
59..................................................      57.4      56.4      55.5      54.5      53.6      52.7      51.7      50.8      49.9      49.0
60..................................................      57.3      56.4      55.4      54.5      53.6      52.6      51.7      50.8      49.8      48.9
61..................................................      57.3      56.4      55.4      54.5      53.5      52.6      51.6      50.7      49.8      48.9
62..................................................      57.3      56.3      55.4      54.4      53.5      52.5      51.6      50.7      49.7      48.8
63..................................................      57.3      56.3      55.3      54.4      53.4      52.5      51.6      50.6      49.7      48.7
64..................................................      57.2      56.3      55.3      54.4      53.4      52.5      51.5      50.6      49.6      48.7
65..................................................      57.2      56.3      55.3      54.3      53.4      52.4      51.5      50.5      49.6      48.7
66..................................................      57.2      56.2      55.3      54.3      53.4      52.4      51.5      50.5      49.6      48.6
67..................................................      57.2      56.2      55.3      54.3      53.3      52.4      51.4      50.5      49.5      48.6
68..................................................      57.2      56.2      55.2      54.3      53.3      52.4      51.4      50.4      49.5      48.6
69..................................................      57.1      56.2      55.2      54.3      53.3      52.3      51.4      50.4      49.5      48.5
70..................................................      57.1      56.2      55.2      54.2      53.3      52.3      51.4      50.4      49.4      48.5
71..................................................      57.1      56.2      55.2      54.2      53.3      52.3      51.3      50.4      49.4      48.5
72..................................................      57.1      56.1      55.2      54.2      53.2      52.3      51.3      50.4      49.4      48.5
73..................................................      57.1      56.1      55.2      54.2      53.2      52.3      51.3      50.3      49.4      48.4
74..................................................      57.1      56.1      55.2      54.2      53.2      52.3      51.3      50.3      49.4      48.4
75..................................................      57.1      56.1      55.1      54.2      53.2      52.2      51.3      50.3      49.4      48.4
76..................................................      57.1      56.1      55.1      54.2      53.2      52.2      51.3      50.3      49.3      48.4
77..................................................      57.1      56.1      55.1      54.2      53.2      52.2      51.3      50.3      49.3      48.4
78..................................................      57.1      56.1      55.1      54.2      53.2      52.2      51.3      50.3      49.3      48.4
79..................................................      57.1      56.1      55.1      54.1      53.2      52.2      51.2      50.3      49.3      48.4
80..................................................      57.1      56.1      55.1      54.1      53.2      52.2      51.2      50.3      49.3      48.3
81..................................................      57.0      56.1      55.1      54.1      53.2      52.2      51.2      50.3      49.3      48.3
82..................................................      57.0      56.1      55.1      54.1      53.2      52.2      51.2      50.3      49.3      48.3
83..................................................      57.0      56.1      55.1      54.1      53.2      52.2      51.2      50.3      49.3      48.3
84..................................................      57.0      56.1      55.1      54.1      53.2      52.2      51.2      50.3      49.3      48.3
85..................................................      57.0      56.1      55.1      54.1      53.2      52.2      51.2      50.2      49.3      48.3
86..................................................      57.0      56.1      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
87..................................................      57.0      56.1      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
88..................................................      57.0      56.1      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
89..................................................      57.0      56.1      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
90..................................................      57.0      56.1      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
91..................................................      57.0      56.1      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
92..................................................      57.0      56.1      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
93..................................................      57.0      56.1      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
94..................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
95..................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3

[[Page 225]]

 
96..................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
97..................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
98..................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
99..................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
100.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
101.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
102.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
103.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
104.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
105.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
106.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
107.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
108.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
109.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
110.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
111.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
112.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
113.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
114.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
115.................................................      57.0      56.0      55.1      54.1      53.1      52.2      51.2      50.2      49.3      48.3
--------------------------------------------------------------------------------------------------------------------------------------------------------


                             Table VI--Ordinary Joint Life and Last Survivor Annuities; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             35        36        37        38        39        40        41        42        43        44
--------------------------------------------------------------------------------------------------------------------------------------------------------
35..................................................      54.0      53.5      53.0      52.6      52.2      51.8      51.4      51.1      50.8      50.5
36..................................................      53.5      53.0      52.5      52.0      51.6      51.2      50.8      50.4      50.1      49.8
37..................................................      53.0      52.5      52.0      51.5      51.0      50.6      50.2      49.8      49.5      49.1
38..................................................      52.6      52.0      51.5      51.0      50.5      50.0      49.6      49.2      48.8      48.5
39..................................................      52.2      51.6      51.0      50.5      50.0      49.5      49.1      48.6      48.2      47.8
40..................................................      51.8      51.2      50.6      50.0      49.5      49.0      48.5      48.1      47.6      47.2
41..................................................      51.4      50.8      50.2      49.6      49.1      48.5      48.0      47.5      47.1      46.7
42..................................................      51.1      50.4      49.8      49.2      48.6      48.1      47.5      47.0      46.6      46.1
43..................................................      50.8      50.1      49.5      48.8      48.2      47.6      47.1      46.6      46.0      45.6
44..................................................      50.5      49.8      49.1      48.5      47.8      47.2      46.7      46.1      45.6      45.1
45..................................................      50.2      49.5      48.8      48.1      47.5      46.9      46.3      45.7      45.1      44.6
46..................................................      50.0      49.2      48.5      47.8      47.2      46.5      45.9      45.3      44.7      44.1
47..................................................      49.7      49.0      48.3      47.5      46.8      46.2      45.5      44.9      44.3      43.7
48..................................................      49.5      48.8      48.0      47.3      46.6      45.9      45.2      44.5      43.9      43.3
49..................................................      49.3      48.5      47.8      47.0      46.3      45.6      44.9      44.2      43.6      42.9
50..................................................      49.2      48.4      47.6      46.8      46.0      45.3      44.6      43.9      43.2      42.6
51..................................................      49.0      48.2      47.4      46.6      45.8      45.1      44.3      43.6      42.9      44.2
52..................................................      48.8      48.0      47.2      46.4      45.6      44.8      44.1      43.3      42.6      41.9
53..................................................      48.7      47.9      47.0      46.2      45.4      44.6      43.9      43.1      42.4      41.7
54..................................................      48.6      47.7      46.9      46.0      45.2      44.4      43.6      42.9      42.1      41.4
55..................................................      48.5      47.6      46.7      45.9      45.1      44.2      43.4      42.7      41.9      41.2
56..................................................      48.3      47.5      46.6      45.8      44.9      44.1      43.3      42.5      41.7      40.9
57..................................................      48.3      47.4      46.5      45.6      44.8      43.9      43.1      42.3      41.5      40.7
58..................................................      48.2      47.3      46.4      45.5      44.7      43.8      43.0      42.1      41.3      40.5
59..................................................      48.1      47.2      46.3      45.4      44.5      43.7      42.8      42.0      41.2      40.4
60..................................................      48.0      47.1      46.2      45.3      44.4      43.6      42.7      41.9      41.0      40.2
61..................................................      47.9      47.0      46.1      45.2      44.3      43.5      42.6      41.7      40.9      40.0
62..................................................      47.9      47.0      46.0      45.1      44.2      43.4      42.5      41.6      40.8      39.9
63..................................................      47.8      46.9      46.0      45.1      44.2      43.3      42.4      41.5      40.6      39.8
64..................................................      47.8      46.8      45.9      45.0      44.1      43.2      42.3      41.4      40.5      39.7
65..................................................      47.7      46.8      45.9      44.9      44.0      43.1      42.2      41.3      40.4      39.6
66..................................................      47.7      46.7      45.8      44.9      44.0      43.1      42.2      41.3      40.4      39.5
67..................................................      47.6      46.7      45.8      44.8      43.9      43.0      42.1      41.2      40.3      39.4
68..................................................      47.6      46.7      45.7      44.8      43.9      42.9      42.0      41.1      40.2      39.3
69..................................................      47.6      46.6      45.7      44.8      43.8      42.9      42.0      41.1      40.2      39.3
70..................................................      47.5      46.6      45.7      44.7      43.8      42.9      41.9      41.0      40.1      39.2
71..................................................      47.5      46.6      45.6      44.7      43.8      42.8      41.9      41.0      40.1      39.1
72..................................................      47.5      46.6      45.6      44.7      43.7      42.8      41.9      40.9      40.0      39.1
73..................................................      47.5      46.5      45.6      44.6      43.7      42.8      41.8      40.9      40.0      39.0
74..................................................      47.5      46.5      45.6      44.6      43.7      42.7      41.8      40.9      39.9      39.0
75..................................................      47.4      46.5      45.5      44.6      43.6      42.7      41.8      40.8      39.9      39.0
76..................................................      47.4      46.5      45.5      44.6      43.6      42.7      41.7      40.8      39.9      38.9
77..................................................      47.4      46.5      45.5      44.6      43.6      42.7      41.7      40.8      39.8      38.9
78..................................................      47.4      46.4      45.5      44.5      43.6      42.6      41.7      40.7      39.8      38.9

[[Page 226]]

 
79..................................................      47.4      46.4      45.5      44.5      43.6      42.6      41.7      40.7      39.8      38.9
80..................................................      47.4      46.4      45.5      44.5      43.6      42.6      41.7      40.7      39.8      38.8
81..................................................      47.4      46.4      45.5      44.5      43.5      42.6      41.6      40.7      39.8      38.8
82..................................................      47.4      46.4      45.4      44.5      43.5      42.6      41.6      40.7      39.7      38.8
83..................................................      47.4      46.4      45.4      44.5      43.5      42.6      41.6      40.7      39.7      38.8
84..................................................      47.4      46.4      45.4      44.5      43.5      42.6      41.6      40.7      39.7      38.8
85..................................................      47.4      46.4      45.4      44.5      43.5      42.6      41.6      40.7      39.7      38.8
86..................................................      47.3      46.4      45.4      44.5      43.5      42.5      41.6      40.6      39.7      38.8
87..................................................      47.3      46.4      45.4      44.5      43.5      42.5      41.6      40.6      39.7      38.7
88..................................................      47.3      46.4      45.4      44.5      43.5      42.5      41.6      40.6      39.7      38.7
89..................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.6      40.6      39.7      38.7
90..................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.6      40.6      39.7      38.7
91..................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.6      40.6      39.7      39.7
92..................................................      47.3      46.4      45.4      44.4      44.4      43.5      42.5      41.6      40.6      38.7
93..................................................      47.3      46.4      45.4      43.5      42.5      41.6      40.6      39.7      39.7      38.7
94..................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.6      40.6      39.7      38.7
95..................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.6      40.6      39.7      38.7
96..................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.6      40.6      39.7      38.7
97..................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.6      40.6      39.6      38.7
98..................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.6      40.6      39.6      38.7
99..................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
100.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
101.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
102.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
103.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
104.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
105.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
106.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
107.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
108.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
109.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
110.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
111.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
112.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
113.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
114.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
114.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
115.................................................      47.3      46.4      45.4      44.4      43.5      42.5      41.5      40.6      39.6      38.7
--------------------------------------------------------------------------------------------------------------------------------------------------------


                             Table VI--Ordinary Joint Life and Last Survivor Annuities; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             45        46        47        48        49        50        51        52        53        54
--------------------------------------------------------------------------------------------------------------------------------------------------------
45..................................................      44.1      43.6      43.2      42.7      42.3      42.0      41.6      41.3      41.0      40.7
46..................................................      43.6      43.1      42.6      42.2      41.8      41.4      41.0      40.6      40.3      40.0
47..................................................      43.2      42.6      42.1      41.7      41.2      40.8      40.4      40.0      39.7      39.3
48..................................................      42.7      42.2      41.7      41.2      40.7      40.2      39.8      39.4      39.0      38.7
49..................................................      42.3      41.8      41.2      40.7      40.2      39.7      39.3      38.8      38.4      38.1
50..................................................      42.0      41.4      40.8      40.2      39.7      39.2      38.7      38.3      37.9      37.5
51..................................................      41.6      41.0      40.4      39.8      39.3      38.7      38.2      37.8      37.3      36.9
52..................................................      41.3      40.6      40.0      39.4      38.8      38.3      37.8      37.3      36.8      36.4
53..................................................      41.0      40.3      39.7      39.0      38.4      37.9      37.3      36.8      36.3      35.8
54..................................................      40.7      40.0      39.3      38.7      38.1      37.5      36.9      36.4      35.8      35.3
55..................................................      40.4      39.7      39.0      38.4      37.7      37.1      36.5      35.9      35.4      34.9
56..................................................      40.2      39.5      38.7      38.1      37.4      36.8      36.1      35.6      35.0      34.4
57..................................................      40.0      39.2      38.5      37.8      37.1      36.4      35.8      35.2      34.6      34.0
58..................................................      39.7      39.0      38.2      37.5      36.8      36.1      35.5      34.8      34.2      33.6
59..................................................      39.6      38.8      38.0      37.3      36.6      35.9      35.2      34.5      33.9      33.3
60..................................................      39.4      38.6      37.8      37.1      36.3      35.6      34.9      34.2      33.6      32.9
61..................................................      39.2      38.4      37.6      36.9      36.1      35.4      34.6      33.9      33.3      32.6
62..................................................      39.1      38.3      37.5      36.7      35.9      35.1      34.4      33.7      33.0      32.3
63..................................................      38.9      38.1      37.3      36.5      35.7      34.9      34.2      33.5      32.7      32.0
64..................................................      38.8      38.0      37.2      36.3      35.5      34.8      34.0      33.2      32.5      31.8
65..................................................      38.7      37.9      37.0      36.2      35.4      34.6      33.8      33.0      32.3      31.6
66..................................................      38.6      37.8      36.9      36.1      35.2      34.4      33.6      32.9      32.1      31.4
67..................................................      38.5      37.7      36.8      36.0      35.1      34.3      33.5      32.7      31.9      31.2
68..................................................      38.4      37.6      36.7      35.8      35.0      34.2      33.4      32.5      31.8      31.0
69..................................................      38.4      37.5      36.6      35.7      34.9      34.1      33.2      32.4      31.6      30.8
70..................................................      38.3      37.4      36.5      35.7      34.8      34.0      33.1      32.3      31.5      30.7

[[Page 227]]

 
71..................................................      38.2      37.3      36.5      35.6      34.7      33.9      33.0      32.2      31.4      30.5
72..................................................      38.2      37.3      36.4      35.5      34.6      33.8      32.9      32.1      31.2      30.4
73..................................................      38.1      37.2      36.3      35.4      34.6      33.7      32.8      32.0      31.1      30.3
74..................................................      38.1      37.2      36.3      35.4      34.5      33.6      32.8      31.9      31.1      30.2
75..................................................      38.1      37.1      36.2      35.3      34.5      33.6      32.7      31.8      31.0      30.1
76..................................................      38.0      37.1      36.2      35.3      34.4      33.5      32.6      31.8      30.9      30.1
77..................................................      38.0      37.1      36.2      35.3      34.4      33.5      32.6      31.7      30.8      30.0
78..................................................      38.0      37.0      36.1      35.2      34.3      33.4      32.5      31.7      30.8      29.9
79..................................................      37.9      37.0      36.1      35.2      34.3      33.4      32.5      31.6      30.7      29.9
80..................................................      37.9      37.0      36.1      35.2      34.2      33.4      32.5      31.6      30.7      29.8
81..................................................      37.9      37.0      36.0      35.1      34.2      33.3      32.4      31.5      30.7      29.8
82..................................................      37.9      36.9      36.0      35.1      34.2      33.3      32.4      31.5      30.6      29.7
83..................................................      37.9      36.9      36.0      35.1      34.2      33.3      32.4      31.5      30.6      29.7
84..................................................      37.8      36.9      36.9      35.0      34.2      33.2      32.3      31.4      30.6      29.7
85..................................................      37.8      36.9      36.0      35.1      34.1      33.2      32.3      31.4      30.5      29.6
86..................................................      38.8      36.9      36.0      35.0      34.1      33.2      32.3      31.4      30.5      29.6
87..................................................      37.8      36.9      35.9      35.0      34.1      33.2      32.3      31.4      30.5      29.6
88..................................................      37.8      36.9      35.9      35.0      34.1      33.2      32.3      31.4      30.5      29.6
89..................................................      37.8      36.9      35.9      35.0      34.1      33.2      32.3      31.4      30.5      29.6
90..................................................      37.8      36.9      35.9      35.0      34.1      33.2      32.3      31.3      30.5      29.6
91..................................................      37.8      36.8      35.9      35.0      34.1      33.2      32.2      31.3      30.4      29.5
92..................................................      37.8      36.8      35.9      35.0      34.1      33.2      32.2      31.3      30.4      29.5
93..................................................      37.8      36.8      35.9      35.0      34.1      33.1      32.2      31.3      30.4      29.5
94..................................................      37.8      36.8      35.9      35.0      34.1      33.1      32.2      31.3      30.4      29.5
95..................................................      37.8      36.8      35.9      35.0      34.0      33.1      32.2      31.3      30.4      29.5
96..................................................      37.8      36.8      35.9      35.0      34.0      33.1      32.2      31.3      30.4      29.5
97..................................................      37.8      36.8      35.9      35.0      34.0      33.1      32.2      31.3      30.4      29.5
98..................................................      37.8      36.8      35.9      35.0      34.0      33.1      32.2      31.3      30.4      29.5
99..................................................      37.8      36.8      35.9      35.0      34.0      33.1      32.2      31.3      30.4      29.5
101.................................................      37.8      36.8      35.9      35.0      34.0      33.1      32.2      31.3      30.4      29.5
102.................................................      37.8      36.8      35.9      35.0      34.0      33.1      32.2      31.3      30.4      29.5
103.................................................      37.7      36.8      35.9      34.9      34.0      33.1      32.2      31.3      30.4      29.5
104.................................................      37.7      36.8      35.9      34.9      34.0      33.1      32.2      31.3      30.4      29.5
105.................................................      37.7      36.8      35.9      34.9      34.0      33.1      32.2      31.3      30.4      29.5
106.................................................      37.7      36.8      35.9      34.9      34.0      33.1      32.2      31.3      30.4      29.5
107.................................................      37.7      36.8      35.9      34.9      34.0      33.1      32.2      31.3      30.4      29.5
108.................................................      37.7      36.8      35.9      34.9      34.0      33.1      32.2      31.3      30.4      29.5
109.................................................      37.7      36.8      35.9      34.9      34.0      33.1      32.2      31.3      30.4      29.5
110.................................................      37.7      36.8      35.9      34.9      34.0      33.1      32.2      31.3      30.4      29.5
111.................................................      37.7      36.8      35.9      34.9      34.0      33.1      32.2      31.3      30.4      29.5
112.................................................      37.7      36.8      35.9      34.9      34.0      33.1      32.2      31.3      30.4      29.5
113.................................................      37.7      36.8      35.9      34.9      34.0      33.1      32.2      31.3      30.4      29.5
114.................................................      37.7      36.8      35.9      34.9      34.0      33.1      32.2      31.3      30.4      29.5
115.................................................      37.7      36.8      35.9      34.9      34.0      33.1      32.2      31.3      30.4      29.5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                             Table VI--Ordinary Joint Life and Last Survivor Annuities; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             55        56        57        58        59        60        61        62        63        64
--------------------------------------------------------------------------------------------------------------------------------------------------------
55..................................................      34.4      33.9      33.5      33.1      32.7      32.3      32.0      31.7      31.4      31.1
56..................................................      33.9      33.4      33.0      32.5      32.1      31.7      31.4      31.0      30.7      30.4
57..................................................      33.5      33.0      32.5      32.0      31.6      31.2      30.8      30.4      30.1      29.8
58..................................................      33.1      32.5      32.0      31.5      31.1      30.6      30.2      29.9      29.5      29.2
59..................................................      32.7      32.1      31.6      31.1      30.6      30.1      29.7      29.3      28.9      28.6
60..................................................      32.3      31.7      31.2      30.6      30.1      29.7      29.2      28.8      28.4      28.0
61..................................................      32.0      31.4      30.8      30.2      29.7      29.2      28.7      28.3      27.8      27.4
62..................................................      31.7      31.0      30.4      29.9      29.3      28.8      28.3      27.8      27.3      26.9
63..................................................      31.4      30.7      30.1      29.5      28.9      28.4      27.8      27.3      26.9      26.4
64..................................................      31.1      30.4      29.8      29.2      28.6      28.0      27.4      26.9      26.4      25.9
65..................................................      30.9      30.2      29.5      28.9      28.2      27.6      27.1      26.5      26.0      25.5
66..................................................      30.6      29.9      29.2      28.6      27.9      27.3      26.7      26.1      25.6      25.1
67..................................................      30.4      29.7      29.0      28.3      27.6      27.0      26.4      25.8      25.2      24.7
68..................................................      30.2      29.5      28.8      28.1      27.4      26.7      26.1      25.5      24.9      24.3
69..................................................      30.1      29.3      28.6      27.8      27.1      26.5      25.8      25.2      24.6      24.0
70..................................................      29.9      29.1      28.4      27.6      26.9      26.2      25.6      24.9      24.3      23.7
71..................................................      29.7      29.0      28.2      27.5      26.7      26.0      25.3      24.7      24.0      23.4
72..................................................      29.6      28.8      28.1      27.3      26.5      25.8      25.1      24.4      23.8      23.1
73..................................................      29.5      28.7      27.9      27.1      26.4      25.6      24.9      24.2      23.5      22.9
74..................................................      29.4      28.6      27.8      27.0      26.2      25.5      24.7      24.0      23.3      22.7

[[Page 228]]

 
75..................................................      29.3      28.5      27.7      26.9      26.1      25.3      24.6      23.8      23.1      22.4
76..................................................      29.2      28.4      27.6      26.8      26.0      25.2      24.4      23.7      23.0      22.3
77..................................................      29.1      28.3      27.5      26.7      25.9      25.1      24.3      23.6      22.8      22.1
78..................................................      29.1      28.2      27.4      26.6      25.8      25.0      24.2      23.4      22.7      21.9
79..................................................      29.0      28.2      27.3      26.5      25.7      24.9      24.1      23.3      22.6      21.8
80..................................................      29.0      28.1      27.3      26.4      25.6      24.8      24.0      23.2      22.4      21.7
81..................................................      28.9      28.1      27.2      26.4      25.5      24.7      23.9      23.1      22.3      21.6
82..................................................      28.9      28.0      27.2      26.3      25.5      24.6      23.8      23.0      22.3      21.5
83..................................................      28.8      28.0      27.1      26.3      25.4      24.6      23.8      23.0      22.2      21.4
84..................................................      28.8      27.9      27.1      26.2      25.4      24.5      23.7      22.9      22.1      21.3
85..................................................      28.8      27.9      27.0      26.2      25.3      24.5      23.7      22.8      22.0      21.3
86..................................................      28.7      27.9      27.0      26.1      25.3      24.5      23.6      22.8      22.0      21.2
87..................................................      28.7      27.8      27.0      26.1      25.3      24.4      23.6      22.8      21.9      21.1
88..................................................      28.7      27.8      27.0      26.1      25.2      24.4      23.5      22.7      21.9      21.1
89..................................................      28.7      27.8      26.9      26.1      25.2      24.4      23.5      22.7      21.9      21.1
90..................................................      28.7      27.8      26.9      26.1      25.2      24.3      23.5      22.7      21.8      21.0
91..................................................      28.7      27.8      26.9      26.0      25.2      24.3      23.5      22.6      21.8      21.0
92..................................................      28.6      27.8      26.9      26.0      25.2      24.3      23.5      22.6      21.8      21.0
93..................................................      28.6      27.8      26.9      26.0      25.1      24.3      23.4      22.6      21.8      20.9
94..................................................      28.6      27.7      26.9      26.0      25.1      24.3      23.4      22.6      21.7      20.9
95..................................................      28.6      27.7      26.9      26.0      25.1      24.3      23.4      22.6      21.7      20.9
96..................................................      28.6      27.7      26.9      26.0      25.1      24.2      23.4      22.6      21.7      20.9
97..................................................      28.6      27.7      26.8      26.0      25.1      24.2      23.4      22.5      21.7      20.9
98..................................................      28.6      27.7      26.8      26.0      25.1      24.2      23.4      22.5      21.7      20.9
99..................................................      28.6      27.7      26.8      26.0      25.1      24.2      23.4      22.5      21.7      20.9
100.................................................      28.6      27.7      26.8      26.0      25.1      24.2      23.4      22.5      21.7      20.8
101.................................................      28.6      27.7      26.8      25.9      25.1      24.2      23.4      22.5      21.7      20.8
102.................................................      28.6      27.7      26.8      25.9      25.1      24.2      23.3      22.5      21.7      20.8
103.................................................      28.6      27.7      26.8      25.9      25.1      24.2      23.3      22.5      21.7      20.8
104.................................................      28.6      27.7      26.8      25.9      25.1      24.2      23.3      22.5      21.6      20.8
105.................................................      28.6      27.7      26.8      25.9      25.1      24.2      23.3      22.5      21.6      20.8
106.................................................      28.6      27.7      26.8      25.9      25.1      24.2      23.3      22.5      21.6      20.8
107.................................................      28.6      27.7      26.8      25.9      25.1      24.2      23.3      22.5      21.6      20.8
108.................................................      28.6      27.7      26.8      25.9      25.1      24.2      23.3      22.5      21.6      20.8
109.................................................      28.6      27.7      26.8      25.9      25.1      24.2      23.3      22.5      21.6      20.8
110.................................................      28.6      27.7      26.8      25.9      25.1      24.2      23.3      22.5      21.6      20.8
111.................................................      28.6      27.7      26.8      25.9      25.0      24.2      23.3      22.5      21.6      20.8
112.................................................      28.6      27.7      26.8      25.9      25.0      24.2      23.3      22.5      21.6      20.8
113.................................................      28.6      27.7      26.8      25.9      25.0      24.2      23.3      22.5      21.6      20.8
114.................................................      28.6      27.7      26.8      25.9      25.0      24.2      23.3      22.5      21.6      20.8
115.................................................      28.6      27.7      26.8      25.9      25.0      24.2      23.3      22.5      21.6      20.8
--------------------------------------------------------------------------------------------------------------------------------------------------------


                             Table VI--Ordinary Joint Life and Last Survivor Annuities; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             65        66        67        68        69        70        71        72        73        74
--------------------------------------------------------------------------------------------------------------------------------------------------------
65..................................................      25.0      24.6      24.2      23.8      23.4      23.1      22.8      22.5      22.2      22.0
66..................................................      24.6      24.1      23.7      23.3      22.9      22.5      22.2      21.9      21.6      21.4
67..................................................      24.2      23.7      23.2      22.8      22.4      22.0      21.7      21.3      21.0      20.8
68..................................................      23.8      23.3      22.8      22.3      21.9      21.5      21.2      20.8      20.5      20.2
69..................................................      23.4      22.9      22.4      21.9      21.5      21.1      20.7      20.3      20.0      19.6
70..................................................      23.1      22.5      22.0      21.5      21.1      20.6      20.2      19.8      19.4      19.1
71..................................................      22.8      22.2      21.7      21.2      20.7      20.2      19.8      19.4      19.0      18.6
72..................................................      22.5      21.9      21.3      20.8      20.3      19.8      19.4      18.9      18.5      18.2
73..................................................      22.2      21.6      21.0      20.5      20.0      19.4      19.0      18.5      18.1      17.7
74..................................................      22.0      21.4      20.8      20.2      19.6      19.1      18.6      18.2      17.7      17.3
75..................................................      21.8      21.1      20.5      19.9      19.3      18.8      18.3      17.8      17.3      16.9
76..................................................      21.6      20.9      20.3      19.7      19.1      18.5      18.0      17.5      17.0      16.5
77..................................................      21.4      20.7      20.1      19.4      18.8      18.3      17.7      17.2      16.7      16.2
78..................................................      21.2      20.5      19.9      19.2      18.6      18.0      17.5      16.9      16.4      15.9
79..................................................      21.1      20.4      19.7      19.0      18.4      17.8      17.2      16.7      16.1      15.6
80..................................................      21.0      20.2      19.5      18.9      18.2      17.6      17.0      16.4      15.9      15.4
81..................................................      20.8      20.1      19.4      18.7      18.1      17.4      16.8      16.2      15.7      15.1
82..................................................      20.7      20.0      19.3      18.6      17.9      17.3      16.6      16.0      15.5      14.9
83..................................................      20.6      19.9      19.2      18.5      17.8      17.1      16.5      15.9      15.3      14.7
84..................................................      20.5      19.8      19.1      18.4      17.7      17.0      16.3      15.7      15.1      14.5
85..................................................      20.5      19.7      19.0      18.3      17.6      16.9      16.2      15.6      15.0      14.4
86..................................................      20.4      19.6      18.9      18.2      17.5      16.8      16.1      15.5      14.8      14.2
87..................................................      20.4      19.6      18.8      18.1      17.4      16.7      16.0      15.4      14.7      14.1

[[Page 229]]

 
88..................................................      20.3      19.5      18.8      18.0      17.3      16.6      15.9      15.3      14.6      14.0
89..................................................      20.3      19.5      18.7      18.0      17.2      16.5      15.8      15.2      14.5      13.9
90..................................................      20.2      19.4      18.7      17.9      17.2      16.5      15.8      15.1      14.5      13.8
91..................................................      20.2      19.4      18.6      17.9      17.1      16.4      15.7      15.0      14.4      13.7
92..................................................      20.2      19.4      18.6      17.8      17.1      16.4      15.7      15.0      14.3      13.7
93..................................................      20.1      19.3      18.6      17.8      17.1      16.3      15.6      14.9      14.3      13.6
94..................................................      20.1      19.3      18.5      17.8      17.0      16.3      15.6      14.9      14.2      13.6
95..................................................      20.1      19.3      18.5      17.8      17.0      16.3      15.6      14.9      14.2      13.5
96..................................................      20.1      19.3      18.5      17.7      17.0      16.2      15.5      14.8      14.2      13.5
97..................................................      20.1      19.3      18.5      17.7      17.0      16.2      15.5      14.8      14.1      13.5
98..................................................      20.1      19.3      18.5      17.7      16.9      16.2      15.5      14.8      14.1      13.4
99..................................................      20.0      19.2      18.5      17.7      16.9      16.2      15.5      14.7      14.1      13.4
100.................................................      20.0      19.2      18.4      17.7      16.9      16.2      15.4      14.7      14.0      13.4
101.................................................      20.0      19.2      18.4      17.7      16.9      16.1      15.4      14.7      14.0      13.3
102.................................................      20.0      19.2      18.4      17.6      16.9      16.1      15.4      14.7      14.0      13.3
103.................................................      20.0      19.2      18.4      17.6      16.9      16.1      15.4      14.7      14.0      13.3
104.................................................      20.0      19.2      18.4      17.6      16.9      16.1      15.4      14.7      14.0      13.3
105.................................................      20.0      19.2      18.4      17.6      16.8      16.1      15.4      14.6      13.9      13.3
106.................................................      20.0      19.2      18.4      17.6      16.8      16.1      15.3      14.6      13.9      13.3
107.................................................      20.0      19.2      18.4      17.6      16.8      16.1      15.3      14.6      13.9      13.2
108.................................................      20.0      19.2      18.4      17.6      16.8      16.1      15.3      14.6      13.9      13.2
109.................................................      20.0      19.2      18.4      17.6      16.8      16.1      15.3      14.6      13.9      13.2
110.................................................      20.0      19.2      18.4      17.6      16.8      16.1      15.3      14.6      13.9      13.2
111.................................................      20.0      19.2      18.4      17.6      16.8      16.0      15.3      14.6      13.9      13.2
112.................................................      20.0      19.2      18.4      17.6      16.8      16.0      15.3      14.6      13.9      13.2
113.................................................      20.0      19.2      18.4      17.6      16.8      16.0      15.3      14.6      13.9      13.2
114.................................................      20.0      19.2      18.4      17.6      16.8      16.0      15.3      14.6      13.9      13.2
115.................................................      20.0      19.2      18.4      17.6      16.8      16.0      15.3      14.6      13.9      13.2
--------------------------------------------------------------------------------------------------------------------------------------------------------


                             Table VI--Ordinary Joint Life and Last Survivor Annuities; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             75        76        77        78        79        80        81        82        83        84
--------------------------------------------------------------------------------------------------------------------------------------------------------
75..................................................      16.5      16.1      15.8      15.4      15.1      14.9      14.6      14.4      14.2      14.0
76..................................................      16.1      15.7      15.4      15.0      14.7      14.4      14.1      13.9      13.7      13.5
77..................................................      15.8      15.4      15.0      14.6      14.3      14.0      13.7      13.4      13.2      13.0
78..................................................      15.4      15.0      14.6      14.2      13.9      13.5      13.2      13.0      12.7      12.5
79..................................................      15.1      14.7      14.3      13.9      13.5      13.2      12.8      12.5      12.3      12.0
80..................................................      14.9      14.4      14.0      13.5      13.2      12.8      12.5      12.2      11.9      11.6
81..................................................      14.6      14.1      13.7      13.2      12.8      12.5      12.1      11.8      11.5      11.2
82..................................................      14.4      13.9      13.4      13.0      12.5      12.2      11.8      11.5      11.1      10.9
83..................................................      14.2      13.7      13.2      12.7      12.3      11.9      11.5      11.1      10.8      10.5
84..................................................      14.0      13.5      13.0      12.5      12.0      11.6      11.2      10.9      10.5      10.2
85..................................................      13.8      13.3      12.8      12.3      11.8      11.4      11.0      10.6      10.2       9.9
86..................................................      13.7      13.1      12.6      12.1      11.6      11.2      10.8      10.4      10.0       9.7
87..................................................      13.5      13.0      12.4      11.9      11.4      11.0      10.6      10.1       9.8       9.4
88..................................................      13.4      12.8      12.3      11.8      11.3      10.8      10.4      10.0       9.6       9.2
89..................................................      13.3      12.7      12.2      11.6      11.1      10.7      10.2       9.8       9.4       9.0
90..................................................      13.2      12.6      12.1      11.5      11.0      10.5      10.1       9.6       9.2       8.8
91..................................................      13.1      12.5      12.0      11.4      10.9      10.4       9.9       9.5       9.1       8.7
92..................................................      13.1      12.5      11.9      11.3      10.8      10.3       9.8       9.4       8.9       8.5
93..................................................      13.0      12.4      11.8      11.3      10.7      10.2       9.7       9.3       8.8       8.4
94..................................................      12.9      12.3      11.7      11.2      10.6      10.1       9.6       9.2       8.7       8.3
95..................................................      12.9      12.3      11.7      11.1      10.6      10.1       9.6       9.1       8.6       8.2
96..................................................      12.9      12.2      11.6      11.1      10.5      10.0       9.5       9.0       8.5       8.1
97..................................................      12.8      12.2      11.6      11.0      10.5       9.9       9.4       8.9       8.5       8.0
98..................................................      12.8      12.2      11.5      11.0      10.4       9.9       9.4       8.9       8.4       8.0
99..................................................      12.7      12.1      11.5      10.9      10.4       9.8       9.3       8.8       8.3       7.9
100.................................................      12.7      12.1      11.5      10.9      10.3       9.8       9.2       8.7       8.3       7.8
101.................................................      12.7      12.1      11.4      10.8      10.3       9.7       9.2       8.7       8.2       7.8
102.................................................      12.7      12.0      11.4      10.8      10.2       9.7       9.2       8.7       8.2       7.7
103.................................................      12.6      12.0      11.4      10.8      10.2       9.7       9.1       8.6       8.1       7.7
104.................................................      12.6      12.0      11.4      10.8      10.2       9.6       9.1       8.6       8.1       7.6
105.................................................      12.6      12.0      11.3      10.7      10.2       9.6       9.1       8.5       8.0       7.6
106.................................................      12.6      11.9      11.3      10.7      10.1       9.6       9.0       8.5       8.0       7.5
107.................................................      12.6      11.9      11.3      10.7      10.1       9.6       9.0       8.5       8.0       7.5
108.................................................      12.6      11.9      11.3      10.7      10.1       9.5       9.0       8.5       8.0       7.5
109.................................................      12.6      11.9      11.3      10.7      10.1       9.5       9.0       8.4       7.9       7.5
110.................................................      12.6      11.9      11.3      10.7      10.1       9.5       9.0       8.4       7.9       7.4

[[Page 230]]

 
111.................................................      12.5      11.9      11.3      10.7      10.1       9.5       8.9       8.4       7.9       7.4
112.................................................      12.5      11.9      11.3      10.6      10.1       9.5       8.9       8.4       7.9       7.4
113.................................................      12.5      11.9      11.2      10.6      10.0       9.5       8.9       8.4       7.9       7.4
114.................................................      12.5      11.9      11.2      10.6      10.0       9.5       8.9       8.4       7.9       7.4
115.................................................      12.5      11.9      11.2      10.6      10.0       9.5       8.9       8.4       7.9       7.4
--------------------------------------------------------------------------------------------------------------------------------------------------------


                             Table VI--Ordinary Joint Life and Last Survivor Annuities; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             85        86        87        88        89        90        91        92        93        94
--------------------------------------------------------------------------------------------------------------------------------------------------------
85..................................................       9.6       9.3       9.1       8.9       8.7       8.5       8.3       8.2       8.0       7.9
86..................................................       9.3       9.1       8.8       8.6       8.3       8.2       8.0       7.8       7.7       7.6
87..................................................       9.1       8.8       8.5       8.3       8.1       7.9       7.7       7.5       7.4       7.2
88..................................................       8.9       8.6       8.3       8.0       7.8       7.6       7.4       7.2       7.1       6.9
89..................................................       8.7       8.3       8.1       7.8       7.5       7.3       7.1       6.9       6.8       6.6
90..................................................       8.5       8.2       7.9       7.6       7.3       7.1       6.9       6.7       6.5       6.4
91..................................................       8.3       8.0       7.7       7.4       7.1       6.9       6.7       6.5       6.3       6.2
92..................................................       8.2       7.8       7.5       7.2       6.9       6.7       6.5       6.3       6.1       5.9
93..................................................       8.0       7.7       7.4       7.1       6.8       6.5       6.3       6.1       5.9       5.8
94..................................................       7.9       7.6       7.2       6.9       6.6       6.4       6.2       5.9       5.8       5.6
95..................................................       7.8       7.5       7.1       6.8       6.5       6.3       6.0       5.8       5.6       5.4
96..................................................       7.7       7.3       7.0       6.7       6.4       6.1       5.9       5.7       5.5       5.3
97..................................................       7.6       7.3       6.9       6.6       6.3       6.0       5.8       5.5       5.3       5.1
98..................................................       7.6       7.2       6.8       6.5       6.2       5.9       5.6       5.4       5.2       5.0
99..................................................       7.5       7.1       6.7       6.4       6.1       5.8       5.5       5.3       5.1       4.9
100.................................................       7.4       7.0       6.6       6.3       6.0       5.7       5.4       5.2       5.0       4.8
101.................................................       7.3       6.9       6.6       6.2       5.9       5.6       5.3       5.1       4.9       4.7
102.................................................       7.3       6.9       6.5       6.2       5.8       5.5       5.3       5.0       4.8       4.6
103.................................................       7.2       6.8       6.4       6.1       5.8       5.5       5.2       4.9       4.7       4.5
104.................................................       7.2       6.8       6.4       6.0       5.7       5.4       5.1       4.8       4.6       4.4
105.................................................       7.1       6.7       6.3       6.0       5.6       5.3       5.0       4.8       4.5       4.3
106.................................................       7.1       6.7       6.3       5.9       5.6       5.3       5.0       4.7       4.5       4.2
107.................................................       7.1       6.6       6.2       5.9       5.5       5.2       4.9       4.6       4.4       4.2
108.................................................       7.0       6.6       6.2       5.8       5.5       5.2       4.9       4.6       4.3       4.1
109.................................................       7.0       6.6       6.2       5.8       5.5       5.1       4.8       4.5       4.3       4.1
110.................................................       7.0       6.6       6.2       5.8       5.4       5.1       4.8       4.5       4.3       4.0
111.................................................       7.0       6.5       6.1       5.7       5.4       5.1       4.8       4.5       4.2       4.0
112.................................................       7.0       6.5       6.1       5.7       5.4       5.0       4.7       4.4       4.2       3.9
113.................................................       6.9       6.5       6.1       5.7       5.4       5.0       4.7       4.4       4.2       3.9
114.................................................       6.9       6.5       6.1       5.7       5.3       5.0       4.7       4.4       4.1       3.9
115.................................................       6.9       6.5       6.1       5.7       5.3       5.0       4.7       4.4       4.1       3.9
--------------------------------------------------------------------------------------------------------------------------------------------------------


                             Table VI--Ordinary Joint Life and Last Survivor Annuities; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             95        96        97        98        99        100       101       102       103       104
--------------------------------------------------------------------------------------------------------------------------------------------------------
95..................................................       5.3       5.1       5.0       4.8       4.7       4.6       4.5       4.4       4.3       4.2
96..................................................       5.1       5.0       4.8       4.7       4.5       4.4       4.3       4.2       4.1       4.0
97..................................................       5.0       4.8       4.7       4.5       4.4       4.3       4.1       4.0       3.9       3.8
98..................................................       4.8       4.7       4.5       4.4       4.2       4.1       4.0       3.9       3.8       3.7
99..................................................       4.7       4.5       4.4       4.2       4.1       4.0       3.8       3.7       3.6       3.5
100.................................................       4.6       4.4       4.3       4.1       4.0       3.8       3.7       3.6       3.5       3.3
101.................................................       4.5       4.3       4.1       4.0       3.8       3.7       3.6       3.4       3.3       3.2
102.................................................       4.4       4.2       4.0       3.9       3.7       3.6       3.4       3.3       3.2       3.1
103.................................................       4.3       4.1       3.9       3.8       3.6       3.5       3.3       3.2       3.0       2.9
104.................................................       4.2       4.0       3.8       3.7       3.5       3.3       3.2       3.1       2.9       2.8
105.................................................       4.1       3.9       3.7       3.6       3.4       3.2       3.1       2.9       2.8       2.7
106.................................................       4.0       3.8       3.6       3.5       3.3       3.1       3.0       2.8       2.7       2.5
107.................................................       4.0       3.8       3.6       3.4       3.2       3.1       2.9       2.7       2.6       2.4
108.................................................       3.9       3.7       3.5       3.3       3.1       3.0       2.8       2.7       2.5       2.3
109.................................................       3.8       3.6       3.4       3.3       3.1       2.9       2.7       2.6       2.4       2.3
110.................................................       3.8       3.6       3.4       3.2       3.0       2.8       2.7       2.5       2.3       2.2
111.................................................       3.8       3.5       3.3       3.2       3.0       2.8       2.6       2.4       2.3       2.1
112.................................................       3.7       3.5       3.3       3.1       2.9       2.8       2.6       2.4       2.2       2.1
113.................................................       3.7       3.5       3.3       3.1       2.9       2.7       2.5       2.4       2.2       2.0
114.................................................       3.7       3.5       3.3       3.1       2.9       2.7       2.5       2.3       2.1       2.0
115.................................................       3.7       3.4       3.2       3.0       2.8       2.7       2.5       2.3       2.1       1.9
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 231]]


                             Table VI--Ordinary Joint Life and Last Survivor Annuities; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                         Ages                            105      106      107      108      109      110      111      112      113      114      115
--------------------------------------------------------------------------------------------------------------------------------------------------------
105..................................................      2.5      2.4      2.3      2.2      2.1      2.0      2.0      1.9      1.8      1.8      1.8
106..................................................      2.4      2.3      2.2      2.1      2.0      1.9      1.8      1.7      1.7      1.6      1.6
107..................................................      2.3      2.2      2.1      1.9      1.8      1.7      1.7      1.6      1.5      1.5      1.4
108..................................................      2.2      2.1      1.9      1.8      1.7      1.6      1.5      1.5      1.4      1.3      1.3
109..................................................      2.1      2.0      1.8      1.7      1.6      1.5      1.4      1.3      1.3      1.2      1.1
110..................................................      2.0      1.9      1.7      1.6      1.5      1.4      1.3      1.2      1.1      1.1      1.0
111..................................................      2.0      1.8      1.7      1.5      1.4      1.3      1.2      1.1      1.0       .9       .9
112..................................................      1.9      1.7      1.6      1.5      1.3      1.2      1.1      1.0       .9       .8       .8
113..................................................      1.8      1.7      1.5      1.4      1.3      1.1      1.0       .9       .8       .7       .7
114..................................................      1.8      1.6      1.5      1.3      1.2      1.1       .9       .8       .7       .6       .6
115..................................................      1.8      1.6      1.4      1.3      1.1      1.0       .9       .8       .7       .6       .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                     Table VIa--Annuities for Joint Life Only; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                              5         6         7         8         9        10        11        12        13        14
--------------------------------------------------------------------------------------------------------------------------------------------------------
5...................................................      69.5      69.0      68.4      67.9      67.3      66.7      66.1      65.5      64.8      64.1
6...................................................      69.0      68.5      68.0      67.5      66.9      66.4      65.8      65.1      64.5      63.8
7...................................................      68.4      68.0      67.5      67.0      66.5      66.0      65.4      64.8      64.2      63.5
8...................................................      67.9      67.5      67.0      66.6      66.1      65.5      65.0      64.4      63.8      63.2
9...................................................      67.3      66.9      66.5      66.1      65.6      65.1      64.6      64.0      63.4      62.8
10..................................................      66.7      66.4      66.0      65.5      65.1      64.6      64.1      63.6      63.0      62.5
11..................................................      66.1      65.8      65.4      65.0      64.6      64.1      63.6      63.1      62.6      62.1
12..................................................      65.5      65.1      64.8      64.4      64.0      63.6      63.1      62.7      62.2      61.7
13..................................................      64.8      64.5      64.2      63.8      63.4      63.0      62.6      62.2      61.7      61.2
14..................................................      64.1      63.8      63.5      63.2      62.8      62.5      62.1      61.7      61.2      60.7
15..................................................      63.4      63.1      62.9      62.6      62.2      61.9      61.5      61.1      60.7      60.2
16..................................................      62.7      62.4      62.2      61.9      61.6      61.3      60.9      60.5      60.1      59.7
17..................................................      61.9      61.7      61.5      61.2      60.9      60.6      60.3      59.9      59.6      59.2
18..................................................      61.2      61.0      60.7      60.5      60.2      60.0      59.7      59.3      59.0      58.6
19..................................................      60.4      60.2      60.0      59.8      59.5      59.3      59.0      58.7      58.4      58.0
20..................................................      59.6      59.4      59.2      59.0      58.8      58.6      58.3      58.0      57.7      57.4
21..................................................      58.8      58.7      58.5      58.3      58.1      57.8      57.6      57.3      57.1      56.8
22..................................................      58.0      57.8      57.7      57.5      57.3      57.1      56.9      56.6      56.4      56.1
23..................................................      57.2      57.0      56.9      56.7      56.5      56.4      56.1      55.9      55.7      55.4
24..................................................      56.3      56.2      56.1      55.9      55.8      55.6      55.4      55.2      55.0      54.7
25..................................................      55.5      55.4      55.2      55.1      55.0      54.8      54.6      54.4      54.2      54.0
26..................................................      54.6      54.5      54.4      54.3      54.1      54.0      53.8      53.7      53.5      53.3
27..................................................      53.8      53.7      53.6      53.4      53.3      53.2      53.0      52.9      52.7      52.5
28..................................................      52.9      52.8      52.7      52.6      52.5      52.4      52.2      52.1      51.9      51.7
29..................................................      52.0      51.9      51.8      51.7      51.6      51.5      51.4      51.3      51.1      51.0
30..................................................      51.1      51.0      51.0      50.9      50.8      50.7      50.6      50.4      50.3      50.2
31..................................................      50.2      50.2      50.1      50.0      49.9      49.8      49.7      49.6      49.5      49.3
32..................................................      49.3      49.3      49.2      49.1      49.0      49.0      48.9      48.8      48.6      48.5
33..................................................      48.4      48.4      48.3      48.2      48.2      48.1      48.0      47.9      47.8      47.7
34..................................................      47.5      47.5      47.4      47.4      47.3      47.2      47.1      47.0      47.0      46.8
35..................................................      46.6      46.6      46.5      46.5      46.4      46.3      46.3      46.2      46.1      46.0
36..................................................      45.7      45.7      45.6      45.6      45.5      45.4      45.4      45.3      45.2      45.1
37..................................................      44.8      44.7      44.7      44.6      44.6      44.5      44.5      44.4      44.3      44.3
38..................................................      43.9      43.8      43.8      43.7      43.7      43.6      43.6      43.5      43.5      43.4
39..................................................      42.9      42.9      42.9      42.8      42.8      42.7      42.7      42.6      42.6      42.5
40..................................................      42.0      42.0      42.0      41.9      41.9      41.8      41.8      41.7      41.7      41.6
41..................................................      41.1      41.1      41.0      41.0      41.0      40.9      40.9      40.8      40.8      40.7
42..................................................      40.2      40.1      40.1      40.1      40.1      40.0      40.0      39.9      39.9      39.8
43..................................................      39.2      39.2      39.2      39.2      39.1      39.1      39.1      39.0      39.0      39.0
44..................................................      38.3      38.3      38.3      38.3      38.2      38.2      38.2      38.1      38.1      38.1
45..................................................      37.4      37.4      37.4      37.3      37.3      37.3      37.3      37.2      37.2      37.2
46..................................................      36.5      36.5      36.5      36.4      36.4      36.4      36.4      36.3      36.3      36.3
47..................................................      35.6      35.6      35.5      35.5      35.5      35.5      35.5      35.4      35.4      35.4
48..................................................      34.7      34.7      34.6      34.6      34.6      34.6      34.6      34.5      34.5      34.5
49..................................................      33.8      33.8      33.7      33.7      33.7      33.7      33.7      33.7      33.6      33.6
50..................................................      32.9      32.9      32.8      32.8      32.8      32.8      32.8      32.8      32.7      32.7
51..................................................      32.0      32.0      31.9      31.9      31.9      31.9      31.9      31.9      31.9      31.8
52..................................................      31.1      31.1      31.1      31.0      31.0      31.0      31.0      31.0      31.0      30.9
53..................................................      30.2      30.2      30.2      30.2      30.1      30.1      30.1      30.1      30.1      30.1
54..................................................      29.3      29.3      29.3      29.3      29.3      29.2      29.2      29.2      29.2      29.2
55..................................................      28.4      28.4      28.4      28.4      28.4      28.4      28.4      28.3      28.3      28.3
56..................................................      27.5      27.5      27.5      27.5      27.5      27.5      27.5      27.5      27.5      27.5
57..................................................      26.7      26.7      26.7      26.6      26.6      26.6      26.6      26.6      26.6      26.6
58..................................................      25.8      25.8      25.8      25.8      25.8      25.8      25.8      25.7      25.7      25.7

[[Page 232]]

 
59..................................................      24.9      24.9      24.9      24.9      24.9      24.9      24.9      24.9      24.9      24.9
60..................................................      24.1      24.1      24.1      24.1      24.1      24.0      24.0      24.0      24.0      24.0
61..................................................      23.2      23.2      23.2      23.2      23.2      23.2      23.2      23.2      23.2      23.2
62..................................................      22.4      22.4      22.4      22.4      22.4      22.4      22.3      22.3      22.3      22.3
63..................................................      21.5      21.5      21.5      21.5      21.5      21.5      21.5      21.5      21.5      21.5
64..................................................      20.7      20.7      20.7      20.7      20.7      20.7      20.7      20.7      20.7      20.7
65..................................................      19.9      19.9      19.9      19.9      19.9      19.9      19.9      19.9      19.9      19.9
66..................................................      19.1      19.1      19.1      19.1      19.1      19.1      19.1      19.1      19.1      19.1
67..................................................      18.3      18.3      18.3      18.3      18.3      18.3      18.3      18.3      18.3      18.3
68..................................................      17.5      17.5      17.5      17.5      17.5      17.5      17.5      17.5      17.5      17.5
69..................................................      16.8      16.8      16.8      16.7      16.7      16.7      16.7      16.7      16.7      16.7
70..................................................      16.0      16.0      16.0      16.0      16.0      16.0      16.0      16.0      16.0      16.0
71..................................................      15.3      15.3      15.3      15.3      15.3      15.3      15.3      15.3      15.3      15.2
72..................................................      14.6      14.6      14.5      14.5      14.5      14.5      14.5      14.5      14.5      14.5
73..................................................      13.9      13.9      13.8      13.8      13.8      13.8      13.8      13.8      13.8      13.8
74..................................................      13.2      13.2      13.2      13.2      13.2      13.2      13.2      13.2      13.2      13.2
75..................................................      12.5      12.5      12.5      12.5      12.5      12.5      12.5      12.5      12.5      12.5
76..................................................      11.9      11.9      11.8      11.8      11.8      11.8      11.8      11.8      11.8      11.8
77..................................................      11.2      11.2      11.2      11.2      11.2      11.2      11.2      11.2      11.2      11.2
78..................................................      10.6      10.6      10.6      10.6      10.6      10.6      10.6      10.6      10.6      10.6
79..................................................      10.0      10.0      10.0      10.0      10.0      10.0      10.0      10.0      10.0      10.0
80..................................................       9.5       9.5       9.5       9.5       9.5       9.5       9.5       9.5       9.4       9.4
81..................................................       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9
82..................................................       8.4       8.4       8.4       8.4       8.4       8.4       8.4       8.4       8.4       8.4
83..................................................       7.9       7.9       7.9       7.9       7.9       7.9       7.9       7.9       7.9       7.9
84..................................................       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4
85..................................................       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9
86..................................................       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5
87..................................................       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1
88..................................................       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7
89..................................................       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3
90..................................................       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0
91..................................................       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7
92..................................................       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4
93..................................................       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1
94..................................................       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9
95..................................................       3.7       3.7       3.7       3.7       3.7       3.7       3.6       3.6       3.6       3.6
96..................................................       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4
97..................................................       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2
98..................................................       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0
99..................................................       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8
100.................................................       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7
101.................................................       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5
102.................................................       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3
103.................................................       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1
104.................................................       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9
105.................................................       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8
106.................................................       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6
107.................................................       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4
108.................................................       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3
109.................................................       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1
110.................................................       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0
111.................................................        .9        .9        .9        .9        .9        .9        .9        .9        .9        .9
112.................................................        .8        .8        .8        .8        .8        .8        .8        .8        .8        .8
113.................................................        .7        .7        .7        .7        .7        .7        .7        .7        .7        .7
114.................................................        .6        .6        .6        .6        .6        .6        .6        .6        .6        .6
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                     Table VIa--Annuities for Joint Life Only; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             15        16        17        18        19        20        21        22        23        24
--------------------------------------------------------------------------------------------------------------------------------------------------------
15..................................................      59.8      59.3      58.8      58.2      57.6      57.0      56.4      55.8      55.1      54.5
16..................................................      59.3      58.8      58.3      57.8      57.2      56.7      56.1      55.5      54.8      54.2
17..................................................      58.8      58.3      57.8      57.3      56.8      56.3      55.7      55.1      54.5      53.9
18..................................................      58.2      57.8      57.3      56.9      56.4      55.9      55.3      54.7      54.2      53.5
19..................................................      57.6      57.2      56.8      56.4      55.9      55.4      54.9      54.4      53.8      53.2
20..................................................      57.0      56.7      56.3      55.9      55.4      54.9      54.5      53.9      53.4      52.8
21..................................................      56.4      56.1      55.7      55.3      54.9      54.5      54.0      53.5      53.0      52.4
22..................................................      55.8      55.5      55.1      54.7      54.4      53.9      53.5      53.0      52.5      52.0

[[Page 233]]

 
23..................................................      55.1      54.8      54.5      54.2      53.8      53.4      53.0      52.5      52.1      51.6
24..................................................      54.5      54.2      53.9      53.5      53.2      52.8      52.4      52.0      51.6      51.1
25..................................................      53.8      53.5      53.2      52.9      52.6      52.2      51.9      51.5      51.1      50.6
26..................................................      53.0      52.8      52.5      52.3      52.0      51.6      51.3      50.9      50.5      50.1
27..................................................      52.3      52.1      51.8      51.6      51.3      51.0      50.7      50.3      50.0      49.6
28..................................................      51.5      51.3      51.1      50.9      50.6      50.3      50.0      49.7      49.4      49.0
29..................................................      50.8      50.6      50.4      50.2      49.9      49.7      49.4      49.1      48.8      48.4
30..................................................      50.0      49.8      49.6      49.4      49.2      49.0      48.7      48.4      48.1      47.8
31..................................................      49.2      49.0      48.9      48.7      48.5      48.3      48.0      47.8      47.5      47.2
32..................................................      48.4      48.2      48.1      47.9      47.7      47.5      47.3      47.1      46.8      46.5
33..................................................      47.6      47.4      47.3      47.1      47.0      46.8      46.6      46.3      46.1      45.9
34..................................................      46.7      46.6      46.5      46.3      46.2      46.0      45.8      45.6      45.4      45.2
35..................................................      45.9      45.8      45.7      45.5      45.4      45.2      45.1      44.9      44.7      44.4
36..................................................      45.0      44.9      44.8      44.7      44.6      44.4      44.3      44.1      43.9      43.7
37..................................................      44.2      44.1      44.0      43.9      43.8      43.6      43.5      43.3      43.2      43.0
38..................................................      43.3      43.2      43.1      43.0      42.9      42.8      42.7      42.5      42.4      42.2
39..................................................      42.4      42.4      42.3      42.2      42.1      42.0      41.9      41.7      41.6      41.4
40..................................................      41.6      41.5      41.4      41.3      41.2      41.1      41.0      40.9      40.8      40.6
41..................................................      40.7      40.6      40.5      40.5      40.4      40.3      40.2      40.1      40.0      39.8
42..................................................      39.8      39.7      39.7      39.6      39.5      39.4      39.4      39.3      39.1      39.0
43..................................................      38.9      38.9      38.8      38.7      38.7      38.6      38.5      38.4      38.3      38.2
44..................................................      38.0      38.0      37.9      37.9      37.8      37.7      37.7      37.6      37.5      37.4
45..................................................      37.1      37.1      37.0      37.0      36.9      36.9      36.8      36.7      36.6      36.5
46..................................................      36.2      36.2      36.2      36.1      36.1      36.0      35.9      35.9      35.8      35.7
47..................................................      35.3      35.3      35.3      35.2      35.2      35.1      35.1      35.0      34.9      34.9
48..................................................      34.5      34.4      34.4      34.4      34.3      34.3      34.2      34.2      34.1      34.0
49..................................................      33.6      33.5      33.5      33.5      33.4      33.4      33.4      33.3      33.2      33.2
50..................................................      32.7      32.7      32.6      32.6      32.6      32.5      32.5      32.4      32.4      32.3
51..................................................      31.8      31.8      31.8      31.7      31.7      31.7      31.6      31.6      31.5      31.5
52..................................................      30.9      30.9      30.9      30.9      30.8      30.8      30.8      30.7      30.7      30.6
53..................................................      30.0      30.0      30.0      30.0      30.0      29.9      29.9      29.9      29.8      29.8
54..................................................      29.2      29.2      29.1      29.1      29.1      29.1      29.0      29.0      29.0      28.9
55..................................................      28.3      28.3      28.3      28.3      28.2      28.2      28.2      28.2      28.1      28.1
56..................................................      27.4      27.4      27.4      27.4      27.4      27.3      27.3      27.3      27.3      27.2
57..................................................      26.6      26.6      26.5      26.5      26.5      26.5      26.5      26.5      26.4      26.4
58..................................................      25.7      25.7      25.7      25.7      25.7      25.6      25.6      25.6      25.6      25.6
59..................................................      24.9      24.8      24.8      24.8      24.8      24.8      24.8      24.8      24.7      24.7
60..................................................      24.0      24.0      24.0      24.0      24.0      23.9      23.9      23.9      23.9      23.9
61..................................................      23.2      23.2      23.1      23.1      23.1      23.1      23.1      23.1      23.1      23.0
62..................................................      22.3      22.3      22.3      22.3      22.3      22.3      22.3      22.2      22.2      22.2
63..................................................      21.5      21.5      21.5      21.5      21.5      21.4      21.4      21.4      21.4      21.4
64..................................................      20.7      20.7      20.7      20.6      20.6      20.6      20.6      20.6      20.6      20.6
65..................................................      19.9      19.8      19.8      19.8      19.8      19.8      19.8      19.8      19.8      19.8
66..................................................      19.1      19.0      19.0      19.0      19.0      19.0      19.0      19.0      19.0      19.0
67..................................................      18.3      18.3      18.3      18.3      18.2      18.2      18.2      18.2      18.2      18.2
68..................................................      17.5      17.5      17.5      17.5      17.5      17.5      17.5      17.5      17.4      17.4
69..................................................      16.7      16.7      16.7      16.7      16.7      16.7      16.7      16.7      16.7      16.7
70..................................................      16.0      16.0      16.0      16.0      16.0      16.0      15.9      15.9      15.9      15.9
71..................................................      15.2      15.2      15.2      15.2      15.2      15.2      15.2      15.2      15.2      15.2
72..................................................      14.5      14.5      14.5      14.5      14.5      14.5      14.5      14.5      14.5      14.5
73..................................................      13.8      13.8      13.8      13.8      13.8      13.8      13.8      13.8      13.8      13.8
74..................................................      13.2      13.1      13.1      13.1      13.1      13.1      13.1      13.1      13.1      13.1
75..................................................      12.5      12.5      12.5      12.5      12.5      12.5      12.5      12.5      12.5      12.5
76..................................................      11.8      11.8      11.8      11.8      11.8      11.8      11.8      11.8      11.8      11.8
77..................................................      11.2      11.2      11.2      11.2      11.2      11.2      11.2      11.2      11.2      11.2
78..................................................      10.6      10.6      10.6      10.6      10.6      10.6      10.6      10.6      10.6      10.6
79..................................................      10.0      10.0      10.0      10.0      10.0      10.0      10.0      10.0      10.0      10.0
80..................................................       9.4       9.4       9.4       9.4       9.4       9.4       9.4       9.4       9.4       9.4
81..................................................       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9
82..................................................       8.4       8.4       8.4       8.4       8.4       8.4       8.4       8.4       8.4       8.4
83..................................................       7.9       7.9       7.9       7.9       7.9       7.9       7.9       7.9       7.8       7.8
84..................................................       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4
85..................................................       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9
86..................................................       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5
87..................................................       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1
88..................................................       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7
89..................................................       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3
90..................................................       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0
91..................................................       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7
92..................................................       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4
93..................................................       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1

[[Page 234]]

 
94..................................................       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9
95..................................................       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.6
96..................................................       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4
97..................................................       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2
98..................................................       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0
99..................................................       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8
100.................................................       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7
101.................................................       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5
102.................................................       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3
103.................................................       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1
104.................................................       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9
105.................................................       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8
106.................................................       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6
107.................................................       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4
108.................................................       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3
109.................................................       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1
110.................................................       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0
111.................................................        .9        .9        .9        .9        .9        .9        .9        .9        .9        .9
112.................................................        .8        .8        .8        .8        .8        .8        .8        .8        .8        .8
113.................................................        .7        .7        .7        .7        .7        .7        .7        .7        .7        .7
114.................................................        .6        .6        .6        .6        .6        .6        .6        .6        .6        .6
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                     Table VIa--Annuities for Joint Life Only; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             25        26        27        28        29        30        31        32        33        34
--------------------------------------------------------------------------------------------------------------------------------------------------------
25..................................................      50.2      49.7      49.2      48.6      48.1      47.5      46.9      46.2      45.6      44.9
26..................................................      49.7      49.2      48.7      48.2      47.7      47.1      46.5      45.9      45.3      44.6
27..................................................      49.2      48.7      48.3      47.8      47.3      46.7      46.2      45.6      45.0      44.3
28..................................................      48.6      48.2      47.8      47.3      46.8      46.3      45.8      45.2      44.6      44.0
29..................................................      48.1      47.7      47.3      46.8      46.4      45.9      45.4      44.8      44.3      43.7
30..................................................      47.5      47.1      46.7      46.3      45.9      45.4      44.9      44.4      43.9      43.3
31..................................................      46.9      46.5      46.2      45.8      45.4      44.9      44.5      44.0      43.5      42.9
32..................................................      46.2      45.9      45.6      45.2      44.8      44.4      44.0      43.5      43.0      42.5
33..................................................      45.6      45.3      45.0      44.6      44.3      43.9      43.5      43.0      42.6      42.1
34..................................................      44.9      44.6      44.3      44.0      43.7      43.3      42.9      42.5      42.1      41.6
35..................................................      44.2      44.0      43.7      43.4      43.1      42.7      42.4      42.0      41.6      41.1
36..................................................      43.5      43.3      43.0      42.7      42.4      42.1      41.8      41.4      41.0      40.6
37..................................................      42.8      42.5      42.3      42.1      41.8      41.5      41.2      40.8      40.5      40.1
38..................................................      42.0      41.8      41.6      41.4      41.1      40.8      40.6      40.2      39.9      39.5
39..................................................      41.3      41.1      40.9      40.7      40.4      40.2      39.9      39.6      39.3      39.0
40..................................................      40.5      40.3      40.1      39.9      39.7      39.5      39.2      39.0      38.7      38.4
41..................................................      39.7      39.5      39.4      39.2      39.0      38.8      38.5      38.3      38.0      37.7
42..................................................      38.9      38.8      38.6      38.4      38.3      38.1      37.8      37.6      37.4      37.1
43..................................................      38.1      38.0      37.8      37.7      37.5      37.3      37.1      36.9      36.7      36.4
44..................................................      37.3      37.2      37.0      36.9      36.7      36.6      36.4      36.2      36.0      35.8
45..................................................      36.5      36.3      36.2      36.1      36.0      35.8      35.6      35.5      35.3      35.1
46..................................................      35.6      35.5      35.4      35.3      35.2      35.0      34.9      34.7      34.5      34.4
47..................................................      34.8      34.7      34.6      34.5      34.4      34.3      34.1      34.0      33.8      33.6
48..................................................      34.0      33.9      33.8      33.7      33.6      33.5      33.4      33.2      33.1      32.9
49..................................................      33.1      33.0      33.0      32.9      32.8      32.7      32.6      32.4      32.3      32.2
50..................................................      32.3      32.2      32.1      32.1      32.0      31.9      31.8      31.7      31.5      31.4
51..................................................      31.4      31.4      31.3      31.2      31.2      31.1      31.0      30.9      30.8      30.6
52..................................................      30.6      30.5      30.5      30.4      30.3      30.3      30.2      30.1      30.0      29.9
53..................................................      29.7      29.7      29.6      29.6      29.5      29.5      29.4      29.3      29.2      29.1
54..................................................      28.9      28.9      28.8      28.8      28.7      28.6      28.6      28.5      28.4      28.3
55..................................................      28.1      28.0      28.0      27.9      27.9      27.8      27.8      27.7      27.6      27.5
56..................................................      27.2      27.2      27.1      27.1      27.0      27.0      26.9      26.9      26.8      26.7
57..................................................      26.4      26.3      26.3      26.3      26.2      26.2      26.1      26.1      26.0      25.9
58..................................................      25.5      25.5      25.5      25.4      25.4      25.4      25.3      25.3      25.2      25.1
59..................................................      24.7      24.7      24.6      24.6      24.6      24.5      24.5      24.5      24.4      24.3
60..................................................      23.9      23.8      23.8      23.8      23.8      23.7      23.7      23.6      23.6      23.5
61..................................................      23.0      23.0      23.0      23.0      22.9      22.9      22.9      22.8      22.8      22.7
62..................................................      22.2      22.2      22.2      22.1      22.1      22.1      22.1      22.0      22.0      21.9
63..................................................      21.4      21.4      21.3      21.3      21.3      21.3      21.3      21.2      21.2      21.2
64..................................................      20.6      20.6      20.5      20.5      20.5      20.5      20.5      20.4      20.4      20.4
65..................................................      19.8      19.8      19.7      19.7      19.7      19.7      19.7      19.6      19.6      19.6
66..................................................      19.0      19.0      19.0      18.9      18.9      18.9      18.9      18.9      18.8      18.8
67..................................................      18.2      18.2      18.2      18.2      18.2      18.1      18.1      18.1      18.1      18.1

[[Page 235]]

 
68..................................................      17.4      17.4      17.4      17.4      17.4      17.4      17.4      17.3      17.3      17.3
69..................................................      16.7      16.7      16.7      16.6      16.6      16.6      16.6      16.6      16.6      16.6
70..................................................      15.9      15.9      15.9      15.9      15.9      15.9      15.9      15.9      15.8      15.8
71..................................................      15.2      15.2      15.2      15.2      15.2      15.2      15.2      15.1      15.1      15.1
72..................................................      14.5      14.5      14.5      14.5      14.5      14.5      14.5      14.4      14.4      14.4
73..................................................      13.8      13.8      13.8      13.8      13.8      13.8      13.8      13.8      13.7      13.7
74..................................................      13.1      13.1      13.1      13.1      13.1      13.1      13.1      13.1      13.1      13.1
75..................................................      12.5      12.5      12.5      12.4      12.4      12.4      12.4      12.4      12.4      12.4
76..................................................      11.8      11.8      11.8      11.8      11.8      11.8      11.8      11.8      11.8      11.8
77..................................................      11.2      11.2      11.2      11.2      11.2      11.2      11.2      11.2      11.2      11.1
78..................................................      10.6      10.6      10.6      10.6      10.6      10.6      10.6      10.6      10.6      10.5
79..................................................      10.0      10.0      10.0      10.0      10.0      10.0      10.0      10.0      10.0      10.0
80..................................................       9.4       9.4       9.4       9.4       9.4       9.4       9.4       9.4       9.4       9.4
81..................................................       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9
82..................................................       8.4       8.4       8.3       8.3       8.3       8.3       8.3       8.3       8.3       8.3
83..................................................       7.8       7.8       7.8       7.8       7.8       7.8       7.8       7.8       7.8       7.8
84..................................................       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4
85..................................................       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9
86..................................................       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5
87..................................................       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1
88..................................................       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7
89..................................................       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3
90..................................................       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0
91..................................................       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7
92..................................................       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4
93..................................................       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1
94..................................................       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9
95..................................................       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.6
96..................................................       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4
97..................................................       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2
98..................................................       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0
99..................................................       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8
100.................................................       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7
101.................................................       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5
102.................................................       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3
103.................................................       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1
104.................................................       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9
105.................................................       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8
106.................................................       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6
107.................................................       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4
108.................................................       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3
109.................................................       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1
110.................................................       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0
111.................................................        .9        .9        .9        .9        .9        .9        .9        .9        .9        .9
112.................................................        .8        .8        .8        .8        .8        .8        .8        .8        .8        .8
113.................................................        .7        .7        .7        .7        .7        .7        .7        .7        .7        .7
114.................................................        .6        .6        .6        .6        .6        .6        .6        .6        .6        .6
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                     Table VIa--Annuities for Joint Life Only; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             35        36        37        38        39        40        41        42        43        44
--------------------------------------------------------------------------------------------------------------------------------------------------------
35..................................................      40.7      40.2      39.7      39.2      38.6      38.0      37.4      36.8      36.2      35.5
36..................................................      40.2      39.7      39.3      38.7      38.2      37.7      37.1      36.5      35.9      35.2
37..................................................      39.7      39.3      38.8      38.3      37.8      37.3      36.7      36.2      35.6      34.9
38..................................................      39.2      38.7      38.3      37.9      37.4      36.9      36.3      35.8      35.2      34.6
39..................................................      38.6      38.2      37.8      37.4      36.9      36.4      35.9      35.4      34.9      34.3
40..................................................      38.0      37.7      37.3      36.9      36.4      36.0      35.5      35.0      34.5      34.0
41..................................................      37.4      37.1      36.7      36.3      35.9      35.5      35.1      34.6      34.1      33.6
42..................................................      36.8      36.5      36.2      35.8      35.4      35.0      34.6      34.1      33.7      33.2
43..................................................      36.2      35.9      35.6      35.2      34.9      34.5      34.1      33.7      33.2      32.8
44..................................................      35.5      35.2      34.9      34.6      34.3      34.0      33.6      33.2      32.8      32.3
45..................................................      34.8      34.6      34.3      34.0      33.7      33.4      33.0      32.7      32.3      31.8
46..................................................      34.1      33.9      33.7      33.4      33.1      32.8      32.5      32.1      31.8      31.4
47..................................................      33.4      33.2      33.0      32.8      32.5      32.2      31.9      31.6      31.2      30.8
48..................................................      32.7      32.5      32.3      32.1      31.8      31.6      31.3      31.0      30.7      30.3
49..................................................      32.0      31.8      31.6      31.4      31.2      30.9      30.7      30.4      30.1      29.8
50..................................................      31.3      31.1      30.9      30.7      30.5      30.3      30.0      29.8      29.5      29.2
51..................................................      30.5      30.4      30.2      30.0      29.8      29.6      29.4      29.2      28.9      28.6

[[Page 236]]

 
52..................................................      29.7      29.6      29.5      29.3      29.1      28.9      28.7      28.5      28.3      28.0
53..................................................      29.0      28.9      28.7      28.6      28.4      28.2      28.1      27.9      27.6      27.4
54..................................................      28.2      28.1      28.0      27.8      27.7      27.5      27.4      27.2      27.0      26.8
55..................................................      27.4      27.3      27.2      27.1      27.0      26.8      26.7      26.5      26.3      26.1
56..................................................      26.7      26.6      26.5      26.3      26.2      26.1      26.0      25.8      25.6      25.4
57..................................................      25.9      25.8      25.7      25.6      25.5      25.4      25.2      25.1      24.9      24.8
58..................................................      25.1      25.0      24.9      24.8      24.7      24.6      24.5      24.4      24.2      24.1
59..................................................      24.3      24.2      24.1      24.1      24.0      23.9      23.8      23.6      23.5      23.4
60..................................................      23.5      23.4      23.4      23.3      23.2      23.1      23.0      22.9      22.8      22.7
61..................................................      22.7      22.6      22.6      22.5      22.4      22.4      22.3      22.2      22.1      22.0
62..................................................      21.9      21.9      21.8      21.7      21.7      21.6      21.5      21.4      21.3      21.2
63..................................................      21.1      21.1      21.0      21.0      20.9      20.8      20.8      20.7      20.6      20.5
64..................................................      20.3      20.3      20.2      20.2      20.1      20.1      20.0      20.0      19.9      19.8
65..................................................      19.6      19.5      19.5      19.4      19.4      19.3      19.3      19.2      19.1      19.1
66..................................................      18.8      18.8      18.7      18.7      18.6      18.6      18.5      18.5      18.4      18.4
67..................................................      18.0      18.0      18.0      17.9      17.9      17.9      17.8      17.8      17.7      17.6
68..................................................      17.3      17.3      17.2      17.2      17.2      17.1      17.1      17.0      17.0      16.9
69..................................................      16.5      16.5      16.5      16.5      16.4      16.4      16.4      16.3      16.3      16.2
70..................................................      15.8      15.8      15.8      15.7      15.7      15.7      15.6      15.6      15.6      15.5
71..................................................      15.1      15.1      15.1      15.0      15.0      15.0      15.0      14.9      14.9      14.9
72..................................................      14.4      14.4      14.4      14.3      14.3      14.3      14.3      14.2      14.2      14.2
73..................................................      13.7      13.7      13.7      13.7      13.7      13.6      13.6      13.6      13.6      13.5
74..................................................      13.1      13.0      13.0      13.0      13.0      13.0      13.0      12.9      12.9      12.9
75..................................................      12.4      12.4      12.4      12.4      12.3      12.3      12.3      12.3      12.3      12.2
76..................................................      11.8      11.8      11.7      11.7      11.7      11.7      11.7      11.7      11.6      11.6
77..................................................      11.1      11.1      11.1      11.1      11.1      11.1      11.1      11.1      11.0      11.0
78..................................................      10.5      10.5      10.5      10.5      10.5      10.5      10.5      10.5      10.5      10.4
79..................................................      10.0      10.0       9.9       9.9       9.9       9.9       9.9       9.9       9.9       9.9
80..................................................       9.4       9.4       9.4       9.4       9.4       9.4       9.4       9.3       9.3       9.3
81..................................................       8.9       8.8       8.8       8.8       8.8       8.8       8.8       8.8       8.8       8.8
82..................................................       8.3       8.3       8.3       8.3       8.3       8.3       8.3       8.3       8.3       8.3
83..................................................       7.8       7.8       7.8       7.8       7.8       7.8       7.8       7.8       7.8       7.8
84..................................................       7.3       7.3       7.3       7.3       7.3       7.3       7.3       7.3       7.3       7.3
85..................................................       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9
86..................................................       6.5       6.5       6.5       6.5       6.4       6.4       6.4       6.4       6.4       6.4
87..................................................       6.1       6.0       6.0       6.0       6.0       6.0       6.0       6.0       6.0       6.0
88..................................................       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.6       5.6       5.6
89..................................................       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3
90..................................................       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0
91..................................................       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.6       4.6
92..................................................       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4
93..................................................       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1
94..................................................       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9
95..................................................       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.6
96..................................................       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4
97..................................................       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2
98..................................................       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0
99..................................................       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8
100.................................................       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.6       2.6
101.................................................       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5
102.................................................       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3
103.................................................       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1
104.................................................       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9
105.................................................       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8
106.................................................       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6
107.................................................       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4
108.................................................       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3
109.................................................       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1
110.................................................       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0
111.................................................        .9        .9        .9        .9        .9        .9        .9        .9        .9        .9
112.................................................        .8        .8        .8        .8        .8        .8        .8        .8        .8        .8
113.................................................        .7        .7        .7        .7        .7        .7        .7        .7        .7        .7
114.................................................        .6        .6        .6        .6        .6        .6        .6        .6        .6        .6
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                     Table VIa--Annuities for Joint Life Only; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             45        46        47        48        49        50        51        52        53        54
--------------------------------------------------------------------------------------------------------------------------------------------------------
45..................................................      31.4      30.9      30.5      30.0      29.4      28.9      28.3      27.7      27.1      26.5

[[Page 237]]

 
46..................................................      30.9      30.5      30.0      29.6      29.1      28.5      28.0      27.4      26.9      26.3
47..................................................      30.5      30.0      29.6      29.2      28.7      28.2      27.7      27.1      26.6      26.0
48..................................................      30.0      29.6      29.2      28.7      28.3      27.8      27.3      26.8      26.3      25.7
49..................................................      29.4      29.1      28.7      28.3      27.9      27.4      26.9      26.5      25.9      25.4
50..................................................      28.9      28.5      28.2      27.4      27.4      27.0      26.5      26.1      25.6      25.1
51..................................................      28.3      28.0      27.7      27.3      26.9      26.5      26.1      25.7      25.2      24.7
52..................................................      27.7      27.4      27.1      26.8      26.5      26.1      25.7      25.3      24.8      24.4
53..................................................      27.1      26.9      26.6      26.3      25.9      25.6      25.2      24.8      24.4      24.0
54..................................................      26.5      26.3      26.0      25.7      25.4      25.1      24.7      24.4      24.0      23.6
55..................................................      25.9      25.7      25.4      25.1      24.9      24.6      24.2      23.9      23.5      23.2
56..................................................      25.2      25.0      24.8      24.6      24.3      24.0      23.7      23.4      23.1      22.7
57..................................................      24.6      24.4      24.2      24.0      23.7      23.5      23.2      22.9      22.6      22.2
58..................................................      23.9      23.7      23.5      23.3      23.1      22.9      22.6      22.4      22.1      21.7
59..................................................      23.2      23.1      22.9      22.7      22.5      22.3      22.1      21.8      21.5      21.2
60..................................................      22.5      22.4      22.2      22.1      21.9      21.7      21.5      21.2      21.0      20.7
61..................................................      21.8      21.7      21.6      21.4      21.2      21.1      20.9      20.6      20.4      20.2
62..................................................      21.1      21.0      20.9      20.7      20.6      20.4      20.2      20.0      19.8      19.6
63..................................................      20.4      20.3      20.2      20.1      19.9      19.8      19.6      19.4      19.2      19.0
64..................................................      19.7      19.6      19.5      19.4      19.3      19.1      19.0      18.8      18.6      18.5
65..................................................      19.0      18.9      18.8      18.7      18.6      18.5      18.3      18.2      18.0      17.9
66..................................................      18.3      18.2      18.1      18.0      17.9      17.8      17.7      17.6      17.4      17.3
67..................................................      17.6      17.5      17.4      17.3      17.3      17.2      17.1      16.9      16.8      16.7
68..................................................      16.9      16.8      16.7      16.7      16.6      16.5      16.4      16.3      16.2      16.1
69..................................................      16.2      16.1      16.1      16.0      15.9      15.8      15.8      15.7      15.6      15.4
70..................................................      15.5      15.4      15.4      15.3      15.3      15.2      15.1      15.0      14.9      14.8
71..................................................      14.8      14.8      14.7      14.7      14.6      14.5      14.5      14.4      14.3      14.2
72..................................................      14.1      14.1      14.1      14.0      14.0      13.9      13.8      13.8      13.7      13.6
73..................................................      13.5      13.5      13.4      13.4      13.3      13.3      13.2      13.2      13.1      13.0
74..................................................      12.8      12.8      12.8      12.7      12.7      12.7      12.6      12.6      12.5      12.4
75..................................................      12.2      12.2      12.2      12.1      12.1      12.1      12.0      12.0      11.9      11.9
76..................................................      11.6      11.6      11.6      11.5      11.5      11.5      11.4      11.4      11.3      11.3
77..................................................      11.0      11.0      11.0      10.9      10.9      10.9      10.8      10.8      10.8      10.7
78..................................................      10.4      10.4      10.4      10.4      10.3      10.3      10.3      10.2      10.2      10.2
79..................................................       9.9       9.8       9.8       9.8       9.8       9.8       9.7       9.7       9.7       9.6
80..................................................       9.3       9.3       9.3       9.3       9.2       9.2       9.2       9.2       9.1       9.1
81..................................................       8.8       8.8       8.7       8.7       8.7       8.7       8.7       8.7       8.6       8.6
82..................................................       8.3       8.2       8.2       8.2       8.2       8.2       8.2       8.2       8.1       8.1
83..................................................       7.8       7.8       7.7       7.7       7.7       7.7       7.7       7.7       7.7       7.6
84..................................................       7.3       7.3       7.3       7.3       7.3       7.2       7.2       7.2       7.2       7.2
85..................................................       6.8       6.8       6.8       6.8       6.8       6.8       6.8       6.8       6.8       6.7
86..................................................       6.4       6.4       6.4       6.4       6.4       6.4       6.4       6.4       6.3       6.3
87..................................................       6.0       6.0       6.0       6.0       6.0       6.0       6.0       6.0       6.0       5.9
88..................................................       5.6       5.6       5.6       5.6       5.6       5.6       5.6       5.6       5.6       5.6
89..................................................       5.3       5.3       5.3       5.3       5.3       5.3       5.2       5.2       5.2       5.2
90..................................................       5.0       4.9       4.9       4.9       4.9       4.9       4.9       4.9       4.9       4.9
91..................................................       4.6       4.6       4.6       4.6       4.6       4.6       4.6       4.6       4.6       4.6
92..................................................       4.4       4.4       4.4       4.3       4.3       4.3       4.3       4.3       4.3       4.3
93..................................................       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1
94..................................................       3.9       3.9       3.8       3.8       3.8       3.8       3.8       3.8       3.8       3.8
95..................................................       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.6
96..................................................       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4
97..................................................       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2
98..................................................       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0
99..................................................       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8
100.................................................       2.6       2.6       2.6       2.6       2.6       2.6       2.6       2.6       2.6       2.6
101.................................................       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5
102.................................................       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3
103.................................................       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1
104.................................................       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9
105.................................................       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8
106.................................................       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6
107.................................................       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4
108.................................................       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3
109.................................................       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1
110.................................................       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0
111.................................................        .9        .9        .9        .9        .9        .9        .9        .9        .9        .9
112.................................................        .8        .8        .8        .8        .8        .8        .8        .8        .8        .8
113.................................................        .7        .7        .7        .7        .7        .7        .7        .7        .7        .7
114.................................................        .6        .6        .6        .6        .6        .6        .6        .6        .6        .6
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 238]]


                                     Table VIa--Annuities for Joint Life Only; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             55        56        57        58        59        60        61        62        63        64
--------------------------------------------------------------------------------------------------------------------------------------------------------
55..................................................      22.7      22.3      21.9      21.4      20.9      20.4      19.9      19.4      18.8      18.3
56..................................................      22.3      21.9      21.5      21.1      20.6      20.1      19.6      19.1      18.6      18.0
57..................................................      21.9      21.5      21.1      20.7      20.3      19.8      19.3      18.8      18.3      17.8
58..................................................      21.4      21.1      20.7      20.3      19.9      19.5      19.0      18.5      18.0      17.5
59..................................................      20.9      20.6      20.3      19.9      19.5      19.1      18.7      18.2      17.7      17.3
60..................................................      20.4      20.1      19.8      19.5      19.1      18.7      18.3      17.9      17.4      17.0
61..................................................      29.9      19.6      19.3      19.0      18.7      18.3      17.9      17.5      17.1      16.7
62..................................................      19.4      19.1      18.8      18.5      18.2      17.9      17.5      17.1      16.8      16.3
63..................................................      18.8      18.6      18.3      18.0      17.7      17.4      17.1      16.8      16.4      16.0
64..................................................      18.3      18.0      17.8      17.5      17.3      17.0      16.7      16.3      16.0      15.6
65..................................................      17.7      17.5      17.3      17.0      16.8      16.5      16.2      15.9      15.6      15.3
66..................................................      17.1      16.9      16.7      16.5      16.3      16.0      15.8      15.5      15.2      14.9
67..................................................      16.5      16.3      16.2      16.0      15.8      15.5      15.3      15.0      14.7      14.5
68..................................................      15.9      15.8      15.6      15.4      15.2      15.0      14.8      14.6      14.3      14.0
69..................................................      15.3      15.2      15.0      14.9      14.7      14.5      14.3      14.1      13.9      13.6
70..................................................      14.7      14.6      14.5      14.3      14.2      14.0      13.8      13.6      13.4      13.2
71..................................................      14.1      14.0      13.9      13.8      13.6      13.5      13.3      13.1      12.9      12.7
72..................................................      13.5      13.4      13.3      13.2      13.1      12.9      12.8      12.6      12.4      12.3
73..................................................      13.0      12.9      12.8      12.7      12.5      12.4      12.3      12.1      12.0      11.8
74..................................................      12.4      12.3      12.2      12.1      12.0      11.9      11.8      11.6      11.5      11.3
75..................................................      11.8      11.7      11.7      11.6      11.5      11.4      11.3      11.1      11.0      10.9
76..................................................      11.2      11.2      11.1      11.0      10.9      10.9      10.8      10.6      10.5      10.4
77..................................................      10.7      10.6      10.6      10.5      10.4      10.3      10.3      10.2      10.0       9.9
78..................................................      10.1      10.1      10.0      10.0       9.9       9.8       9.8       9.7       9.6       9.5
79..................................................       9.6       9.6       9.5       9.5       9.4       9.3       9.3       9.2       9.1       9.0
80..................................................       9.1       9.0       9.0       9.0       8.9       8.9       8.8       8.7       8.7       8.6
81..................................................       8.6       8.5       8.5       8.5       8.4       8.4       8.3       8.3       8.2       8.1
82..................................................       8.1       8.1       8.0       8.0       8.0       7.9       7.9       7.8       7.8       7.7
83..................................................       7.6       7.6       7.6       7.5       7.5       7.5       7.4       7.4       7.3       7.3
84..................................................       7.2       7.1       7.1       7.1       7.1       7.0       7.0       7.0       6.9       6.9
85..................................................       6.7       6.7       6.7       6.7       6.6       6.6       6.6       6.5       6.5       6.5
86..................................................       6.3       6.3       6.3       6.3       6.2       6.2       6.2       6.2       6.1       6.1
87..................................................       5.9       5.9       5.9       5.9       5.9       5.8       5.8       5.8       5.8       5.7
88..................................................       5.6       5.5       5.5       5.5       5.5       5.5       5.5       5.4       5.4       5.4
89..................................................       5.2       5.2       5.2       5.2       5.2       5.1       5.1       5.1       5.1       5.1
90..................................................       4.9       4.9       4.9       4.9       4.9       4.8       4.8       4.8       4.8       4.8
91..................................................       4.6       4.6       4.6       4.6       4.6       4.5       4.5       4.5       4.5       4.5
92..................................................       4.3       4.3       4.3       4.3       4.3       4.3       4.3       4.2       4.2       4.2
93..................................................       4.1       4.1       4.0       4.0       4.0       4.0       4.0       4.0       4.0       4.0
94..................................................       3.8       3.8       3.8       3.8       3.8       3.8       3.8       3.8       3.8       3.7
95..................................................       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.6       3.5       3.5
96..................................................       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.3       3.3       3.3
97..................................................       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.1       3.1
98..................................................       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0
99..................................................       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8
100.................................................       2.6       2.6       2.6       2.6       2.6       2.6       2.6       2.6       2.6       2.6
101.................................................       2.5       2.4       2.4       2.4       2.4       2.4       2.4       2.4       2.4       2.4
102.................................................       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.2
103.................................................       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1
104.................................................       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9
105.................................................       1.8       1.8       1.8       1.8       1.8       1.8       1.7       1.7       1.7       1.7
106.................................................       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6
107.................................................       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4
108.................................................       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3
109.................................................       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1
110.................................................       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0
111.................................................        .9        .9        .9        .9        .9        .9        .9        .9        .9        .9
112.................................................        .8        .8        .8        .8        .8        .8        .8        .8        .8        .8
113.................................................        .7        .7        .7        .7        .7        .7        .7        .7        .7        .7
114.................................................        .6        .6        .6        .6        .6        .6        .6        .6        .6        .6
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                     Table VIa--Annuities for Joint Life Only; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             65        66        67        68        69        70        71        72        73        74
--------------------------------------------------------------------------------------------------------------------------------------------------------
65..................................................      14.9      14.5      14.1      13.7      13.3      12.9      12.5      12.0      11.6      11.2
66..................................................      14.5      14.2      13.8      13.4      13.1      12.6      12.2      11.8      11.4      11.0
67..................................................      14.1      13.8      13.5      13.1      12.8      12.4      12.0      11.6      11.2      10.8
68..................................................      13.7      13.4      13.1      12.8      12.5      12.1      11.7      11.4      11.0      10.6
69..................................................      13.3      13.1      12.8      12.5      12.1      11.8      11.4      11.1      10.7      10.4

[[Page 239]]

 
70..................................................      12.9      12.6      12.4      12.1      11.8      11.5      11.2      10.8      10.5      10.1
71..................................................      12.5      12.2      12.0      11.7      11.4      11.2      10.9      10.5      10.2       9.9
72..................................................      12.0      11.8      11.6      11.4      11.1      10.8      10.5      10.2       9.9       9.6
73..................................................      11.6      11.4      11.2      11.0      10.7      10.5      10.2       9.9       9.7       9.4
74..................................................      11.2      11.0      10.8      10.6      10.4      10.1       9.9       9.6       9.4       9.1
75..................................................      10.7      10.5      10.4      10.2      10.0       9.8       9.5       9.3       9.1       8.8
76..................................................      10.3      10.1       9.9       9.8       9.6       9.4       9.2       9.0       8.8       8.5
77..................................................       9.8       9.7       9.5       9.4       9.2       9.0       8.8       8.6       8.4       8.2
78..................................................       9.4       9.2       9.1       9.0       8.8       8.7       8.5       8.3       8.1       7.9
79..................................................       8.9       8.8       8.7       8.6       8.4       8.3       8.1       8.0       7.8       7.6
80..................................................       8.5       8.4       8.3       8.2       8.0       7.9       7.8       7.6       7.5       7.3
81..................................................       8.0       8.0       7.9       7.9       7.7       7.5       7.4       7.3       7.1       7.0
82..................................................       7.6       7.5       7.5       7.4       7.3       7.2       7.1       6.9       6.8       6.7
83..................................................       7.2       7.1       7.1       7.0       6.9       6.8       6.7       6.6       6.5       6.4
84..................................................       6.8       6.7       6.7       6.6       6.5       6.4       6.4       6.3       6.2       6.0
85..................................................       6.4       6.4       6.3       6.2       6.2       6.1       6.0       5.9       5.8       5.7
86..................................................       6.0       6.0       5.9       5.9       5.8       5.8       5.7       5.6       5.5       5.4
87..................................................       5.7       5.6       5.6       5.6       5.5       5.4       5.4       5.3       5.2       5.2
88..................................................       5.3       5.3       5.3       5.2       5.2       5.1       5.1       5.0       5.0       4.9
89..................................................       5.0       5.0       5.0       4.9       4.9       4.8       4.8       4.7       4.7       4.6
90..................................................       4.7       4.7       4.7       4.6       4.6       4.6       4.5       4.5       4.4       4.4
91..................................................       4.5       4.4       4.4       4.4       4.3       4.3       4.3       4.2       4.2       4.1
92..................................................       4.2       4.2       4.1       4.1       4.1       4.1       4.0       4.0       3.9       3.9
93..................................................       3.9       3.9       3.9       3.9       3.9       3.8       3.8       3.8       3.7       3.7
94..................................................       3.7       3.7       3.7       3.7       3.6       3.6       3.6       3.6       3.5       3.5
95..................................................       3.5       3.5       3.5       3.5       3.4       3.4       3.4       3.4       3.3       3.3
96..................................................       3.3       3.3       3.3       3.3       3.3       3.2       3.2       3.2       3.2       3.1
97..................................................       3.1       3.1       3.1       3.1       3.1       3.1       3.0       3.0       3.0       3.0
98..................................................       2.9       2.9       2.9       2.9       2.9       2.9       2.9       2.9       2.8       2.8
99..................................................       2.8       2.8       2.8       2.7       2.7       2.7       2.7       2.7       2.7       2.6
100.................................................       2.6       2.6       2.6       2.6       2.6       2.5       2.5       2.5       2.5       2.5
101.................................................       2.4       2.4       2.4       2.4       2.4       2.4       2.4       2.4       2.3       2.3
102.................................................       2.2       2.2       2.2       2.2       2.2       2.2       2.2       2.2       2.2       2.2
103.................................................       2.1       2.1       2.1       2.1       2.1       2.0       2.0       2.0       2.0       2.0
104.................................................       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       .19       1.9
105.................................................       1.7       1.7       1.7       1.7       .17       1.7       1.7       1.7       1.7       1.7
106.................................................       1.6       1.6       .16       1.6       1.6       1.6       1.6       1.6       1.5       1.5
107.................................................       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4
108.................................................       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3
109.................................................       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1
110.................................................       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0
111.................................................        .9        .9        .9        .9        .9        .9        .9        .9        .9        .9
112.................................................        .8        .8        .8        .8        .8        .8        .8        .8        .8        .8
113.................................................        .7        .7        .7        .7        .7        .6        .6        .6        .6        .6
114.................................................        .6        .6        .6        .6        .6        .6        .5        .5        .5        .5
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                     Table VIa--Annuities for Joint Life Only; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             75        76        77        78        79        80        81        82        83        84
--------------------------------------------------------------------------------------------------------------------------------------------------------
75..................................................       8.6       8.3       8.0       7.7       7.4       7.1       6.8       6.5       6.2       5.9
76..................................................       8.3       8.0       7.8       7.5       7.2       6.9       6.7       6.4       6.1       5.8
77..................................................       8.0       7.8       7.5       7.3       7.0       6.8       6.5       6.2       5.9       5.7
78..................................................       7.7       7.5       7.3       7.0       6.8       6.6       6.3       6.0       5.8       5.5
79..................................................       7.4       7.2       7.0       6.8       6.6       6.3       6.1       5.9       5.6       5.4
80..................................................       7.1       6.9       6.8       6.6       6.3       6.1       5.9       5.7       5.5       5.2
81..................................................       6.8       6.7       6.5       6.3       6.1       5.9       5.7       5.5       5.3       5.1
82..................................................       6.5       6.4       6.2       6.0       5.9       5.7       5.5       5.3       5.1       4.9
83..................................................       6.2       6.1       5.9       5.8       5.6       5.5       5.3       5.1       4.9       4.7
84..................................................       5.9       5.8       5.7       5.5       5.4       5.2       5.1       4.9       4.7       4.6
85..................................................       5.6       5.5       5.4       5.3       5.2       5.0       4.9       4.7       4.6       4.4
86..................................................       5.4       5.3       5.1       5.0       4.9       4.8       4.7       4.5       4.4       4.2
87..................................................       5.1       5.0       4.9       4.8       4.7       4.6       4.4       4.3       4.2       4.1
88..................................................       4.8       4.7       4.6       4.5       4.4       4.3       4.2       4.1       4.0       3.9
89..................................................       4.5       4.5       4.4       4.3       4.2       4.1       4.0       3.9       3.8       3.7
90..................................................       4.3       4.2       4.2       4.1       4.0       3.9       3.8       3.8       3.7       3.5
91..................................................       4.1       4.0       4.0       3.9       3.8       3.7       3.7       3.6       3.5       3.4
92..................................................       3.9       3.8       3.7       3.7       3.6       3.6       3.5       3.4       3.3       3.2
93..................................................       3.7       3.6       3.6       3.5       3.4       3.4       3.3       3.2       3.2       3.1

[[Page 240]]

 
94..................................................       3.5       3.4       3.4       3.3       3.3       3.2       3.2       3.1       3.0       3.0
95..................................................       3.3       3.2       3.2       3.2       3.1       3.1       3.0       3.0       2.9       2.8
96..................................................       3.1       3.1       3.0       3.0       3.0       2.9       2.9       2.8       2.8       2.7
97..................................................       2.9       2.9       2.9       2.9       2.8       2.8       2.7       2.7       2.6       2.6
98..................................................       2.8       2.8       2.7       2.7       2.7       2.6       2.6       2.6       2.5       2.5
99..................................................       2.6       2.6       2.6       2.6       2.5       2.5       2.5       2.4       2.4       2.3
100.................................................       2.5       2.5       2.4       2.4       2.4       2.4       2.3       2.3       2.3       2.2
101.................................................       2.3       2.3       2.3       2.3       2.2       2.2       2.2       2.2       2.1       2.1
102.................................................       2.2       2.1       2.1       2.1       2.1       2.1       2.0       2.0       2.0       2.0
103.................................................       2.0       2.0       2.0       2.0       1.9       1.9       1.9       1.9       1.9       1.8
104.................................................       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.7       1.7       1.7
105.................................................       1.7       1.7       1.7       1.7       1.6       1.6       1.6       1.6       1.6       1.6
106.................................................       1.5       1.5       1.5       1.5       1.5       1.5       1.5       1.5       1.5       1.4
107.................................................       1.4       1.4       1.4       1.4       1.4       1.4       1.3       1.3       1.3       1.3
108.................................................       1.3       1.2       1.2       1.2       1.2       1.2       1.2       1.2       1.2       1.2
109.................................................       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1
110.................................................       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0
111.................................................        .9        .9        .9        .9        .9        .9        .9        .9        .8        .8
112.................................................        .8        .8        .8        .7        .7        .7        .7        .7        .7        .7
113.................................................        .6        .6        .6        .6        .6        .6        .6        .6        .6        .6
114.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                     Table VIa--Annuities for Joint Life Only; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             85        86        87        88        89        90        91        92        93        94
--------------------------------------------------------------------------------------------------------------------------------------------------------
85..................................................       4.2       4.1       3.9       3.8       3.6       3.4       3.3       3.2       3.0       2.9
86..................................................       4.1       3.9       3.8       3.6       3.5       3.3       3.2       3.1       2.9       2.8
87..................................................       3.9       3.8       3.6       3.5       3.4       3.2       3.1       3.0       2.8       2.7
88..................................................       3.8       3.6       3.5       3.4       3.2       3.1       3.0       2.9       2.8       2.6
89..................................................       3.6       3.5       3.4       3.2       3.1       3.0       2.9       2.8       2.7       2.6
90..................................................       3.4       3.3       3.2       3.1       3.0       2.9       2.8       2.7       2.6       2.5
91..................................................       3.3       3.2       3.1       3.0       2.9       2.8       2.7       2.6       2.5       2.4
92..................................................       3.2       3.1       3.0       2.9       2.8       2.7       2.6       2.5       2.4       2.3
93..................................................       3.0       2.9       2.8       2.8       2.7       2.6       2.5       2.4       2.3       2.3
94..................................................       2.9       2.8       2.7       2.6       2.6       2.5       2.4       2.3       2.3       2.2
95..................................................       2.8       2.7       2.6       2.5       2.5       2.4       2.3       2.2       2.2       2.1
96..................................................       2.6       2.6       2.5       2.4       2.4       2.3       2.2       2.2       2.1       2.0
97..................................................       2.5       2.5       2.4       2.3       2.3       2.2       2.2       2.1       2.0       2.0
98..................................................       2.4       2.4       2.3       2.2       2.2       2.1       2.1       2.0       2.0       1.9
99..................................................       2.3       2.2       2.2       2.1       2.1       2.0       2.0       1.9       1.9       1.8
100.................................................       2.2       2.1       2.1       2.0       2.0       1.9       1.9       1.9       1.8       1.8
101.................................................       2.1       2.0       2.0       1.9       1.9       1.9       1.8       1.8       1.7       1.7
102.................................................       1.9       1.9       1.9       1.8       1.8       1.8       1.7       1.7       1.6       1.6
103.................................................       1.8       1.8       1.8       1.7       1.7       1.7       1.6       1.6       1.5       1.5
104.................................................       1.7       1.7       1.6       1.6       1.6       1.5       1.5       1.5       1.5       1.4
105.................................................       1.6       1.5       1.5       1.5       1.5       1.4       1.4       1.4       1.4       1.3
106.................................................       1.4       1.4       1.4       1.4       1.4       1.3       1.3       1.3       1.3       1.2
107.................................................       1.3       1.3       1.3       1.3       1.2       1.2       1.2       1.2       1.2       1.2
108.................................................       1.2       1.2       1.2       1.1       1.1       1.1       1.1       1.1       1.1       1.1
109.................................................       1.1       1.1       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0
110.................................................        .9        .9        .9        .9        .9        .9        .9        .9        .9        .9
111.................................................        .8        .8        .8        .8        .8        .8        .8        .8        .8        .8
112.................................................        .7        .7        .7        .7        .7        .7        .7        .7        .7        .7
113.................................................        .6        .6        .6        .6        .6        .6        .6        .6        .6        .6
114.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                     Table VIa--Annuities for Joint Life Only; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Ages                             95        96        97        98        99        100       101       102       103       104
--------------------------------------------------------------------------------------------------------------------------------------------------------
95..................................................       2.0       2.0       1.9       1.8       1.8       1.7       1.6       1.6       1.5       1.4
96..................................................       2.0       1.9       1.9       1.8       1.7       1.7       1.6       1.5       1.5       1.4
97..................................................       1.9       1.9       1.8       1.7       1.7       1.6       1.6       1.5       1.4       1.3
98..................................................       1.8       1.8       1.7       1.7       1.6       1.6       1.5       1.5       1.4       1.3
99..................................................       1.8       1.7       1.7       1.6       1.6       1.5       1.5       1.4       1.4       1.3
100.................................................       1.7       1.7       1.6       1.6       1.5       1.5       1.4       1.4       1.3       1.3

[[Page 241]]

 
101.................................................       1.6       1.6       1.6       1.5       1.5       1.4       1.4       1.3       1.3       1.2
102.................................................       1.6       1.5       1.5       1.5       1.4       1.4       1.3       1.3       1.2       1.2
103.................................................       1.5       1.5       1.4       1.4       1.4       1.3       1.3       1.2       1.2       1.1
104.................................................       1.4       1.4       1.3       1.3       1.3       1.3       1.2       1.2       1.1       1.1
105.................................................       1.3       1.3       1.3       1.2       1.2       1.2       1.2       1.1       1.1       1.0
106.................................................       1.2       1.2       1.2       1.2       1.1       1.1       1.1       1.1       1.0       1.0
107.................................................       1.1       1.1       1.1       1.1       1.1       1.0       1.0       1.0       1.0         9
108.................................................       1.0       1.0       1.0       1.0       1.0       1.0       1.0        .9        .9        .9
109.................................................       1.0        .9        .9        .9        .9        .9        .9        .9        .8        .8
110.................................................        .9        .9        .8        .8        .8        .8        .8        .8        .8        .8
111.................................................        .8        .8        .8        .8        .8        .7        .7        .7        .7        .7
112.................................................        .7        .7        .7        .7        .7        .7        .7        .7        .6        .6
113.................................................        .6        .6        .6        .6        .6        .6        .6        .6        .6        .6
114.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                     Table VIaa--Annuities for Joint Life Only; Two Lives--Expected Return Multiples
--------------------------------------------------------------------------------------------------------------------------------------------------------
                   Ages                        105       106       107       108       109       110       111       112       113       114       115
--------------------------------------------------------------------------------------------------------------------------------------------------------
105.......................................       1.0       1.0        .9        .9        .8        .7        .7        .6        .6        .5        .5
106.......................................       1.0        .9        .9        .8        .8        .7        .7        .6        .6        .5        .5
107.......................................        .9        .9        .8        .8        .7        .7        .7        .6        .6        .5        .5
108.......................................        .9        .8        .8        .8        .7        .7        .6        .6        .5        .5        .5
109.......................................        .8        .8        .7        .7        .7        .7        .6        .6        .5        .5        .5
110.......................................        .7        .7        .7        .7        .7        .6        .6        .6        .5        .5        .5
111.......................................        .7        .7        .7        .6        .6        .6        .6        .5        .5        .5        .5
112.......................................        .6        .6        .6        .6        .6        .6        .5        .5        .5        .5        .5
113.......................................        .6        .6        .6        .5        .5        .5        .5        .5        .5        .5        .5
114.......................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
115.......................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                        Table VII--Percent Value of Refund Feature; Duration of Guaranteed Amount
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                    Years--
                         Age                         ---------------------------------------------------------------------------------------------------
                                                          1         2         3         4         5         6         7         8         9        10
--------------------------------------------------------------------------------------------------------------------------------------------------------
5...................................................         0         0         0         0         0         0         0         0         0         0
6...................................................         0         0         0         0         0         0         0         0         0         0
7...................................................         0         0         0         0         0         0         0         0         0         0
8...................................................         0         0         0         0         0         0         0         0         0         0
9...................................................         0         0         0         0         0         0         0         0         0         0
10..................................................         0         0         0         0         0         0         0         0         0         0
11..................................................         0         0         0         0         0         0         0         0         0         0
12..................................................         0         0         0         0         0         0         0         0         0         0
13..................................................         0         0         0         0         0         0         0         0         0         0
14..................................................         0         0         0         0         0         0         0         0         0         0
15..................................................         0         0         0         0         0         0         0         0         0         0
16..................................................         0         0         0         0         0         0         0         0         0         0
17..................................................         0         0         0         0         0         0         0         0         0         0
18..................................................         0         0         0         0         0         0         0         0         0         0
19..................................................         0         0         0         0         0         0         0         0         0         0
20..................................................         0         0         0         0         0         0         0         0         0         0
21..................................................         0         0         0         0         0         0         0         0         0         0
22..................................................         0         0         0         0         0         0         0         0         0         0
23..................................................         0         0         0         0         0         0         0         0         0         0
24..................................................         0         0         0         0         0         0         0         0         0         0
25..................................................         0         0         0         0         0         0         0         0         0         0
26..................................................         0         0         0         0         0         0         0         0         0         0
27..................................................         0         0         0         0         0         0         0         0         0         0
28..................................................         0         0         0         0         0         0         0         0         0         0
29..................................................         0         0         0         0         0         0         0         0         0         0
30..................................................         0         0         0         0         0         0         0         0         0         0
31..................................................         0         0         0         0         0         0         0         0         0         0
32..................................................         0         0         0         0         0         0         0         0         0         0
33..................................................         0         0         0         0         0         0         0         0         0         0
34..................................................         0         0         0         0         0         0         0         0         0         0
35..................................................         0         0         0         0         0         0         0         0         0         0

[[Page 242]]

 
36..................................................         0         0         0         0         0         0         0         0         0         0
37..................................................         0         0         0         0         0         0         0         0         0         1
38..................................................         0         0         0         0         0         0         0         0         0         1
39..................................................         0         0         0         0         0         0         0         0         1         1
40..................................................         0         0         0         0         0         0         0         1         1         1
41..................................................         0         0         0         0         0         0         0         1         1         1
42..................................................         0         0         0         0         0         0         1         1         1         1
43..................................................         0         0         0         0         0         0         1         1         1         1
44..................................................         0         0         0         0         0         1         1         1         1         1
45..................................................         0         0         0         0         0         1         1         1         1         1
46..................................................         0         0         0         0         1         1         1         1         1         1
47..................................................         0         0         0         0         1         1         1         1         1         1
48..................................................         0         0         0         0         1         1         1         1         1         1
49..................................................         0         0         0         1         1         1         1         1         1         2
50..................................................         0         0         0         1         1         1         1         1         1         2
51..................................................         0         0         0         1         1         1         1         1         2         2
52..................................................         0         0         0         1         1         1         1         1         2         2
53..................................................         0         0         1         1         1         1         1         2         2         2
54..................................................         0         0         1         1         1         1         1         2         2         2
55..................................................         0         0         1         1         1         1         2         2         2         2
56..................................................         0         0         1         1         1         1         2         2         2         3
57..................................................         0         0         1         1         1         2         2         2         3         3
58..................................................         0         1         1         1         1         2         2         2         3         3
59..................................................         0         1         1         1         1         2         2         3         3         4
60..................................................         0         1         1         1         2         2         2         3         3         4
61..................................................         0         1         1         1         2         2         3         3         4         4
62..................................................         0         1         1         2         2         2         3         4         4         5
63..................................................         0         1         1         2         2         3         3         4         5         5
64..................................................         0         1         1         2         2         3         4         4         5         6
65..................................................         0         1         2         2         3         3         4         5         6         6
66..................................................         1         1         2         2         3         4         5         5         6         7
67..................................................         1         1         2         3         3         4         5         6         7         8
68..................................................         1         1         2         3         4         5         6         7         8         9
69..................................................         1         1         2         3         4         5         6         7         8        10
70..................................................         1         2         3         4         5         6         7         8         9        11
71..................................................         1         2         3         4         5         6         8         9        10        12
72..................................................         1         2         3         4         6         7         8        10        11        13
73..................................................         1         2         4         5         6         8         9        11        13        14
74..................................................         1         3         4         5         7         9        10        12        14        16
75..................................................         1         3         4         6         8         9        11        13        15        17
76..................................................         2         3         5         7         9        10        12        15        17        19
77..................................................         2         4         5         7         9        12        14        16        18        21
78..................................................         2         4         6         8        10        13        15        18        20        23
79..................................................         2         4         7         9        11        14        17        19        22        25
80..................................................         2         5         7        10        13        15        18        21        24        27
81..................................................         3         5         8        11        14        17        20        23        26        29
82..................................................         3         6         9        12        15        19        22        25        28        32
83..................................................         3         7        10        13        17        20        24        27        31        34
84..................................................         4         7        11        15        19        22        26        30        33        37
85..................................................         4         8        12        16        20        24        28        32        36        40
86..................................................         4         9        13        18        22        27        31        35        39        42
87..................................................         5        10        15        20        24        29        33        37        41        45
88..................................................         5        11        16        21        26        31        36        40        44        48
89..................................................         6        12        18        23        28        33        38        43        47        50
90..................................................         7        13        19        25        31        36        41        45        49        53
91..................................................         7        14        21        27        33        38        43        48        52        55
92..................................................         8        15        22        29        35        40        45        50        54        58
93..................................................         9        17        24        31        37        43        48        52        56        60
94..................................................         9        18        26        33        39        45        50        54        58        62
95..................................................        10        19        27        35        41        47        52        57        60        64
96..................................................        11        20        29        36        43        49        54        59        62        66
97..................................................        11        21        30        38        45        51        56        61        64        68
98..................................................        12        23        32        40        47        53        58        63        66        69
99..................................................        13        24        34        42        49        55        60        65        68        71
100.................................................        14        26        36        44        52        58        63        67        70        73
101.................................................        14        27        38        47        54        60        65        69        72        75
102.................................................        15        29        40        49        56        62        67        71        74        77
103.................................................        17        31        42        52        59        65        69        73        76        78
104.................................................        18        33        45        55        62        67        72        75        78        80

[[Page 243]]

 
105.................................................        19        36        48        58        65        70        74        77        80        82
106.................................................        21        38        51        61        68        73        77        79        82        84
107.................................................        23        42        55        64        71        75        79        81        84        85
108.................................................        25        45        58        67        73        78        81        83        85        87
109.................................................        28        49        62        71        76        80        83        85        87        88
110.................................................        31        52        66        74        79        82        85        87        88        89
111.................................................        34        57        70        77        82        85        87        88        90        91
112.................................................        37        61        73        80        84        87        88        90        91        92
113.................................................        41        66        77        83        86        88        90        91        92        93
114.................................................        45        70        80        85        88        90        92        93        93        94
115.................................................        50        75        83        88        90        92        93        94        94        95
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                        Table VII--Percent Value of Refund Feature; Duration of Guaranteed Amount
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                    Years--
                         Age                         ---------------------------------------------------------------------------------------------------
                                                         11        12        13        14        15        16        17        18        19        20
--------------------------------------------------------------------------------------------------------------------------------------------------------
5...................................................         0         0         0         0         0         0         0         0         0         0
6...................................................         0         0         0         0         0         0         0         0         0         0
7...................................................         0         0         0         0         0         0         0         0         0         0
8...................................................         0         0         0         0         0         0         0         0         0         0
9...................................................         0         0         0         0         0         0         0         0         0         0
10..................................................         0         0         0         0         0         0         0         0         0         0
11..................................................         0         0         0         0         0         0         0         0         0         0
12..................................................         0         0         0         0         0         0         0         0         0         0
13..................................................         0         0         0         0         0         0         0         0         0         0
14..................................................         0         0         0         0         0         0         0         0         0         0
15..................................................         0         0         0         0         0         0         0         0         0         0
16..................................................         0         0         0         0         0         0         0         0         0         0
17..................................................         0         0         0         0         0         0         0         0         0         0
18..................................................         0         0         0         0         0         0         0         0         0         0
19..................................................         0         0         0         0         0         0         0         0         0         0
20..................................................         0         0         0         0         0         0         0         0         0         1
21..................................................         0         0         0         0         0         0         0         0         0         1
22..................................................         0         0         0         0         0         0         0         0         1         1
23..................................................         0         0         0         0         0         0         0         1         1         1
24..................................................         0         0         0         0         0         0         0         1         1         1
25..................................................         0         0         0         0         0         0         1         1         1         1
26..................................................         0         0         0         0         0         0         1         1         1         1
27..................................................         0         0         0         0         0         1         1         1         1         1
28..................................................         0         0         0         0         1         1         1         1         1         1
29..................................................         0         0         0         0         1         1         1         1         1         1
30..................................................         0         0         0         1         1         1         1         1         1         1
31..................................................         0         0         0         1         1         1         1         1         1         1
32..................................................         0         0         1         1         1         1         1         1         1         1
33..................................................         0         0         1         1         1         1         1         1         1         1
34..................................................         0         1         1         1         1         1         1         1         1         1
35..................................................         0         1         1         1         1         1         1         1         1         1
36..................................................         1         1         1         1         1         1         1         1         1         1
37..................................................         1         1         1         1         1         1         1         1         1         1
38..................................................         1         1         1         1         1         1         1         1         1         2
39..................................................         1         1         1         1         1         1         1         1         2         2
40..................................................         1         1         1         1         1         1         1         2         2         2
41..................................................         1         1         1         1         1         1         2         2         2         2
42..................................................         1         1         1         1         1         2         2         2         2         2
43..................................................         1         1         1         1         2         2         2         2         2         3
44..................................................         1         1         1         2         2         2         2         2         3         3
45..................................................         1         1         2         2         2         2         2         3         3         3
46..................................................         1         2         2         2         2         2         3         3         3         3
47..................................................         1         2         2         2         2         2         3         3         3         4
48..................................................         2         2         2         2         2         3         3         3         4         4
49..................................................         2         2         2         2         3         3         3         4         4         4
50..................................................         2         2         2         3         3         3         3         4         4         5
51..................................................         2         2         3         3         3         3         4         4         4         5
52..................................................         2         2         3         3         3         4         4         5         5         5
53..................................................         2         3         3         3         4         4         5         5         5         6
54..................................................         3         3         3         4         4         4         5         5         6         7
55..................................................         3         3         4         4         4         5         5         6         7         7

[[Page 244]]

 
56..................................................         3         3         4         4         5         5         6         7         7         8
57..................................................         3         4         4         5         5         6         6         7         8         9
58..................................................         4         4         5         5         6         6         7         8         9         9
59..................................................         4         5         5         6         6         7         8         9         9        10
60..................................................         4         5         6         6         7         8         9        10        10        11
61..................................................         5         6         6         7         8         9        10        10        11        13
62..................................................         5         6         7         8         9        10        11        12        13        14
63..................................................         6         7         8         9        10        11        12        13        14        15
64..................................................         7         8         8         9        10        12        13        14        15        17
65..................................................         7         8         9        10        12        13        14        15        17        18
66..................................................         8         9        10        12        13        14        15        17        18        20
67..................................................         9        10        11        13        14        15        17        18        20        22
68..................................................        10        11        13        14        15        17        19        20        22        24
69..................................................        11        12        14        15        17        19        20        22        24        26
70..................................................        12        14        15        17        19        20        22        24        26        28
71..................................................        13        15        17        18        20        22        24        26        28        30
72..................................................        15        17        18        20        22        24        26        28        30        32
73..................................................        16        18        20        22        24        26        28        31        33        35
74..................................................        18        20        22        24        26        28        31        33        35        37
75..................................................        19        22        24        26        28        31        33        35        38        40
76..................................................        21        24        26        28        31        33        36        38        40        43
77..................................................        23        26        28        31        33        36        38        41        43        45
78..................................................        25        28        31        33        36        38        41        43        46        48
79..................................................        28        30        33        36        38        41        44        46        48        51
80..................................................        30        33        36        38        41        44        46        49        51        53
81..................................................        32        35        38        41        44        47        49        51        54        56
82..................................................        35        38        41        44        47        49        52        54        56        58
83..................................................        38        41        44        47        49        52        54        57        59        61
84..................................................        40        44        47        49        52        55        57        59        61        63
85..................................................        43        46        49        52        55        57        59        62        63        65
86..................................................        46        49        52        55        57        60        62        64        66        67
87..................................................        48        52        55        57        60        62        64        66        68        69
88..................................................        51        54        57        60        62        64        66        68        70        71
89..................................................        54        57        60        62        65        67        68        70        72        73
90..................................................        56        59        62        64        67        69        70        72        74        75
91..................................................        59        62        64        67        69        71        72        74        75        76
92..................................................        61        64        66        69        71        72        74        75        77        78
93..................................................        63        66        68        70        72        74        75        77        78        79
94..................................................        65        68        70        72        74        75        77        78        79        80
95..................................................        67        69        72        74        75        77        78        79        81        82
96..................................................        69        71        73        75        77        78        80        81        82        83
97..................................................        70        73        75        77        78        80        81        82        83        84
98..................................................        72        74        76        78        79        81        82        83        84        85
99..................................................        74        76        78        79        81        82        83        84        85        86
100.................................................        75        78        79        81        82        83        84        85        86        86
101.................................................        77        79        81        82        83        84        85        86        87        87
102.................................................        79        81        82        83        84        85        86        87        88        88
103.................................................        80        82        83        85        86        87        87        88        89        89
104.................................................        82        84        85        86        87        88        88        89        90        90
105.................................................        84        85        86        87        88        89        89        90        90        91
106.................................................        85        86        87        88        89        90        90        91        91        92
107.................................................        87        88        89        89        90        91        91        92        92        93
108.................................................        88        89        90        90        91        92        92        93        93        93
109.................................................        89        90        91        92        92        93        93        93        94        94
110.................................................        90        91        92        92        93        93        94        94        94        95
111.................................................        92        92        93        93        94        94        95        95        95        95
112.................................................        93        93        94        94        95        95        95        96        96        96
113.................................................        94        94        95        95        95        96        96        96        96        97
114.................................................        95        95        95        96        96        96        97        97        97        97
115.................................................        95        96        96        96        97        97        97        97        97        98
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                        Table VII--Percent Value of Refund Feature; Duration of Guaranteed Amount
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                    Years--
                         Age                         ---------------------------------------------------------------------------------------------------
                                                         21        22        23        24        25        26        27        28        29        30
--------------------------------------------------------------------------------------------------------------------------------------------------------
5...................................................         0         0         0         0         0         0         0         0         0         0
6...................................................         0         0         0         0         0         0         0         0         0         0

[[Page 245]]

 
7...................................................         0         0         0         0         0         0         0         0         0         0
8...................................................         0         0         0         0         0         0         0         0         0         1
9...................................................         0         0         0         0         0         0         0         0         1         1
10..................................................         0         0         0         0         0         0         0         1         1         1
11..................................................         0         0         0         0         0         0         1         1         1         1
12..................................................         0         0         0         0         0         0         1         1         1         1
13..................................................         0         0         0         0         0         1         1         1         1         1
14..................................................         0         0         0         0         1         1         1         1         1         1
15..................................................         0         0         0         1         1         1         1         1         1         1
16..................................................         0         0         1         1         1         1         1         1         1         1
17..................................................         0         0         1         1         1         1         1         1         1         1
18..................................................         0         1         1         1         1         1         1         1         1         1
19..................................................         1         1         1         1         1         1         1         1         1         1
20..................................................         1         1         1         1         1         1         1         1         1         1
21..................................................         1         1         1         1         1         1         1         1         1         1
22..................................................         1         1         1         1         1         1         1         1         1         1
23..................................................         1         1         1         1         1         1         1         1         1         1
24..................................................         1         1         1         1         1         1         1         1         1         1
25..................................................         1         1         1         1         1         1         1         1         1         1
26..................................................         1         1         1         1         1         1         1         1         1         1
27..................................................         1         1         1         1         1         1         1         1         1         2
28..................................................         1         1         1         1         1         1         1         1         2         2
29..................................................         1         1         1         1         1         1         1         2         2         2
30..................................................         1         1         1         1         1         1         2         2         2         2
31..................................................         1         1         1         1         1         2         2         2         2         2
32..................................................         1         1         1         1         2         2         2         2         2         2
33..................................................         1         1         1         2         2         2         2         2         2         2
34..................................................         1         1         2         2         2         2         2         2         2         3
35..................................................         1         2         2         2         2         2         2         2         3         3
36..................................................         2         2         2         2         2         2         2         3         3         3
37..................................................         2         2         2         2         2         2         3         3         3         3
38..................................................         2         2         2         2         2         3         3         3         3         4
39..................................................         2         2         2         2         3         3         3         3         4         4
40..................................................         2         2         3         3         3         3         3         4         4         4
41..................................................         2         3         3         3         3         3         4         4         4         5
42..................................................         3         3         3         3         3         4         4         4         5         5
43..................................................         3         3         3         4         4         4         4         5         5         6
44..................................................         3         3         4         4         4         4         5         5         6         6
45..................................................         3         4         4         4         5         5         5         6         6         7
46..................................................         4         4         4         5         5         5         6         6         7         7
47..................................................         4         4         5         5         5         6         6         7         7         8
48..................................................         4         5         5         5         6         6         7         7         8         9
49..................................................         5         5         5         6         6         7         8         8         9        10
50..................................................         5         5         6         6         7         8         8         9        10        10
51..................................................         5         6         6         7         8         8         9        10        11        11
52..................................................         6         7         7         8         8         9        10        11        11        12
53..................................................         7         7         8         8         9        10        11        12        13        14
54..................................................         7         8         8         9        10        11        12        13        14        15
55..................................................         8         9         9        10        11        12        13        14        15        16
56..................................................         9         9        10        11        12        13        14        15        16        18
57..................................................         9        10        11        12        13        14        15        17        18        19
58..................................................        10        11        12        13        14        16        17        18        19        21
59..................................................        11        12        13        15        16        17        18        20        21        22
60..................................................        12        14        15        16        17        19        20        21        23        24
61..................................................        14        15        16        17        19        20        22        23        25        26
62..................................................        15        16        18        19        20        22        23        25        27        28
63..................................................        16        18        19        21        22        24        25        27        29        30
64..................................................        18        19        21        23        24        26        28        29        31        33
65..................................................        20        21        23        25        26        28        30        31        33        35
66..................................................        21        23        25        27        28        30        32        34        35        37
67..................................................        23        25        27        29        31        32        34        36        38        40
68..................................................        25        27        29        31        33        35        37        38        40        42
69..................................................        28        29        31        33        35        37        39        41        43        44
70..................................................        30        32        34        36        38        40        42        43        45        47
71..................................................        32        34        36        38        40        42        44        46        47        49
72..................................................        35        37        39        41        43        45        46        48        50        51
73..................................................        37        39        41        43        45        47        49        51        52        54
74..................................................        40        42        44        46        48        50        51        53        54        56
75..................................................        42        44        46        48        50        52        54        55        57        58

[[Page 246]]

 
76..................................................        45        47        49        51        53        54        56        58        59        60
77..................................................        47        50        51        53        55        57        58        60        61        62
78..................................................        50        52        54        56        57        59        61        62        63        64
79..................................................        53        55        56        58        60        61        63        64        65        66
80..................................................        55        57        59        60        62        63        65        66        67        68
81..................................................        58        59        61        63        64        66        67        68        69        70
82..................................................        60        62        63        65        66        68        69        70        71        72
83..................................................        62        64        66        67        68        70        71        72        73        74
84..................................................        65        66        68        69        70        71        72        73        74        75
85..................................................        67        68        70        71        72        73        74        75        76        77
86..................................................        69        70        72        73        74        75        76        77        77        78
87..................................................        71        72        73        75        76        76        77        78        79        80
88..................................................        73        74        75        76        77        78        79        80        80        81
89..................................................        74        76        77        78        79        79        80        81        81        82
90..................................................        76        77        78        79        80        81        81        82        83        83
91..................................................        78        79        79        80        81        82        83        83        84        84
92..................................................        79        80        81        82        82        83        84        84        85        85
93..................................................        80        81        82        83        83        84        85        85        86        86
94..................................................        81        82        83        84        84        85        85        86        86        87
95..................................................        82        83        84        85        85        86        86        87        87        88
96..................................................        83        84        85        86        86        87        87        88        88        88
97..................................................        84        85        86        86        87        87        88        88        89        89
98..................................................        85        86        87        87        88        88        89        89        89        90
99..................................................        86        87        87        88        88        89        89        90        90        90
100.................................................        87        88        88        89        89        90        90        90        91        91
101.................................................        88        89        89        90        90        90        91        91        91        92
102.................................................        89        89        90        90        91        91        91        92        92        92
103.................................................        90        90        91        91        91        92        92        92        93        93
104.................................................        91        91        91        92        92        92        93        93        93        93
105.................................................        91        92        92        92        93        93        93        94        94        94
106.................................................        92        93        93        93        93        94        94        94        94        95
107.................................................        93        93        94        94        94        94        95        95        95        95
108.................................................        94        94        94        94        95        95        95        95        95        96
109.................................................        94        95        95        95        95        95        96        96        96        96
110.................................................        95        95        95        96        96        96        96        96        96        96
111.................................................        96        96        96        96        96        96        97        97        97        97
112.................................................        96        96        96        97        97        97        97        97        97        97
113.................................................        97        97        97        97        97        97        97        98        98        98
114.................................................        97        97        97        98        98        98        98        98        98        98
115.................................................        98        98        98        98        98        98        98        98        98        98
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                        Table VII--Percent Value of Refund Feature; Duration of Guaranteed Amount
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                    Years--
                         Age                         ---------------------------------------------------------------------------------------------------
                                                         31        32        33        34        35        36        37        38        39        40
--------------------------------------------------------------------------------------------------------------------------------------------------------
5...................................................         0         1         1         1         1         1         1         1         1         1
6...................................................         0         1         1         1         1         1         1         1         1         1
7...................................................         1         1         1         1         1         1         1         1         1         1
8...................................................         1         1         1         1         1         1         1         1         1         1
9...................................................         1         1         1         1         1         1         1         1         1         1
10..................................................         1         1         1         1         1         1         1         1         1         1
11..................................................         1         1         1         1         1         1         1         1         1         1
12..................................................         1         1         1         1         1         1         1         1         1         1
13..................................................         1         1         1         1         1         1         1         1         1         1
14..................................................         1         1         1         1         1         1         1         1         1         1
15..................................................         1         1         1         1         1         1         1         1         1         1
16..................................................         1         1         1         1         1         1         1         1         1         1
17..................................................         1         1         1         1         1         1         1         1         1         1
18..................................................         1         1         1         1         1         1         1         1         1         2
19..................................................         1         1         1         1         1         1         1         1         2         2
20..................................................         1         1         1         1         1         1         1         2         2         2
21..................................................         1         1         1         1         1         1         2         2         2         2
22..................................................         1         1         1         1         1         2         2         2         2         2
23..................................................         1         1         1         2         2         2         2         2         2         2
24..................................................         1         1         2         2         2         2         2         2         2         2
25..................................................         1         2         2         2         2         2         2         2         2         3
26..................................................         2         2         2         2         2         2         2         2         3         3

[[Page 247]]

 
27..................................................         2         2         2         2         2         2         2         3         3         3
28..................................................         2         2         2         2         2         2         3         3         3         3
29..................................................         2         2         2         2         2         3         3         3         3         4
30..................................................         2         2         2         3         3         3         3         3         4         4
31..................................................         2         2         3         3         3         3         3         4         4         4
32..................................................         2         3         3         3         3         3         4         4         4         5
33..................................................         3         3         3         3         3         4         4         4         5         5
34..................................................         3         3         3         3         4         4         4         5         5         5
35..................................................         3         3         3         4         4         4         5         5         5         6
36..................................................         3         4         4         4         4         5         5         5         6         6
37..................................................         4         4         4         4         5         5         6         6         6         7
38..................................................         4         4         5         5         5         6         6         7         7         8
39..................................................         4         5         5         5         6         6         7         7         8         8
40..................................................         5         5         5         6         6         7         7         8         8         9
41..................................................         5         5         6         6         7         7         8         9         9        10
42..................................................         6         6         6         7         7         8         9         9        10        11
43..................................................         6         7         7         8         8         9         9        10        11        12
44..................................................         7         7         8         8         9        10        10        11        12        13
45..................................................         7         8         8         9        10        10        11        12        13        14
46..................................................         8         9         9        10        11        11        12        13        14        15
47..................................................         9         9        10        11        12        12        13        14        15        16
48..................................................         9        10        11        12        13        14        15        16        17        18
49..................................................        10        11        12        13        14        15        16        17        18        19
50..................................................        11        12        13        14        15        16        17        18        20        21
51..................................................        12        13        14        15        16        17        19        20        21        22
52..................................................        13        14        15        17        18        19        20        21        23        24
53..................................................        15        16        17        18        19        20        22        23        24        26
54..................................................        16        17        18        19        21        22        23        25        26        28
55..................................................        17        18        20        21        22        24        25        27        28        30
56..................................................        19        20        21        23        24        26        27        29        30        32
57..................................................        20        22        23        25        26        28        29        31        32        34
58..................................................        22        24        25        27        28        30        31        33        34        36
59..................................................        24        25        27        28        30        32        33        35        36        38
60..................................................        26        27        29        31        32        34        35        37        38        40
61..................................................        28        29        31        33        34        36        37        39        40        42
62..................................................        30        32        33        35        36        38        40        41        42        44
63..................................................        32        34        35        37        39        40        42        43        45        46
64..................................................        34        36        38        39        41        42        44        45        47        48
65..................................................        37        38        40        42        43        45        46        47        49        50
66..................................................        39        41        42        44        45        47        48        50        51        52
67..................................................        41        43        45        46        48        49        50        52        53        54
68..................................................        44        45        47        48        50        51        52        54        55        56
69..................................................        46        48        49        51        52        53        54        56        57        58
70..................................................        48        50        51        53        54        55        57        58        59        60
71..................................................        51        52        54        55        56        57        59        60        61        62
72..................................................        53        54        56        57        58        59        60        62        62        63
73..................................................        55        57        58        59        60        61        62        63        64        65
74..................................................        57        59        60        61        62        63        64        65        66        67
75..................................................        59        61        62        63        64        65        66        67        68        69
76..................................................        62        63        64        65        66        67        68        69        69        70
77..................................................        64        65        66        67        68        69        70        70        71        72
78..................................................        66        67        68        69        70        70        71        72        73        73
79..................................................        67        68        69        70        71        72        73        73        74        75
80..................................................        69        70        71        72        73        74        74        75        76        76
81..................................................        71        72        73        74        74        75        76        76        77        78
82..................................................        73        74        74        75        76        77        77        78        78        79
83..................................................        74        75        76        77        77        78        79        79        80        80
84..................................................        76        77        77        78        79        79        80        80        81        81
85..................................................        78        78        79        79        80        81        81        82        82        83
86..................................................        79        80        80        81        81        82        82        83        83        84
87..................................................        80        81        81        82        83        83        83        84        84        85
88..................................................        82        82        83        83        84        84        85        85        85        86
89..................................................        83        83        84        84        85        85        85        86        86        87
90..................................................        84        84        85        85        86        86        86        87        87        87
91..................................................        85        85        86        86        87        87        87        88        88        88
92..................................................        86        86        87        87        87        88        88        88        89        89
93..................................................        87        87        87        88        88        88        89        89        89        90
94..................................................        87        88        88        88        89        89        89        90        90        90
95..................................................        88        88        89        89        89        90        90        90        91        91

[[Page 248]]

 
96..................................................        89        89        89        90        90        90        91        91        91        91
97..................................................        89        90        90        90        91        91        91        91        92        92
98..................................................        90        90        91        91        91        91        92        92        92        92
99..................................................        91        91        91        92        92        92        92        92        93        93
100.................................................        91        92        92        92        92        92        93        93        93        93
101.................................................        92        92        92        93        93        93        93        93        94        94
102.................................................        92        93        93        93        93        94        94        94        94        94
103.................................................        93        93        93        94        94        94        94        94        94        95
104.................................................        94        94        94        94        94        95        95        95        95        95
105.................................................        94        94        95        95        95        95        95        95        95        95
106.................................................        95        95        95        95        95        95        96        96        96        96
107.................................................        95        95        96        96        96        96        96        96        96        96
108.................................................        96        96        96        96        96        96        96        96        97        97
109.................................................        96        96        96        97        97        97        97        97        97        97
110.................................................        97        97        97        97        97        97        97        97        97        97
111.................................................        97        97        97        97        97        97        98        98        98        98
112.................................................        97        97        98        98        98        98        98        98        98        98
113.................................................        98        98        98        98        98        98        98        98        98        98
114.................................................        98        98        98        98        98        98        98        98        98        99
115.................................................        98        98        98        99        99        99        99        99        99        99
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                      Table VIII--Temporary Life Annuities; \1\ One Life--Expected Return Multiples
                                                             [See footnote at end of tables]
                                                      Temporary Period--Maximum Duration of Annuity
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                    Years--
                         Age                         ---------------------------------------------------------------------------------------------------
                                                          1         2         3         4         5         6         7         8         9        10
--------------------------------------------------------------------------------------------------------------------------------------------------------
5...................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
6...................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
7...................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
8...................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
9...................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
10..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
11..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
12..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
13..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
14..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
15..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
16..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
17..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
18..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
19..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
20..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
21..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
22..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
23..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
24..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
25..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
26..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
27..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
28..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
29..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
30..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
31..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
32..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
33..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
34..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
35..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
36..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0      10.0
37..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0       9.9
38..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0       9.9
39..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       9.0       9.9
40..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       8.9       9.9
41..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       8.9       9.9
42..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       8.0       8.9       9.9
43..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       7.9       8.9       9.9

[[Page 249]]

 
44..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       7.9       8.9       9.9
45..................................................       1.0       2.0       3.0       4.0       5.0       6.0       7.0       7.9       8.9       9.9
46..................................................       1.0       2.0       3.0       4.0       5.0       6.0       6.9       7.9       8.9       9.9
47..................................................       1.0       2.0       3.0       4.0       5.0       6.0       6.9       7.9       8.9       9.9
48..................................................       1.0       2.0       3.0       4.0       5.0       6.0       6.9       7.9       8.9       9.9
49..................................................       1.0       2.0       3.0       4.0       5.0       6.0       6.9       7.9       8.9       9.8
50..................................................       1.0       2.0       3.0       4.0       5.0       5.9       6.9       7.9       8.9       9.8
51..................................................       1.0       2.0       3.0       4.0       5.0       5.9       6.9       7.9       8.9       9.8
52..................................................       1.0       2.0       3.0       4.0       5.0       5.9       6.9       7.9       8.8       9.8
53..................................................       1.0       2.0       3.0       4.0       5.0       5.9       6.9       7.9       8.8       9.8
54..................................................       1.0       2.0       3.0       4.0       4.9       5.9       6.9       7.9       8.8       9.8
55..................................................       1.0       2.0       3.0       4.0       4.9       5.9       6.9       7.8       8.8       9.7
56..................................................       1.0       2.0       3.0       4.0       4.9       5.9       6.9       7.8       8.8       9.7
57..................................................       1.0       2.0       3.0       4.0       4.9       5.9       6.9       7.8       8.8       9.7
58..................................................       1.0       2.0       3.0       4.0       4.9       5.9       6.9       7.8       8.7       9.7
59..................................................       1.0       2.0       3.0       4.0       4.9       5.9       6.8       7.8       8.7       9.6
60..................................................       1.0       2.0       3.0       3.9       4.9       5.9       6.8       7.8       8.7       9.6
61..................................................       1.0       2.0       3.0       3.9       4.9       5.9       6.8       7.7       8.7       9.6
62..................................................       1.0       2.0       3.0       3.9       4.9       5.8       6.8       7.7       8.6       9.5
63..................................................       1.0       2.0       3.0       3.9       4.9       5.8       6.8       7.7       8.6       9.5
64..................................................       1.0       2.0       3.0       3.9       4.9       5.8       6.7       7.6       8.5       9.4
65..................................................       1.0       2.0       3.0       3.9       4.9       5.8       6.7       7.6       8.5       9.3
66..................................................       1.0       2.0       2.9       3.9       4.8       5.8       6.7       7.6       8.4       9.3
67..................................................       1.0       2.0       2.9       3.9       4.8       5.7       6.6       7.5       8.4       9.2
68..................................................       1.0       2.0       2.9       3.9       4.8       5.7       6.6       7.5       8.3       9.1
69..................................................       1.0       2.0       2.9       3.9       4.8       5.7       6.6       7.4       8.2       9.0
70..................................................       1.0       2.0       2.9       3.9       4.8       5.6       6.5       7.3       8.1       8.9
71..................................................       1.0       2.0       2.9       3.8       4.7       5.6       6.5       7.3       8.1       8.8
72..................................................       1.0       2.0       2.9       3.8       4.7       5.6       6.4       7.2       8.0       8.7
73..................................................       1.0       2.0       2.9       3.8       4.7       5.5       6.3       7.1       7.9       8.6
74..................................................       1.0       1.9       2.9       3.8       4.6       5.5       6.3       7.0       7.7       8.4
75..................................................       1.0       1.9       2.9       3.8       4.6       5.4       6.2       6.9       7.6       8.3
76..................................................       1.0       1.9       2.8       3.7       4.6       5.4       6.1       6.8       7.5       8.1
77..................................................       1.0       1.9       2.8       3.7       4.5       5.3       6.0       6.7       7.3       7.9
78..................................................       1.0       1.9       2.8       3.7       4.5       5.2       5.9       6.6       7.2       7.7
79..................................................       1.0       1.9       2.8       3.6       4.4       5.1       5.8       6.4       7.0       7.5
80..................................................       1.0       1.9       2.8       3.6       4.4       5.1       5.7       6.3       6.8       7.3
81..................................................       1.0       1.9       2.8       3.6       4.3       5.0       5.6       6.1       6.6       7.0
82..................................................       1.0       1.9       2.7       3.5       4.2       4.9       5.4       6.0       6.4       6.8
83..................................................       1.0       1.9       2.7       3.5       4.1       4.8       5.3       5.8       6.2       6.5
84..................................................       1.0       1.8       2.7       3.4       4.1       4.6       5.2       5.6       6.0       6.3
85..................................................       1.0       1.8       2.6       3.3       4.0       4.5       5.0       5.4       5.7       6.0
86..................................................       1.0       1.8       2.6       3.3       3.9       4.4       4.8       5.2       5.5       5.7
87..................................................        .9       1.8       2.5       3.2       3.8       4.3       4.7       5.0       5.3       5.5
88..................................................        .9       1.8       2.5       3.1       3.7       4.1       4.5       4.8       5.0       5.2
89..................................................        .9       1.8       2.5       3.1       3.6       4.0       4.3       4.6       4.8       4.9
90..................................................        .9       1.7       2.4       3.0       3.4       3.8       4.1       4.4       4.5       4.7
91..................................................        .9       1.7       2.4       2.9       3.3       3.7       4.0       4.2       4.3       4.4
92..................................................        .9       1.7       2.3       2.8       3.2       3.5       3.8       4.0       4.1       4.2
93..................................................        .9       1.7       2.3       2.7       3.1       3.4       3.6       3.8       3.9       4.0
94..................................................        .9       1.6       2.2       2.7       3.0       3.3       3.5       3.6       3.7       3.8
95..................................................        .9       1.6       2.2       2.6       2.9       3.1       3.3       3.4       3.5       3.6
96..................................................        .9       1.6       2.1       2.5       2.8       3.0       3.2       3.3       3.3       3.4
97..................................................        .9       1.6       2.1       2.4       2.7       2.9       3.0       3.1       3.2       3.2
98..................................................        .9       1.5       2.0       2.4       2.6       2.8       2.9       3.0       3.0       3.0
99..................................................        .9       1.5       2.0       2.3       2.5       2.6       2.7       2.8       2.8       2.8
100.................................................        .9       1.5       1.9       2.2       2.4       2.5       2.6       2.6       2.6       2.7
101.................................................        .8       1.4       1.8       2.1       2.3       2.4       2.4       2.5       2.5       2.5
102.................................................        .8       1.4       1.8       2.0       2.1       2.2       2.3       2.3       2.3       2.3
103.................................................        .8       1.4       1.7       1.9       2.0       2.1       2.1       2.1       2.1       2.1
104.................................................        .8       1.3       1.6       1.8       1.9       1.9       1.9       1.9       1.9       1.9
105.................................................        .8       1.3       1.5       1.7       1.7       1.8       1.8       1.8       1.8       1.8
106.................................................        .8       1.2       1.4       1.5       1.6       1.6       1.6       1.6       1.6       1.6
107.................................................        .7       1.1       1.3       1.4       1.4       1.4       1.4       1.4       1.4       1.4
108.................................................        .7       1.1       1.2       1.3       1.3       1.3       1.3       1.3       1.3       1.3
109.................................................        .7       1.0       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1
110.................................................        .7        .9       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0
111.................................................        .6        .8        .9        .9        .9        .9        .9        .9        .9        .9

[[Page 250]]

 
112.................................................        .6        .7        .8        .8        .8        .8        .8        .8        .8        .8
113.................................................        .6        .6        .7        .7        .7        .7        .7        .7        .7        .7
114.................................................        .5        .6        .6        .6        .6        .6        .6        .6        .6        .6
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                      Table VIII--Temporary Life Annuities;\1\ One Life--Expected Return Multiples
                                                             [See footnote at end of tables]
                                                      Temporary Period--Maximum Duration of Annuity
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                    Years--
                         Age                         ---------------------------------------------------------------------------------------------------
                                                         11        12        13        14        15        16        17        18        19        20
--------------------------------------------------------------------------------------------------------------------------------------------------------
5...................................................      11.0      12.0      13.0      14.0      15.0      16.0      17.0      18.0      19.0      19.9
6...................................................      11.0      12.0      13.0      14.0      15.0      16.0      17.0      18.0      19.0      19.9
7...................................................      11.0      12.0      13.0      14.0      15.0      16.0      17.0      18.0      19.0      19.9
8...................................................      11.0      12.0      13.0      14.0      15.0      16.0      17.0      18.0      18.9      19.9
9...................................................      11.0      12.0      13.0      14.0      15.0      16.0      17.0      18.0      18.9      19.9
10..................................................      11.0      12.0      13.0      14.0      15.0      16.0      17.0      18.0      18.9      19.9
11..................................................      11.0      12.0      13.0      14.0      15.0      16.0      17.0      17.9      18.9      19.9
12..................................................      11.0      12.0      13.0      14.0      15.0      16.0      17.0      17.9      18.9      19.9
13..................................................      11.0      12.0      13.0      14.0      15.0      16.0      17.0      17.9      18.9      19.9
14..................................................      11.0      12.0      13.0      14.0      15.0      16.0      16.9      17.9      18.9      19.9
15..................................................      11.0      12.0      13.0      14.0      15.0      16.0      16.9      17.9      18.9      19.9
16..................................................      11.0      12.0      13.0      14.0      15.0      16.0      16.9      17.9      18.9      19.9
17..................................................      11.0      12.0      13.0      14.0      15.0      15.9      16.9      17.9      18.9      19.9
18..................................................      11.0      12.0      13.0      14.0      15.0      15.9      16.9      17.9      18.9      19.9
19..................................................      11.0      12.0      13.0      14.0      15.0      15.9      16.9      17.9      18.9      19.9
20..................................................      11.0      12.0      13.0      14.0      14.9      15.9      16.9      17.9      18.9      19.9
21..................................................      11.0      12.0      13.0      14.0      14.9      15.9      16.9      17.9      18.9      19.9
22..................................................      11.0      12.0      13.0      14.0      14.9      15.9      16.9      17.9      18.9      19.9
23..................................................      11.0      12.0      13.0      13.9      14.9      15.9      16.9      17.9      18.9      19.9
24..................................................      11.0      12.0      13.0      13.9      14.9      15.9      16.9      17.9      18.9      19.9
25..................................................      11.0      12.0      13.0      13.9      14.9      15.9      16.9      17.9      18.9      19.9
26..................................................      11.0      12.0      12.9      13.9      14.9      15.9      16.9      17.9      18.9      19.9
27..................................................      11.0      12.0      12.9      13.9      14.9      15.9      16.9      17.9      18.9      19.9
28..................................................      11.0      12.0      12.9      13.9      14.9      15.9      16.9      17.9      18.9      19.8
29..................................................      11.0      12.0      12.9      13.9      14.9      15.9      16.9      17.9      18.9      19.8
30..................................................      11.0      11.9      12.9      13.9      14.9      15.9      16.9      17.9      18.8      19.8
31..................................................      11.0      11.9      12.9      13.9      14.9      15.9      16.9      17.9      18.8      19.8
32..................................................      11.0      11.9      12.9      13.9      14.9      15.9      16.9      17.8      18.8      19.8
33..................................................      11.0      11.9      12.9      13.9      14.9      15.9      16.9      17.8      18.8      19.8
34..................................................      10.9      11.9      12.9      13.9      14.9      15.9      16.8      17.8      18.8      19.8
35..................................................      10.9      11.9      12.9      13.9      14.9      15.9      16.8      17.8      18.8      19.7
36..................................................      10.9      11.9      12.9      13.9      14.9      15.8      16.8      17.8      18.8      19.7
37..................................................      10.9      11.9      12.9      13.9      14.9      15.8      16.8      17.8      18.7      19.7
38..................................................      10.9      11.9      12.9      13.9      14.8      15.8      16.8      17.8      18.7      19.7
39..................................................      10.9      11.9      12.9      13.9      14.8      15.8      16.8      17.7      18.7      19.6
40..................................................      10.9      11.9      12.9      13.8      14.8      15.8      16.7      17.7      18.7      19.6
41..................................................      10.9      11.9      12.9      13.8      14.8      15.8      16.7      17.7      18.6      19.6
42..................................................      10.9      11.9      12.8      13.8      14.8      15.7      16.7      17.6      18.6      19.5
43..................................................      10.9      11.9      12.8      13.8      14.8      15.7      16.7      17.6      18.6      19.5
44..................................................      10.9      11.8      12.8      13.8      14.7      15.7      16.6      17.6      18.5      19.4
45..................................................      10.9      11.8      12.8      13.8      14.7      15.7      16.6      17.5      18.5      19.4
46..................................................      10.9      11.8      12.8      13.7      14.7      15.6      16.6      17.5      18.4      19.3
47..................................................      10.8      11.8      12.8      13.7      14.7      15.6      16.5      17.5      18.4      19.3
48..................................................      10.8      11.8      12.7      13.7      14.6      15.6      16.5      17.4      18.3      19.2
49..................................................      10.8      11.8      12.7      13.7      14.6      15.5      16.4      17.4      18.3      19.2
50..................................................      10.8      11.7      12.7      13.6      14.6      15.5      16.4      17.3      18.2      19.1
51..................................................      10.8      11.7      12.7      13.6      14.5      15.4      16.3      17.2      18.1      19.0
52..................................................      10.8      11.7      12.6      13.6      14.5      15.4      16.3      17.2      18.0      18.9
53..................................................      10.7      11.7      12.6      13.5      14.4      15.3      16.2      17.1      18.0      18.8
54..................................................      10.7      11.6      12.6      13.5      14.4      15.3      16.2      17.0      17.9      18.7
55..................................................      10.7      11.6      12.5      13.4      14.3      15.2      16.1      16.9      17.8      18.6
56..................................................      10.7      11.6      12.5      13.4      14.3      15.1      16.0      16.8      17.6      18.4
57..................................................      10.6      11.5      12.4      13.3      14.2      15.1      15.9      16.7      17.5      18.3
58..................................................      10.6      11.5      12.4      13.3      14.1      15.0      15.8      16.6      17.4      18.1

[[Page 251]]

 
59..................................................      10.6      11.4      12.3      13.2      14.0      14.9      15.7      16.4      17.2      17.9
60..................................................      10.5      11.4      12.3      13.1      13.9      14.7      15.5      16.3      17.0      17.7
61..................................................      10.5      11.3      12.2      13.0      13.8      14.6      15.4      16.1      16.8      17.5
62..................................................      10.4      11.3      12.1      12.9      13.7      14.5      15.2      15.9      16.6      17.2
63..................................................      10.3      11.2      12.0      12.8      13.6      14.3      15.0      15.7      16.3      17.0
64..................................................      10.3      11.1      11.9      12.7      13.4      14.1      14.8      15.5      16.1      16.7
65..................................................      10.2      11.0      11.8      12.5      13.2      13.9      14.6      15.2      15.8      16.3
66..................................................      10.1      10.9      11.6      12.4      13.1      13.7      14.4      14.9      15.5      16.0
67..................................................      10.0      10.8      11.5      12.2      12.9      13.5      14.1      14.7      15.2      15.6
68..................................................       9.9      10.6      11.4      12.0      12.7      13.3      13.8      14.3      14.8      15.3
69..................................................       9.8      10.5      11.2      11.8      12.4      13.0      13.5      14.0      14.4      14.8
70..................................................       9.6      10.3      11.0      11.6      12.2      12.7      13.2      13.7      14.0      14.4
71..................................................       9.5      10.2      10.8      11.4      11.9      12.4      12.9      13.3      13.6      13.9
72..................................................       9.4      10.0      10.6      11.2      11.7      12.1      12.5      12.9      13.2      13.5
73..................................................       9.2       9.8      10.4      10.9      11.4      11.8      12.1      12.5      12.7      13.0
74..................................................       9.0       9.6      10.1      10.6      11.0      11.4      11.7      12.0      12.3      12.5
75..................................................       8.8       9.4       9.9      10.3      10.7      11.0      11.3      11.6      11.8      12.0
76..................................................       8.6       9.1       9.6      10.0      10.3      10.6      10.9      11.1      11.3      11.4
77..................................................       8.4       8.9       9.3       9.7      10.0      10.2      10.5      10.6      10.8      10.9
78..................................................       8.2       8.6       9.0       9.3       9.6       9.8      10.0      10.2      10.3      10.4
79..................................................       7.9       8.3       8.7       9.0       9.2       9.4       9.5       9.7       9.8       9.8
80..................................................       7.7       8.0       8.3       8.6       8.8       9.0       9.1       9.2       9.3       9.3
81..................................................       7.4       7.7       8.0       8.2       8.4       8.5       8.6       8.7       8.8       8.8
82..................................................       7.1       7.4       7.6       7.8       8.0       8.1       8.2       8.2       8.3       8.3
83..................................................       6.8       7.1       7.3       7.4       7.5       7.6       7.7       7.8       7.8       7.8
84..................................................       6.5       6.7       6.9       7.0       7.1       7.2       7.3       7.3       7.3       7.4
85..................................................       6.2       6.4       6.6       6.7       6.7       6.8       6.8       6.9       6.9       6.9
86..................................................       5.9       6.1       6.2       6.3       6.4       6.4       6.4       6.5       6.5       6.5
87..................................................       5.6       5.8       5.9       5.9       6.0       6.0       6.0       6.1       6.1       6.1
88..................................................       5.3       5.4       5.5       5.6       5.6       5.6       5.7       5.7       5.7       5.7
89..................................................       5.1       5.1       5.2       5.3       5.3       5.3       5.3       5.3       5.3       5.3
90..................................................       4.8       4.9       4.9       4.9       5.0       5.0       5.0       5.0       5.0       5.0
91..................................................       4.5       4.6       4.6       4.6       4.7       4.7       4.7       4.7       4.7       4.7
92..................................................       4.3       4.3       4.3       4.4       4.4       4.4       4.4       4.4       4.4       4.4
93..................................................       4.0       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1
94..................................................       3.8       3.8       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9
95..................................................       3.6       3.6       3.6       3.6       3.7       3.7       3.7       3.7       3.7       3.7
96..................................................       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4
97..................................................       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2
98..................................................       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0
99..................................................       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8
100.................................................       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7
101.................................................       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5
102.................................................       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3
103.................................................       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1
104.................................................       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9
105.................................................       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8
106.................................................       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6
107.................................................       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4
108.................................................       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3
109.................................................       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1
110.................................................       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0
111.................................................        .9        .9        .9        .9        .9        .9        .9        .9        .9        .9
112.................................................        .8        .8        .8        .8        .8        .8        .8        .8        .8        .8
113.................................................        .7        .7        .7        .7        .7        .7        .7        .7        .7        .7
114.................................................        .6        .6        .6        .6        .6        .6        .6        .6        .6        .6
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                      Table VIII--Temporary Life Annuities; \1\ One Life--Expected Return Multiples
                                                             [See footnote at end of tables]
                                                      Temporary Period--Maximum Duration of Annuity
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                    Years--
                         Age                         ---------------------------------------------------------------------------------------------------
                                                         21        22        23        24        25        26        27        28        29        30
--------------------------------------------------------------------------------------------------------------------------------------------------------
5...................................................      20.9      21.9      22.9      23.9      24.9      25.9      26.9      27.9      28.9      29.9

[[Page 252]]

 
6...................................................      20.9      21.9      22.9      23.9      24.9      25.9      26.9      27.9      28.9      29.9
7...................................................      20.9      21.9      22.9      23.9      24.9      25.9      26.9      27.9      28.9      29.9
8...................................................      20.9      21.9      22.9      23.9      24.9      25.9      26.9      27.9      28.9      29.8
9...................................................      20.9      21.9      22.9      23.9      24.9      25.9      26.9      27.9      28.9      29.8
10..................................................      20.9      21.9      22.9      23.9      24.9      25.9      26.9      27.9      28.8      29.8
11..................................................      20.9      21.9      22.9      23.9      24.9      25.9      26.9      27.9      28.8      29.8
12..................................................      20.9      21.9      22.9      23.9      24.9      25.9      26.9      27.8      28.8      29.8
13..................................................      20.9      21.9      22.9      23.9      24.9      25.9      26.9      27.8      28.8      29.8
14..................................................      20.9      21.9      22.9      23.9      24.9      25.9      26.8      27.8      28.8      29.8
15..................................................      20.9      21.9      22.9      23.9      24.9      25.9      26.8      27.8      28.8      29.8
16..................................................      20.9      21.9      22.9      23.9      24.9      25.8      26.8      27.8      28.8      29.8
17..................................................      20.9      21.9      22.9      23.9      24.9      25.8      26.8      27.8      28.8      29.8
18..................................................      20.9      21.9      22.9      23.9      24.8      25.8      26.8      27.8      28.8      29.7
19..................................................      20.9      21.9      22.9      23.9      24.8      25.8      26.8      27.8      28.8      29.7
20..................................................      20.9      21.9      22.9      23.8      24.8      25.8      26.8      27.8      28.7      29.7
21..................................................      20.9      21.9      22.9      23.8      24.8      25.8      26.8      27.8      28.7      29.7
22..................................................      20.9      21.9      22.8      23.8      24.8      25.8      26.8      27.7      28.7      29.7
23..................................................      20.9      21.9      22.8      23.8      24.8      25.8      26.7      27.7      28.7      29.7
24..................................................      20.9      21.8      22.8      23.8      24.8      25.8      26.7      27.7      28.7      29.6
25..................................................      20.9      21.8      22.8      23.8      24.8      25.7      26.7      27.7      28.6      29.6
26..................................................      20.8      21.8      22.8      23.8      24.8      25.7      26.7      27.7      28.6      29.6
27..................................................      20.8      21.8      22.8      23.8      24.7      25.7      26.7      27.6      28.6      29.5
28..................................................      20.8      21.8      22.8      23.7      24.7      25.7      26.6      27.6      28.6      29.5
29..................................................      20.8      21.8      22.8      23.7      24.7      25.7      26.6      27.6      28.5      29.5
30..................................................      20.8      21.8      22.7      23.7      24.7      25.6      26.6      27.5      28.5      29.4
31..................................................      20.8      21.8      22.7      23.7      24.6      25.6      26.6      27.5      28.4      29.4
32..................................................      20.8      21.7      22.7      23.7      24.6      25.6      26.5      27.5      28.4      29.3
33..................................................      20.8      21.7      22.7      23.6      24.6      25.5      26.5      27.4      28.4      29.3
34..................................................      20.7      21.7      22.7      23.6      24.6      25.5      26.4      27.4      28.3      29.2
35..................................................      20.7      21.7      22.6      23.6      24.5      25.5      26.4      27.3      28.2      29.2
36..................................................      20.7      21.6      22.6      23.5      24.5      25.4      26.3      27.3      28.2      29.1
37..................................................      20.7      21.6      22.6      23.5      24.4      25.4      26.3      27.2      28.1      29.0
38..................................................      20.6      21.6      22.5      23.4      24.4      25.3      26.2      27.1      28.0      28.9
39..................................................      20.6      21.5      22.5      23.4      24.3      25.2      26.1      27.0      27.9      28.8
40..................................................      20.6      21.5      22.4      23.3      24.3      25.2      26.1      27.0      27.8      28.7
41..................................................      20.5      21.4      22.4      23.3      24.2      25.1      26.0      26.9      27.7      28.6
42..................................................      20.5      21.4      22.3      23.2      24.1      25.0      25.9      26.8      27.6      28.5
43..................................................      20.4      21.3      22.2      23.2      24.0      24.9      25.8      26.6      27.5      28.3
44..................................................      20.4      21.3      22.2      23.1      24.0      24.8      25.7      26.5      27.3      28.2
45..................................................      20.3      21.2      22.1      23.0      23.9      24.7      25.6      26.4      27.2      28.0
46..................................................      20.2      21.1      22.0      22.9      23.8      24.6      25.4      26.2      27.0      27.8
47..................................................      20.2      21.1      21.9      22.8      23.6      24.5      25.3      26.1      26.8      27.6
48..................................................      20.1      21.0      21.8      22.7      23.5      24.3      25.1      25.9      26.6      27.4
49..................................................      20.0      20.9      21.7      22.6      23.4      24.2      25.0      25.7      26.4      27.1
50..................................................      19.9      20.8      21.6      22.4      23.2      24.0      24.8      25.5      26.2      26.9
51..................................................      19.8      20.7      21.5      22.3      23.1      23.8      24.6      25.3      25.9      26.6
52..................................................      19.7      20.6      21.4      22.1      22.9      23.6      24.3      25.0      25.7      26.3
53..................................................      19.6      20.4      21.2      22.0      22.7      23.4      24.1      24.7      25.3      25.9
54..................................................      19.5      20.3      21.0      21.8      22.5      23.2      23.8      24.4      25.0      25.6
55..................................................      19.3      20.1      20.8      21.6      22.2      22.9      23.5      24.1      24.6      25.2
56..................................................      19.2      19.9      20.6      21.3      22.0      22.6      23.2      23.7      24.3      24.7
57..................................................      19.0      19.7      20.4      21.1      21.7      22.3      22.8      23.4      23.8      24.3
58..................................................      18.8      19.5      20.2      20.8      21.4      21.9      22.5      22.9      23.4      23.8
59..................................................      18.6      19.3      19.9      20.5      21.1      21.6      22.0      22.5      22.9      23.2
60..................................................      18.4      19.0      19.6      20.2      20.7      21.2      21.6      22.0      22.4      22.7
61..................................................      18.1      18.7      19.3      19.8      20.3      20.7      21.1      21.5      21.8      22.1
62..................................................      17.8      18.4      18.9      19.4      19.9      20.3      20.6      21.0      21.2      21.5
63..................................................      17.5      18.1      18.5      19.0      19.4      19.8      20.1      20.4      20.6      20.8
64..................................................      17.2      17.7      18.1      18.6      18.9      19.3      19.5      19.8      20.0      20.2
65..................................................      16.8      17.3      17.7      18.1      18.4      18.7      18.9      19.2      19.3      19.5
66..................................................      16.5      16.9      17.3      17.6      17.9      18.1      18.3      18.5      18.7      18.8
67..................................................      16.1      16.4      16.8      17.1      17.3      17.5      17.7      17.9      18.0      18.1
68..................................................      15.6      16.0      16.3      16.5      16.7      16.9      17.1      17.2      17.3      17.4
69..................................................      15.2      15.5      15.7      16.0      16.1      16.3      16.4      16.5      16.6      16.7
70..................................................      14.7      15.0      15.2      15.4      15.5      15.7      15.8      15.8      15.9      15.9
71..................................................      14.2      14.4      14.6      14.8      14.9      15.0      15.1      15.2      15.2      15.2
72..................................................      13.7      13.9      14.1      14.2      14.3      14.4      14.4      14.5      14.5      14.5
73..................................................      13.2      13.3      13.5      13.6      13.7      13.7      13.8      13.8      13.8      13.9

[[Page 253]]

 
74..................................................      12.6      12.8      12.9      13.0      13.0      13.1      13.1      13.1      13.2      13.2
75..................................................      12.1      12.2      12.3      12.4      12.4      12.5      12.5      12.5      12.5      12.5
76..................................................      11.5      11.6      11.7      11.8      11.8      11.8      11.8      11.9      11.9      11.9
77..................................................      11.0      11.1      11.1      11.2      11.2      11.2      11.2      11.2      11.2      11.2
78..................................................      10.4      10.5      10.5      10.6      10.6      10.6      10.6      10.6      10.6      10.6
79..................................................       9.9       9.9      10.0      10.0      10.0      10.0      10.0      10.0      10.0      10.0
80..................................................       9.4       9.4       9.4       9.4       9.5       9.5       9.5       9.5       9.5       9.5
81..................................................       8.8       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9
82..................................................       8.3       8.4       8.4       8.4       8.4       8.4       8.4       8.4       8.4       8.4
83..................................................       7.8       7.9       7.9       7.9       7.9       7.9       7.9       7.9       7.9       7.9
84..................................................       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4
85..................................................       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9
86..................................................       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5
87..................................................       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1
88..................................................       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7
89..................................................       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3
90..................................................       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0
91..................................................       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7
92..................................................       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4
93..................................................       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1
94..................................................       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9
95..................................................       3.7       3.7       3.7       3.7       3.7       3.7       3.7       3.7       3.7       3.7
96..................................................       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4
97..................................................       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2
98..................................................       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0
99..................................................       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8
100.................................................       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7
101.................................................       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5
102.................................................       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3
103.................................................       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1
104.................................................       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9
105.................................................       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8
106.................................................       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6
107.................................................       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4
108.................................................       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3
109.................................................       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1
110.................................................       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0
111.................................................        .9        .9        .9        .9        .9        .9        .9        .9        .9        .9
112.................................................        .8        .8        .8        .8        .8        .8        .8        .8        .8        .8
113.................................................        .7        .7        .7        .7        .7        .7        .7        .7        .7        .7
114.................................................        .6        .6        .6        .6        .6        .6        .6        .6        .6        .6
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                      Table VIII--Temporary Life Annuities;\1\ One Life--Expected Return Multiples
                                                             [See footnote at end of tables]
                                                      Temporary Period--Maximum Duration of Annuity
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                    Years--
                         Age                         ---------------------------------------------------------------------------------------------------
                                                         31        32        33        34        35        36        37        38        39        40
--------------------------------------------------------------------------------------------------------------------------------------------------------
5...................................................      30.8      31.8      32.8      33.8      34.8      35.8      36.8      37.7      38.7      39.7
6...................................................      30.8      31.8      32.8      33.8      34.8      35.8      36.8      37.7      38.7      39.7
7...................................................      30.8      31.8      32.8      33.8      34.8      35.8      36.7      37.7      38.7      39.7
8...................................................      30.8      31.8      32.8      33.8      34.8      35.7      36.7      37.7      38.7      39.7
9...................................................      30.8      31.8      32.8      33.8      34.8      35.7      36.7      37.7      38.7      39.6
10..................................................      30.8      31.8      32.8      33.8      34.7      35.7      36.7      37.7      38.6      39.6
11..................................................      30.8      31.8      32.8      33.8      34.7      35.7      36.7      37.7      38.6      39.6
12..................................................      30.8      31.8      32.8      33.7      34.7      35.7      36.7      37.6      38.6      39.6
13..................................................      30.8      31.8      32.7      33.7      34.7      35.7      36.6      37.6      38.6      39.5
14..................................................      30.8      31.8      32.7      33.7      34.7      35.7      36.6      37.6      38.6      39.5
15..................................................      30.8      31.7      32.7      33.7      34.7      35.6      36.6      37.6      38.5      39.5
16..................................................      30.8      31.7      32.7      33.7      34.6      35.6      36.6      37.5      38.5      39.4
17..................................................      30.7      31.7      32.7      33.7      34.6      35.6      36.5      37.5      38.5      39.4
18..................................................      30.7      31.7      32.7      33.6      34.6      35.6      36.5      37.5      38.4      39.4
19..................................................      30.7      31.7      32.6      33.6      34.6      35.5      36.5      37.4      38.4      39.3
20..................................................      30.7      31.7      32.6      33.6      34.5      35.5      36.4      37.4      38.3      39.3

[[Page 254]]

 
21..................................................      30.7      31.6      32.6      33.6      34.5      35.5      36.4      37.4      38.3      39.2
22..................................................      30.6      31.6      32.6      33.5      34.5      35.4      36.4      37.3      38.2      39.2
23..................................................      30.6      31.6      32.5      33.5      34.4      35.4      36.3      37.3      38.2      39.1
24..................................................      30.6      31.5      32.5      33.5      34.4      35.3      36.3      37.2      38.1      39.0
25..................................................      30.6      31.5      32.5      33.4      34.3      35.3      36.2      37.1      38.1      39.0
26..................................................      30.5      31.5      32.4      33.4      34.3      35.2      36.2      37.1      38.0      38.9
27..................................................      30.5      31.4      32.4      33.3      34.2      35.2      36.1      37.0      37.9      38.8
28..................................................      30.5      31.4      32.3      33.3      34.2      35.1      36.0      36.9      37.8      38.7
29..................................................      30.4      31.4      32.3      33.2      34.1      35.0      35.9      36.8      37.7      38.6
30..................................................      30.4      31.3      32.2      33.1      34.1      35.0      35.8      36.7      37.6      38.5
31..................................................      30.3      31.2      32.2      33.1      34.0      34.9      35.8      36.6      37.5      38.3
32..................................................      30.3      31.2      32.1      33.0      33.9      34.8      35.6      36.5      37.4      38.2
33..................................................      30.2      31.1      32.0      32.9      33.8      34.7      35.5      36.4      37.2      38.0
34..................................................      30.1      31.0      31.9      32.8      33.7      34.6      35.4      36.2      37.1      37.9
35..................................................      30.1      31.0      31.8      32.7      33.6      34.4      35.3      36.1      36.9      37.7
36..................................................      30.0      30.9      31.7      32.6      33.5      34.3      35.1      35.9      36.7      37.4
37..................................................      29.9      30.8      31.6      32.5      33.3      34.1      34.9      35.7      36.5      37.2
38..................................................      29.8      30.7      31.5      32.3      33.2      34.0      34.7      35.5      36.2      37.0
39..................................................      29.7      30.5      31.4      32.2      33.0      33.8      34.5      35.3      36.0      36.7
40..................................................      29.6      30.4      31.2      32.0      32.8      33.6      34.3      35.0      35.7      36.4
41..................................................      29.4      30.2      31.0      31.8      32.6      33.3      34.1      34.7      35.4      36.0
42..................................................      29.3      30.1      30.9      31.6      32.4      33.1      33.8      34.4      35.1      35.7
43..................................................      29.1      29.9      30.7      31.4      32.1      32.8      33.5      34.1      34.7      35.3
44..................................................      28.9      29.7      30.5      31.2      31.9      32.5      33.2      33.8      34.3      34.9
45..................................................      28.8      29.5      30.2      30.9      31.6      32.2      32.8      33.4      33.9      34.4
46..................................................      28.5      29.3      30.0      30.6      31.3      31.9      32.4      33.0      33.5      33.9
47..................................................      28.3      29.0      29.7      30.3      30.9      31.5      32.0      32.5      33.0      33.4
48..................................................      28.1      28.7      29.4      30.0      30.6      31.1      31.6      32.1      32.5      32.9
49..................................................      27.8      28.4      29.0      29.6      30.2      30.7      31.1      31.5      31.9      32.3
50..................................................      27.5      28.1      28.7      29.2      29.7      30.2      30.6      31.0      31.4      31.7
51..................................................      27.2      27.8      28.3      28.8      29.3      29.7      30.1      30.4      30.7      31.0
52..................................................      26.8      27.4      27.9      28.4      28.8      29.2      29.5      29.8      30.1      30.3
53..................................................      26.5      27.0      27.4      27.9      28.3      28.6      28.9      29.2      29.4      29.6
54..................................................      26.1      26.5      27.0      27.4      27.7      28.0      28.3      28.5      28.7      28.9
55..................................................      25.6      26.1      26.5      26.8      27.1      27.4      27.6      27.8      28.0      28.1
56..................................................      25.2      25.6      25.9      26.2      26.5      26.7      26.9      27.1      27.2      27.3
57..................................................      24.7      25.0      25.3      25.6      25.8      26.0      26.2      26.3      26.5      26.5
58..................................................      24.1      24.4      24.7      25.0      25.2      25.3      25.5      25.6      25.7      25.7
59..................................................      23.6      23.8      24.1      24.3      24.4      24.6      24.7      24.8      24.9      24.9
60..................................................      23.0      23.2      23.4      23.6      23.7      23.8      23.9      24.0      24.0      24.1
61..................................................      22.3      22.5      22.7      22.9      23.0      23.1      23.1      23.2      23.2      23.3
62..................................................      21.7      21.9      22.0      22.1      22.2      22.3      22.3      22.4      22.4      22.4
63..................................................      21.0      21.1      21.3      21.4      21.4      21.5      21.5      21.6      21.6      21.6
64..................................................      20.3      20.4      20.5      20.6      20.6      20.7      20.7      20.7      20.8      20.8
65..................................................      19.6      19.7      19.8      19.8      19.9      19.9      19.9      19.9      19.9      20.0
66..................................................      18.9      19.0      19.0      19.1      19.1      19.1      19.1      19.1      19.1      19.1
67..................................................      18.2      18.2      18.3      18.3      18.3      18.3      18.3      18.3      18.4      18.4
68..................................................      17.4      17.5      17.5      17.5      17.5      17.6      17.6      17.6      17.6      17.6
69..................................................      16.7      16.7      16.8      16.8      16.8      16.8      16.8      16.8      16.8      16.8
70..................................................      16.0      16.0      16.0      16.0      16.0      16.0      16.0      16.0      16.0      16.0
71..................................................      15.3      15.3      15.3      15.3      15.3      15.3      15.3      15.3      15.3      15.3
72..................................................      14.6      14.6      14.6      14.6      14.6      14.6      14.6      14.6      14.6      14.6
73..................................................      13.9      13.9      13.9      13.9      13.9      13.9      13.9      13.9      13.9      13.9
74..................................................      13.2      13.2      13.2      13.2      13.2      13.2      13.2      13.2      13.2      13.2
75..................................................      12.5      12.5      12.5      12.5      12.5      12.5      12.5      12.5      12.5      12.5
76..................................................      11.9      11.9      11.9      11.9      11.9      11.9      11.9      11.9      11.9      11.9
77..................................................      11.2      11.2      11.2      11.2      11.2      11.2      11.2      11.2      11.2      11.2
78..................................................      10.6      10.6      10.6      10.6      10.6      10.6      10.6      10.6      10.6      10.6
79..................................................      10.0      10.0      10.0      10.0      10.0      10.0      10.0      10.0      10.0      10.0
80..................................................       9.5       9.5       9.5       9.5       9.5       9.5       9.5       9.5       9.5       9.5
81..................................................       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9       8.9
82..................................................       8.4       8.4       8.4       8.4       8.4       8.4       8.4       8.4       8.4       8.4
83..................................................       7.9       7.9       7.9       7.9       7.9       7.9       7.9       7.9       7.9       7.9
84..................................................       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4       7.4
85..................................................       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9       6.9
86..................................................       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5       6.5
87..................................................       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1       6.1
88..................................................       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7       5.7

[[Page 255]]

 
89..................................................       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3       5.3
90..................................................       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0       5.0
91..................................................       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7       4.7
92..................................................       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4       4.4
93..................................................       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1       4.1
94..................................................       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9       3.9
95..................................................       3.7       3.7       3.7       3.7       3.7       3.7       3.7       3.7       3.7       3.7
96..................................................       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4       3.4
97..................................................       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2       3.2
98..................................................       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0       3.0
99..................................................       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8       2.8
100.................................................       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7       2.7
101.................................................       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5       2.5
102.................................................       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3       2.3
103.................................................       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1       2.1
104.................................................       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9       1.9
105.................................................       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8       1.8
106.................................................       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6       1.6
107.................................................       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4       1.4
108.................................................       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3       1.3
109.................................................       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1       1.1
110.................................................       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0       1.0
111.................................................        .9        .9        .9        .9        .9        .9        .9        .9        .9        .9
112.................................................        .8        .8        .8        .8        .8        .8        .8        .8        .8        .8
113.................................................        .7        .7        .7        .7        .7        .7        .7        .7        .7        .7
114.................................................        .6        .6        .6        .6        .6        .6        .6        .6        .6        .6
115.................................................        .5        .5        .5        .5        .5        .5        .5        .5        .5        .5
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The multiples in this table are not applicable to annuities for a term certain; for such cases see paragraph (c) of Sec.  1.72-5.


If (a) the terms of the contract involve a life or lives, and are such 
that the above tables cannot be correctly applied, and (b) the amounts 
received under the contract are at least partly ``amounts received as an 
annuity'' under a contract to which section 72 applies, the taxpayer may 
submit with his return an actuarial computation based upon the 
applicable annuity table (described below) with ages set back one year, 
showing the appropriate factors applied in his case, subject to the 
approval of the Commissioner upon examination of such return. The 
applicable annuity table is the 1937 Standard Annuity Table (if the 
investment in the contract does not include a post-June 1986 investment 
in the contract) or the gender-neutral version of the 1983 Basic Table 
(if the investment in the contract includes a post-June 1986 investment 
in the contract). In the case of a contract to which Sec. 1.72-6(d) 
(relating to contracts in which amounts were invested both before July 
1, 1986, and after June 30, 1986) applies, the actuarial computation 
shall be based on both tables in accordance with the principles of Sec. 
1.72-6(d). Computations involving factors to compensate for the effects 
of contingencies other than mortality, such as marriage or remarriage, 
re-employment, recovery from disability, or the like, will not be 
approved.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as 
amended by T.D. 8115, 51 FR 45706, Dec. 19, 1986; T.D. 8115, 60 FR 
16381, Mar. 30, 1995 ]



Sec. 1.72-10  Effect of transfer of contracts on investment in the 
contract.

    (a) If a contract to which section 72 applies, or any interest 
therein, is transferred for a valuable consideration, by assignment or 
otherwise, only the actual value of the consideration given for such 
transfer and the amount of premiums or other consideration subsequently 
paid by the transferee shall be included in the transferee's aggregate 
of premiums or other consideration paid. In accordance with the 
provisions of section 72(g)(3) and paragraph (b) of Sec. 1.72-4, an 
annuity

[[Page 256]]

starting date shall be determined for the transferee without regard to 
the annuity starting date, if any, of the transferor. In determining the 
transferee's investment in the contract, the aggregate amount of 
premiums or other consideration paid shall be reduced by all amounts 
received by the transferee before the receipt of an amount as an annuity 
or before the annuity starting date, whichever is the later, to the 
extent that such amounts were excludable from his gross income under the 
applicable income tax law at the time of receipt. For the treatment of 
amounts received by the transferee subsequent to both the annuity 
starting date and the date of receipt of a payment as an annuity, but 
not received as annuity payments, see Sec. 1.72-11. For a limitation on 
adjustments to the basis of annuity contracts sold, see section 1021.
    (b) In the case of a transfer of such a contract without valuable 
consideration, the annuity starting date and the expected return under 
the contract shall be determined as though no such transfer had taken 
place. See paragraph (b) of Sec. 1.72-4. The transferee shall include 
the aggregate of premiums or other consideration paid or deemed to have 
been paid by his transferor in the aggregate of premiums or other 
consideration as though paid by him. In determining the transferee's 
investment in the contract, the transferee's aggregate amount of 
premiums or other consideration paid (as so found) shall be reduced by 
all amounts either received or deemed to have been received by himself 
or his transferor before the annuity starting date, or before the date 
on which an amount is first received as an annuity, whichever is the 
later, to the extent that such amounts were excludable from the gross 
income of the actual recipient under the applicable income tax law at 
the time of receipt. For treatment of amounts received subsequent to 
both the above dates by such transferee, but not received as annuity 
payments, see Sec. 1.72-11.



Sec. 1.72-11  Amounts not received as annuity payments.

    (a) Introductory. (1) This section applies to amounts received under 
a contract to which section 72 applies if either:
    (i) Paragraph (b) of Sec. 1.72-2 is inapplicable to such amounts.
    (ii) Paragraph (b) of Sec. 1.72-2 is applicable but the annuity 
payments received differ either in amount, duration, or both, from those 
originally provided under the contract, or
    (iii) Paragraph (b) of Sec. 1.72 is applicable, but such annuity 
payments are received by a beneficiary after the death of an annuitant 
(or annuitants) in full discharge of the obligation under the contract 
and solely because of a guarantee.

The payments referred to in subdivision (i) of this subparagraph include 
all amounts other than ``amounts received as an annuity'' as that term 
is defined in paragraphs (b) (2) and (3) of Sec. 1.72-2. If such 
amounts are received as dividends or payments in the nature of 
dividends, or as a return of premiums, see paragraph (b) of this 
section. If such amounts are paid in full discharge of the obligation 
under the contract and are in the nature of a refund of the 
consideration, see paragraph (c) of this section. If such amounts are 
paid upon the surrender, redemption, or maturity of the contract, see 
paragraph (d) of this section. The payments referred to in subdivision 
(ii) of this subparagraph include all annuity payments which are paid as 
the result of a modification or an exchange of the annuity obligations 
originally provided under a contract for different annuity obligations 
(whether or not such modification or exchange is accompanied by the 
payment of an amount to which subdivision (i) of this subparagraph 
applies). If the duration of the new annuity obligations differs from 
the duration of the old annuity obligations, paragraph (e) of this 
section applies to the new annuity obligations and paragraph (d) of this 
section applies to any lump sum payment received. If, however, the 
duration of the new annuity obligations is the same as the duration of 
the old obligations, paragraph (f) of this section applies to the new 
obligations and to any lump sum received in connection therewith. The 
annuity payments referred to in subdivision (iii) of this subparagraph 
are annuity payments which are made to a beneficiary after

[[Page 257]]

the death of annuitant (or annuitants) in full discharge of the 
obligations under a contract because of a provision in the contract 
requiring the payment of a guaranteed amount or minimum number of 
payments for a fixed period; see paragraph (c) of this section.
    (2) The principles of this section apply, to the extent appropriate 
thereto, to amounts paid which are taxable under section 72 (except, for 
taxable years beginning before January 1, 1964, section 72(e)(3)) in 
accordance with sections 402 and 403 and the regulations thereunder. 
However, if contributions used to purchase the contract include amounts 
for which a deduction was allowed under section 404 as contributions on 
behalf of an owner-employee, the rules of this section are modified by 
the rules of paragraph (b) of Sec. 1.72-17. Further, in applying the 
provisions of this section, the aggregate premiums or other 
consideration paid shall not include contributions on behalf of self-
employed individuals to the extent that deductions were allowed under 
section 404 for such contributions. Nor, shall the aggregate of premiums 
or other consideration paid include amounts used to purchase life, 
accident, health, or other insurance protection for an owner-employee. 
See paragraph (b)(4) of Sec. 1.72-16 and paragraph (c) of Sec. 1.72-
17. The principles of this section also apply to payments made in the 
manner described in paragraph (b)(3)(i) of Sec. 1.72-2.
    (b) Amounts received in the nature of dividends or similar 
distributions. (1) If dividends (or payments in the nature of dividends 
or a return of premiums or other consideration) are received under a 
contract to which section 72 applies and such payments are received 
before the annuity starting date or before the date on which an amount 
is first received as an annuity, whichever is the later, such payments 
are includible in the gross income of the recipient only to the extent 
that they, taken together with all previous payments received under the 
contract which were excludable from the gross income of the recipient 
under the applicable income tax law, exceed the aggregate of premiums or 
other consideration paid or deemed to have been paid by the recipient. 
Such payments shall also be subtracted from the consideration paid (or 
deemed paid) both for the purpose of determining an exclusion ratio to 
be applied to subsequent amounts paid as an annuity and for the purpose 
of determining the applicability of section 72(d) and Sec. 1.72-13, 
relating to employee contributions recoverable in three years.
    (2) If dividends or payments in the nature of dividends are paid 
under a contract to which section 72 applies and such payments are 
received on or after the annuity starting date or the date on which an 
amount is first received as an annuity, whichever is later, such 
payments shall be fully includible in the gross income of the recipient. 
The receipt of such payments shall not affect the aggregate of premiums 
or other consideration paid nor the amounts contributed or deemed to 
have been contributed by an employee as otherwise calculated for 
purposes of section 72. Since the investment in the contract and the 
expected return are not affected by a payment which is fully includible 
in the gross income of the recipient under this rule, the exclusion 
ratio will not be affected by such payment and will continue to be 
applied to amounts received as annuity payments in the future as though 
such payment had not been made. This subparagraph shall apply to amounts 
received under a contract described in paragraph (b)(3)(i) of Sec. 
1.72-2 to the extent that the amounts received exceed the portion of the 
investment in the contract allocable to each taxable year in accordance 
with paragraph (d)(3) of Sec. 1.72-4. Hence, such excess is fully 
includible in the gross income of the recipient.
    (c) Amounts received in the nature of a refund of the consideration 
under a contract and in full discharge of the obligation thereof. (1) 
Any amount received under a contract to which section 72 applies, if it 
is at least in part a refund of the consideration paid, including 
amounts payable to a beneficiary after the death of an annuitant by 
reason of a provision in the contract for a life annuity with minimum 
period of payments certain or with a minimum amount which must be paid 
in any event, shall be considered an amount received in the nature of a 
refund of

[[Page 258]]

the consideration paid for such contract. If such an amount is in full 
discharge of an obligation to pay a fixed amount (whether in a lump sum 
or otherwise) or to pay amounts for a fixed number of years (including 
amounts described in paragraph (b)(3)(i) of Sec. 1.72-2), it shall be 
included in the gross income of the recipient only to the extent that 
it, when added to amounts previously received under the contract which 
were excludable from gross income under the law applicable at the time 
of receipt, exceeds the aggregate of premiums or other consideration 
paid. See section 73(e)(2)(A). This paragraph shall not apply if the 
total of the amounts to be paid in discharge of the obligation can in 
any event exceed the total of the annuity payments which would otherwise 
fully discharge the obligation. For rules to be applied in such a case, 
see paragraph (e) of this section.
    (2) The principles of subparagraph (1) of this paragraph may be 
illustrated by the following examples:

    Example (1). A, a male employee, retired on December 31, 1954, at 
the age of 60. A life annuity of $75 per month was payable to him 
beginning January 31, 1955. The annuity contract guaranteed that if A 
did not live for at least ten years after his retirement his 
beneficiary, B, would receive the monthly payments for any balance of 
such ten-year period which remained at the date of A's death. Under 
section 72, A was deemed to have paid $3,600 toward the cost of the 
annuity. A lived for five years after his retirement receiving a total 
of $4,500 in annuity payments. After A's death, B began receiving the 
monthly payments of $75 beginning with the January 31, 1960 payment. B 
will exclude such payments from his gross income throughout 1960, 1961, 
and 1962, and will exclude only $18 of the first payment in 1963 from 
his gross income for that year. Thereafter, B will include the entire 
amount of all such payments in his gross income for the taxable year of 
receipt. This result is determined as follows:

A's investment in the contract (unadjusted)....................   $3,600
Multiple from Table III of Sec.  1.72-9 for male, age       11  .......
 60, where duration of guaranteed amount is 10 years
 (percent)............................................
Subtract value of the refund feature to the nearest dollar (11       396
 percent of $3,600)............................................
                                                                --------
Investment in the contract adjusted for the present value of       3,204
 the refund feature without discount for interest..............
                                                                --------
Aggregate of premiums or other consideration paid..............    3,600
A's exclusion ratio ($3,204/$16,380 [$900x18.2])           19.6
 (percent)............................................
Subtract amount excludable during five years A received              882
 payments (19.6 percent of $4,500 [$900x5])....................
Remainder of aggregate of premiums or other consideration paid     2,718
 excludable from gross income of B under section 72(e).........
 


As a result of the above computation, the number of payments to B which 
will exhaust the remainder of consideration paid which is excludable 
from gross income of the recipient is 36\6/25\ ($2,718/$75) and B will 
exclude the payments from his gross income for three years, then exclude 
only $18 of the first payment for the fourth year from his gross income, 
and thereafter include the entire amount of all payments he receives in 
his gross income.
    Example (2). The facts are the same as in example (1), except that 
B, the beneficiary, elects to receive $50 per month for his life in lieu 
of the payments guaranteed under the original contractual obligation. 
Since such amounts will be received as an annuity and may, because of 
the length of time B may live, exceed the amount guaranteed, they are 
not amounts to which this paragraph applies. See paragraph (e) of this 
section.
    Example (3). The facts are the same as in example (1), except that 
B, the beneficiary, elects to receive the remaining guaranteed amount in 
installments which are larger or smaller than the $75 per month provided 
until, under the terms of the contract, the guaranteed amount is 
exhausted. The rule of subparagraph (1) of this paragraph and the 
computation illustrated in example (1) apply to such installments since 
the total of such installments will not exceed the original amount 
guaranteed to be paid at A's death in any event.
    Example (4). C pays $12,000 for a contract providing that he is to 
be paid an annuity of $1,000 per year for 15 years. His exclusion ratio 
is therefore 80 percent ($12,000/$15,000). He directs that the annuity 
is to be paid to D, his beneficiary, if he should die before the full 
15-year period has expired. C dies after 5 years and D is paid $1,000 in 
1960. D will include $200 ($1,000-$800 [80 percent of $1,000]) in his 
gross income for the taxable year in which he receives the $1,000 since 
section 72(e) and this section do not apply to the annuity payments made 
in accordance with the provisions and during the term of the contract. D 
will continue with the same exclusion ratio used by C (80 percent).
    Example (5). In 1954, E paid $50,000 into a fund and was promised an 
annual income for life the amount of which would depend in part upon the 
earnings realized from the investment of the fund in accordance with an 
agreed formula. The contract also specified that if E should die before 
ten years had elapsed, his beneficiary, F, would be paid the

[[Page 259]]

amounts determined annually under the formula until ten payments had 
been received by E and F together. E died in 1960, having received five 
payments totaling $30,000. Assuming that $22,000 of this amount was 
properly excludable from E's gross income prior to his death, F will 
exclude from his gross income the payments he receives until the taxable 
year in which his total receipts from the fund exceed $28,000 ($50,000-
$22,000). F will include any excess over the $28,000 in his gross income 
for that taxable year. Thereafter, F will include in his gross income 
the entire amount of any payments made to him from the fund.
    Example (6). Assume the facts are the same as in example (1), except 
that the total investment in the contract is made after June 30, 1986, 
that A is to receive payments under the life annuity contract beginning 
on January 31, 1987, and that B will begin to receive the monthly 
payments on January 31, 1992. B will exclude the $75 monthly payments 
from gross income throughout 1992, 1993, and 1994. B will exclude only 
the first two monthly payments and $21 of the third monthly payment in 
1995. This is determined as follows:

A's investment in the contract (unadjusted).................      $3,600
Multiple from Table VII, age 60, 10 years (percent).........           4
      Subtract value of the refund feature (4 percent of            $144
       $3,600...............................................
                                                             -----------
Investment in the contract adjusted for the present value of      $3,456
 the refund feature without discount for interest...........
Aggregate of premiums or other consideration paid...........   $3,600.00
  A's exclusion ratio ($3,456/$21,780 [$900x24.2]) (percent)        15.9
  Subtract amount excludable during five years A received        $715.50
   payments (15.9 percent of $4,500 [$900x5])...............
                                                             -----------
  Remainder of aggregate of premiums or other consideration    $2,884.50
   paid excludable from gross income of B under section
   72(e)....................................................
 


As a result of the above computation, the number of payments to B which 
will exhaust the remainder of consideration paid which is excludable 
from gross income of the recipient is 38 23/50 ($2,884.50/75) and B will 
exclude the payments from gross income for three years, then exclude 
only the first two monthly payments and $34.50 of the third. Thereafter 
B shall include the entire amount of all payments received in gross 
income.

    (3) For the purpose of applying the rule contained in subparagraph 
(1) of this paragraph, it is immaterial whether the recipient of the 
amount received in full discharge of the obligation is the same person 
as the recipient of amounts previously received under the contract which 
were excludable from gross income, except in the case of a contract 
transferred for a valuable consideration, with respect to which see 
paragraph (a) of Sec. 1.72-10. For the limit on the tax, for taxable 
years beginning before January 1, 1964, attributable to the receipt of a 
lump sum to which this paragraph applies, see paragraph (g) of this 
section.
    (d) Amounts received upon the surrender, redemption, or maturity of 
a contract. (1) Any amount received upon the surrender, redemption, or 
maturity of a contract to which section 72 applies, which is not 
received as an annuity under the regulations of paragraph (b) of Sec. 
1.72-2, shall be included in the gross income of the recipient to the 
extent that it, when added to amounts previously received under the 
contract and which were excludable from the gross income of the 
recipient under the law applicable at the time of receipt, exceeds the 
aggregate of premiums or other consideration paid. See section 
72(e)(2)(B). If amounts are to be received as an annuity, whether in 
lieu of or in addition to amounts described in the preceding sentence, 
such amounts shall be included in the gross income of the recipient in 
accordance with the provisions of paragraph (e) or (f) of this section, 
whichever is applicable. The rule stated in the first sentence of this 
paragraph shall not apply to payments received as an annuity or 
otherwise after the date of the first receipt of an amount as an annuity 
subsequent to the maturity, redemption, or surrender of the original 
contract. If amounts are so received and are other than amounts received 
as an annuity, they are includible in the gross income of the recipient. 
See section 72(e)(1)(A) and paragraph (b)(2) of this section.
    (2) For the purpose of applying the rule contained in subparagraph 
(1) of this paragraph, it is immaterial whether the recipient of the 
amount received upon the surrender, redemption, or maturity of the 
contract is the same as the recipient of amounts previously received 
under the contract which were excludable from gross income, except in 
the case of a contract transferred for a valuable consideration, with 
respect to which see paragraph (a) of Sec. 1.72-10. For the limit on 
the amount of tax, for taxable years beginning before January 1, 1964, 
attributable to the receipt of

[[Page 260]]

certain lump sums to which this paragraph applies, see paragraph (g) of 
this section.
    (e) Periodic payments received for a different term. If, after the 
date on which an amount is first received as an annuity under a contract 
to which section 72 applies, the terms of the contract are modified or 
the annuity obligations are exchanged so that periodic payments are to 
be received for a different term than originally provided under the 
contract (whether or not accompanied by the receipt of a lump sum to 
which paragraph (d) of this section applies), the rules of this 
paragraph shall apply to such payments. Hence, the provisions of section 
72(e) and paragraphs (b), (c), (d), and (f) of this section are 
inapplicable for the purpose of determining the includibility of such 
payments in gross income and the general principles of section 72 with 
respect to the use of an exclusion ratio shall be applied to such 
payments as if they were provided under a new contract received in 
exchange for the contract providing the original annuity payments. If 
such payments are received as the result of the surrender, redemption, 
or discharge of a contract to which section 72 applies, they shall be 
considered to be received as an annuity under a contract exchanged for 
the contract whose redemption, surrender, or discharge was involved. For 
the purpose of determining the extent to which the payments so received 
are to be included in the gross income of the recipient, an exclusion 
ratio shall be determined for such contract as of the later of January 
1, 1954, or the first day of the first period for which an amount is 
received as an annuity thereunder, whichever is the later. See paragraph 
(b) of Sec. 1.72-4. In determining the investment in the contract for 
this purpose, any lump sum amount received at the time of the exchange 
shall not be considered an amount to which paragraph (a)(2) of Sec. 
1.72-6 applies. However, such lump sum shall be subtracted from the 
aggregate of premiums or other consideration paid to the extent it is 
excludable as an amount not received as an annuity under this section as 
if it were an amount received before the annuity starting date of the 
contract obtained in exchange.
    (f) Periodic payments received for the same term after a lump sum 
withdrawal. (1) If, after the date of the first receipt of a payment as 
an annuity, the annuitant receives a lump sum and is thereafter to 
receive annuity payments in a reduced amount under the contract for the 
same term, life, or lives as originally specified in the contract, a 
portion of the contract shall be considered to have been surrendered or 
redeemed in consideration of the payment of such lump sum and the 
exclusion ratio originally determined for the contract shall continue to 
apply to the amounts received as an annuity without regard to the fact 
that such amounts are less than the original amounts which were to be 
paid periodically. The lump sum shall be includible in the gross income 
of the recipient in accordance with the provisions of subparagraph (2) 
of this paragraph. However, except in the case of amounts to which 
sections 402 and 403 apply, the tax, for taxable years beginning before 
January 1, 1964, attributable to the inclusion of all or part of the 
lump sum in gross income shall not exceed the amount determined under 
section 72(e)(3) and paragraph (g) of this section. For taxable years 
beginning after December 31, 1963, such amounts may be taken into 
account in computations under sections 1301 through 1305 (relating to 
income averaging).
    (2) There shall be excluded from gross income that portion of the 
lump sum which bears the same ratio to the aggregate premiums or other 
consideration paid for the contract, as reduced by all amounts 
previously received under the contract and excludable from the gross 
income of the recipient under the applicable income tax law, as:
    (i) In the case of payments to be made in the manner described in 
paragraph (b)(2) of Sec. 1.72-2, the amount of the reduction in the 
annuity payments to be made thereafter bears to the annuity payments 
originally provided under the contract, or
    (ii) In the case of a contract providing for payments to be made in 
the manner described in paragraph (b)(3)(i) of Sec. 1.72-2, the amount 
of the reduction in the number of units per period to be

[[Page 261]]

paid thereafter bears to the number of units per period payable under 
the contract immediately before the lump sum withdrawal.
    (3) This paragraph may be illustrated by the following examples:

    Example (1). Taxpayer A pays $20,000 for an annuity contract 
providing for payments to him of $100 per month for his life. At the 
annuity starting date he has a life expectancy of 20 years. His expected 
return is therefore $24,000 and the exclusion ratio is five-sixths. He 
continues to receive the original annuity payments for 5 years, 
receiving a total of $6,000, and properly excludes a total of $5,000 
from his gross income in his income tax returns for those years. At the 
beginning of the next year, A agrees with the insurer to take a reduced 
annuity of $75 per month and a lump sum payment of $4,000 in cash. Of 
the lump sum he receives, he will include $250 and exclude $3,750 from 
his gross income for his taxable year of receipt, determined as follows:

Aggregate of premiums or other consideration paid..........      $20,000
Less amounts received as an annuity to the extent they were       $5,000
 excludable from A's income................................
                                                            ------------
Remainder of the consideration.............................      $15,000
                                                            ============
Ratio of the reduction in the amount of the annuity           25/$100 or
 payments to the original annuity payments.................        \1/4\
Lump sum received..........................................       $4,000
Less one-fourth of the remainder of the consideration (\1/        $3,750
 4\ of $15,000)............................................
                                                            ------------
Portion of the lump sum includible in gross income.........         $250
 


For taxable years beginning before January 1, 1964, the limit on tax of 
section 72(e)(3), as in effect before such date, applies to the portion 
of the lump sum includible in gross income. For taxable years beginning 
after December 31, 1963, such portion may be taken into account in 
computations under sections 1301 through 1305 (relating to income 
averaging). If, in this example, the annuity were a pension payable to A 
as a retired employee, but the facts were otherwise the same (assuming 
that, for instance, the $20,000 aggregate of premiums or other 
consideration paid were A's contributions as determined under section 
72(f) and Sec. 1.72-8) the result would be the same except that the tax 
attributable to the inclusion of the $250 in A's gross income, for 
taxable years beginning before January 1, 1964, would not be limited by 
section 72(e)(3), as in effect before such date. If such a lump sum is 
received in a taxable year beginning after December 31, 1963, the 
portion of such sum includible in gross income may be taken into account 
in computations under sections 1301 through 1305 (relating to income 
averaging).
    Example (2). Taxpayer B pays $30,000 for a contract providing for 
monthly payments to be made to him for 15 years with respect to the 
principal and earnings of 10 units of an investment fund. B receives 
$12,000 during the first 5 years of participation and of this amount he 
has properly excluded a total of $10,000 from his gross income in his 
income returns for the taxable years, since $2,000 of $2,400 he received 
in each such year represented his investment divided by the term of the 
annuity ($30,000/15). At the beginning of the 6th year, B agrees to take 
$11,000 in a lump sum and thereafter to accept the payments arising with 
respect to five units for the remaining 10 years of payments in full 
discharge of the original obligations of the contract. B shall include 
$1,000 in his gross income for the 6th year as the result of the lump 
sum he receives and allocates $1,000 of his original investment in the 
contract to each of the remaining 10 years with respect to the payments 
which will continue, determined as follows:

Aggregate of premiums or other consideration paid.............   $30,000
Total amount received and excludable from gross income........   $10,000
                                                               ---------
Remainder of the consideration................................   $20,000
                                                               =========
Ratio of units discontinued to the total units originally         \5/10\
 provided.....................................................  or \1/2\
Lump sum received at the time of reduction in the number of      $11,000
 units to be paid.............................................
Less one-half of the remainder of the consideration (\1/2\ of    $10,000
 $20,000).....................................................
                                                               ---------
Portion of the lump sum received and includible in gross          $1,000
 income.......................................................
                                                               =========
Remainder of the consideration less the portion of such          $10,000
 remainder attributable to the excludable portion of the lump
 sum ($20,000-$10,000)........................................
Remainder of the consideration properly allocable to each         $1,000
 taxable year for the remaining 10 years ($10,000/10).........
 


For the taxable years beginning before January 1, 1964, the limit on tax 
of section 72(e)(3), as in effect before such date, applies to the 
portion of the lump sum received and includible in gross income. For 
taxable years beginning after December 31, 1963, such portion may be 
taken into account in computations under sections 1301 through 1305 
(relating to income averaging).

    (g) Limit on tax attributable to the receipt of a lump sum. (1) For 
taxable years beginning before January 1, 1964, if the entire amount of 
the proceeds received upon the redemption, maturity, surrender, or 
discharge of a contract to which section 72 applies is received in a 
lump sum and paragraph (c), (d), or (f) of this section is applicable in 
determining the portion of such amount which is includible in gross 
income, the

[[Page 262]]

tax attributable to such portion shall not exceed the tax which would 
have been attributable thereto had such portion been received ratably in 
the taxable year in which received and the 2 preceding taxable years. 
The amount of tax attributable to the includible portion of the lump sum 
received shall be the lesser of:
    (i) The difference between the amount of tax for the taxable year of 
receipt computed by including such portion in gross income and the 
amount of tax for such taxable year computed by excluding such portion 
from gross income; or
    (ii) The difference between the total amount of tax for the taxable 
year of receipt and the 2 preceding taxable years computed by including 
one-third of such portion in gross income for each of the 3 taxable 
years, and the total amount of the tax for the taxable year of receipt 
and the 2 preceding taxable years computed by entirely excluding such 
portion from the gross income of all 3 taxable years.

For the definition of ``taxable year'', see section 441(b). This 
subparagraph shall not apply, for taxable years beginning before January 
1, 1964, to payments excepted from the application of section 72(e)(3), 
as in effect before such date, under the provisions of section 402 or 
403. See paragraph (a) of Sec. 1.72-2 and paragraph (d) of Sec. 1.72-
14.
    (2) For taxable years beginning after December 31, 1963, any amount 
includible in gross income to which this section relates may be taken 
into account in computations under sections 1301 through 1305 (relating 
to income averaging).
    (h) Amounts deemed to be paid or received by a transferee. Amounts 
deemed to have been paid or received by a transferee for the purposes of 
Sec. 1.72-10 shall also be deemed to have been so paid or received by 
such transferee for the purposes of this section. Thus, if a donee is 
deemed to have paid the premiums or other consideration actually paid by 
his transferor for the purposes of section 72(g) and paragraph (b) of 
Sec. 1.72-10, such consideration shall be deemed premiums or other 
consideration paid by the donee for the purposes of this section.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6885, 31 FR 
7798, June 2, 1966; T.D. 8115, 51 FR 45734, Dec. 19, 1986]



Sec. 1.72-12  Effect of taking an annuity in lieu of a lump sum upon 
the maturity of a contract.

    If a contract to which section 72 applies provides for the payment 
of a lump sum in full discharge of the obligation thereunder and the 
obligee entitled thereto, prior to receiving any portion of such lump 
sum and within 60 days after the date on which such lump sum first 
becomes payable, exercises an option or irrevocably agrees with the 
obligor to take, in lieu thereof, payments which will constitute 
``amounts received as an annuity'', as that term is defined in paragraph 
(b) of Sec. 1.72-2, no part of such lump sum shall be deemed to have 
been received by the obligee at the time he was first entitled thereto 
merely because he would have been entitled to such amount had he not 
exercised the option or made such an agreement with the obligor.



Sec. 1.72-13  Special rule for employee contributions recoverable in 
three years.

    (a) Amounts received as an annuity. (1) Section 72(d) provides a 
special rule for the treatment of amounts received as an annuity by an 
employee (or by the beneficiary or beneficiaries of an employee) under a 
contract to which section 72 applies. This special rule is applicable 
only in the event that:
    (i) At least part of the consideration paid for the contract is 
contributed by the employer, and
    (ii) The aggregate amount receivable as an annuity under such 
contract by the employee (or by his beneficiary or beneficiaries if the 
employee died before any amount was received as an annuity under the 
contract) within the 3-year period beginning on the date (whether or not 
before January 1, 1954) on which an amount is first received as an 
annuity equals or exceeds the total consideration contributed (or deemed 
contributed under section 72(f) and Sec. 1.72-8) by the employee as of 
such date as reduced by all amounts previously received and excludable 
from the gross

[[Page 263]]

income of the recipient under the applicable income tax law.

In such an event, section 72(d) provides that all amounts received as an 
annuity under the contract during a taxable year to which the Code 
applies shall be excluded from gross income until the total of the 
amounts excluded under that section plus all amounts excluded under 
prior income tax laws equals or exceeds the consideration contributed 
(or deemed contributed) by the employee. The excess, if any, and all 
amounts received by any recipient thereafter (whether or not received as 
an annuity), shall be fully included in gross income. See paragraph (b) 
of this section.
    (2) If the aggregate amount receivable as an annuity under the 
contract within three years from the date on which an amount is first 
received as an annuity thereunder will not equal or exceed the 
consideration contributed (or deemed contributed) by the employee in 
accordance with the provisions of Sec. 1.72-8, computed as of such 
date, the special rule of section 72(d) shall not apply to amounts 
received as an annuity under the contract and the general rules of 
section 72 shall apply thereto.
    (3) The aggregate of the amounts receivable as an annuity within the 
prescribed 3-year period shall be the total of all annuity payments 
anticipatable by an employee (or a beneficiary or beneficiaries of an 
employee, if the employee died before any amount was received as an 
annuity) under the contract as a whole as defined in paragraph (a) of 
Sec. 1.72-2. See paragraph (a)(3) of Sec. 1.72-2 for rules for 
determining what constitutes ``the contract'' in the case of 
distributions from an employees' trust or plan.
    (4) If subparagraphs (1) and (3) of this paragraph apply to amounts 
received as an annuity under a contract, the rule prescribed in 
subparagraph (1) of this paragraph shall apply to all amounts so 
received thereunder regardless of the fact that they may be payable (i) 
to more than one beneficiary, (ii) for the same or different intervals, 
(iii) in different sums, or (iv) for a different period certain, life, 
or lives.
    (5) For purposes of section 72(d), contributions which are made with 
respect to a self-employed individual and which are allowed as a 
deduction under section 404(a) are not considered contributions by the 
employee, but such contributions are considered contributions by the 
employer. A contribution which is deemed paid in a prior taxable year 
under the provisions of section 404(a)(6) shall be considered made with 
respect to a self-employed individual if the individual on whose behalf 
the contribution is made was self-employed for the taxable year in which 
the contribution is deemed paid, whether or not such individual is self-
employed at the time the contribution is actually paid. Contributions 
with respect to a self-employed individual who is an owner-employee used 
to purchase life, accident, health, or other insurance protection for 
such owner-employee shall not be treated as consideration for the 
contract contributed by the employee in computing the employee 
contributions for purposes of section 72(d).
    (b) Amounts not received as an annuity. If the rule of paragraph (a) 
of this section applies to a contract and, after the date on which an 
annuity payment is first received, amounts are received other than as an 
annuity under such contract in a taxable year to which the Code applies, 
they shall be included in the gross income of the recipient in 
accordance with the provisions of Sec. 1.72-11. Thus, if such amounts 
are received as a dividend or a similar distribution after the date on 
which an amount is first received as an annuity under the contract, they 
shall be included in the gross income of the recipient (in accordance 
with section 72(e)(1)(A) and paragraph (b)(2) of Sec. 1.72-11. All 
other amounts not received as an annuity shall be included in the gross 
income of the recipient in accordance with the provisions of section 
72(e)(1)(B) and paragraph (c), (d), or (f), whichever is applicable, of 
Sec. 1.72-11. See section 72(e)(2).
    (c) Amounts received after the exhaustion of employee contributions. 
(1) Amounts received under a contract to which the rule of paragraph (a) 
of this section applies (whether or not such amounts are received as an 
annuity) shall be included in the gross income of

[[Page 264]]

the recipient if such amounts are received after the date on which the 
aggregate of all amounts excluded from gross income by the recipients 
under section 72(d) and prior income tax laws equalled or exceeded the 
consideration contributed (or deemed contributed) by the employee.
    (2) If the rule of paragraph (a) of this section applies to amounts 
received by an employee (or his beneficiary or beneficiaries) under a 
joint and survivor annuity contract, payments made to a prior annuitant 
may entirely exhaust the amounts excludable from gross income. In such 
case, amounts paid to the surviving annuitant (or annuitants) shall be 
included in gross income by such recipients.
    (d) Application of section 72(d) to a contract, trust, or plan 
providing for payments in a manner described in paragraph (b)(3)(i) of 
Sec. 1.72-2. For the purpose of applying section 72(d) and this 
section, any amount received in the nature of a periodic payment under a 
contract, trust, or plan which provides for the payment of amounts in a 
manner described in paragraph (b)(3)(i) of Sec. 1.72-2 shall be 
considered an amount received as an annuity notwithstanding the 
provisions of any other section of the regulations under section 72. The 
special exclusion rule of section 72(d) and paragraph (a) of this 
section shall apply to all amounts so received if the first amount 
received, when multiplied by the number of periodic payments to be made 
within the three years beginning on the date of its receipt, results in 
an amount in excess of the aggregate premiums or other consideration 
contributed (or deemed contributed) by the employee as of that date. If 
more than one series of periodic payments is to be paid under the same 
contract, trust, or plan, all payments anticipatable, whether because 
fixed in amount or determinable in the manner described in the preceding 
sentence, shall be aggravated for the purpose of determining the 
applicability of section 72 (d) to the contract, trust, or plan as a 
whole.
    (e) Inapplicability of section 72(d) and this section. Section 72(d) 
and this section do not apply to:
    (1) Amounts received as proceeds of a life insurance contract to 
which section 101(a) applies, nor to
    (2) Amounts paid to a surviving annuitant under a joint and survivor 
annuity contract to which paragraph (b)(3) of Sec. 1.72-5 applies, nor 
to
    (3) Amounts paid to an annuitant under Chapter 73 of Title 10 of the 
United States Code with respect to which section 72(o) and Sec. 1.122-1 
apply.

See also paragraph (d) of Sec. 1.72-14.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6497, 25 FR 
10021, Oct. 20, 1960; T.D. 6676, 28 FR 10135, Sept. 17, 1963; T.D. 7043, 
35 FR 8477, June 2, 1970]



Sec. 1.72-14  Exceptions from application of principles of section 72.

    (a) Payments of interest. If any amount is received under an 
agreement to pay interest on a sum or sums held by the obligor, such 
amount shall not be excludable from the gross income of the recipient 
under the provisions of section 72 to the extent that it is an actual 
interest payment. See section 72(j). An amount shall be considered to be 
held under an agreement to pay interest thereon if the amount payable 
after the term of the annuity (whether for a term certain or for a life 
or lives) is substantially equal to or larger than the aggregate amount 
of premiums or other consideration paid therefor. For this purpose, 
however, the aggregate amount of premiums or other consideration paid 
shall include all contributions made by an employer and not merely those 
to which section 72(f) applies.
    (b) Alimony payments. To the extent that payments made to a wife are 
includable in her gross income by reason of either or both section 71 
and 682, they shall not be excluded from the wife's gross income under 
the principles of section 72 although made under a contract to which 
that section applies. However, section 72 shall apply in the case of 
amounts received under such a contract if a husband and wife are 
entitled to make and do make a single return jointly.
    (c) Certain ``face-amount certificates.'' The principles of section 
72 do not apply to ``face-amount certificates'' described in section 
72(1) which were issued before January 1, 1955.
    (d) Employer plans. The provisions of Sec. Sec. 1.72-1 to 1.72-13, 
inclusive, shall be disregarded to the extent that they are

[[Page 265]]

inconsistent with the treatment of amounts received provided in section 
402 (relating to the taxability of a beneficiary of an employees' 
trust), section 403 (relating to the taxation of employee annuities), or 
the regulations under either of such sections.



Sec. 1.72-15  Applicability of section 72 to accident or health plans.

    (a) Applicability of section. This section provides the rules for 
determining the taxation of amounts received from an employer-
established plan which provides for distributions that are taxable under 
section 72 (or for distributions that are taxable under section 402 
(a)(2) or (e), or section 403(a)(2), in the case of lump sum 
distributions) and which also provides for distributions that may be 
excludable from gross income under section 104 or 105 as accident or 
health benefits. For example, this section will apply to a pension plan 
described in section 401 and exempt under section 501 which provides for 
the payment of pensions at retirement and the payment of an earlier 
pension in the event of permanent disability. This section will also 
apply to a profit-sharing plan described in section 401 and exempt under 
section 501 which provides for periodic distribution of the amount 
standing to the account of a participant during any period that the 
participant is absent from work due to a personal injury or sickness and 
for the distribution of any balance standing to the account of the 
participant upon his separation from service. For purposes of this 
section, the term ``contributions of the employee'' includes 
contributions by the employer which were includible in the employee's 
gross income. For special rules for taxable years ending before January 
27, 1975, relating to certain accident or health benefits which were 
treated as distributions to which section 72 applied, see paragraph (i) 
of this section.
    (b) General rule. Section 72 does not apply to any amount received 
as an accident or health benefit, and the tax treatment of any such 
amount shall be determined under sections 104 and 105. See paragraphs 
(c) and (d) of this section, paragraph (d) of Sec. 1.104-1, and 
Sec. Sec. 1.105-1 through 1.105-5. Section 72 (or, in the case of 
certain total distributions, section 402(a)(2) or section 403(a)(2)) 
does apply to any amount which is received under a plan to which this 
section applies and which is not an accident or health benefit. See 
paragraph (e) of this section.
    (c) Accident or health benefits attributable to employee 
contributions. (1) If a plan to which this section applies provides that 
any portion of the accident or health benefits is attributable to the 
contributions of the employee to such plan, then such portion of such 
benefits is excludable from gross income under section 104(a)(3) and 
paragraph (d) of Sec. 1.104-1. Neither section 72 nor section 105 
applies to any accident or health benefits (whether paid before or after 
retirement) attributable to contributions of the employee. Since such 
portion is excludable under section 104(a)(3), such portion is not 
subject to the dollar limitation of section 105(d) and if such portion 
is payable after the retirement of the employee, it is excludable 
without regard to the provisions of Sec. 1.105-4 and section 72.
    (2) In determining the taxation of any amounts received as accident 
or health benefits from a plan to which this secton applies, the first 
step is to determine the portion, if any, of the contributions of the 
employee which is used to provide the accident or health benefits and 
the portion of the accident or health benefits attributable to such 
portion of the employee's contributions. If such a plan expressly 
provides that the accident or health benefits are provided in whole or 
in part by employee contributions and the portion of employee 
contributions to be used for such purpose, the contributions so used 
will be treated as used to provide accident or health benefits. However, 
if the plan does not expressly provide that the accident or health 
benefits are to be provided with employee contributions and the portion 
of employee contributions to be used for such purpose, it will be 
presumed that none of the employee contributions is used to provide such 
benefits. Thus, in the case of a contributory pension plan, it will be 
presumed that the disability pension is provided by employer 
contributions, unless the plan expressly provides otherwise, or in the 
case of a contributory profit-sharing plan providing that a

[[Page 266]]

portion of the amount standing to the account of each participant will 
be used to purchase accident or health insurance, it will be presumed 
that such insurance is purchased with employer contributions, unless the 
plan expressly provides otherwise. Similarly, unless the plan expressly 
provides otherwise, it will be presumed that if a contributory profit-
sharing plan provides for periodic distributions from the account of a 
participant during any absence from work because of a personal injury or 
sickness, all such distributions which do not exceed the contributions 
of the employer plus earnings thereon are provided by employer 
contributions.
    (3) Any employee contributions that are treated under subparagraph 
(2) of this paragraph as used to provide accident or health benefits 
shall not be included for any purpose under section 72 as employee 
contributions or as aggregate premiums or other consideration paid. 
Thus, in the case of a pension plan, or in the case of a profit-sharing 
plan providing that a portion of the amount standing to the account of 
each participant will be used to purchase accident or health insurance, 
any employee whose contributions are so used must make the adjustment 
provided by this subparagraph irrespective of whether such employee 
receives any accident or health benefits under such plan. However, in 
the case of a profit-sharing plan providing for periodic distributions 
from the account of a participant during any absence from work because 
of a personal injury or sickness, an adjustment under this subparagraph 
is required only when an employee receives distributions in excess of 
the employer contributions and earnings thereon or receives 
distributions consisting in whole or in part of his own contributions.
    (4) If any of the employee contributions are treated under 
subparagraph (2) of this paragraph as used to provide any of the 
accident or health benefits, the portion of the benefits attributable to 
employee contributions shall be determined in accordance with Sec. 
1.105-1. Any accident or health benefits that are excludable under 
section 104(a)(3) shall not be included in the expected return for 
purposes of section 72.
    (d) Accident or health benefits attributable to employer 
contributions. Any amounts received as accident or health benefits and 
not attributable to contributions of the employee are includable in 
gross income except to the extent that such amounts are excludable from 
gross income under section 105 (b), (c), or (d) and the regulations 
thereunder. Thus, such amounts may be excludable under section 105(d) as 
payments under a wage continuation plan. However, if such payments, when 
added to other such payments attributable to employer contributions, 
exceed the limitations of section 105(d), then the excess is includable 
in gross income under section 105(a). Such excess is not excludable 
under section 72. See, however, paragraph (i) of this section, for 
special rules for taxable years ending before January 27, 1975, relating 
to certain accident or health benefits which were treated as 
distributions to which section 72 applied.
    (e) Other benefits under the plan. The taxability of amounts that 
are received under a plan to which this section applies and that are not 
accident or health benefits is determined under section 72 (or, in the 
case of certain total distributions, under section 402(a)(2) or section 
403(a)(2)) without regard to any exclusion or inclusion of accident or 
health benefits under sections 104 and 105. For example, the investment 
in the contract or aggregate premiums paid is determined without regard 
to the exclusion of any amount under section 104 or 105, and the annuity 
starting date is determined without regard to the receipt of any 
accident or health benefits. However, if any employee contributions are 
used to provide any accident or health benefits, the investment in the 
contract or aggregate premiums paid must be adjusted as provided in 
paragraph (c)(3) of this section.
    (f) Examples. The principles of this section may be illustrated by 
the following examples:

    Example (1). A, an employee, is a participant in a contributory 
pension plan described in section 401(a) and exempt under section 
501(a). Such plan provides for the payment of a pension to each 
participant when he retires at age 65 or when he retires earlier if the 
retirement is due to permanent and total disability. In 1964, A, who was 
age

[[Page 267]]

52, became totally and permanently disabled because of an injury, was 
hospitalized, and commenced to receive a pension of $74 a week under 
this plan. The weekly amounts received by A do not exceed 75 percent of 
his ``regular weekly rate of wages'' under section 105(d). A had 
contributed $11,500 to the plan. The plan does not expressly provide 
that any portion of the disability pension is purchased with employee 
contributions. Accordingly, it is presumed that no portion of the 
disability pension is purchased with A's contributions. The disability 
pension which A receives qualifies as payments under a wage continuation 
plan for purposes of section 105(d) and Sec. 1.105-4, and if such 
payments are the only accident or health benefits which are attributable 
to the contributions of his employer, such payments are entirely 
excludable under section 105(d) until A reaches age 65, his mandatory 
retirement age under the plan. The payments which A receives after he 
becomes age 65 are taxable under section 72. The payments which A 
receives do constitute an annuity as defined in paragraph (b) of Sec. 
1.72-2, but since the amounts which he will receive during the first 
three years after attaining age 65 exceed his contributions, he shall 
exclude under Sec. 1.72-13 the entire amount of all payments that he 
receives as an annuity after attaining age 65 until such amounts equal 
his contributions to the plan, or $11,500. Thereafter, the payments that 
he receives under the plan are includible in gross income.
    Example (2). B, an employee, is a participant in a contributory 
profit-sharing plan described in section 401(a) and exempt under section 
501(a). Such plan provides that, in the event a participant is absent 
from work because of a personal injury or sickness, he will be paid $125 
a week out of his account in such plan. Such weekly amount does not 
exceed 75 percent of B's ``regular weekly rate of wages'' under section 
105(d). Any amount standing to the account of a participant at the time 
of his separation from service will be paid to him at such time. During 
1964, B incurred a personal injury, was hospitalized, and as a result 
was absent from work for nine weeks. He received nine weekly payments of 
$125, or a total of $1,125, on account of such absence from work. At the 
time B was injured, he had contributed $5,000 to the plan. The plan did 
not expressly provide that a participant's contributions are to be used 
to provide for the distributions during disability. Accordingly, it is 
presumed that B's contributions were not used to provide the accident or 
health benefits under the plan. Since these weekly payments are paid 
because of B's absence from work due to the injury, and since such 
payments are considered as attributable to contributions of his 
employer, such payments are required under section 105(a) to be included 
in B's gross income except to the extent that they are excludable under 
section 105(d). If B receives no other payments under a wage 
continuation plan attributable to contributions of his employer, during 
the first 30 days in the period of absence $75 of each weekly payment is 
excludable from gross income under section 105(d), but $50 of each 
weekly payment is includable in gross income under section 105(a). 
Amounts attributable to the period of absence in excess of 30 days are 
excludable from gross income under section 105(d) to the extent of $100 
a week and includible in gross income under section 105(a) to the extent 
of $25 a week. The excludable portion of payments does not reduce B's 
investment in the contract or the amount of premiums considered to have 
been paid by B for purposes of any subsequent computations under section 
72.
    Example (3). The facts are the same as in example (2) except that B 
was absent from work for 130 weeks. At the time B was injured, his 
employer had contributed $10,000 to the plan on his account, and $6,000 
of earnings of the plan had been allocated to his account. Thus, at the 
time he was injured, B's account included $21,000, and $14,000 of such 
amount consists of employer contributions of $10,000 plus earnings of 
$4,000 thereon. The first 112 weekly payments (totaling $14,000) which B 
receives are treated in the manner set forth in example (2). However, 
since the remaining payments exceed the employer contributions plus 
earnings thereon, such remaining payments are considered to be 
distributions of B's contributions plus earnings thereon. Since the 
total of such payments, or $2,250, is less than B's contributions to the 
plan, $5,000, the entire amount of such payments is excludable from B's 
gross income, but a corresponding adjustment with respect to the return 
of B's contributions shall be made to his consideration in determining 
the taxation of any lump sum paid to B upon separation from service.

    (g) Payments to or on behalf of a self-employed individual. A self-
employed individual is not considered an employee for purposes of 
section 105, relating to amounts received by employees under accident 
and health plans, nor for purposes of excluding under section 104(a)(3) 
amounts received by him under an accident and health plan as referred to 
in section 105(e). See section 105(g) and paragraph (a) of Sec. 1.105-
1. Therefore, the other paragraphs of this section are not applicable to 
amounts received by or on behalf of a self-employed individual. Except 
where accident or health benefits are provided through an insurance 
contract or

[[Page 268]]

an arrangement having the effect of insurance, all amounts received by 
or on behalf of a self-employed individual from a plan described in 
section 401(a) and exempt under section 501(a) or a plan described in 
section 403(a) shall be taxed as otherwise provided in section 72, 402, 
or 403. If the accident or health benefits are paid under an insurance 
contract or under an arrangement having the effect of insurance, section 
104(a)(3) shall apply. Section 72 shall not apply to any amounts 
received under such circumstances. For the treatment of the amounts paid 
for such accident or health benefits, see section 404(e)(3) and 
paragraph (f) of Sec. 1.404(e)-1.
    (h) Medical benefits for retired employees, etc. Employer 
contributions to provide medical benefits described in section 401(h) 
under a qualified pension or annuity plan are not includible in the 
gross income of the employee on whose behalf such contributions were 
made. Similarly, if the trustee of a trust forming a part of a qualified 
pension plan applies employer contributions which have been contributed 
to provide medical benefits described in section 401(h) or earnings 
thereon, to purchase insurance contracts which provide such benefits, 
the amount so applied is not includible in the gross income of the 
employee on whose behalf such insurance was purchased. The payment of 
medical benefits described in section 401(h) as defined in paragraph (a) 
of Sec. 1.401-14 under a plan established by an employer shall be 
treated in the same manner as the payment of any other accident or 
health benefits under an employer-established plan. See paragraphs (b), 
(c), and (d) of this section.
    (i) Special rules. (1) Special rule for taxable years ending before 
January 27, 1975. A taxpayer who has reached retirement age, as defined 
in Sec. 1.79-2(b)(3) (hereinafter referred to as ``initial retirement 
age''), before January 27, 1975, and who has received payments under a 
plan described in paragraph (a) of this section, which are wage 
continuation benefits to which section 105(d) and this section apply, or 
which are treated as such by reason of the employee having so agreed 
under Sec. 1.105-6, shall be entitled to an exclusion, in taxable years 
ending before January 27, 1975, with respect to payments received after 
initial retirement age but before mandatory retirement age, as defined 
in Sec. 1.105-4(a)(3)(i)(B), which is the greater of:
    (i) The amount actually excluded on an original return under section 
72 (b) or (d) with respect to payments received after initial retirement 
age, to the extent such amount does not exceed an amount properly 
excludable under section 72 (b) or (d) if this paragraph and paragraph 
(b) of this section did not apply; or
    (ii) The amount that would have been properly excludable under 
section 105(d) during the same period.
    (2) Investment in the annuity contract. A taxpayer described in 
paragraph (i)(1) of this section, shall redetermine his investment in, 
consideration for, or basis of his annuity contract (hereinafter 
referred to in this paragraph as the ``investment in the contract'') in 
accordance with the applicable rules of section 72 and the regulations 
thereunder, and the rules of this paragraph. In making such 
redetermination the taxpayer's investment in his contract shall be 
decreased, by the excess (if any) of the amount which the taxpayer is 
entitled to exclude under paragraph (i)(1) of this section over the 
amount which could have been excluded under section 105(d) (subject to 
the limitations contained in such provision). Such investment in the 
contract shall be decreased only by the excess of the amount excluded 
under section 72 in taxable years ending before January 27, 1975, over 
the amount which could have been excluded under section 105(d) during 
the same period. For example, the investment in the contract shall not 
be decreased in the case of an individual who was retired from work on 
account of injury or sickness or a full taxable year, if the amount 
excluded under section 72 was less than $5,200, since the entire amount 
could have been excluded under section 105(d). On the other hand, if the 
amount excluded under section 72 was equal to or greater than $5,200 for 
a full taxable year, for example, $6,000 for the full taxable year, then 
$5,200 shall be treated as excluded under section 105(d) and the 
investment in the contract shall be reduced by $800 ($6,000-$5,200).

[[Page 269]]

    (3) Surviving annuitants and beneficiaries. (i) The rights of a 
surviving annuitant or beneficiary, with respect to the application of 
the rules of section 72, shall be based on the employee's investment in 
his annuity contract, as adjusted in accordance with the provisions of 
this paragraph. Thus, where an employee dies after having recomputed his 
investment as provided in paragraph (i)(2) of this section, and his 
contract provided a survivorship element, the survivor would assume the 
employee's recomputed investment for purposes of determining 
excludability of amounts under section 72.
    (ii) Where a beneficiary failed to increase the amount treated as an 
employee's contribution toward his annuity contract to reflect the 
employee death benefit under section 101(b) and Sec. 1.72-8(b), because 
the employee had treated his initial retirement age as his annuity 
starting date, such beneficiary may apply section 101(b) as if the 
appropriate addition to basis had been made in the year of the 
employee's death, but only if the employee had not reached his mandatory 
retirement age (as defined in section Sec. 1.105-4(a)(3)(i)(B)). For 
purposes of this paragraph, the amount treated as the secton 101(b) 
death benefit would be valued as of the date of the employee's death.
    (4) Records. (i) For purposes of section 72 (b) and (d), and this 
section, the taxpayer shall maintain such records as are necessary to 
substantiate the amount treated as his investment in his annuity 
contract.
    (ii) The Commissioner may prescribe a form and instructions with 
respect to the taxpayer's past and current treatment of amounts received 
under section 72 or 105, and the taxpayer's computation, or 
recomputation, of his investment in his annuity contract. Such form may 
be required to be filed with the taxpayer's returns for years in which 
amounts are excluded under section 72 or 105.
    (5) Cross references. (i) See section 72(b)(4) and Sec. 1.72-4(b) 
with respect to annuity starting dates.
    (ii) See Sec. Sec. 1.72-8(b) and 1.101-2(a)(2) with respect to 
treating certain amounts received by an estate or beneficiary as 
employee death benefits.
    (iii) See Sec. 1.105-4(a)(3)(i)(B) for the definition of 
``mandatory retirement age.''
    (iv) See Sec. 1.105-6 with respect to the application of section 
105(d) to certain amounts received as retirement annuities before 
January 27, 1975, where the employee would otherwise have been eligible 
for benefits to which section 105(d) applies.
    (6) Examples. The provisions of this paragraph may be illustrated by 
the following examples. In such examples assume that the plan does not 
expressly provide that any portion of the disability pension is 
purchased with employee contributions. Accordingly, it is presumed that 
no portion of the disability pension is purchased with employee 
contributions. Also, assume that in each case the taxpayer retired only 
after he had been absent from work for at least 30 days on account of 
personal injuries or sickness:

    Example (1). A, a calendar year taxpayer, retired because of 
disability on January 1, 1968, his 58th birthday, receiving $80 per week 
($4,160 per year) under a plan which qualifies as a wage continuation 
plan under section 105(d) and Sec. 1.105-4. Under the plan, A's initial 
retirement age is age 60 (January 1, 1970), and his mandatory retirement 
age is 65 (January 1, 1975). A's consideration for the contract was 
$10,000. For payments received in 1968 and 1969 A excluded the entire 
amount under section 105(d). Payments received with respect to periods 
after A's initial retirement age (January 1, 1970) were excluded under 
section 72(d) until his entire $10,000 consideration for his contract 
had been excluded. Thus, A applied section 72(d) to exclude $4,160 each 
year for taxable years 1970 and 1971, and $1,680 ($10,000-
($4,160+$4,160)) for 1972. In late 1974 A realized that he was entitled 
to treat the full amount received under his annuity as excludable under 
secton 105(d) rather than section 72 for the taxable years 1970 through 
1974. Consequently, A filed amended returns for 1972 and 1973 excluding 
an additional $2,480 ($4,160-$1,680) and $4,160, respectively, claiming 
refunds based upon such additional exclusions. Moreover, A's annuity 
starting date is January 1, 1975 (A's mandatory retirement age), and he 
excludes under section 72(d) for 1975, 1976, and 1977, $4,160, $4,160 
and $1,680 ($10,000-($4,160+$4,160)), respectively.
    Example (2). B, a calendar year taxpayer retired because of 
disability, July 1, 1970, on his 58th birthday, receiving $1,000 per 
month under a plan which qualifies as a wage continuation plan for 
purposes of section 105(d)

[[Page 270]]

and Sec. 1.105-4. Under the plan, B's initial retirement age is age 60 
(July 1, 1972), and his mandatory retirement age is 65 (July 1, 1977). 
B's consideration for the contract was $25,000. For payments received in 
1970 and 1971 B excluded under section 105(d) $2,600 and $5,200, 
respectively, of the $6,000 (6x$1,000) and $12,000 (12x$1,000) received 
under the plan. For the period January 1, 1972, through June 30, 1972, B 
excluded an additional $2,600 under section 105(d). For the period July 
1, 1972, through December 31, 1972, B excluded under section 72(d)(1) 
the entire $6,000 in payments received under the plan. Similarly, under 
section 72(d)(1), B excluded the entire $12,000 in payments received 
under the plan in 1973, and in 1974 B excluded the remaining $7,000 of 
his annuity basis. In 1975, B realized that he will be entitled to take 
full advantage of the exclusion under section 105(d) for periods through 
June 30, 1977, when he would reach age 65. B need not file amended 
returns for 1972, 1973, and 1974, even though the amounts he excluded 
under section 72(d) (exceeded the amount he was entitled to exclude 
under section 105(d)). He must, however, recompute the amount that will 
be treated as his investment in his annuity contract. Thus, on July 1, 
1977, B's annuity starting date, his investment in his annuity contract 
would be $13,000, recomputed as follows:

B's original investment.......................................   $25,000
Less amounts excluded under section 72 to the extent they
 exceed amounts that would have been excludable during the
 same period under section 105(d):
    1972 ($6,000-2,600).......................................     3,400
    1973 ($12,000-5,200)......................................     6,800
    1974 ($7,000-5,200).......................................     1,800
                                                               ---------
      Total...................................................    12,000
B's recomputed investment in his annuity contract.............   $13,000
                                                               =========
 

    Example (3). Assume the same facts as in example (2) except that B's 
investment in his annuity contract is $37,000, and he excluded under 
section 72(b) 16.9 percent, or $2,028, of the $12,000 received per year. 
Thus, for the period July 1, 1972, through December 31, 1972, B excluded 
under section 72(b) $1,014 (16.9 percent of $6,000), and $2,028 in both 
1973 and 1974. B files amended returns for 1972, 1973 and 1974 claiming 
the exclusion under section 105(d). Thus, B restored to income $1,014 
for 1972, and $2,028 for both 1973 and 1974, claiming $2,600 ($5,200-
$2,600) exclusion under section 105(d) for 1972 and a $5,200 exclusion 
in both 1973 and 1974. Thus, for 1972 B is entitled to an additional 
exclusion of $1,586 ($2,600-$1,014), and, for both 1973 and 1974, an 
additional exclusion of $3,172 ($5,200-$2,028). On July 1, 1977, B's 
investment in the contract is $37,000.
    Example (4). C, a calendar year taxpayer, retired because of 
disability on January 1, 1965, his 58th birthday, receiving payments of 
$500 per month under a plan which qualifies as a wage continuation plan 
for purposes of section 105(d) and Sec. 1.105-4. C had contributed 
$18,000 toward the cost of his annuity contract. Under the plan, C's 
initial retirement age is age 60 (January 1, 1967) and C's mandatory 
retirement age is age 70 (January 1, 1977). For taxable years 1965 and 
1966 C excluded from gross income under section 105(d) $5,200 of the 
$6,000 (12x$500) he received from his employer as wage continuation 
benefits. On January 1, 1967, C began excluding all of the benefits C 
received in accordance with the rules of section 72(d). Thus, for 1967, 
1968 and 1969, C excluded 100 percent of the annuity payments. For his 
taxable years 1970 through 1973, C included in his gross income all 
annuity payments. In 1974, C realized that he will be entitled to use 
the exclusion under section 105(d) through December 31, 1976 (until he 
reaches age 70). In 1974, C filed a timely claim for refund for his 
taxable years 1971, 1972, and 1973 (refunds for taxable year 1970 and 
prior years were barred by the statute of limitations), and continues to 
claim the exclusion under section 105(d) for 1974, 1975, and 1976. For 
1977, C treats January 1, 1977, as the annuity starting date, and treats 
$15,600 as the investment in the contract. The $15,600 represents the 
$18,000 original investment in the contract reduced by the excess, 
$2,400, of the amount excluded under section 72 for 1967, 1968 and 1969 
($18,000) over the amount excludable under section 105(d) ($5,200x3) for 
such years.
    Example (5). (i) D, a calendar year taxpayer, retired because of 
disability on June 30, 1965, receiving $100 per month under a plan which 
qualifies as a wage continuation plan for purposes of section 105(d) and 
Sec. 1.105-4. Under the plan, the initial retirement age of D, whose 
birthday is January 1, is age 60 (January 1, 1967), and D's mandatory 
retirement age is age 70 (January 1, 1977). D had contributed $6,000 
toward the cost of the annuity contract under such plan. For 1965 and 
1966, D excluded under section 105(d) the entire amount received under 
the plan ($1600 and $1,200 respectively). For 1967 through 1973, D 
excluded $330 per year under section 72(b), or 27.5 percent of the 
$1,200 payment received under the plan per year.
    (ii) In 1974, D realized that he will be entitled to use the 
exclusion provided in section 105(d) up until January 1, 1977, when he 
reaches his mandatory retirement age, and that he improperly applied 
section 72 to payments received in the years 1967 through 1973. In 1974, 
D filed a timely claim for refund with respect to the section 105(d) 
wage continuation benefits, for 1971, 1972 and 1973 (refunds for taxable 
year 1970 and prior years were barred by the statute of limitations), 
and continues to claim the section 105(d) exclusion for 1974, 1975 and 
1976. D is entitled to an additional exclusion of $870 ($1,200-$330) for 
each of the years 1971, 1972 and 1973.

[[Page 271]]

    (iii) Upon reaching mandatory retirement age on January 1, 1977, D 
treats such date as the annuity starting date, and treats $6,000 as the 
investment in the contract. The investment in the contract is not 
reduced, because the amount excluded under section 72(b) for 1967 
through 1970 ($330 per year) does not exceed the amount excludable under 
section 105(d) ($1,200 per year), and the $330 per year excluded for 
1971, 1972, and 1973 were restored to the investment in the contract. 
Therefore, assuming that D would be entitled to exclude 41.3 percent of 
the payments under the plan if the annuity starting date is January 1, 
1977, D would be entitled to exclude $495.60 (41.3 percent of $1,200) 
per annum.
    Example (6). Assume the facts stated in example (5) except that D's 
investment in his annuity contract is $100,000 and he received payments 
equaling $10,000 per year. Assume also, that D had excluded under 
section 72(b) 54.9 percent of the payments received under the plan 
through 1974. Consequently, he excluded $5,490 (54.9 percent of $10,000) 
from his gross income for the years 1967 through 1974. D need not file 
amended returns for 1971, 1972, 1973, and 1974, even though the amount 
he excluded under section 72(b) exceeded the amounts he was entitled to 
exclude under section 105(d). He must, however, recompute the amount 
that will be treated as his investment in his annuity contract. Thus, on 
January 1, 1977, D's annuity starting date, his investment in his 
annuity contract would be $97,680. This figure represents the original 
investment ($100,000) reduced by the amount excluded under section 72(b) 
for the years 1967-1974 (8x$5,490 = $43,920) over the amount properly 
excludable during those years under section 105(d) ($5,200x8 = $41,600).
    Example (7). Assume the same facts as in example (6) except that D's 
mandatory retirement age is 63 (January 1, 1970). D would redetermine 
his exclusion ratio for purposes of section 72(b) as of January 1, 1970, 
since D's mandatory retirement age is D's annuity starting date. D would 
treat $99,130 as his investment in his annuity contract as of such date 
for purposes of section 72(b). Assuming refunds for 1970 and prior 
taxable years were barred by the statute of limitations, the $99,130 
represents the original investment of $100,000 reduced by the excess of 
the amount excluded under section 72(b) for 1967, 1968, and 1969 
($5,490x3 = $16,470) over the amount otherwise excludable during those 
years under section 105(d) ($5,200x3 = $15,600). Therefore, assuming 
that D would be entitled to exclude 61.2 of the payments received under 
the plan if the annuity starting date is January 1, 1970, D would be 
entitled to exclude $6,120 (61.2 percent of the $10,000 received under 
the plan) per annum for 1971 and subsequent years. However, D is not 
entitled to exclude the additional $630 ($6,120-$5,490) for 1970, 
because credit or refund for 1970 and prior years is barred by the 
statute of limitations.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6676, 28 FR 
10135, Sept. 17, 1963; T.D. 6722, 29 FR 5069, Apr. 14, 1964; T.D. 6770, 
29 FR 15366, Nov. 17, 1964; T.D. 7352, 40 FR 16664, Apr. 14, 1975]



Sec. 1.72-16  Life insurance contracts purchased under qualified 
employee plans.

    (a) Applicability of section. This section provides rules for the 
tax treatment of premiums paid under qualified pension, annuity, or 
profit-sharing plans for the purchase of life insurance contracts and 
rules for the tax treatment of the proceeds of such a life insurance 
contract and of annuity contracts purchased under such plans. For 
purposes of this section, the term ``life insurance contract'' means a 
retirement income, an endowment, or other contract providing life 
insurance protection. The rules of this section apply to plans covering 
only common-law employees as well as to plans covering self-employed 
individuals.
    (b) Treatment of cost of life insurance protection. (1) The rules of 
this paragraph are applicable to any life insurance contract--
    (i) Purchased as a part of a plan described in section 403(a), or
    (ii) Purchased by a trust described in section 401(a) which is 
exempt from tax under section 501(a) if the proceeds of such contract 
are payable directly or indirectly to a participant in such trust or to 
a beneficiary of such participant.

The proceeds of a contract described in subdivision (ii) of this 
subparagraph will be considered payable indirectly to a participant or 
beneficiary of such participant where they are payable to the trustee 
but under the terms of the plan the trustee is required to pay over all 
of such proceeds to the beneficiary.
    (2) If under a plan or trust described in subparagraph (1) of this 
paragraph, amounts which were allowed as a deduction under section 404, 
or earnings of the trust, are applied toward the purchase of a life 
insurance contract described in subparagraph (1) of this paragraph, the 
cost of the life insurance protection under such contract shall be 
included in the gross income of

[[Page 272]]

the participant for the taxable year or years in which such 
contributions or earnings are so applied.
    (3) If the amount payable upon death at any time during the year 
exceeds the cash value of the insurance policy at the end of the year, 
the entire amount of such excess is considered current life insurance 
protection. The cost of such insurance will be considered to be a 
reasonable net premium cost, as determined by the Commissioner, for such 
amount of insurance for the appropriate period.
    (4) The amount includible in the gross income of the employee under 
this paragraph shall be considered as premiums or other consideration 
paid or contributed by the employee only with respect to any benefits 
attributable to the contract (within the meaning of paragraph (a)(3) of 
Sec. 1.72-2) providing the life insurance protection. However, if under 
the rules of this paragraph an owner-employee is required to include any 
amounts in his gross income, such amounts shall not in any case be 
treated as part of his investment in the contract.
    (5) The determination of the cost of life insurance protection may 
be illustrated by the following example:

    Example. An annual premium policy purchased by a qualified trust for 
a common-law employee provides an annuity of $100 per month upon 
retirement at age 65, with a minimum death benefit of $10,000. The 
insurance payable if death occurred in the first year would be $10,000. 
The cash value at the end of the first year is 0. The net insurance is 
therefore $10,000 minus 0, or $10,000. Assuming that the Commissioner 
has determined that a reasonable net premium cost for the employee's age 
is $5.85 per $1,000, the premium for $10,000 of life insurance is 
therefore $58.50, and this is the amount to be reported as income by the 
employee for his taxable year in which the premium is paid. The balance 
of the premium is the amount contributed for the annuity, which is not 
taxable to the employee under a plan meeting the requirements of section 
401(a), except as provided under section 402(a). Assuming that the cash 
value at the end of the second year is $500, the net insurance would 
then be $9,500 for the second year. With a net 1-year term rate of $6.30 
for the employee's age in the second year, the amount to be reported as 
income to the employee would be $59.85.

    (6) This paragraph shall not apply if the trust has a right under 
any circumstances to retain any part of the proceeds of the life 
insurance contract. But see paragraph (c)(4) of this section relating to 
the taxability of the distribution of such proceeds to a beneficiary.
    (c) Treatment of proceeds of life insurance and annuity contracts. 
(1) If under a qualified pension, annuity, or profit-sharing plan, there 
is purchased either--
    (i) A life insurance contract described in paragraph (b)(1) of this 
section, and the employee either paid the cost of the insurance or was 
taxable on the cost of the insurance under paragraph (b) of this 
section, or
    (ii) An annuity contract,

the amounts payable under any such contract by reason of the death of 
the employee are taxable under the rules of subparagraph (2) of this 
paragraph, except in the case of a joint and survivor annuity.
    (2)(i) In the case of an annuity contract, the death benefit is the 
accumulation of the premiums (plus earnings thereon) which is intended 
to fund pension or other deferred benefits under a pension, annuity, or 
profit-sharing plan. Such death benefits are not in the nature of life 
insurance and are not excludable from gross income under section 101(a).
    (ii) In the case of a life insurance contract under which there is a 
reserve accumulation which is intended to fund pension or other deferred 
benefits under a pension, annuity, or profit-sharing plan, such reserve 
accumulation constitutes the source of the cash value of the contract 
and approximates the amount of such cash value. The portion of the 
proceeds paid upon the death of the insured employee which is equal to 
the cash value immediately before death is not excludable from gross 
income under section 101(a). The remaining portion, if any, of the 
proceeds paid to the beneficiary by reason of the death of the insured 
employee--that is, the amount in excess of the cash value--constitutes 
current insurance protection and is excludable under section 101(a).
    (iii) The death benefit under an annuity contract, or the portion of 
the death proceeds under a life insurance contract which is equal to the 
cash

[[Page 273]]

value of the contract immediately before death, constitutes a 
distribution under the plan consisting in whole or in part of deferred 
compensation and is taxable to the beneficiary in accordance with 
section 72(m)(3) and the provisions of this paragraph, except to the 
extent that the limited exclusion from income provided in section 101(b) 
is applicable.
    (iv) In the case of a life insurance contract under which the 
benefits are paid at a date or dates later than the death of the 
employee, section 101(d) is applicable only to the portion of the 
benefits which is attributable to the amount excludable under section 
101(a). The portion of such benefits which is attributable to the cash 
value of the contract immediately before death is taxable under section 
72, and in such case, any amount excludable under section 101(b) is 
treated as additional consideration paid by the employee in accordance 
with section 101(b)(2)(D).
    (3) The application of the rules under subparagraph (2) of this 
paragraph with respect to the taxability of proceeds of a life insurance 
contract paid by reason of the death of an insured common-law employee 
who has paid no contributions under the plan is illustrated by the 
following examples:

    Example (1). 

Total face amount of the contract payable in a lump sum at       $25,000
 time of death................................................
Cash value of the contract immediately before death...........    11,000
                                                               ---------
Excess over cash value, excludable under section 101(a).......    14,000
                                                               =========
Cash value subject to limited exclusion under section 101(b)..    11,000
Excludable under section 101(b) (assuming that there is no         5,000
 other death benefit paid by or on behalf of any employer with
 respect to the employee).....................................
                                                               ---------
Balance taxable in accordance with section 402(a)(2) or            6,000
 403(a)(2) (assuming a total distribution in one taxable year
 of the distributee)..........................................
Portion of premiums taxed to employee under the provisions of        940
 paragraph (b) of this section and considered as contributions
 of the employee..............................................
                                                               ---------
Balance taxable as long-term capital gain.....................     5,060
 

    Example (2). The facts are the same as in example (1), except that 
the contract provides that the beneficiary may elect within 60 days 
after the death of the employee either to take the $25,000 or to receive 
10 annual installments of $3,000 each, and the beneficiary elects to 
receive the 10 installments. In addition, the employee's rights to the 
cash value immediately before his death were forfeitable at least to the 
extent of $5,000. Section 101(d) is applicable to the amount excludable 
under section 101(a), that is, $14,000. The portion of each annual 
installment of $3,000 which is attributable to this $14,000 is 
determined by allocating each installment in accordance with the ratio 
which this $14,000 bears to the total amount which was payable at death 
($25,000). Accordingly, the portion of each annual installment which is 
subject to section 101(d) is $1,680 (\14/25\ of $3,000), of which $1,400 
(\1/10\ of $14,000) is excludable under section 101(a), and the 
remaining $280 is includible in the gross income of the beneficiary. 
However, if the beneficiary is a surviving spouse as defined in section 
101(d)(3), the exclusion provided by section 101(d)(1)(B) is applicable 
to such $280. The remaining portion of each annual $3,000 installment, 
$1,320, is attributable to the cash value of the contract and is treated 
under section 72, as follows:

Amount actually contributed by the employee...................         0
Amount considered contributed by employee by reason of section    $5,000
 101(b).......................................................
Portion of premiums taxed to employee under the provisions of       $940
 paragraph (b) of this section and considered as contributions
 of the employee..............................................
                                                               ---------
Investment in the contract....................................    $5,940
Expected return, 10x$1,320....................................   $13,200
Exclusion ratio, $5,940/$13,200...............................      0.45
Annual exclusion, 0.45x$1,320.................................      $594
 


Accordingly, $594 of the $1,320 portion of each annual installment is 
excludable each year under section 72, and the remaining $726 is 
includible. Thus, if the beneficiary is not a surviving spouse, a total 
of $1,006 ($280 plus $726) of each annual $3,000 installment is 
includible in income each year. If the beneficiary is a surviving 
spouse, and can exclude all of the $280 under section 101(d)(1)(B), the 
amount includible in gross income each year is $726 of each annual 
$3,000 installment.

    (4) If an employee neither paid the total cost of the life insurance 
protection provided under a life insurance contract, nor was taxable 
under paragraph (b) of this section with respect thereto, no part of the 
proceeds of such a contract which are paid to the beneficiaries of the 
employee as a death benefit is excludable under section 101(a). The 
entire distribution is taxable to the beneficiaries under section 402(a) 
or 403(a) except to the extent that a limited exclusion may be allowable 
under section 101(b).

[T.D. 6676, 28 FR 10135, Sept. 17, 1963]

[[Page 274]]



Sec. 1.72-17  Special rules applicable to owner-employees.

    (a) In general. Under section 401(c) and section 403(a), certain 
self-employed individuals may participate in qualified pension, annuity, 
and profit-sharing plans, and the amounts received by such individuals 
from such plans are taxable under section 72. Section 72(m) and this 
section contain special rules for the taxation of amounts received from 
qualified pension, profit-sharing, or annuity plans covering an owner-
employee. For purposes of section 72 and the regulations thereunder, the 
term ``employee'' shall include the self-employed individual who is 
treated as an employee by section 401(c)(1) (see paragraph (b) of Sec. 
1.401-10), and the term ``owner-employee'' has the meaning assigned to 
it in section 401(c)(3) (see paragraph (d) of Sec. 1.401-10). See also 
paragraph (a)(2) of Sec. 1.401-10 for the rule for determining when a 
plan covers an owner-employee. For purposes of this section, a self-
employed individual may not treat as consideration for the contract 
contributed by the employee any contributions under the plan for which 
deductions were allowed under section 404 and which, consequently, are 
considered employer contributions.
    (b) Certain amounts received before annuity starting date. (1) The 
rules of this paragraph are applicable to amounts received from a 
qualified pension, profit-sharing, or annuity plan by an employee (or 
his beneficiary) who is or was an owner-employee with respect to such 
plan when such amounts--
    (i) Are received before the annuity starting date; and
    (ii) Are not received as an annuity.

For the definition of annuity starting date, see paragraph (b) of Sec. 
1.72-4 and subparagraph (4) of this paragraph. As to what constitutes 
amounts not received as an annuity, see paragraphs (c) and (d) of Sec. 
1.72-11.
    (2) Amounts to which this paragraph applies shall be included in the 
recipient's gross income for the taxable year in which received. 
However, the sum of the amounts so included under this subparagraph in 
all taxable years shall not exceed the aggregate deductions allowed 
under section 404 for premiums or other consideration paid under the 
plan on behalf of the employee while he was an owner-employee, including 
any such deductions taken in the taxable year of receipt.
    (3) Any amounts to which this paragraph applies and which are not 
includible in gross income under the rules of subparagraph (2) of this 
paragraph shall be subject to the provisions of section 72(e) and Sec. 
1.72-11. However, for taxable years beginning before January 1, 1964, 
section 72(e)(3), as in effect before such date, shall not apply to such 
amounts. For taxable years beginning after December 31, 1963, such 
amounts (other than amounts subject to a penalty under section 72(m)(5) 
and paragraph (e) of this section) may be taken into account in 
computations under sections 1301 through 1305 (relating to income 
averaging).
    (4) Under section 401(d)(4), a qualified pension, profit-sharing, or 
annuity plan may not provide for distributions to an owner-employee 
before he reaches age 59\1/2\ years, except in the case of his earlier 
disability. Therefore, in the case of a distribution from a qualified 
plan to an individual for whom contributions have been made to the plan 
as an owner-employee, the annuity starting date cannot be prior to the 
time such individual attains the age 59\1/2\ years unless he is entitled 
to benefits before reaching such age because of his disability. For 
taxable years beginning after December 31, 1966, see section 72(m)(7) 
and paragraph (f) of this section for the meaning of disabled. For 
taxable years beginning before January 1, 1967, see section 213(g)(3) 
for the meaning of disabled.
    (5) The rules of this paragraph are not applicable to amounts 
credited to an individual in his capacity as a policy-holder of an 
annuity, endowment, or life insurance contract which are in the nature 
of a dividend or refund of premium, and which are applied in accordance 
with paragraph (a)(4) of Sec. 1.404(a)-8 towards the purchase of 
benefits under the policy.
    (6) The rules of this paragraph may be illustrated by the following 
example:

    Example. B, a self-employed individual, received $8,000 as a 
distribution under a qualified pension plan before the annuity starting 
date. At the time of such distribution, $10,000 had been contributed 
(the whole amount

[[Page 275]]

being allowed as a deduction) under the plan on behalf of such 
individual while he was a common-law employee and $5,000 had been 
contributed under the plan on his behalf while he was an owner-employee, 
of which $2,500 was allowed as a deduction. In addition, B had 
contributed $1,000 on his own behalf as an employee under the plan. Of 
the $8,000, $2,500 (the amount allowed as a deduction with respect to 
contributions on behalf of the individual while he was an owner-
employee) is includable in gross income under subparagraph (2) of this 
paragraph. With respect to the remaining $5,500, B has a basis of 
$3,500, consisting of the $2,500 contributed on his behalf while he was 
an owner-employee which was not allowed as a deduction and the $1,000 
which B contributed as an employee. The difference between the $5,500 
and B's basis of $3,500, or $2,000, is includable in gross income under 
section 72(e).

    (c) Amounts paid for life, accident, health, or other insurance. 
Amounts used to purchase life, accident, health, or other insurance 
protection for an owner-employee shall not be taken into account in 
computing the following:
    (1) The aggregate amount of premiums or other consideration paid for 
the contract for purposes of determining the investment in the contract 
under section 72(c)(1)(A) and Sec. 1.72-6;
    (2) The consideration for the contract contributed by the employee 
for purposes of section 72(d)(1) and Sec. 1.72-13, which provide the 
method of taxing employees' annuities where the employee's contributions 
will be recoverable within 3 years; and
    (3) The aggregate premiums or other consideration paid for purposes 
of section 72(e)(1)(B) and Sec. 1.72-11, which provide the rules for 
taxing amounts not received as annuities prior to the annuity starting 
date.

The cost of such insurance protection will be considered to be a 
reasonable net premium cost, as determined by the Commissioner, for the 
appropriate period.
    (d) Amounts constructively received. (1) If during any taxable year 
an owner-employee assigns or pledges (or agrees to assign or pledge) any 
portion of his interest in a trust described in section 401(a) which is 
exempt from tax under section 501(a), or any portion of the value of a 
contract purchased as part of a plan described in section 403(a), such 
portion shall be treated as having been received by such owner-employee 
as a distribution from the trust or as an amount received under the 
contract during such taxable year.
    (2) If during any taxable year an owner-employee receives, either 
directly or indirectly, any amount from any insurance company as a loan 
under a contract purchased by a trust described in section 401(a) which 
is exempt from tax under section 501(a) or purchased as part of a plan 
described in section 403(a), and issued by such insurance company, such 
amount shall be treated as an amount received under the contract during 
such taxable year. An owner-employee will be considered to have received 
an amount under a contract if a premium, which is otherwise in default, 
is paid by the insurance company in the form of a loan against the cash 
surrender value of the contract. Further, an owner-employee will be 
considered to have received an amount to which this subparagraph applies 
if an amount is received from the issuer of a face-amount certificate as 
a loan under such a certificate purchased as part of a qualified trust 
or plan.
    (e) Penalties applicable to certain amounts received by owner-
employees. (1)(i) The rules of this paragraph are applicable to amounts, 
to the extent includable in gross income, received from a trust 
described in section 401(a) or under a plan described in section 403(a) 
by or on behalf of an individual who is or has been an owner-employee 
with respect to such plan or trust--
    (a) Which are received before the owner-employee reaches the age 
59\1/2\ years and which are attributable to contributions paid on behalf 
of such owner-employee (whether or not paid by him) while he was an 
owner-employee (see subdivision (ii) of this subparagraph),
    (b) Which are in excess of the benefits provided for such owner-
employee under the plan formula (see subdivision (iii) of this 
subparagraph), or
    (c) Which are received by reason of a distribution of the owner-
employee's entire interest under the provisions of section 401(e)(2)(E), 
relating to excess contributions on behalf of an owner-employee which 
are willfully made.
    (ii) The amounts referred to in subdivision (i)(a) of this 
subparagraph do not include--

[[Page 276]]

    (a) Amounts received by reason of the owner-employee becoming 
disabled, or
    (b) Amounts received by the owner-employee in his capacity as a 
policy-holder of an annuity, endowment, or life insurance contract which 
are in the nature of a dividend or similar distribution.

Amounts attributable to contributions paid on behalf of an owner-
employee and which are paid to a person other than the owner-employee 
before the owner-employee dies or reaches the age 59\1/2\ shall be 
considered received by the owner-employee for purposes of this 
paragraph. For taxable years beginning after December 31, 1966, see 
section 72(m)(7) and paragraph (f) of this section for the meaning of 
disabled. For taxable years beginning before January 1, 1967, see 
section 213(g)(3) for the meaning of disabled. For taxable years 
beginning after December 31, 1968, if an amount is not included in the 
amounts referred to in subdivision (i)(a) of this subparagraph solely by 
reason of the owner-employee becoming disabled and if a penalty would 
otherwise be applicable with respect to all or a portion of such amount, 
then for the taxable year in which such amount is received, there must 
be submitted with the owner-employee's income tax return a doctor's 
statement as to the impairment, and a statement by the owner-employee 
with respect to the effect of such impairment upon his substantial 
gainful activity and the date such impairment occurred. For taxable 
years which are subsequent to the first taxable year beginning after 
December 31, 1968, with respect to which the statements referred to in 
the preceding sentence are submitted, the owner-employee may, in lieu of 
such statements, submit a statement declaring the continued existence 
(without substantial diminution) of the impairment and its continued 
effect upon his substantial gainful activity.
    (iii) This paragraph applies to amounts described in subdivision 
(i)(b) of this subparagraph (relating to excess benefits) even though a 
portion of such amounts may be attributable to contributions made on 
behalf of an individual while he was not an owner-employee and even 
though the amounts are received by his successor. However, these amounts 
do not include the portion of a distribution to which section 402(a)(2) 
or 403(a)(2) (relating to certain total distributions in one taxable 
year) applies.
    (iv)(a) For purposes of subdivision (i)(a) of this subparagraph, the 
portion of any distribution or payment attributable to contributions on 
behalf of an employee-participant while he was an owner-employee 
includes the contributions made on his behalf while he was an owner-
employee and the increments in value attributable to such contributions.
    (b) The increments in value of an individual's account may be 
allocated to contributions on his behalf while he was an owner-employee 
either by maintaining a separate account, or an accounting, which 
reflects the actual increment attributable to such contributions, or by 
the method described in (c) of this subdivision.
    (c) Where an individual is covered under the same plan both as an 
owner-employee and as a nonowner-employee, the portion of the increment 
in value of his interest attributable to contributions made on his 
behalf while he was an owner-employee may be determined by multiplying 
the total increment in value in his account by a fraction. The numerator 
of the fraction is the total contributions made on behalf of the 
individual as an owner-employee, weighted for the number of years that 
each contribution was in the plan. The denominator is the total 
contributions made on behalf of the individual, whether or not an owner-
employee, weighted for the number of years each contribution was in the 
plan. The contributions are weighted for the number of years in the plan 
by multiplying each contribution by the number of years it was in the 
plan. For purposes of this computation, any forfeiture allocated to the 
account of the individual is treated as a contribution to the account 
made at the time so allocated.
    (d) The method described in (c) of this subdivision may be 
illustrated by the following example:

    Example. B was a member of the XYZ Partnership and a participant in 
the partnership's profit-sharing plan which was created in 1963. Until 
the end of 1967, B's interest in

[[Page 277]]

the partnership was less than 10 percent. On January 1, 1968, B obtained 
an interest in excess of 10 percent in the partnership and continued to 
participate in the profit-sharing plan until 1972. During 1972, prior to 
the time he attained the age of 59\1/2\ years and during a time when he 
was not disabled, B withdrew his entire interest in the profit-sharing 
plan. At that time his interest was $15,000, $9,600 contributions and 
$5,400 increment attributable to the contributions. The portion of the 
increment attributable to contributions while B was an owner-employee is 
$667.80, determined as follows:

------------------------------------------------------------------------
                                      A             B             C
                               -----------------------------------------
                                                Number of
                                                  years     Contribution
                                Contribution  contribution  weighted for
                                                 was in       years in
                                                 trust--     trust (AxB)
------------------------------------------------------------------------
1972..........................      $1,000             0             0
1971..........................         800             1           800
1970..........................       1,200             2         2,400
1969..........................         600             3         1,800
1968..........................         200             4           800
1967..........................         400             5         2,000
1966..........................       2,000             6        12,000
1965..........................       1,000             7         7,000
1964..........................       1,500             8        12,000
1963..........................         900             9         8,100
                               -----------------------------------------
  Total.......................      $9,600    ............      46,900
------------------------------------------------------------------------

Total weighted contributions as owner-employee (1968-1972)--5,800.

Total weighted contributions--46,900.
$5,400x(5,800/46,900) = $667.80

    (2)(i) If the aggregate of the amounts to which this paragraph 
applies received by any person in his taxable year equals or exceeds 
$2,500 the tax with respect to such amount shall be the greater of--
    (a) The increase in tax attributable to the inclusion of the amounts 
so received in his gross income for the taxable year in which received, 
or
    (b) 110 percent of the aggregate increase in taxes, for such taxable 
year and the four immediately preceding taxable years, which would have 
resulted if such amounts had been included in such person's gross income 
ratably over such taxable years. However, if deductions were allowed 
under section 404 for contributions to the plan on behalf of the 
individual as an owner-employee for less than four prior taxable years 
(whether or not consecutive), the number of immediately preceding 
taxable years taken into account shall be the number of prior taxable 
years in which such deductions were allowed.
    (ii) If the aggregate of the amounts to which this paragraph applies 
received by any person in his taxable year is less than $2,500, the tax 
with respect to such amounts shall be 110 percent of the increase in tax 
which results from including such amounts in the person's gross income 
for the taxable year in which received.
    (3)(i) For purposes of making the ratable inclusion computations of 
subparagraph (2)(i) of this paragraph, the taxable income of the 
recipient for each taxable year involved (notwithstanding section 63, 
relating to definition of taxable income) shall be treated as being not 
less than the amount required to be treated as includible in the taxable 
year pursuant to the ratable inclusion.
    (ii) For purposes of subparagraph (2)(i)(a) and (ii) of this 
paragraph, the recipient's taxable income (notwithstanding section 63, 
relating to definition of taxable income) shall be treated as being not 
less than the aggregate of the amounts to which this paragraph applies 
reduced by the deductions allowed the recipient for such taxable year 
under section 151 (relating to deductions for personal exemptions).
    (iii) In any case in which the application of subdivision (i) or 
(ii) of this subparagraph results in an increase in taxable income for 
any taxable year, the resulting increase in taxes imposed by section 1 
or 3 for such taxable year shall be reduced by the credits against tax 
provided by section 31 (tax withheld on wages) and section 39 (certain 
uses of gasoline and lubricating oil), but shall not be reduced by any 
other credits against tax.
    (4) The application of the rules of subparagraph (2)(i) and (3) of 
this paragraph may be illustrated by the following example:

    Example. B, a sole proprietor and a calendar-year basis taxpayer, 
established a qualified pension trust to which he made annual 
contributions for 10 years of 10 percent of his earned income. B 
withdrew his entire interest in the trust during 1973 when he was 55 
years old and not disabled and for which, without regard to the 
distribution, he had a net operating loss and for which he is allowed 
under section 151 a deduction for one

[[Page 278]]

personal exemption. The portion of the distribution includible in B's 
gross income is $25,750. In addition, B had a net operating loss for 
1972. The other 3 taxable years involved in the computation under 
subparagraph (2)(i) of this paragraph were years of substantial income. 
For purposes of determining B's increase in tax attributable to the 
receipt of the $25,750 (before the application of the provisions of 
subparagraph (2)(i)(b) of this paragraph), B's taxable income for the 
year he received the $25,750 is treated, under subparagraph (3)(ii) of 
this paragraph, as being $25,000 ($25,750 minus $750, the amount of the 
deduction allowed for each personal exemption under section 151 for 
1973). For purposes of determining whether 110 percent of the aggregate 
increase in taxes which would have resulted if 20 percent of the amount 
of the withdrawal had been included in B's gross income for the year of 
receipt and for each of the 4 preceding taxable years is greater (and 
thus is the amount of his increase in tax attributable to the receipt of 
the $25,750), B's taxable income for the taxable year of receipt, and 
for the immediately preceding taxable year, is treated, under 
subparagraph (3)(i) of this paragraph, as being $5,150 ($25,750 divided 
by 5).

    (f) Meaning of disabled. (1) For taxable years beginning after 
December 31, 1966, section 72(m)(7) provides that an individual shall be 
considered to be disabled if he is unable to engage in any substantial 
gainful activity by reason of any medically determinable physical or 
mental impairment which can be expected to result in death or to be of 
long-continued and indefinite duration. In determing whether an 
individual's impairment makes him unable to engage in any substantial 
gainful activity, primary consideration shall be given to the nature and 
severity of his impairment. Consideration shall also be given to other 
factors such as the individual's education, training, and work 
experience. The substantial gainful activity to which section 72(m)(7) 
refers is the activity, or a comparable activity, in which the 
individual customarily engaged prior to the arising of the disability 
(or prior to retirement if the individual was retired at the time the 
disability arose).
    (2) Whether or not the impairment in a particular case constitutes a 
disability is to be determined with reference to all the facts in the 
case. The following are examples of impairments which would ordinarily 
be considered as preventing substantial gainful activity:
    (i) Loss of use of two limbs;
    (ii) Certain progressive diseases which have resulted in the 
physical loss or atrophy of a limb, such as diabetes, multiple 
sclerosis, or Buerger's disease;
    (iii) Diseases of the heart, lungs, or blood vessels which have 
resulted in major loss of heart or lung reserve as evidenced by X-ray, 
electrocardiogram, or other objective findings, so that despite medical 
treatment breathlessness, pain, or fatigue is produced on slight 
exertion, such as walking several blocks, using public transportation, 
or doing small chores;
    (iv) Cancer which is inoperable and progressive;
    (v) Damage to the brain or brain abnormality which has resulted in 
severe loss of judgment, intellect, orientation, or memory;
    (vi) Mental diseases (e.g. psychosis or severe psychoneurosis) 
requiring continued institutionalization or constant supervision of the 
individual;
    (vii) Loss or diminution of vision to the extent that the affected 
individual has a central visual acuity of no better than 20/200 in the 
better eye after best correction, or has a limitation in the fields of 
vision such that the widest diameter of the visual fields subtends an 
angle no greater than 20 degrees;
    (viii) Permanent and total loss of speech;
    (ix) Total deafness uncorrectible by a hearing aid.

The existence of one or more of the impairments described in this 
subparagraph (or of an impairment of greater severity) will not, 
however, in and of itself always permit a finding that an individual is 
disabled as defined in section 72(m)(7). Any impairment, whether of 
lesser or greater severity, must be evaluated in terms of whether it 
does in fact prevent the individual from engaging in his customary or 
any comparable substantial gainful activity.
    (3) In order to meet the requirements of section 72(m)(7), an 
impairment must be expected either to continue for a long and indefinite 
period or to result in death. Ordinarily, a terminal illness because of 
disease or injury would result in disability. Indefinite is used in

[[Page 279]]

the sense that it cannot reasonably be anticipated that the impairment 
will, in the foreseeable future, be so diminished as no longer to 
prevent substantial gainful activity. For example, an individual who 
suffers a bone fracture which prevents him from working for an extended 
period of time will not be considered disabled, if his recovery can be 
expected in the foreseeable future; if the fracture persistently fails 
to knit, the individual would ordinarily be considered disabled.
    (4) An impairment which is remediable does not constitute a 
disability within the meaning of section 72(m)(7). An individual will 
not be deemed disabled if, with reasonable effort and safety to himself, 
the impairment can be diminished to the extent that the individual will 
not be prevented by the impairment from engaging in his customary or any 
comparable substantial gainful activity.
    (g) Years to which this section applies. This section applies to 
taxable years ending before September 3, 1974. For taxable years ending 
after September 2, 1974, see Sec. 1.72-17A.

[T.D. 6676, 28 FR 10136, Sept. 17, 1963, as amended by T.D. 6885, 31 FR 
7800, June 2, 1966; T.D. 6985, 33 FR 19811, Dec. 27, 1968; T.D. 7114, 36 
FR 9018, May 18, 1971; T.D. 7636, 44 FR 47049, Aug. 10, 1979]



Sec. 1.72-17A  Special rules applicable to employee annuities and 
distributions under deferred compensation plans to self-employed 
individuals and owner-employees.

    (a) In general. Section 72(m) and this section contain special rules 
for the taxation of amounts received from qualified pension, profit-
sharing, or annuity plans covering an owner-employee. This section 
applies to such amounts for taxable years of the recipient ending after 
September 2, 1974, unless another date is specified. For purposes of 
this section, the term ``employee'' shall include the self-employed 
individual who is treated as an employee by section 401(c)(1), and the 
term ``owner-employee'' has the meaning assigned to it in section 
401(c)(3). Paragraph (b) of this section provides rules dealing with the 
computation of consideration paid by self-employed individuals and 
paragraph (c) of this section provides rules dealing with such 
computation when insurance is purchased for owner-employees. Paragraph 
(d) of this section provides rules for constructive receipt and, for 
purposes of these rules, treats as an owner-employee an individual for 
whose benefit an individual retirement account or annuity described in 
section 408 (a) or (b) is maintained after December 31, 1974. Paragraph 
(e) of this section provides rules for penalties provided by section 
72(m)(5) with respect to certain distributions received by owner-
employees or their successors. Paragraph (f) of this section provides 
rules for determining whether a person is disabled within the meaning of 
section 72(m)(7). See Sec. 1.72-16, relating to life insurance 
contracts purchased under qualified employee plans, for rules under 
section 72(m)(3).
    (b) Computation of consideration paid by self-employed individuals. 
Under section 72(m)(2), consideration paid or contributed for the 
contract by any self-employed individual shall for purposes of section 
72 be deemed not to include any contributions paid or contributed under 
a plan described in paragraph (a), or any other plan of deferred 
compensation described in section 404(a) (whether or not qualified), if 
the contributions are--
    (1) Paid under such plan with respect to a time during which the 
employee was an employee only by reason of sections 401(c)(1) and 
404(a)(8), and
    (2) Deductible under section 404 by the employer, including an 
employer within the meaning of sections 401(c)(4) and 404(a)(8), of such 
self-employed individual at the time of such payment, or subsequent to 
such time of payment.

For purposes of this paragraph the term ``consideration paid or 
contributed for the contract'' has the same meaning as under 
subparagraphs (1), (2), and (3) of paragraph (c) of this section.
    (c) Amounts paid for life, accident, health, or other insurance. 
Under section 72(m)(2), amounts used to purchase life, accident, health, 
or other insurance protection for an owner-employee shall not be taken 
into account in computing the following:
    (1) The aggregate amount of premiums or other consideration paid for

[[Page 280]]

the contract for purposes of determining the investment in the contract 
under section 72(c)(1)(A) and Sec. 1.72-6;
    (2) The consideration for the contract contributed by the employee 
for purposes of section 72(d)(1) and Sec. 1.72-13, which provide the 
method of taxing employee's annuities where the employee's contributions 
will be recoverable within 3 years; and
    (3) The aggregate premiums or other consideration paid for purposes 
of section 72(e)(1)(B) and Sec. 1.72-11, which provide the rules for 
taxing amounts not received as annuities prior to the annuity starting 
date.

The cost of such insurance protection will be considered to be a 
reasonable net premium cost, as determined by the Commissioner, for the 
appropriate period.
    (d) Amounts constructively received. (1) The references in this 
paragraph (d) to section 72(m)(4) are to that section as in effect on 
August 13, 1982. Section 236(b)(1) of the Tax Equity and Fiscal 
Responsibility Act of 1982 (96 Stat. 324) repealed section 72(m)(4), 
generally effective for assignments, pledges and loans made after August 
13, 1982, and added section 72(p). See section 72(p) and Sec. 1.72(p)-1 
for rules governing the income tax treatment of certain assignments, 
pledges and loans from qualified employer plans made after August 13, 
1982.
    (2) Under section 72(m)(4)(A), if during any taxable year an owner-
employee assigns or pledges (or agrees to assign or pledge) any portion 
of his interest in a trust described in section 401(a) which is exempt 
from tax under section 501(a), or any portion of the value of a contract 
purchased as part of a plan described in section 403(a), such portion 
shall be treated as having been received by such owner-employee as a 
distribution from the trust or as an amount received under the contract 
during such taxable year.
    (3)(i) Under paragraphs (4)(A) and (6) of section 72(m), if after 
December 31, 1974, during any taxable year an individual for whose 
benefit an individual retirement account or annuity described in section 
408 (a) or (b) is maintained assigns or pledges (or agrees to assign or 
pledge) any portion of his interest in such account or annuity, such 
portion shall be treated as having been received by such individual as a 
distribution from such account or trust during such taxable year. See 
subsections (d) and (f) of section 408 and the regulations thereunder 
for the tax treatment of an amount treated as a distribution under this 
subparagraph.
    (ii) Notwithstanding subdivision (i) of this subparagraph, if an 
individual retirement account or annuity, or portion thereof, is subject 
to the additional tax imposed by section 408(f), that amount shall be 
deemed not to be a distribution under section 72(m)(4)(A) and 
subdivision (i) of this subparagraph.
    (4) Under section 72(m)(4)(B), if during any taxable year an owner-
employee receives, either directly or indirectly, any amount from any 
insurance company as a loan under a contract purchased by a trust 
described in section 401(a) which is exempt from tax under section 
501(a) or purchased as part of a plan described in section 403(a), and 
issued by such insurance company, such amount shall be treated as an 
amount received under the contract during such taxable year. An owner-
employee will be considered to have received an amount under a contract 
if a premium, which is otherwise in default, is paid by the insurance 
company in the form of a loan against the cash surrender value of the 
contract. Further, an owner-employee will be considered to have received 
an amount to which this subparagraph applies if an amount is received 
from the issuer of a face-amount certificate as a loan under such a 
certificate purchased as part of a qualified trust or plan.
    (e) Penalties applicable to certain amounts received with respect to 
owner-employees under section 72(m)(5). (1)(i) For taxable years of the 
recipient beginning after December 31, 1975, if any person receives an 
amount to which subparagraph (2) of this paragraph applies, his tax 
under Chapter 1 for the taxable year in which such amount is received 
shall be increased by an amount equal to 10 percent of the portion of 
the amount so received which is includible in his gross income for such 
taxable year.

[[Page 281]]

    (ii) For taxable years of the recipient beginning before January 1, 
1976, see subparagraph (3) of this paragraph.
    (2)(i) This subparagraph is applicable to amounts, to the extent 
includible in gross income, received from a qualified trust described in 
section 401(a) or under a plan described in section 403(a) by or on 
behalf of an individual who is or has been an owner-employee with 
respect to such trust or plan--
    (A) Which are received before the owner-employee reaches the age of 
59\1/2\ years, and which are attributable to contributions paid on 
behalf of such owner-employee by his employer (that is employer 
contributions within the meaning of section 401(c)(5)(A) and the 
increments in value attributable to such employer contributions) and the 
increments in value attributable to contributions made by him as an 
owner-employee while he was an owner-employee (that is, the increments 
attributable to owner-employee contributions within the meaning of 
section 401(c)(5)(B), but not such contributions; see subdivision (ii) 
of this subparagraph).
    (B) Which are in excess of the benefits provided for such owner-
employee under the plan formula (see subdivision (iii) of this 
subparagraph), or
    (C) Which are subject to the transitional rules with respect to 
willful excess contributions made on behalf of an owner-employee in his 
employer's taxable years which begin before January 1, 1976 (see 
subdivision (v) of this subparagraph).
    (ii) The amounts referred to in subdivision (i)(A) of this 
subparagraph do not include--
    (A) Amounts received by reason of the owner-employee becoming 
disabled (see paragraph (f) of this section).
    (B) Amounts received by the owner-employee in his capacity as a 
policyholder of an annuity, endowment, or life insurance contract which 
are in the nature of a dividend or similar distribution, or
    (C) Amounts attributable to contributions (and increments in value 
thereon) made for years for which the recipient was not an owner-
employee.

If an amount is not included in the amounts referred to in subdivision 
(i)(A) of this subparagraph solely by reason of the owner-employee's 
becoming disabled and if a penalty would otherwise be applicable with 
respect to all or a portion of such amount, then for the owner-
employee's taxable year in which such amount is received, there must be 
submitted with his income tax return a doctor's statement as to the 
impairment, and a statement by the owner-employee with respect to the 
effect of such impairment upon his substantial gainful activity and the 
date such impairment occurred. For taxable years which are subsequent to 
the first taxable year with respect to which the statements referred to 
in the preceding sentence are submitted, the owner-employee may, in lieu 
of such statements, submit a statement declaring the continued existence 
(without substantial diminution) of the impairment and its continued 
effect upon his substantial gainful activity.
    (iii) This subparagraph applies to amounts described in subdivision 
(i)(B) of this subparagraph (relating to benefits in excess of the plan 
formula) even though a portion of such amounts may be attributable to 
contributions made on behalf of an individual while he was not an owner-
employee and even if he is deceased and the amounts are received by his 
successor.
    (iv)(A) The rules described in subdivisions (i)(A) and (iii) of this 
subparagraph, relating to the treatment under section 72(m)(5)(A)(i) of 
certain premature distributions, may be illustrated by the following 
example:

    Example. (1) A was a member of the X partnership, consisting of 
partners A through I, and a participant in the partnership's qualified 
profit-sharing plan which was established on January 1, 1972. A's 
taxable years, the X partnership's taxable years, the plan years, and 
other relevant years are all calendar years at all relevant times. For 
the three calendar years, 1972 through 1974, A was an owner-employee in 
the X partnership. On January 1, 1975, new partners J and K became 
partners in the X partnership, and as of that date, each of partners A 
through K held a \1/11\ interest in the capital and profits of the X 
partnership. On that date, A became a partner who was not an owner-
employee. A continued in this status for the 2 calendar years 1975 and 
1976. On January 1, 1977, when A was 50 years old and not disabled, he 
liquidated his interest in the X partnership and

[[Page 282]]

became an employee of an unrelated employer. On that date, A received a 
distribution representing his entire interest in the X partnership's 
plan of $54,000 cash in violation of the plan provision required by 
section 401(d)(4)(B). As of that date, the distribution was attributable 
to the following sources and times, computed by the plan in a manner 
consistent with the subparagraph:

----------------------------------------------------------------------------------------------------------------
                                              A                  B                  C                  D
                                     ---------------------------------------------------------------------------
                                                                              Increments in      Increments in
           Calendar years              X contributions   A's contributions        value              value
                                        on behalf of A       made as an      attributable to    attributable to
                                       deductible under       employee       column A yearly    column B yearly
                                           sec. 404                           contributions      contributions
----------------------------------------------------------------------------------------------------------------
1977................................                  0                  0                  0                  0
1976................................             $7,500             $2,500               $900               $300
1975................................              7,500              2,500              4,000              1,300
1974................................              7,500              2,500              1,800                700
1973................................              2,500              2,500              1,200              1,200
1972................................              2,500              2,500              1,300              1,300
                                     ---------------------------------------------------------------------------
 Totals.............................             27,500             12,500              9,200              4,800
----------------------------------------------------------------------------------------------------------------

    (2) The amount of the $54,000 distribution to which subdivision 
(i)(A) of this subparagraph applies is $20,000, computed as follows:

X contributions on behalf of A made in years A was an owner-
 employee:
  1974........................................................    $7,500
  1973........................................................     2,500
  1972........................................................     2,500
                                                               ---------
    Total.....................................................    12,500
                                                               =========
 
Increments in value attributable to such contributions:
  1974........................................................     1,800
  1973........................................................     1,200
  1972........................................................     1,300
                                                               ---------
    Total.....................................................     4,300
                                                               =========
 
Increments in value attributable to contributions made by A as
 an employee for years in which he was an owner-employee:
  1974........................................................       700
  1973........................................................     1,200
  1972........................................................     1,300
                                                               ---------
    Total.....................................................     3,200
                                                               =========
    Grand total...............................................    20,000
                                                               =========
 


In this example, the $20,000 amount computed above would be includible 
in A's gross income for 1977 and would be subject to the 10 percent tax 
described in subparagraph (1)(i) of this paragraph.
    (3) Subdivision (i)(A) of this subparagraph does not apply to the 
contributions made by X on behalf of A for 1976 and 1975 ($7,500 each 
year, totaling $15,000) nor to the increments in value attributable to 
those contributions ($900 for 1976 and $4,000 for 1975, totaling 
$4,900), because A was not an owner-employee with respect to these two 
years, 1976 and 1975, on account of which these employer contributions 
were made. For the same reason, subdivision (i)(A) of this subparagraph 
does not apply to the increments in value attributable to A's 
contributions for 1976 and 1975 ($300 and $1,300, respectively, totaling 
$1,600).

See section 4972(c) for the amount of employee contributions which is 
permitted to be contributed by an owner-employee (as an employee) 
without subjecting an owner-employee to the tax on excess contributions.
    (4) Subdivision (i)(A) of this subparagraph does not apply to the 
contributions made by A, as an employee during the years when he was an 
owner-employee ($2,500 during each of the years 1972, 1973, and 1974, 
totaling $7,500), because the distribution was received in a taxable 
year of A ending after September 2, 1974; see subparagraph (3) of this 
paragraph. Furthermore, because the distribution of the amount of A's 
contributions ($12,500) constitutes consideration for the contract paid 
by A for purposes of section 72, the $7,500 amount described in the 
preceding sentence is not includible in his gross income, and that 
amount is not subject to the rules of this subparagraph; see subdivision 
(i) of this subparagraph, and paragraphs (b) and (c) of this section.

    (B) The increments in value of an individual's account may be 
allocated to contributions on his behalf, by his employer or by such 
individual as an owner-employee, while he was an owner-employee either 
by maintaining a separate account, or an accounting, which reflects the 
actual increment attributable to such contributions, or by the method 
described in (C) of this subdivision.
    (C) Where an individual is covered under the same plan both as an 
owner-employee and as a non-owner-employee, the portion of the increment 
in value of his interest attributable to contributions made on his 
behalf while

[[Page 283]]

he was an owner-employee may be determined by multiplying the total 
increment in value in his account by a fraction. The numerator of the 
fraction is the total contributions made on behalf of the individual as 
an owner-employee, weighted for the number of years that each 
contribution was in the plan. The denominator is the total contributions 
made on behalf of the individual, whether or not as an owner-employee, 
weighted for the number of years each contribution was in the plan. The 
contributions are weighted for the number of years in the plan by 
multiplying each contribution by the number of years it was in the plan. 
For purposes of this computation, any forfeiture allocated to the 
account of the individual is treated as a contribution to the account 
made at the time so allocated. For purposes of this computation, where 
the individual has received a prior distribution from such account, an 
appropriate adjustment must be made to reflect such prior distribution.
    (D) The method described in (C) of this subdivision may be 
illustrated by the following example:

    Example. B was a member of the XYZ Partnership and a participant in 
the partnership's profit-sharing plan which was created in 1973. Until 
the end of 1977, B's interest in the partnership was less than 10 
percent. On January 1, 1978, B obtained an interest in excess of 10 
percent in the partnership and continued to participate in the profit-
sharing plan until 1982. During 1982, prior to the time he attained the 
age of 59\1/2\ years and during a time when he was not disabled, B, who 
had not received any prior plan distributions, withdrew his entire 
interest in the profit-sharing plan. At the time his interest was 
$15,000, $9,600 contributions and $5,400 increment attributable to the 
contributions. The portion of the increment attributable to 
contributions while B was an owner-employee is $667.80, determined as 
follows:

------------------------------------------------------------------------
                                      A             B             C
                               -----------------------------------------
                                                Number of   Contribution
                                                  years     weighted for
                                Contribution  contribution    years in
                                              was in trust   trust (AxB)
------------------------------------------------------------------------
1982..........................       $1,000              0             0
1981..........................          800              1           800
1980..........................        1,200              2         2,400
1979..........................          600              3         1,800
1978..........................          200              4           800
1977..........................          400              5         2,000
1976..........................        2,000              6        12,000
1975..........................        1,000              7         7,000
1974..........................        1,500              8        12,000
1973..........................          900              9         8,100
                               -----------------------------------------
 Total........................        9,600   ............        46,900
------------------------------------------------------------------------

Total weighted contributions as owner-employee (1978-1982)=$5,800.

Total weighted contributions=$46,900.
[GRAPHIC] [TIFF OMITTED] TC14NO91.169

    (E)(1) The rules set forth in subdivision (iv)(E)(2) of this 
subparagraph shall be used to determine the amounts to which subdivision 
(i)(A) of this subparagraph applies in the case of a distribution of 
less than the entire balance of the employee's account from a plan in 
which he has been covered at different times as owner-employee or as an 
employee other than an owner-employee.
    (2) Distributions or payments from a plan for any employee taxable 
year shall be deemed to be attributable to contributions to the plan, 
and increments thereon, in the following order--
    (i) Excess contributions, within the meaning of section 4972 (b), 
designated as such by the trustee;
    (ii) Employee contributions;
    (iii) Employer contributions, other than those described in( i), and 
the increments in value attributable to the employee's own contributions 
and his employer's contributions on the basis of the taxable years of 
his employer in succeeding order of time whether or not the employee was 
an owner-employee for any such year.

For purposes of (iii) of this subdivision, the time of contributions 
made on the basis of any employer taxable year shall take into account 
the rule specified in section 404(a)(6), relating to time when 
contributions deemed made.
    (v) The amounts referred to in subdivision (i)(C) of this 
subparagraph are amounts which are received by reason of a distribution 
of the owner-employee's entire interest under the provisions of section 
401(e)(2)(E), as in effect on September 1, 1974, relating to excess 
contributions on behalf of an owner-employee which are willfully made.

[[Page 284]]

Notwithstanding the preceding sentence, an owner-employee's entire 
interest in all plans with respect to which he is an owner-employee 
(within the meaning of subsections (d)(8)(C) and (e)(2)(E)(ii) of 
section 401, as in effect on September 1, 1974) does not include any 
distribution or payment attributable to his employer's contributions or 
his own contributions made with respect to his employer's taxable years 
beginning after December 31, 1975. However, his entire interest in all 
plans does include all of the distribution or payment attributable to 
his employer's contributions and his own contributions made with respect 
to all of his employer's taxable years beginning before January 1, 1976, 
if any portion thereof is attributable in whole or in part to such a 
willful excess contribution and such entire interest is received because 
of a willful excess contribution pursuant to section 401(e)(2)(E)(ii). A 
distribution or payment is described in the preceding sentence even 
though it is received in an owner-employee's taxable year beginning 
after December 31, 1975. For purposes of computing the increments in 
value attributable to employer taxable years which begin before January 
1, 1976, and such increments attributable to such years beginning after 
December 31, 1975, the rules specified in subdivision (iv)(B), (C), (D), 
and (E) of this subparagraph shall be applied to the extent applicable. 
See Sec. 1.401(e)-4(c) for transitional rules with respect to 
contributions described in this subdivision.
    (3)(i) For taxable years of the recipient beginning before January 
1, 1976, the tax with respect to amounts to which subparagraph (2) of 
this paragraph applies shall be computed under subparagraphs (B), (C), 
(D), and (E) of section 72(m)(5) as such subparagraphs were in effect 
prior to the amendments made by subsections (g)(1) and (2)(A) of section 
2001 of the Employee Retirement Income Security Act of 1974 (88 Stat. 
957) except as provided in subdivisions (ii) and (iii) of this 
subparagraph (see paragraph (e) of Sec. 1.72-17). For purposes of the 
preceding sentence, amounts to which subparagraph (2) of this paragraph 
applies in the case of an amount described in section 72(m)(5)(A)(i) 
shall be determined under subdivisions (i)(a) and (ii) of Sec. 1.72-
17(e)(1), except as provided in subdivision (ii) of this subparagraph. 
For purposes of the first sentence of this subdivision, amounts to which 
subparagraph (2) of this paragraph applies in the case of an amount 
described in section 72(m)(5)(A)(ii) shall be determined under 
subdivisions (i)(b) and (iii) of Sec. 1.72-17(e)(1), except as provided 
in subdivision (iii) of this subparagraph.
    (ii) For purposes of applying section 72(m)(5)(A)(i), after the 
amendment made by section 2001(h)(3) of such Act, and subdivisions 
(i)(a) and (ii) of Sec. 1.72-17(e)(1), to a distribution or payment 
received in recipient taxable years ending after September 2, 1974, and 
beginning before January 1, 1976, with respect to contributions made on 
behalf of an owner-employee which were made by him as an owner-employee 
(that is, employee contributions within the meaning of section 
401(c)(5)(B)) the portion of any distribution or payment attributable to 
such contributions shall not include such contributions but shall 
include the increments in value attributable to such contributions.
    (iii) For purposes of applying section 72(m)(5)(D) and subdivisions 
(i)(b) and (iii) of Sec. 1.72-17(e)(1) to recipient taxable years 
beginning after December 31, 1973, and beginning before January 1, 1976, 
in the case of distributions or payments made after December 31, 1973, 
the amounts to which section 402 (a)(2) or 403(a)(2) applies after the 
amendments made by section 2005(b) (1) and (2) of such Act (88 Stat. 990 
and 991) (which are amounts to which subdivision (i)(b) of Sec. 1.72-
17(e)(1) does not apply) shall be deemed to be the amount which is 
treated as a gain from the sale or exchange of a capital asset held for 
more than 6 months under either of such sections.
    (f) Meaning of disabled. (1) Section 72(m)(7) provides that an 
individual shall be considered to be disabled if he is unable to engage 
in any substantial gainful activity by reason of any medically 
determinable physical or mental impairment which can be expected to 
result in death or to be of long-continued and indefinite duration. In 
determining whether an individual's impairment makes him unable to 
engage in

[[Page 285]]

any substantial gainful activity, primary consideration shall be given 
to the nature and severity of his impairment. Consideration shall also 
be given to other factors such as the individual's education, training, 
and work experience. The substantial gainful activity to which section 
72(m)(7) refers is the activity, or a comparable activity, in which the 
individual customarily engaged prior to the arising of the disability or 
prior to retirement if the individual was retired at the time the 
disability arose.
    (2) Whether or not the impairment in a particular case constitutes a 
disability is to be determined with reference to all the facts in the 
case. The following are examples of impairments which would ordinarily 
be considered as preventing substantial gainful activity:
    (i) Loss of use of two limbs;
    (ii) Certain progressive diseases which have resulted in the 
physical loss or atrophy of a limb, such as diabetes, multiple 
sclerosis, or Buerger's disease;
    (iii) Diseases of the heart, lungs, or blood vessels which have 
resulted in major loss of heart or lung reserve as evidenced by X-ray, 
electrocardiogram, or other objective findings, so that despite medical 
treatment breathlessness, pain, or fatigue is produced on slight 
exertion, such as walking several blocks, using public transportation, 
or doing small chores;
    (iv) Cancer which is inoperable and progressive;
    (v) Damage to the brain or brain abnormality which has resulted in 
severe loss of judgment, intellect, orientation, or memory;
    (vi) Mental diseases (e.g. psychosis or severe psychoneurosis) 
requiring continued institutionalization or constant supervision of the 
individual;
    (vii) Loss or diminution of vision to the extent that the affected 
individual has a central visual acuity of no better than 20/200 in the 
better eye after best correction, or has a limitation in the fields of 
vision such that the widest diameter of the visual fields subtends an 
angle no greater than 20 degrees;
    (viii) Permanent and total loss of speech;
    (ix) Total deafness uncorrectible by a hearing aid.

The existence of one or more of the impairments described in this 
subparagraph (or of an impairment of greater severity) will not, 
however, in and of itself always permit a finding that an individual is 
disabled as defined in section 72(m)(7). Any impairment, whether of 
lesser or greater severity, must be evaluated in terms of whether it 
does in fact prevent the individual from engaging in his customary or 
any comparable substantial gainful activity.
    (3) In order to meet the requirements of section 72(m)(7), an 
impairment must be expected either to continue for a long and indefinite 
period or to result in death. Ordinarily, a terminal illness because of 
disease or injury would result in disability. The term ``indefinite'' is 
used in the sense that it cannot reasonably be anticipated that the 
impairment will, in the foreseeable future, be so diminished as no 
longer to prevent substantial gainful activity. For example, an 
individual who suffers a bone fracture which prevents him from working 
for an extended period of time will not be considered disabled, if his 
recovery can be expected in the foreseeable future; if the fracture 
persistently fails to knit, the individual would ordinarily be 
considered disabled.
    (4) An impairment which is remediable does not constitute a 
disability within the meaning of section 72(m)(7). An individual will 
not be deemed disabled if, with reasonable effort and safety to himself, 
the impairment can be diminished to the extent that the individual will 
not be prevented by the impairment from engaging in his customary or any 
comparable substantial gainful activity.

[T.D. 7636, 44 FR 47049, Aug. 10, 1979, as amended by T.D. 8894, 65 FR 
46591, July 31, 2000]



Sec. 1.72-18  Treatment of certain total distributions with respect to 
self-employed individuals.

    (a) In general. The Self-Employed Individuals Tax Retirement Act of 
1962 permits self-employed individuals to be treated as employees for 
purposes of

[[Page 286]]

participation in pension, profit-sharing, and annuity plans described in 
sections 401(a) and 403(a). In general, amounts received by a 
distributee or payee which are attributable to contributions made on 
behalf of a participant while he was self-employed are taxed in the same 
manner as amounts which are attributable to contributions made on behalf 
of a common-law employee. However, such amounts which are paid in one 
taxable year representing the total distributions payable to a 
distributee or payee with respect to an employee are not eligible for 
the capital gains treatment of section 402(a)(2) or 403(a)(2). This 
section sets forth the treatment of such distributions, except where 
such a distribution is subject to the penalties of section 72(m)(5) and 
paragraph (e) of Sec. 1.72-17.
    (b) Distributions to which this section applies. (1)(i) Except as 
provided in subparagraphs (2) and (3) of this paragraph, this section 
applies to amounts distributed to a distributee in one taxable year of 
the distributee in the case of an employees' trust described in section 
401(a) which is exempt under section 501(a), or to amounts paid to a 
payee in one taxable year of the payee in the case of an annuity plan 
described in section 403(a), which constitute the total distributions 
payable, or the total amounts payable, to the distributee or payee with 
respect to an employee.
    (ii) For the total distributions or amounts payable to a distributee 
or payee to be considered paid within one taxable year of the 
distributee or payee for purposes of this section, all amounts to the 
credit of the employee-participant through the end of such taxable year 
which are payable to the distributee or payee must be distributed or 
paid within such taxable year. Thus, the provisions of this section are 
not applicable to a distribution or payment to a distributee or payee if 
the trust or plan retains any amounts after the close of such taxable 
year which are payable to the same distributee or payee even though the 
amounts retained may be attributable to contributions on behalf of the 
employee-participant while he was a common-law employee in the business 
with respect to which the plan was established.
    (iii) For purposes of this section, the total amounts payable to a 
distributee or the amounts to the credit of the employee do not include 
United States Retirement Plan Bonds held by a trust to the credit of the 
employee. Thus, a distribution to a distributee by a qualified trust may 
constitute a distribution to which this section applies even though the 
trust retains retirement plan bonds registered in the name of the 
employee on whose behalf the distribution is made which are to be 
distributed to the same distributee. Moreover, the proceeds of a 
retirement bond received as part of a distribution which constitutes the 
total distributions payable to the distributee are not entitled to the 
special tax treatment of this section. See section 405(d) and paragraph 
(a)(1) of Sec. 1.405-3.
    (iv) If the amounts payable to a distributee from a qualified trust 
with respect to an employee-participant includes an annuity contract, 
such contract must be distributed along with all other amounts payable 
to the distributee in order to have a distribution to which this section 
applies. However, the proceeds of an annuity contract received in a 
total distribution will not be entitled to the tax treatment of this 
section unless the contract is surrendered in the taxable year of the 
distributee in which the total distribution was received.
    (v) In the case of a qualified annuity plan, the term ``total 
amounts'' means all annuities payable to a payee. If more than one 
annuity contract is received under the plan by a distributee, this 
section shall not apply to an amount received on surrender of any such 
contracts unless all contracts under the plan payable to the payee are 
surrendered within one taxable year of the payee.
    (vi)(a) The provisions of this section are applicable where the 
total amounts payable to a distributee or payee are paid within one 
taxable year of the distributee or payee whether or not a portion of the 
employee-participant's interest which is payable to another distributee 
or payee is paid within the same taxable year. However, a distributee or 
payee who, in prior taxable

[[Page 287]]

years received amounts (except amounts described in (b) of this 
subdivision) after the employee-participant ceases to be eligible for 
additional contributions to be made on his behalf, does not receive a 
distribution or payment to which this section applies, even though the 
total amount remaining to be paid to such distributee or payee with 
respect to such employee is paid within one taxable year. On the other 
hand, a distribution to a distributee or payee prior to the time that 
the employee-participant ceases to be eligible for additional 
contributions on his behalf does not preclude the application of this 
section to a later distribution to the same distributee or payee.
    (b) The receipt of an amount which constitutes--
    (1) A payment in the nature of a dividend or similar distribution to 
an individual in his capacity as a policyholder of an annuity, 
endowment, or life insurance contract, or
    (2) A return of excess contributions which were not willfully made,

does not prevent the application of this section to a total distribution 
even though the amount is received after the employee-participant ceases 
to be eligible for additional contributions and in a taxable year other 
than the taxable year in which the total amount is received.
    (vii) For purposes of this section, the total amounts payable to a 
distributee or payee, or the amounts to the credit of the employee, do 
not include any amounts which have been placed in a separate account for 
the funding of medical benefits described in section 401(h) as defined 
in paragraph (a) of Sec. 1.401-14. Thus, a distribution by a qualified 
trust or annuity plan may constitute a distribution to which this 
section applies even though amounts attributable to the funding of 
section 401(h) medical benefits as defined in paragraph (a) of Sec. 
1.401-14 are not so distributed.
    (2) This section shall apply--
    (i) Only if the distribution or payment is made--
    (a) On account of the employee's death at any time,
    (b) After the employee has attained the age 59\1/2\ years, or
    (c) After the employee has become disabled; and
    (ii) Only to so much of the distribution or payment as is 
attributable to contributions made on behalf of an employee while he was 
a self-employed individual in the business with respect to which the 
plan was established. Any distribution or payment, or any portion 
thereof, which is not so attributable shall be subject to the rules of 
taxation which apply to any distribution or payment that is attributable 
to contributions on behalf of common-law employees.

For taxable years beginning after December 31, 1966, see section 
72(m)(7) and paragraph (f) of Sec. 1.72-17 for the meaning of disabled. 
For taxable years beginning before January 1, 1967, see section 
213(g)(3) for the meaning of disabled. For taxable years beginning after 
December 31, 1968, if this section is applicable by reason of the 
distribution or payment being made after the employee has become 
disabled, then for the taxable year in which the amounts to which this 
section applies are distributed or paid, there shall be submitted with 
the recipient's income tax return a doctor's statement as to the nature 
and effect of the employee's impairment.
    (3) This section shall not apply to--
    (i) Distributions or payments to which the penalty provisions of 
section 72(m)(5) and paragraph (e) of Sec. 1.72-17 apply,
    (ii) Distributions or payments from a trust or plan made to or on 
behalf of an individual prior to the time such individual ceases to be 
eligible for additional contributions (except the contribution 
attributable to the last year of service) to be made to the trust or 
plan on his behalf as a self-employed individual, and
    (iii) Distributions or payments made to the employee from a plan or 
trust unless contributions which were allowed as a deduction under 
section 404 have been made on behalf of such employee as a self-employed 
individual under such trust or plan for 5 or more taxable years (whether 
or not consecutive) prior to the taxable year in which such 
distributions or payments are made. Distributions or payments to which 
this section does not apply by

[[Page 288]]

reason of this subdivision are taxed as otherwise provided in section 
72. However, for taxable years beginning before January 1, 1964, section 
72(e)(3), as in effect before such date, is not applicable. For taxable 
years beginning after December 31, 1963, such distributions or payments 
may be taken into account in computations under sections 1301 through 
1305 (relating to income averaging).
    (4) The portion of any distribution or payment attributable to 
contributions on behalf of an employee-participant while he was self-
employed includes the contributions made on his behalf while he was 
self-employed and the increments in value attributable to such 
contributions. Where the amounts to the credit of an employee-
participant include amounts attributable to contributions on his behalf 
while he was a self-employed individual and amounts attributable to 
contributions on his behalf while he was a common-law employee, the 
increment in value attributable to the employee-participant's interest 
shall be allocated to the contributions on his behalf while he was self-
employed either by maintaining a separate account, or an accounting, 
which reflects the actual increment attributable to such contributions, 
or by the method described in paragraph (e)(1)(iv)(c) of Sec. 1.72-17. 
However, if the latter method is used, the numerator of the fraction is 
the total contributions made on behalf of the individual as a self-
employed individual, weighted for the number of years that each 
contribution was in the plan.
    (c) Amounts includible in gross income. (1) Where a total 
distribution or payment to which this section applies is made to one 
distributee or payee and includes the total amount remaining to the 
credit of the employee-participant on whose behalf the distribution or 
payment was made, the distributee or payee shall include in gross income 
an amount equal to the portion of the distribution or payment which 
exceeds the employee-participant's investment in the contract. For 
purposes of this paragraph, the investment in the contract shall be 
reduced by any amounts previously received from the plan or trust by or 
on behalf of the employee-participant which were excludable from gross 
income as a return of the investment in the contract.
    (2) In the case of a distribution to which this section applies and 
which is made to more than one distributee or payee, each element of the 
amounts to the credit of an employee-participant shall be allocated 
among the several distributees or payees on the basis of the ratio of 
the value of the distributee's or payee's distribution or payment to the 
total amount to the credit of the employee-participant. The elements to 
be so allocated include the investment in the contract, the increments 
in value, and the portion of the amounts to the credit of the employee-
participant which is attributable to the contributions on behalf of the 
employee-participant while he was a self-employed individual.
    (d) Computation of tax. (1) The tax attributable to the amounts to 
which this section applies for the taxable year in which such amounts 
are received is the greater of--
    (i) 5 times the increase in tax which would result from the 
inclusion in gross income of the recipient of 20 percent of so much of 
the amount so received as is includible in gross income, or
    (ii) 5 times the increase which would result if the taxable income 
of the recipient for such taxable year equaled 20 percent of the excess 
of the aggregate of the amounts so received and includible in gross 
income over the amount of the deductions allowed the recipient for such 
taxable year under section 151 (relating to deduction for personal 
exemptions).

In any case in which the application of subdivision (ii) of this 
subparagraph results in an increase in taxable income for any taxable 
year, the resulting increase in taxes imposed by section 1 or 3 for such 
taxable year shall be reduced by the credit against tax provided by 
section 31 (tax withheld on wages), but shall not be reduced by any 
other credits against tax.
    (2) The application of the rules of this paragraph may be 
illustrated by the following example:

    Example. B, a sole proprietor and a calendar-year basis taxpayer, 
established a qualified pension trust to which he made annual 
contributions for 10 years of 10 percent

[[Page 289]]

of his earned income. B withdrew his entire interest in the trust during 
1973, for which year, without regard to the distribution, he had a net 
operating loss and is allowed under section 151 a deduction for one 
personal exemption. At the time of the withdrawal, B was 64 years old. 
The amount of the distribution that is includible in his gross income is 
$25,750. Because of B's net operating loss, the tax attributable to the 
distribution is determined under the rule of subparagraph (1)(ii) of 
this paragraph. For purposes of determining the tax attributable to the 
$25,750, B's taxable income for 1973 is treated, under subparagraph 
(1)(ii) of this paragraph, as being 20 percent of $25,000 ($25,750 minus 
$750, the amount of the deduction allowed for each personal exemption 
under section 151 for 1973). Thus, under subparagraph (1) of this 
paragraph, the tax attributable to the $25,750 would be 5 times the 
increase which would result if the taxable income of B for the taxable 
year he received such amount equaled $5,000. B has had no amounts 
withheld from wages and thus is not entitled to reduce the increase in 
taxes by the credit against tax provided in section 31 and may not 
reduce the increase in taxes by any other credits against tax.

[T.D. 6676, 28 FR 10138, Sept. 17, 1963, as amended by T.D. 6722, 29 FR 
5070, Apr. 14, 1964, T.D. 6885, 31 FR 7800, June 2, 1966, T.D. 6985, 33 
FR 19812, Dec. 27, 1968; T.D. 7114, 36 FR 9018, May 18, 1971]



Sec. 1.72(e)-1T  Treatment of distributions where substantially all 
contributions are employee contributions (temporary).

    Q-1: How did the Tax Reform Act (TRA) of 1984 change the law with 
regard to the treatment of non-annuity distributions (i.e., amounts 
distributed prior to the annuity starting date and not received as 
annuities) from a qualified plan that is treated as a single contract 
under section 72 and under which substantially all of the contributions 
are employee contributions?
    A-1: (a) Prior to the amendment of section 72(e) by the TRA of 1984, 
non-annuity distributions from such a qualified plan generally were 
allocable, first, to nondeductible employee contributions and thus were 
not includible in gross income. After distributions equaled the balance 
of nondeductible employee contributions, further non-annuity 
distributions generally were includible in gross income.
    (b) Pursuant to section 72(e)(7), as added by the TRA of 1984, non-
annuity distributions from such a qualified plan that are allocable to 
investment in the plan after August 13, 1982 (as determined in 
accordance with section 72(e)(5)(B)), generally will be treated, first, 
as allocable to income and, second, as allocable to nondeductible 
employee contributions. Distributions allocable to income are includible 
in gross income. Distributions allocable to nondeductible employee 
contributions are not includible in gross income.
    Q-2: To which qualified plans and contracts does section 72(e)(7) 
apply?
    A-2: Section 72(e)(7) applies to any plan or contract under which 
substantially all of the contributions are employee contributions if--
    (a) Such plan is described in section 401(a) and the related trust 
or trusts are exempt from tax under section 501(a); or
    (b) Such contract is--
    (1) Purchased by a trust described in (a) above,
    (2) Purchased as part of a plan described in section 403(a), or
    (3) Described in section 403(b).
    Q-3: What is the definition of a qualified plan or contract under 
which substantially all of the contributions are employee contributions?
    A-3: (a) A qualified plan or contract under which substantially all 
of the contributions are employee contributions is a plan or contract 
with respect to which 85 percent or more of the total contributions 
during the ``representative period'' are employee contributions. The 
``representative period'' means the five-plan-year period preceding the 
plan year during which a distribution occurs. However, if less than 85 
percent of the total contributions for all plan years during which the 
plan or contract is in existence prior to the plan year of distribution 
are employee contributions, then the plan or contract is not one with 
respect to which substantially all of the contributions are employee 
contributions.
    (b) For purposes of the 85 percent test, contributions made to a 
predecessor plan or contract are aggregated with contributions made to 
the plan or contract to which the 85 percent test is being applied (the 
successor plan or contract). For purposes of the preceding sentence, a 
predecessor plan or

[[Page 290]]

contract is a plan or contract the terms of which are substantially the 
same as the successor plan or contract.
    Q-4: What is the definition of employee contributions for purposes 
of section 72(e)(7)?
    A-4: For purposes of section 72(e)(7), employee contributions are 
those amounts contributed by the employee and those amounts considered 
contributed by the employee under section 72(f). For example, amounts 
contributed to a section 401(k) qualified cash or deferred arrangement, 
pursuant to an employee's election to defer such amounts, are employer 
contributions to the extent that such amounts are not currently 
includible in gross income. In addition, deductible employee 
contributions under section 72(o) are disregarded in their entirety 
(i.e., treated as neither employee contributions nor employer 
contributions) in determining whether substantially all the 
contributions are employee contributions.
    Q-5: How is the 85 percent test of section 72(e)(7) applied to a 
qualified plan or contract?
    A-5: (a) Except as provided in paragraphs (b), (c), and (d), the 85 
percent test is applied separately with respect to each contract under 
section 72.
    (b) If a single qualified plan described in section 401(a) or 
section 403(a) comprises more than one contract under section 72, 
regardless of whether such plan includes multiple trusts or combinations 
of profit-sharing and pension features, these contracts are aggregated 
for purposes of applying the 85 percent test. Thus, if substantially all 
of the contributions under a qualified plan comprising two contracts 
under section 72 are employee contributions, section 72(e)(5)(D) shall 
not apply to non-annuity distributions under either of the contracts.
    (c) With respect to the plans maintained by the Federal Government 
or by instrumentalities of the Federal Government, the 85 percent test 
shall be applied by aggregating all such plans. This aggregation rule 
applies only to those plans that are actively administered by the 
Federal Government or an instrumentality thereof. Thus, if a plan of the 
Federal Government is administered by a commercial financial 
institution, it would not be aggregated with other plans of the Federal 
Government and its instrumentalities for purposes of applying the 85 
percent test.
    (d) In the case of a contract described in section 403(b), the 85 
percent test is applied separately to each such contract.
    Q-6: Is a loan from a qualified plan or contract described in 
section 72(e)(7) treated as a distribution under section 72(e)(4)(A)?
    A-6: Yes. Pursuant to section 72(e)(4)(A), if an employee receives, 
either directly or indirectly, any amount as a loan from a qualified 
plan or contract described in section 72(e)(7), such amount shall be 
treated as a distribution from the plan or contract of an amount not 
received as an annuity. Similarly, if an employee assigns or pledges, or 
agrees to assign or pledge, any portion of the value of any qualified 
plan or contract, such portion shall be treated as a distribution from 
the plan or contract of an amount not received as an annuity.
    Q-7: Does the five percent penalty for premature distributions from 
annuity contracts, as described in section 72(q), apply to distributions 
from a qualified plan or contract described in section 72(e)(7)?
    A-7: No.
    Q-8: When is section 72(e)(7) effective?
    A-8: Section 72(e)(7) is effective for amounts received or loans 
made on or after October 17, 1984. For purposes of this effective date 
provision, loan amounts outstanding on October 16, 1984, which are 
renegotiated, extended, renewed, or revised after that date generally 
are treated as loans made on the date of the renegotiation, etc.

[T.D. 8073, 51 FR 4314, Feb. 4, 1986; 51 FR 7262, Mar. 3, 1986]



Sec. 1.72(p)-1  Loans treated as distributions.

    The questions and answers in this section provide guidance under 
section 72(p) pertaining to loans from qualified employer plans 
(including government plans and tax-sheltered annuities and employer 
plans that were formerly qualified). The examples included in

[[Page 291]]

the questions and answers in this section are based on the assumption 
that a bona fide loan is made to a participant from a qualified defined 
contribution plan pursuant to an enforceable agreement (in accordance 
with paragraph (b) of Q&A-3 of this section), with adequate security and 
with an interest rate and repayment terms that are commercially 
reasonable. (The particular interest rate used, which is solely for 
illustration, is 8.75 percent compounded annually.) In addition, unless 
the contrary is specified, it is assumed in the examples that the amount 
of the loan does not exceed 50 percent of the participant's 
nonforfeitable account balance, the participant has no other outstanding 
loan (and had no prior loan) from the plan or any other plan maintained 
by the participant's employer or any other person required to be 
aggregated with the employer under section 414(b), (c) or (m), and the 
loan is not excluded from section 72(p) as a loan made in the ordinary 
course of an investment program as described in Q&A-18 of this section. 
The regulations and examples in this section do not provide guidance on 
whether a loan from a plan would result in a prohibited transaction 
under section 4975 of the Internal Revenue Code or on whether a loan 
from a plan covered by Title I of the Employee Retirement Income 
Security Act of 1974 (88 Stat. 829) (ERISA) would be consistent with the 
fiduciary standards of ERISA or would result in a prohibited transaction 
under section 406 of ERISA. The questions and answers are as follows:
    Q-1: In general, what does section 72(p) provide with respect to 
loans from a qualified employer plan?
    A-1: (a) Loans. Under section 72(p), an amount received by a 
participant or beneficiary as a loan from a qualified employer plan is 
treated as having been received as a distribution from the plan (a 
deemed distribution), unless the loan satisfies the requirements of Q&A-
3 of this section. For purposes of section 72(p) and this section, a 
loan made from a contract that has been purchased under a qualified 
employer plan (including a contract that has been distributed to the 
participant or beneficiary) is considered a loan made under a qualified 
employer plan.
    (b) Pledges and assignments. Under section 72(p), if a participant 
or beneficiary assigns or pledges (or agrees to assign or pledge) any 
portion of his or her interest in a qualified employer plan as security 
for a loan, the portion of the individual's interest assigned or pledged 
(or subject to an agreement to assign or pledge) is treated as a loan 
from the plan to the individual, with the result that such portion is 
subject to the deemed distribution rule described in paragraph (a) of 
this Q&A-1. For purposes of section 72(p) and this section, any 
assignment or pledge of (or agreement to assign or to pledge) any 
portion of a participant's or beneficiary's interest in a contract that 
has been purchased under a qualified employer plan (including a contract 
that has been distributed to the participant or beneficiary) is 
considered an assignment or pledge of (or agreement to assign or pledge) 
an interest in a qualified employer plan. However, if all or a portion 
of a participant's or beneficiary's interest in a qualified employer 
plan is pledged or assigned as security for a loan from the plan to the 
participant or the beneficiary, only the amount of the loan received by 
the participant or the beneficiary, not the amount pledged or assigned, 
is treated as a loan.
    Q-2: What is a qualified employer plan for purposes of section 
72(p)?
    A-2: For purposes of section 72(p) and this section, a qualified 
employer plan means--
    (a) A plan described in section 401(a) which includes a trust exempt 
from tax under section 501(a);
    (b) An annuity plan described in section 403(a);
    (c) A plan under which amounts are contributed by an individual's 
employer for an annuity contract described in section 403(b);
    (d) Any plan, whether or not qualified, established and maintained 
for its employees by the United States, by a State or political 
subdivision thereof, or by an agency or instrumentality of the United 
States, a State or a political subdivision of a State; or

[[Page 292]]

    (e) Any plan which was (or was determined to be) described in 
paragraph (a), (b), (c), or (d) of this Q&A-2.
    Q-3: What requirements must be satisfied in order for a loan to a 
participant or beneficiary from a qualified employer plan not to be a 
deemed distribution?
    A-3: (a) In general. A loan to a participant or beneficiary from a 
qualified employer plan will not be a deemed distribution to the 
participant or beneficiary if the loan satisfies the repayment term 
requirement of section 72(p)(2)(B), the level amortization requirement 
of section 72(p)(2)(C), and the enforceable agreement requirement of 
paragraph (b) of this Q&A-3, but only to the extent the loan satisfies 
the amount limitations of section 72(p)(2)(A).
    (b) Enforceable agreement requirement. A loan does not satisfy the 
requirements of this paragraph unless the loan is evidenced by a legally 
enforceable agreement (which may include more than one document) and the 
terms of the agreement demonstrate compliance with the requirements of 
section 72(p)(2) and this section. Thus, the agreement must specify the 
amount and date of the loan and the repayment schedule. The agreement 
does not have to be signed if the agreement is enforceable under 
applicable law without being signed. The agreement must be set forth 
either--
    (1) In a written paper document;
    (2) In an electronic medium that is reasonably accessible to the 
participant or the beneficiary and that is provided under a system that 
satisfies the following requirements:
    (i) The system must be reasonably designed to preclude any 
individual other than the participant or the beneficiary from requesting 
a loan.
    (ii) The system must provide the participant or the beneficiary with 
a reasonable opportunity to review and to confirm, modify, or rescind 
the terms of the loan before the loan is made.
    (iii) The system must provide the participant or the beneficiary, 
within a reasonable time after the loan is made, a confirmation of the 
loan terms either through a written paper document or through an 
electronic medium that is reasonably accessible to the participant or 
the beneficiary and that is provided under a system that is reasonably 
designed to provide the confirmation in a manner no less understandable 
to the participant or beneficiary than a written document and, under 
which, at the time the confirmation is provided, the participant or the 
beneficiary is advised that he or she may request and receive a written 
paper document at no charge, and, upon request, that document is 
provided to the participant or beneficiary at no charge; or
    (3) In such other form as may be approved by the Commissioner.
    Q-4: If a loan from a qualified employer plan to a participant or 
beneficiary fails to satisfy the requirements of Q&A-3 of this section, 
when does a deemed distribution occur?
    A-4: (a) Deemed distribution. For purposes of section 72, a deemed 
distribution occurs at the first time that the requirements of Q&A-3 of 
this section are not satisfied, in form or in operation. This may occur 
at the time the loan is made or at a later date. If the terms of the 
loan do not require repayments that satisfy the repayment term 
requirement of section 72(p)(2)(B) or the level amortization requirement 
of section 72(p)(2)(C), or the loan is not evidenced by an enforceable 
agreement satisfying the requirements of paragraph (b) of Q&A-3 of this 
section, the entire amount of the loan is a deemed distribution under 
section 72(p) at the time the loan is made. If the loan satisfies the 
requirements of Q&A-3 of this section except that the amount loaned 
exceeds the limitations of section 72(p)(2)(A), the amount of the loan 
in excess of the applicable limitation is a deemed distribution under 
section 72(p) at the time the loan is made. If the loan initially 
satisfies the requirements of section 72(p)(2)(A), (B) and (C) and the 
enforceable agreement requirement of paragraph (b) of Q&A-3 of this 
section, but payments are not made in accordance with the terms 
applicable to the loan, a deemed distribution occurs as a result of the 
failure to make such payments. See Q&A-10 of this section regarding when 
such a deemed distribution occurs and the amount thereof and Q&A-11 of 
this section regarding

[[Page 293]]

the tax treatment of a deemed distribution.
    (b) Examples. The following examples illustrate the rules in 
paragraph (a) of this Q&A-4 and are based upon the assumptions described 
in the introductory text of this section:

    Example 1. (i) A participant has a nonforfeitable account balance of 
$200,000 and receives $70,000 as a loan repayable in level quarterly 
installments over five years.
    (ii) Under section 72(p), the participant has a deemed distribution 
of $20,000 (the excess of $70,000 over $50,000) at the time of the loan, 
because the loan exceeds the $50,000 limit in section 72(p)(2)(A)(i). 
The remaining $50,000 is not a deemed distribution.
    Example 2. (i) A participant with a nonforfeitable account balance 
of $30,000 borrows $20,000 as a loan repayable in level monthly 
installments over five years.
    (ii) Because the amount of the loan is $5,000 more than 50% of the 
participant's nonforfeitable account balance, the participant has a 
deemed distribution of $5,000 at the time of the loan. The remaining 
$15,000 is not a deemed distribution. (Note also that, if the loan is 
secured solely by the participant's account balance, the loan may be a 
prohibited transaction under section 4975 because the loan may not 
satisfy 29 CFR 2550.408b-1(f)(2).)
    Example 3. (i) The nonforfeitable account balance of a participant 
is $100,000 and a $50,000 loan is made to the participant repayable in 
level quarterly installments over seven years. The loan is not eligible 
for the section 72(p)(2)(B)(ii) exception for loans used to acquire 
certain dwelling units.
    (ii) Because the repayment period exceeds the maximum five-year 
period in section 72(p)(2)(B)(i), the participant has a deemed 
distribution of $50,000 at the time the loan is made.
    Example 4. (i) On August 1, 2002, a participant has a nonforfeitable 
account balance of $45,000 and borrows $20,000 from a plan to be repaid 
over five years in level monthly installments due at the end of each 
month. After making monthly payments through July 2003, the participant 
fails to make any of the payments due thereafter.
    (ii) As a result of the failure to satisfy the requirement that the 
loan be repaid in level monthly installments, the participant has a 
deemed distribution. See paragraph (c) of Q&A-10 of this section 
regarding when such a deemed distribution occurs and the amount thereof.

    Q-5: What is a principal residence for purposes of the exception in 
section 72(p)(2)(B)(ii) from the requirement that a loan be repaid in 
five years?
    A-5: Section 72(p)(2)(B)(ii) provides that the requirement in 
section 72(p)(2)(B)(i) that a plan loan be repaid within five years does 
not apply to a loan used to acquire a dwelling unit which will within a 
reasonable time be used as the principal residence of the participant (a 
principal residence plan loan). For this purpose, a principal residence 
has the same meaning as a principal residence under section 121.
    Q-6: In order to satisfy the requirements for a principal residence 
plan loan, is a loan required to be secured by the dwelling unit that 
will within a reasonable time be used as the principal residence of the 
participant?
    A-6: A loan is not required to be secured by the dwelling unit that 
will within a reasonable time be used as the participant's principal 
residence in order to satisfy the requirements for a principal residence 
plan loan.
    Q-7: What tracing rules apply in determining whether a loan 
qualifies as a principal residence plan loan?
    A-7: The tracing rules established under section 163(h)(3)(B) apply 
in determining whether a loan is treated as for the acquisition of a 
principal residence in order to qualify as a principal residence plan 
loan.
    Q-8: Can a refinancing qualify as a principal residence plan loan?
    A-8: (a) Refinancings. In general, no, a refinancing cannot qualify 
as a principal residence plan loan. However, a loan from a qualified 
employer plan used to repay a loan from a third party will qualify as a 
principal residence plan loan if the plan loan qualifies as a principal 
residence plan loan without regard to the loan from the third party.
    (b) Example. The following example illustrates the rules in 
paragraph (a) of this Q&A-8 and is based upon the assumptions described 
in the introductory text of this section:

    Example. (i) On July 1, 2003, a participant requests a $50,000 plan 
loan to be repaid in level monthly installments over 15 years. On August 
1, 2003, the participant acquires a principal residence and pays a 
portion of the purchase price with a $50,000 bank loan. On September 1, 
2003, the plan loans $50,000 to the participant, which the participant 
uses to pay the bank loan.

[[Page 294]]

    (ii) Because the plan loan satisfies the requirements to qualify as 
a principal residence plan loan (taking into account the tracing rules 
of section 163(h)(3)(B)), the plan loan qualifies for the exception in 
section 72(p)(2)(B)(ii).

    Q-9: Does the level amortization requirement of section 72(p)(2)(C) 
apply when a participant is on a leave of absence without pay?
    A-9: (a) Leave of absence. The level amortization requirement of 
section 72(p)(2)(C) does not apply for a period, not longer than one 
year (or such longer period as may apply under section 414(u) and 
paragraph (b) of this Q&A-9), that a participant is on a bona fide leave 
of absence, either without pay from the employer or at a rate of pay 
(after applicable employment tax withholdings) that is less than the 
amount of the installment payments required under the terms of the loan. 
However, the loan (including interest that accrues during the leave of 
absence) must be repaid by the latest permissible term of the loan and 
the amount of the installments due after the leave ends must not be less 
than the amount required under the terms of the original loan.
    (b) Military service. In accordance with section 414(u)(4), if a 
plan suspends the obligation to repay a loan made to an employee from 
the plan for any part of a period during which the employee is 
performing service in the uniformed services (as defined in 38 U.S.C. 
chapter 43), whether or not qualified military service, such suspension 
shall not be taken into account for purposes of section 72(p) or this 
section. Thus, if a plan suspends loan repayments for any part of a 
period during which the employee is performing military service 
described in the preceding sentence, such suspension shall not cause the 
loan to be deemed distributed even if the suspension exceeds one year 
and even if the term of the loan is extended. However, the loan will not 
satisfy the repayment term requirement of section 72(p)(2)(B) and the 
level amortization requirement of section 72(p)(2)(C) unless loan 
repayments resume upon the completion of such period of military service 
and the loan is repaid thereafter by amortization in substantially level 
installments over a period that ends not later than the latest 
permissible term of the loan.
    (c) Latest permissible term of a loan. For purposes of this Q&A-9, 
the latest permissible term of a loan is the latest date permitted under 
section 72(p)(2)(B) (i.e., five years from the date of the loan, 
assuming that the replacement loan does not qualify for the exception at 
section 72(p)(2)(B)(ii) for principal residence plan loans) plus any 
additional period of suspension permitted under paragraph (b) of this 
Q&A-9.
    (d) Examples. The following examples illustrate the rules of this 
Q&A-9 and are based upon the assumptions described in the introductory 
text of this section:

    Example 1. (i) On July 1, 2003, a participant with a nonforfeitable 
account balance of $80,000 borrows $40,000 to be repaid in level monthly 
installments of $825 each over 5 years. The loan is not a principal 
residence plan loan. The participant makes 9 monthly payments and 
commences an unpaid leave of absence that lasts for 12 months. The 
participant was not performing military service during this period. 
Thereafter, the participant resumes active employment and resumes making 
repayments on the loan until the loan is repaid. The amount of each 
monthly installment is increased to $1,130 in order to repay the loan by 
June 30, 2008.
    (ii) Because the loan satisfies the requirements of section 
72(p)(2), the participant does not have a deemed distribution. 
Alternatively, section 72(p)(2) would be satisfied if the participant 
continued the monthly installments of $825 after resuming active 
employment and on June 30, 2008 repaid the full balance remaining due.
    Example 2. (i) The facts are the same as in Example 1, except the 
participant was on leave of absence performing service in the uniformed 
services (as defined in chapter 43 of title 38, United States Code) for 
two years and the rate of interest charged during this period of 
military service is reduced to 6 percent compounded annually under 50 
App. section 526 (relating to the Soldiers' and Sailors' Civil Relief 
Act Amendments of 1942). After the military service ends on April 2, 
2006, the participant resumes active employment on April 19, 2006, 
continues the monthly installments of $825 thereafter, and on June 30, 
2010, repays the full balance remaining due ($6,487).
    (ii) Because the loan satisfies the requirements of section 72(p)(2) 
and paragraph (b) of this Q&A-9, the participant does not have a deemed 
distribution. Alternatively, section 72(p)(2) would also be satisfied if 
the amount of each monthly installment after April 19, 2006, is 
increased to $930 in order to repay the

[[Page 295]]

loan by June 30, 2010 (without any balance remaining due then).

    Q-10: If a participant fails to make the installment payments 
required under the terms of a loan that satisfied the requirements of 
Q&A-3 of this section when made, when does a deemed distribution occur 
and what is the amount of the deemed distribution?
    A-10: (a) Timing of deemed distribution. Failure to make any 
installment payment when due in accordance with the terms of the loan 
violates section 72(p)(2)(C) and, accordingly, results in a deemed 
distribution at the time of such failure. However, the plan 
administrator may allow a cure period and section 72(p)(2)(C) will not 
be considered to have been violated if the installment payment is made 
not later than the end of the cure period, which period cannot continue 
beyond the last day of the calendar quarter following the calendar 
quarter in which the required installment payment was due.
    (b) Amount of deemed distribution. If a loan satisfies Q&A-3 of this 
section when made, but there is a failure to pay the installment 
payments required under the terms of the loan (taking into account any 
cure period allowed under paragraph (a) of this Q&A-10), then the amount 
of the deemed distribution equals the entire outstanding balance of the 
loan (including accrued interest) at the time of such failure.
    (c) Example. The following example illustrates the rules in 
paragraphs (a) and (b) of this Q&A-10 and is based upon the assumptions 
described in the introductory text of this section:

    Example. (i) On August 1, 2002, a participant has a nonforfeitable 
account balance of $45,000 and borrows $20,000 from a plan to be repaid 
over 5 years in level monthly installments due at the end of each month. 
After making all monthly payments due through July 31, 2003, the 
participant fails to make the payment due on August 31, 2003 or any 
other monthly payments due thereafter. The plan administrator allows a 
three-month cure period.
    (ii) As a result of the failure to satisfy the requirement that the 
loan be repaid in level installments pursuant to section 72(p)(2)(C), 
the participant has a deemed distribution on November 30, 2003, which is 
the last day of the three-month cure period for the August 31, 2003 
installment. The amount of the deemed distribution is $17,157, which is 
the outstanding balance on the loan at November 30, 2003. Alternatively, 
if the plan administrator had allowed a cure period through the end of 
the next calendar quarter, there would be a deemed distribution on 
December 31, 2003 equal to $17,282, which is the outstanding balance of 
the loan at December 31, 2003.

    Q-11: Does section 72 apply to a deemed distribution as if it were 
an actual distribution?
    A-11: (a) Tax basis. If the employee's account includes after-tax 
contributions or other investment in the contract under section 72(e), 
section 72 applies to a deemed distribution as if it were an actual 
distribution, with the result that all or a portion of the deemed 
distribution may not be taxable.
    (b) Section 72(t) and (m). Section 72(t) (which imposes a 10 percent 
tax on certain early distributions) and section 72(m)(5) (which imposes 
a separate 10 percent tax on certain amounts received by a 5-percent 
owner) apply to a deemed distribution under section 72(p) in the same 
manner as if the deemed distribution were an actual distribution.
    Q-12: Is a deemed distribution under section 72(p) treated as an 
actual distribution for purposes of the qualification requirements of 
section 401, the distribution provisions of section 402, the 
distribution restrictions of section 401(k)(2)(B) or 403(b)(11), or the 
vesting requirements of Sec. 1.411(a)-7(d)(5) (which affects the 
application of a graded vesting schedule in cases involving a prior 
distribution)?
    A-12: No; thus, for example, if a participant in a money purchase 
plan who is an active employee has a deemed distribution under section 
72(p), the plan will not be considered to have made an in-service 
distribution to the participant in violation of the qualification 
requirements applicable to money purchase plans. Similarly, the deemed 
distribution is not eligible to be rolled over to an eligible retirement 
plan and is not considered an impermissible distribution of an amount 
attributable to elective contributions in a section 401(k) plan. See 
also Sec. 1.402(c)-2, Q&A-4(d) and Sec. 1.401(k)-1(d)(5)(iii).
    Q-13: How does a reduction (offset) of an account balance in order 
to repay a plan loan differ from a deemed distribution?

[[Page 296]]

    A-13: (a) Difference between deemed distribution and plan loan 
offset amount. (1) Loans to a participant from a qualified employer plan 
can give rise to two types of taxable distributions--
    (i) A deemed distribution pursuant to section 72(p); and
    (ii) A distribution of an offset amount.
    (2) As described in Q&A-4 of this section, a deemed distribution 
occurs when the requirements of Q&A-3 of this section are not satisfied, 
either when the loan is made or at a later time. A deemed distribution 
is treated as a distribution to the participant or beneficiary only for 
certain tax purposes and is not a distribution of the accrued benefit. A 
distribution of a plan loan offset amount (as defined in Sec. 1.402(c)-
2, Q&A-9(b)) occurs when, under the terms governing a plan loan, the 
accrued benefit of the participant or beneficiary is reduced (offset) in 
order to repay the loan (including the enforcement of the plan's 
security interest in the accrued benefit). A distribution of a plan loan 
offset amount could occur in a variety of circumstances, such as where 
the terms governing the plan loan require that, in the event of the 
participant's request for a distribution, a loan be repaid immediately 
or treated as in default.
    (b) Plan loan offset. In the event of a plan loan offset, the amount 
of the account balance that is offset against the loan is an actual 
distribution for purposes of the Internal Revenue Code, not a deemed 
distribution under section 72(p). Accordingly, a plan may be prohibited 
from making such an offset under the provisions of section 401(a), 
401(k)(2)(B) or 403(b)(11) prohibiting or limiting distributions to an 
active employee. See Sec. 1.402(c)-2, Q&A-9(c), Example 6. See also 
Q&A-19 of this section for rules regarding the treatment of a loan after 
a deemed distribution.
    Q-14: How is the amount includible in income as a result of a deemed 
distribution under section 72(p) required to be reported?
    A-14: The amount includible in income as a result of a deemed 
distribution under section 72(p) is required to be reported on Form 
1099-R (or any other form prescribed by the Commissioner).
    Q-15: What withholding rules apply to plan loans?
    A-15: To the extent that a loan, when made, is a deemed distribution 
or an account balance is reduced (offset) to repay a loan, the amount 
includible in income is subject to withholding. If a deemed distribution 
of a loan or a loan repayment by benefit offset results in income at a 
date after the date the loan is made, withholding is required only if a 
transfer of cash or property (excluding employer securities) is made to 
the participant or beneficiary from the plan at the same time. See 
Sec. Sec. 35.3405-1, f-4, and 31.3405(c)-1, Q&A-9 and Q&A-11, of this 
chapter for further guidance on withholding rules.
    Q-16: If a loan fails to satisfy the requirements of Q&A-3 of this 
section and is a prohibited transaction under section 4975, is the 
deemed distribution of the loan under section 72(p) a correction of the 
prohibited transaction?
    A-16: No, a deemed distribution is not a correction of a prohibited 
transaction under section 4975. See Sec. Sec. 141.4975-13 and 
53.4941(e)-1(c)(1) of this chapter for guidance concerning correction of 
a prohibited transaction.
    Q-17: What are the income tax consequences if an amount is 
transferred from a qualified employer plan to a participant or 
beneficiary as a loan, but there is an express or tacit understanding 
that the loan will not be repaid?
    A-17: If there is an express or tacit understanding that the loan 
will not be repaid or, for any reason, the transaction does not create a 
debtor-creditor relationship or is otherwise not a bona fide loan, then 
the amount transferred is treated as an actual distribution from the 
plan for purposes of the Internal Revenue Code, and is not treated as a 
loan or as a deemed distribution under section 72(p).
    Q-18: If a qualified employer plan maintains a program to invest in 
residential mortgages, are loans made pursuant to the investment program 
subject to section 72(p)?
    A-18: (a) Residential mortgage loans made by a plan in the ordinary 
course

[[Page 297]]

of an investment program are not subject to section 72(p) if the 
property acquired with the loans is the primary security for such loans 
and the amount loaned does not exceed the fair market value of the 
property. An investment program exists only if the plan has established, 
in advance of a specific investment under the program, that a certain 
percentage or amount of plan assets will be invested in residential 
mortgages available to persons purchasing the property who satisfy 
commercially customary financial criteria. A loan will not be considered 
as made under an investment program if--
    (1) Any of the loans made under the program matures upon a 
participant's termination from employment;
    (2) Any of the loans made under the program is an earmarked asset of 
a participant's or beneficiary's individual account in the plan; or
    (3) The loans made under the program are made available only to 
participants or beneficiaries in the plan.
    (b) Paragraph (a)(3) of this Q&A-18 shall not apply to a plan which, 
on December 20, 1995, and at all times thereafter, has had in effect a 
loan program under which, but for paragraph (a)(3) of this Q&A-18, the 
loans comply with the conditions of paragraph (a) of this Q&A-18 to 
constitute residential mortgage loans in the ordinary course of an 
investment program.
    (c) No loan that benefits an officer, director, or owner of the 
employer maintaining the plan, or their beneficiaries, will be treated 
as made under an investment program.
    (d) This section does not provide guidance on whether a residential 
mortgage loan made under a plan's investment program would result in a 
prohibited transaction under section 4975, or on whether such a loan 
made by a plan covered by Title I of ERISA would be consistent with the 
fiduciary standards of ERISA or would result in a prohibited transaction 
under section 406 of ERISA. See 29 CFR 2550.408b-1.
    Q-19: If there is a deemed distribution under section 72(p), is the 
interest that accrues thereafter on the amount of the deemed 
distribution an indirect loan for income tax purposes and what effect 
does the deemed distribution have on subsequent loans?
    A-19: (a) General rule. Except as provided in paragraph (b) of this 
Q&A-19, a deemed distribution of a loan is treated as a distribution for 
purposes of section 72. Therefore, a loan that is deemed to be 
distributed under section 72(p) ceases to be an outstanding loan for 
purposes of section 72, and the interest that accrues thereafter under 
the plan on the amount deemed distributed is disregarded for purposes of 
applying section 72 to the participant or the beneficiary. Even though 
interest continues to accrue on the outstanding loan (and is taken into 
account for purposes of determining the tax treatment of any subsequent 
loan in accordance with paragraph (b) of this Q&A-19), this additional 
interest is not treated as an additional loan (and thus, does not result 
in an additional deemed distribution) for purposes of section 72(p). 
However, a loan that is deemed distributed under section 72(p) is not 
considered distributed for all purposes of the Internal Revenue Code. 
See Q&A-11 through Q&A-16 of this section.
    (b) Effect on subsequent loans--(1) Application of section 
72(p)(2)(A). A loan that is deemed distributed under section 72(p) 
(including interest accruing thereafter) and that has not been repaid 
(such as by a plan loan offset) is considered outstanding for purposes 
of applying section 72(p)(2)(A) to determine the maximum amount of any 
subsequent loan to the participant or beneficiary.
    (2) Additional security for subsequent loans. If a loan is deemed 
distributed to a participant or beneficiary under section 72(p) and has 
not been repaid (such as by a plan loan offset), then no payment made 
thereafter to the participant or beneficiary is treated as a loan for 
purposes of section 72(p)(2) unless the loan otherwise satisfies section 
72(p)(2) and this section and either of the following conditions is 
satisfied:
    (i) There is an arrangement among the plan, the participant or 
beneficiary, and the employer, enforceable under applicable law, under 
which repayments will be made by payroll withholding. For this purpose, 
an arrangement will not fail to be enforceable merely because a party 
has the right to revoke the arrangement prospectively.

[[Page 298]]

    (ii) The plan receives adequate security from the participant or 
beneficiary that is in addition to the participant's or beneficiary's 
accrued benefit under the plan.
    (3) Condition no longer satisfied. If, following a deemed 
distribution that has not been repaid, a payment is made to a 
participant or beneficiary that satisfies the conditions in paragraph 
(b)(2) of this Q&A-19 for treatment as a plan loan and, subsequently, 
before repayment of the second loan, the conditions in paragraph (b)(2) 
of this Q&A-19 are no longer satisfied with respect to the second loan 
(for example, if the loan recipient revokes consent to payroll 
withholding), the amount then outstanding on the second loan is treated 
as a deemed distribution under section 72(p).
    Q-20: May a participant refinance an outstanding loan or have more 
than one loan outstanding from a plan?
    A-20: (a) Refinancings and multiple loans--(1) General rule. A 
participant who has an outstanding loan that satisfies section 72(p)(2) 
and this section may refinance that loan or borrow additional amounts 
if, under the facts and circumstances, the loans collectively satisfy 
the amount limitations of section 72(p)(2)(A) and the prior loan and the 
additional loan each satisfy the requirements of section 72(p)(2)(B) and 
(C) and this section. For this purpose, a refinancing includes any 
situation in which one loan replaces another loan.
    (2) Loans that repay a prior loan and have a later repayment date. 
For purposes of section 72(p)(2) and this section (including the amount 
limitations of section 72(p)(2)(A)), if a loan that satisfies section 
72(p)(2) is replaced by a loan (a replacement loan) and the term of the 
replacement loan ends after the latest permissible term of the loan it 
replaces (the replaced loan), then the replacement loan and the replaced 
loan are both treated as outstanding on the date of the transaction. For 
purposes of the preceding sentence, the latest permissible term of the 
replaced loan is the latest date permitted under section 72(p)(2)(C) 
(i.e., five years from the original date of the replaced loan, assuming 
that the replaced loan does not qualify for the exception at section 
72(p)(2)(B)(ii) for principal residence plan loans and that no 
additional period of suspension applied to the replaced loan under Q&A-9 
(b) of this section). Thus, for example, if the term of the replacement 
loan ends after the latest permissible term of the replaced loan and the 
sum of the amount of the replacement loan plus the outstanding balance 
of all other loans on the date of the transaction, including the 
replaced loan, fails to satisfy the amount limitations of section 
72(p)(2)(A), then the replacement loan results in a deemed distribution. 
This paragraph (a)(2) does not apply to a replacement loan if the terms 
of the replacement loan would satisfy section 72(p)(2) and this section 
determined as if the replacement loan consisted of two separate loans, 
the replaced loan (amortized in substantially level payments over a 
period ending not later than the last day of the latest permissible term 
of the replaced loan) and, to the extent the amount of the replacement 
loan exceeds the amount of the replaced loan, a new loan that is also 
amortized in substantially level payments over a period ending not later 
than the last day of the latest permissible term of the replacement 
loan.
    (b) Examples. The following examples illustrate the rules of this 
Q&A-20 and are based on the assumptions described in the introductory 
text of this section:

    Example 1. (i) A participant with a vested account balance that 
exceeds $100,000 borrows $40,000 from a plan on January 1, 2005, to be 
repaid in 20 quarterly installments of $2,491 each. Thus, the term of 
the loan ends on December 31, 2009. On January 1, 2006, when the 
outstanding balance on the loan is $33,322, the loan is refinanced and 
is replaced by a new $40,000 loan from the plan to be repaid in 20 
quarterly installments. Under the terms of the refinanced loan, the loan 
is to be repaid in level quarterly installments (of $2,491 each) over 
the next 20 quarters. Thus, the term of the new loan ends on December 
31, 2010.
    (ii) Under section 72(p)(2)(A), the amount of the new loan, when 
added to the outstanding balance of all other loans from the plan, must 
not exceed $50,000 reduced by the excess of the highest outstanding 
balance of loans from the plan during the 1-year period ending on 
December 31, 2005, over the outstanding balance of loans from the plan 
on January 1, 2006, with such outstanding balance to be determined 
immediately prior to the new $40,000 loan. Because the term of the

[[Page 299]]

new loan ends later than the term of the loan it replaces, under 
paragraph (a)(2) of this Q&A-20, both the new loan and the loan it 
replaces must be taken into account for purposes of applying section 
72(p)(2), including the amount limitations in section 72(p)(2)(A). The 
amount of the new loan is $40,000, the outstanding balance on January 1, 
2006, of the loan it replaces is $33,322, and the highest outstanding 
balance of loans from the plan during 2005 was $40,000. Accordingly, 
under section 72(p)(2)(A), the sum of the new loan and the outstanding 
balance on January 1, 2006, of the loan it replaces must not exceed 
$50,000 reduced by $6,678 (the excess of the $40,000 maximum outstanding 
loan balance during 2005 over the $33,322 outstanding balance on January 
1, 2006, determined immediately prior to the new loan) and, thus, must 
not exceed $43,322. The sum of the new loan ($40,000) and the 
outstanding balance on January 1, 2006, of the loan it replaces 
($33,322) is $73,322. Since $73,322 exceeds the $43,322 limit under 
section 72(p)(2)(A) by $30,000, there is a deemed distribution of 
$30,000 on January 1, 2006.
    (iii) However, no deemed distribution would occur if, under the 
terms of the refinanced loan, the amount of the first 16 installments on 
the refinanced loan were equal to $2,907, which is the sum of the $2,491 
originally scheduled quarterly installment payment amount under the 
first loan, plus $416 (which is the amount required to repay, in level 
quarterly installments over 5 years beginning on January 1, 2006, the 
excess of the refinanced loan over the January 1, 2006, balance of the 
first loan ($40,000 minus $33,322 equals $6,678)), and the amount of the 
4 remaining installments was equal to $416. The refinancing would not be 
subject to paragraph (a)(2) of this Q&A-20 because the terms of the new 
loan would satisfy section 72(p)(2) and this section (including the 
substantially level amortization requirements of section 72(p)(2)(B) and 
(C)) determined as if the new loan consisted of 2 loans, one of which is 
in the amount of the first loan ($33,322) and is amortized in 
substantially level payments over a period ending December 31, 2009 (the 
last day of the term of the first loan) and the other of which is in the 
additional amount ($6,678) borrowed under the new loan. Similarly, the 
transaction also would not result in a deemed distribution (and would 
not be subject to paragraph (a)(2) of this Q&A-20) if the terms of the 
refinanced loan provided for repayments to be made in level quarterly 
installments (of $2,990 each) over the next 16 quarters.
    Example 2. (i) The facts are the same as in Example 1(i), except 
that the applicable interest rate used by the plan when the loan is 
refinanced is significantly lower due to a reduction in market rates of 
interest and, under the terms of the refinanced loan, the amount of the 
first 16 installments on the refinanced loan is equal to $2,848 and the 
amount of the next 4 installments on the refinanced loan is equal to 
$406. The $2,848 amount is the sum of $2,442 to repay the first loan by 
December 31, 2009 (the term of the first loan), plus $406 (which is the 
amount to repay, in level quarterly installments over 5 years beginning 
on January 1, 2006, the $6,678 excess of the refinanced loan over the 
January 1, 2006, balance of the first loan).
    (ii) The transaction does not result in a deemed distribution (and 
is not subject to paragraph (a)(2) of this Q&A-20) because the terms of 
the new loan would satisfy section 72(p)(2) and this section (including 
the substantially level amortization requirements of section 72(p)(2)(B) 
and (C)) determined as if the new loan consisted of 2 loans, one of 
which is in the amount of the first loan ($33,322) and is amortized in 
substantially level payments over a period ending December 31, 2009 (the 
last day of the term of the first loan), and the other of which is in 
the additional amount ($6,678) borrowed under the new loan. The 
transaction would also not result in a deemed distribution (and not be 
subject to paragraph (a)(2) of this Q&A-20) if the terms of the new loan 
provided for repayments to be made in level quarterly installments (of 
$2,931 each) over the next 16 quarters.

    Q-21: Is a participant's tax basis under the plan increased if the 
participant repays the loan after a deemed distribution?
    A-21: (a) Repayments after deemed distribution. Yes, if the 
participant or beneficiary repays the loan after a deemed distribution 
of the loan under section 72(p), then, for purposes of section 72(e), 
the participant's or beneficiary's investment in the contract (tax 
basis) under the plan increases by the amount of the cash repayments 
that the participant or beneficiary makes on the loan after the deemed 
distribution. However, loan repayments are not treated as after-tax 
contributions for other purposes, including sections 401(m) and 
415(c)(2)(B).
    (b) Example. The following example illustrates the rules in 
paragraph (a) of this Q&A-21 and is based on the assumptions described 
in the introductory text of this section:

    Example. (i) A participant receives a $20,000 loan on January 1, 
2003, to be repaid in 20 quarterly installments of $1,245 each. On 
December 31, 2003, the outstanding loan balance ($19,179) is deemed 
distributed as a result of a failure to make quarterly installment 
payments that were due on September 30, 2003 and December 31, 2003. On 
June 30, 2004, the

[[Page 300]]

participant repays $5,147 (which is the sum of the three installment 
payments that were due on September 30, 2003, December 31, 2003, and 
March 31, 2004, with interest thereon to June 30, 2004, plus the 
installment payment due on June 30, 2004). Thereafter, the participant 
resumes making the installment payments of $1,245 from September 30, 
2004 through December 31, 2007. The loan repayments made after December 
31, 2003 through December 31, 2007 total $22,577.
    (ii) Because the participant repaid $22,577 after the deemed 
distribution that occurred on December 31, 2003, the participant has 
investment in the contract (tax basis) equal to $22,577 (14 payments of 
$1,245 each plus a single payment of $5,147) as of December 31, 2007.

    Q-22: When is the effective date of section 72(p) and the 
regulations in this section?
    A-22: (a) Statutory effective date. Section 72(p) generally applies 
to assignments, pledges, and loans made after August 13, 1982.
    (b) Regulatory effective date. This section applies to assignments, 
pledges, and loans made on or after January 1, 2002.
    (c) Loans made before the regulatory effective date--(1) General 
rule. A plan is permitted to apply Q&A-19 and Q&A-21 of this section to 
a loan made before the regulatory effective date in paragraph (b) of 
this Q&A-22 (and after the statutory effective date in paragraph (a) of 
this Q&A-22) if there has not been any deemed distribution of the loan 
before the transition date or if the conditions of paragraph (c)(2) of 
this Q&A-22 are satisfied with respect to the loan.
    (2) Consistency transition rule for certain loans deemed distributed 
before the regulatory effective date. (i) The rules in this paragraph 
(c)(2) of this Q&A-22 apply to a loan made before the regulatory 
effective date in paragraph (b) of this Q&A-22 (and after the statutory 
effective date in paragraph (a) of this Q&A-22) if there has been any 
deemed distribution of the loan before the transition date.
    (ii) The plan is permitted to apply Q&A-19 and Q&A-21 of this 
section to the loan beginning on any January 1, but only if the plan 
reported, in Box 1 of Form 1099-R, for a taxable year no later than the 
latest taxable year that would be permitted under this section (if this 
section had been in effect for all loans made after the statutory 
effective date in paragraph (a) of this Q&A-22), a gross distribution of 
an amount at least equal to the initial default amount. For purposes of 
this section, the initial default amount is the amount that would be 
reported as a gross distribution under Q&A-4 and Q&A-10 of this section 
and the transition date is the January 1 on which a plan begins applying 
Q&A-19 and Q&A-21 of this section to a loan.
    (iii) If a plan applies Q&A-19 and Q&A-21 of this section to such a 
loan, then the plan, in its reporting and withholding on or after the 
transition date, must not attribute investment in the contract (tax 
basis) to the participant or beneficiary based upon the initial default 
amount.
    (iv) This paragraph (c)(2)(iv) of this Q&A-22 applies if--
    (A) The plan attributed investment in the contract (tax basis) to 
the participant or beneficiary based on the deemed distribution of the 
loan;
    (B) The plan subsequently made an actual distribution to the 
participant or beneficiary before the transition date; and
    (C) Immediately before the transition date, the initial default 
amount (or, if less, the amount of the investment in the contract so 
attributed) exceeds the participant's or beneficiary's investment in the 
contract (tax basis). If this paragraph (c)(2)(iv) of this Q&A-22 
applies, the plan must treat the excess (the loan transition amount) as 
a loan amount that remains outstanding and must include the excess in 
the participant's or beneficiary's income at the time of the first 
actual distribution made on or after the transition date.
    (3) Examples. The rules in paragraph (c)(2) of this Q&A-22 are 
illustrated by the following examples, which are based on the 
assumptions described in the introductory text of this section (and, 
except as specifically provided in the examples, also assume that no 
distributions are made to the participant and that the participant has 
no investment in the contract with respect to the plan). Example 1, 
Example 2, and Example 4 of this paragraph (c)(3) of this Q&A-22 
illustrate the application of the rules in paragraph (c)(2) of this

[[Page 301]]

Q&A-22 to a plan that, before the transition date, did not treat 
interest accruing after the initial deemed distribution as resulting in 
additional deemed distributions under section 72(p). Example 3 of this 
paragraph (c)(3) of this Q&A-22 illustrates the application of the rules 
in paragraph (c)(2) of this Q&A-22 to a plan that, before the transition 
date, treated interest accruing after the initial deemed distribution as 
resulting in additional deemed distributions under section 72(p). The 
examples are as follows:

    Example 1. (i) In 1998, when a participant's account balance under a 
plan is $50,000, the participant receives a loan from the plan. The 
participant makes the required repayments until 1999 when there is a 
deemed distribution of $20,000 as a result of a failure to repay the 
loan. For 1999, as a result of the deemed distribution, the plan 
reports, in Box 1 of Form 1099-R, a gross distribution of $20,000 (which 
is the initial default amount in accordance with paragraph (c)(2)(ii) of 
this Q&A-22) and, in Box 2 of Form 1099-R, a taxable amount of $20,000. 
The plan then records an increase in the participant's tax basis for the 
same amount ($20,000). Thereafter, the plan disregards, for purposes of 
section 72, the interest that accrues on the loan after the 1999 deemed 
distribution. Thus, as of December 31, 2001, the total taxable amount 
reported by the plan as a result of the deemed distribution is $20,000 
and the plan's records show that the participant's tax basis is the same 
amount ($20,000). As of January 1, 2002, the plan decides to apply Q&A-
19 of this section to the loan. Accordingly, it reduces the 
participant's tax basis by the initial default amount of $20,000, so 
that the participant's remaining tax basis in the plan is zero. 
Thereafter, the amount of the outstanding loan is not treated as part of 
the account balance for purposes of section 72. The participant attains 
age 59\1/2\ in the year 2003 and receives a distribution of the full 
account balance under the plan consisting of $60,000 in cash and the 
loan receivable. At that time, the plan's records reflect an offset of 
the loan amount against the loan receivable in the participant's account 
and a distribution of $60,000 in cash.
    (ii) For the year 2003, the plan must report a gross distribution of 
$60,000 in Box 1 of Form 1099-R and a taxable amount of $60,000 in Box 2 
of Form 1099-R.
    Example 2. (i) The facts are the same as in Example 1, except that 
in 1999, immediately prior to the deemed distribution, the participant's 
account balance under the plan totals $50,000 and the participant's tax 
basis is $10,000. For 1999, the plan reports, in Box 1 of Form 1099-R, a 
gross distribution of $20,000 (which is the initial default amount in 
accordance with paragraph (c)(2)(ii) of this Q&A-22) and reports, in Box 
2 of Form 1099-R, a taxable amount of $16,000 (the $20,000 deemed 
distribution minus $4,000 of tax basis ($10,000 times ($20,000/$50,000)) 
allocated to the deemed distribution). The plan then records an increase 
in tax basis equal to the $20,000 deemed distribution, so that the 
participant's remaining tax basis as of December 31, 1999, totals 
$26,000 ($10,000 minus $4,000 plus $20,000). Thereafter, the plan 
disregards, for purposes of section 72, the interest that accrues on the 
loan after the 1999 deemed distribution. Thus, as of December 31, 2001, 
the total taxable amount reported by the plan as a result of the deemed 
distribution is $16,000 and the plan's records show that the 
participant's tax basis is $26,000. As of January 1, 2002, the plan 
decides to apply Q&A-19 of this section to the loan. Accordingly, it 
reduces the participant's tax basis by the initial default amount of 
$20,000, so that the participant's remaining tax basis in the plan is 
$6,000. Thereafter, the amount of the outstanding loan is not treated as 
part of the account balance for purposes of section 72. The participant 
attains age 59\1/2\ in the year 2003 and receives a distribution of the 
full account balance under the plan consisting of $60,000 in cash and 
the loan receivable. At that time, the plan's records reflect an offset 
of the loan amount against the loan receivable in the participant's 
account and a distribution of $60,000 in cash.
    (ii) For the year 2003, the plan must report a gross distribution of 
$60,000 in Box 1 of Form 1099-R and a taxable amount of $54,000 in Box 2 
of Form 1099-R.
    Example 3. (i) In 1993, when a participant's account balance in a 
plan is $100,000, the participant receives a loan of $50,000 from the 
plan. The participant makes the required loan repayments until 1995 when 
there is a deemed distribution of $28,919 as a result of a failure to 
repay the loan. For 1995, as a result of the deemed distribution, the 
plan reports, in Box 1 of Form 1099-R, a gross distribution of $28,919 
(which is the initial default amount in accordance with paragraph 
(c)(2)(ii) of this Q&A-22) and, in Box 2 of Form 1099-R, a taxable 
amount of $28,919. For 1995, the plan also records an increase in the 
participant's tax basis for the same amount ($28,919). Each year 
thereafter through 2001, the plan reports a gross distribution equal to 
the interest accruing that year on the loan balance, reports a taxable 
amount equal to the interest accruing that year on the loan balance 
reduced by the participant's tax basis allocated to the gross 
distribution, and records a net increase in the participant's tax basis 
equal to that taxable amount. As of December 31, 2001, the taxable 
amount reported by the plan as a result of the loan totals $44,329 and 
the plan's records for purposes of section

[[Page 302]]

72 show that the participant's tax basis totals the same amount 
($44,329). As of January 1, 2002, the plan decides to apply Q&A-19 of 
this section. Accordingly, it reduces the participant's tax basis by the 
initial default amount of $28,919, so that the participant's remaining 
tax basis in the plan is $15,410 ($44,329 minus $28,919). Thereafter, 
the amount of the outstanding loan is not treated as part of the account 
balance for purposes of section 72. The participant attains age 59\1/2\ 
in the year 2003 and receives a distribution of the full account balance 
under the plan consisting of $180,000 in cash and the loan receivable 
equal to the $28,919 outstanding loan amount in 1995 plus interest 
accrued thereafter to the payment date in 2003. At that time, the plan's 
records reflect an offset of the loan amount against the loan receivable 
in the participant's account and a distribution of $180,000 in cash.
    (ii) For the year 2003, the plan must report a gross distribution of 
$180,000 in Box 1 of Form 1099-R and a taxable amount of $164,590 in Box 
2 of Form 1099-R ($180,000 minus the remaining tax basis of $15,410).
    Example 4. (i) The facts are the same as in Example 1, except that 
in 2000, after the deemed distribution, the participant receives a 
$10,000 hardship distribution. At the time of the hardship distribution, 
the participant's account balance under the plan totals $50,000. For 
2000, the plan reports, in Box 1 of Form 1099-R, a gross distribution of 
$10,000 and, in Box 2 of Form 1099-R, a taxable amount of $6,000 (the 
$10,000 actual distribution minus $4,000 of tax basis ($10,000 times 
($20,000/$50,000)) allocated to this actual distribution). The plan then 
records a decrease in tax basis equal to $4,000, so that the 
participant's remaining tax basis as of December 31, 2000, totals 
$16,000 ($20,000 minus $4,000). After 1999, the plan disregards, for 
purposes of section 72, the interest that accrues on the loan after the 
1999 deemed distribution. Thus, as of December 31, 2001, the total 
taxable amount reported by the plan as a result of the deemed 
distribution plus the 2000 actual distribution is $26,000 and the plan's 
records show that the participant's tax basis is $16,000. As of January 
1, 2002, the plan decides to apply Q&A-19 of this section to the loan. 
Accordingly, it reduces the participant's tax basis by the initial 
default amount of $20,000, so that the participant's remaining tax basis 
in the plan is reduced from $16,000 to zero. However, because the 
$20,000 initial default amount exceeds $16,000, the plan records a loan 
transition amount of $4,000 ($20,000 minus $16,000). Thereafter, the 
amount of the outstanding loan, other than the $4,000 loan transition 
amount, is not treated as part of the account balance for purposes of 
section 72. The participant attains age 59\1/2\ in the year 2003 and 
receives a distribution of the full account balance under the plan 
consisting of $60,000 in cash and the loan receivable. At that time, the 
plan's records reflect an offset of the loan amount against the loan 
receivable in the participant's account and a distribution of $60,000 in 
cash.
    (ii) In accordance with paragraph (c)(2)(iv) of this Q&A-22, the 
plan must report in Box 1 of Form 1099-R a gross distribution of $64,000 
and in Box 2 of Form 1099-R a taxable amount for the participant for the 
year 2003 equal to $64,000 (the sum of the $60,000 paid in the year 2003 
plus $4,000 as the loan transition amount).

    (d) Effective date for Q&A-19(b)(2) and Q&A-20. Q&A-19(b)(2) and 
Q&A-20 of this section apply to assignments, pledges, and loans made on 
or after January 1, 2004.

[T.D. 8894, 65 FR 46591, July 31, 2000, as amended by T.D. 9021, 67 FR 
71824, Dec. 3, 2002; 68 FR 9532, 9535, Feb. 28, 2003; T.D. 9169, 69 FR 
78153, Dec. 29, 2004]



Sec. 1.73-1  Services of child.

    (a) Compensation for personal services of a child shall, regardless 
of the provisions of State law relating to who is entitled to the 
earnings of the child, and regardless of whether the income is in fact 
received by the child, be deemed to be the gross income of the child and 
not the gross income of the parent of the child. Such compensation, 
therefore, shall be included in the gross income of the child and shall 
be reflected in the return rendered by or for such child. The income of 
a minor child is not required to be included in the gross income of the 
parent for income tax purposes. For requirements for making the return 
by such child, or for such child by his guardian, or other person 
charged with the care of his person or property, see section 6012.
    (b) In the determination of taxable income or adjusted gross income, 
as the case may be, all expenditures made by the parent or the child 
attributable to amounts which are includible in the gross income of the 
child and not of the parent solely by reason of section 73 are deemed to 
have been paid or incurred by the child. In such determination, the 
child is entitled to take deductions not only for expenditures made on 
his behalf by his parent which would be commonly considered as business 
expenses, but also for other expenditures such as charitable 
contributions made by the parent in the name

[[Page 303]]

of the child and out of the child's earnings.
    (c) For purposes of section 73, the term ``parent'' includes any 
individual who is entitled to the services of the child by reason of 
having parental rights and duties in respect of the child. See section 
6201(c) and the regulations in Part 301 of this chapter (Procedure and 
Administration) for assessment of tax against the parent in certain 
cases.



Sec. 1.74-1  Prizes and awards.

    (a) Inclusion in gross income. (1) Section 74(a) requires the 
inclusion in gross income of all amounts received as prizes and awards, 
unless such prizes or awards qualify as an exclusion from gross income 
under subsection (b), or unless such prize or award is a scholarship or 
fellowship grant excluded from gross income by section 117. Prizes and 
awards which are includible in gross income include (but are not limited 
to) amounts received from radio and television giveaway shows, door 
prizes, and awards in contests of all types, as well as any prizes and 
awards from an employer to an employee in recognition of some 
achievement in connection with his employment.
    (2) If the prize or award is not made in money but is made in goods 
or services, the fair market value of the goods or services is the 
amount to be included in income.
    (b) Exclusion from gross income. Section 74(b) provides an exclusion 
from gross income of any amount received as a prize or award, if (1) 
such prize or award was made primarily in recognition of past 
achievements of the recipient in religious, charitable, scientific, 
educational, artistic, literary, or civic fields; (2) the recipient was 
selected without any action on his part to enter the contest or 
proceedings; and (3) the recipient is not required to render substantial 
future services as a condition to receiving the prize or award. Thus, 
such awards as the Nobel prize and the Pulitzer prize would qualify for 
the exclusion. Section 74(b) does not exclude prizes or awards from an 
employer to an employee in recognition of some achievement in connection 
with his employment.
    (c) Scholarships and fellowship grants. See section 117 and the 
regulations thereunder for provisions relating to scholarships and 
fellowship grants.



Sec. 1.75-1  Treatment of bond premiums in case of dealers in tax-exempt 
securities.

    (a) In general. (1) Section 75 requires certain adjustments to be 
made by dealers in securities with respect to premiums paid on municipal 
bonds which are held for sale to customers in the ordinary course of the 
trade or business. The adjustments depend upon the method of accounting 
used by the taxpayer in computing the gross income from the trade or 
business. See paragraphs (b) and (c) of this section.
    (2) The term ``municipal bond'' under section 75 means any 
obligation issued by a government or political subdivision thereof if 
the interest on the obligation is excludable from gross income under 
section 103. However, such term does not include an obligation--
    (i) If the earliest maturity or call date of the obligation is more 
than 5 years from the date of acquisition by the taxpayer or the 
obligation is sold or otherwise disposed of by the taxpayer within 30 
days after the date of acquisition by him, and
    (ii) If, in case of an obligation acquired after December 31, 1957, 
the amount realized upon its sale (or, in the case of any other 
disposition, its fair market value at the time of disposition) is higher 
than its adjusted basis.

For purposes of this subparagraph, the amount realized on the sale of 
the obligation, or the fair market value of the obligation, shall not 
include any amount attributable to interest, and the adjusted basis 
shall be computed without regard to any adjustment for amortization of 
bond premium required under section 75 and section 1016(a)(6). For 
purposes of determining whether the obligation is sold or otherwise 
disposed of by the taxpayer within 30 days after the date of its 
acquisition by him, it is immaterial whether or not such 30-day period 
is entirely within one taxable year.
    (3) The term ``cost of securities sold'' means the amount 
ascertained by subtracting the inventory value of the

[[Page 304]]

closing inventory of a taxable year from the sum of the inventory value 
of the opening inventory for such year and the cost of securities and 
other property purchased during such year which would properly be 
included in the inventory of the taxpayer if on hand at the close of the 
taxable year.
    (b) Inventories not valued at cost. (1) In the case of a dealer in 
securities who computes gross income from his trade or business by the 
use of inventories and values such inventories on any basis other than 
cost, the adjustment required by section 75 is, except as provided in 
subparagraph (2) of this paragraph, the reduction of ``cost of 
securities sold'' by the amount equal to the amortizable bond premium 
which would be disallowed as a deduction under section 171(a)(2) with 
respect to the municipal bond if the dealer were an ordinary investor 
holding such bond. Such amortizable bond premium is computed under 
section 171(b) by reference to the cost or other original basis of the 
bond on the date of acquisition (determined without regard to section 
1013, relating to inventory value on a subsequent date).
    (2) With respect to an obligation acquired after December 31, 1957, 
which has as its earliest maturity or call date a date more than five 
years from the date on which it was acquired by the taxpayer, the 
following rules shall apply:
    (i) If the taxpayer holds the obligation at the end of the taxable 
year, he is not required by section 75 to reduce the ``cost of 
securities sold'' for such year with respect to the obligation.
    (ii) If the taxpayer sells or otherwise disposes of the obligation 
during the taxable year, he shall reduce the ``cost of securities sold'' 
for the taxable year of the sale or disposition unless he sold the 
obligation for more than its adjusted basis or otherwise disposed of it 
when its fair market value was more than its adjusted basis. For 
purposes of determining whether or not the taxpayer sold the obligation 
for more than its adjusted basis, or otherwise disposed of it when its 
fair market value was more than its adjusted basis, the amount realized 
on the sale of the obligation, or the fair market value of the 
obligation, shall not include any amount attributable to interest, and 
the adjusted basis shall be computed without regard to any adjustment 
for amortization of bond premium required under sections 75 and 
1016(a)(6). The amount of the reduction referred to in the first 
sentence of this subdivision is the total amount by which the adjusted 
basis of the obligation would be required to be reduced under section 
1016(a)(5) were the obligation subject to the amortizable bond premium 
provisions of section 171; that is, the amount of the amortizable bond 
premium attributable to the period during which the obligation was held 
which would be disallowed as a deduction under section 171(a)(2) if the 
taxpayer were an ordinary investor.
    (3) This paragraph may be illustrated by the following examples:

    Example (1). X, a dealer in securities who values his inventories on 
a basis other than cost, makes his income tax returns on the calendar 
year basis. On July 1, 1954, he bought, for $1,060 each, three municipal 
bonds (A, B, an C) having a face obligation of $1,000, and maturing on 
July 1, 1959. Bond A is sold on December 31, 1954, bond B is sold on 
December 31, 1955, and bond C is sold on June 30, 1956. For each bond 
the amortizable bond premium to maturity is $60, the period from date of 
acquisition to maturity is 60 months, and the amortizable bond premium 
per month is $1. The adjustment for each of the years 1954, 1955, and 
1956 is as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                       Adjustment to ``cost of
                                                                                       securities sold'' for--
                Bond                      Date acquired            Date sold       -----------------------------
                                                                                      1954      1955      1956
----------------------------------------------------------------------------------------------------------------
A..................................  July 1, 1954..........  Dec. 31, 1954........        $6
B..................................  July 1, 1954..........  Dec. 31, 1955........         6       $12
C..................................  July 1, 1954..........  Jun. 30, 1956........         6        12        $6
                                                                                   -----------------------------
      Total.......................................................................        18        24         6
----------------------------------------------------------------------------------------------------------------


[[Page 305]]

    Example (2). Y is a dealer in securities who values his inventories 
on a basis other than cost. He makes his income tax returns on the 
calendar year basis. On January 1, 1958, Y bought five bonds (D, E, F, 
G, and H) issued by various municipalities. Each bond has a face 
obligation of $1,000 and was purchased for $1,060. The interest on each 
is excludable from gross income under section 103. Bonds D, E, and F 
mature on December 31, 1962, and bonds G and H mature on December 31, 
1967. The amortizable bond premium per month is $1 with respect to bonds 
D, E, and F, and is $.50 with respect to bonds G and H. The following 
table indicates the reduction in ``cost of securities sold'' which Y 
should make for the years shown, assuming that he sells the bonds on the 
dates and for the prices set forth:

----------------------------------------------------------------------------------------------------------------
                                                                                       Adjustment to ``cost of
                                                                            Sale       securities sold'' for--
                   Bond                               Date sold             price  -----------------------------
                                                                                      1958      1959      1960
----------------------------------------------------------------------------------------------------------------
D.........................................  Feb. 1, 1959................    $1,090       $12        $1
E.........................................  Jan. 30, 1958...............     1,100      None
F.........................................  Jan. 30, 1958...............     1,000         1
G.........................................  Dec. 31, 1960...............     1,065      None      None      None
H.........................................  Dec. 31, 1960...............     1,050      None      None       $18
                                                                                   -----------------------------
    Total...............................................................  ........        13         1        18
----------------------------------------------------------------------------------------------------------------


An adjustment to ``cost of securities sold'' must be made with respect 
to bond D (even though it was ultimately sold at a gain) because the 
bond neither had an earliest maturity or call date of more than 5 years 
from the date on which Y acquired it, nor was it disposed of within 30 
days after such date. An adjustment must be made for the years 1958 and 
1959 since section 75(a)(1) requires that an adjustment be made with 
respect to such a bond at the close of each taxable year in which it is 
held. On the other hand, since bonds E, F, G, and H either were disposed 
of within 30 days after the date of such acquisition or had an earliest 
maturity or call date more than 5 years from the date of acquisition, 
and were acquired after December 31, 1957, it is necessary to determine 
whether Y disposed of them at a loss so as to require an adjustment 
under section 75. No adjustment is necessary with respect to bonds E and 
G because they were sold at a gain. An adjustment to ``cost of 
securities sold'' is required with respect to bonds F and H because they 
were sold at a loss. As in the case of bond D, an adjustment with 
respect to bond F is made in 1958 in accordance with section 75(a)(1); 
however, the adjustment with respect to bond H is made entirely in 1960, 
the taxable year in which Y sold that bond, in accordance with the last 
sentence of section 75(a). If Y had acquired bonds before January 1, 
1958, it would be unnecessary to determine whether they were disposed of 
at a loss since that factor is significant only with respect to bonds 
acquired on or after that date.

    (c) Inventories not used or inventories valued at cost. (1) In the 
case of a dealer in securities who computes gross income from his trade 
or business without the use of inventories or by use of inventories 
valued at cost, the adjustment required by section 75 is a reduction of 
the adjusted basis of each municipal bond sold or otherwise disposed of 
during the taxable year. The amount of such reduction is the total 
amount by which the adjusted basis of the bond would be required to be 
reduced under section 1016(a)(5) were the bond subject to the 
amortizable bond premium provisions of section 171; that is, the amount 
of the amortizable bond premium attributable to the period during which 
the bond was held which would be disallowed as a deduction under section 
171(a)(2) if the taxpayer were an ordinary investor.
    (2) Subparagraph (1) of this paragraph may be illustrated by the 
following example:

    Example. Z, a dealer in securities who values his inventories on the 
basis of cost, makes his income tax returns on the calendar year basis. 
On January 1, 1954, he buys, for $1,060 each, three municipal bonds (I, 
J, and K) having a face obligation of $1,000, and maturing on January 1, 
1959. Bond I is sold on December 31, 1954, bond J is sold on June 30, 
1955, and bond K is sold on December 31, 1956. For each bond, the 
amortizable bond premium to maturity is $60, the period from the date of 
acquisition to maturity is 60 months, and the amortizable bond premium 
per month is $1.

[[Page 306]]



----------------------------------------------------------------------------------------------------------------
                                                                                          Adjustment for--
                Bond                      Date acquired            Date sold       -----------------------------
                                                                                      1954      1955      1956
----------------------------------------------------------------------------------------------------------------
I..................................  Jan. 1, 1954..........  Dec. 31, 1954........       $12
J..................................  Jan. 1, 1954..........  June 30, 1955........      None       $18
K..................................  Jan. 1, 1954..........  Dec. 31, 1956........      None      None       $36
----------------------------------------------------------------------------------------------------------------

    (d) Bonds acquired before July 1, 1950. Under section 203(c) of the 
Revenue Act of 1950, adjustment is required for a municipal bond 
acquired before July 1, 1950, only with respect to taxable years 
beginning on or after that date. Accordingly, if the municipal bond was 
acquired before July 1, 1950, then for purposes of section 75 the 
amortizable bond premium under section 171 must be computed after 
adjusting the bond premium to the extent proper to reflect unamortized 
bond premium for so much of the holding period (as determined under 
section 1223) as precedes the taxable year of the dealer beginning on or 
after July 1, 1950. Thus, in example (1) of paragraph (b) and in the 
example in paragraph (c) of this section, the first taxable year 
beginning on or after July 1, 1950, is, for each dealer, the taxable 
year beginning January 1, 1951. If each dealer had purchased for $1,060 
on April 1, 1950, a municipal bond having a face obligation of $1,000 
and maturing April 1, 1955, and had sold such bond on February 28, 1955, 
the adjustment under section 75 would be computed as follows:

------------------------------------------------------------------------
                                                      Dealer X  Dealer Z
------------------------------------------------------------------------
Bond premium........................................       $60       $60
Adjustment for holding period prior to Jan. 1, 1951.         9         9
                                                     -------------------
Amortizable bond premium to maturity, as adjusted...        51        51
Amortizable bond premium per month..................         1         1
Total adjustments under sec. (o), 1939 Code, for            36      None
 years 1951-53......................................
Adjustment under sec. 75 for 1954...................        12      None
Adjustment under sec. 75 for 1955...................         2        50
------------------------------------------------------------------------


[T.D. 6647, 28 FR 3519, Apr. 11, 1963]



Sec. 1.77-1  Election to consider Commodity Credit Corporation loans as 
income.

    A taxpayer who receives a loan from the Commodity Credit Corporation 
may, at his election, include the amount of such loan in his gross 
income for the taxable year in which the loan is received. If a taxpayer 
makes such an election (or has made such an election under section 123 
of the Internal Revenue Code of 1939 or under section 223(d) of the 
Revenue Act of 1939 (53 Stat. 897)), then for subsequent taxable years 
he shall include in his gross income all amounts received during those 
years as loans from the Commodity Credit Corporation, unless he secures 
the permission of the Commissioner to change to a different method of 
accounting. Application for permission to change such method of 
accounting and the basis upon which the return is made shall be filed 
with the Commission of Internal Revenue, Washington, D.C. 20224, within 
90 days after the beginning of the taxable year to be covered by the 
return.



Sec. 1.77-2  Effect of election to consider commodity credit loans as 
income.

    (a) If a taxpayer elects or has elected under section 77, section 
123 of the Internal Revenue Code of 1939, or section 223(d) of the 
Revenue Act of 1939 (53 Stat. 897), as amended, to include in his gross 
income the amount of a loan from the Commodity Credit Corporation for 
the taxable year in which it is received, then--
    (1) No part of the amount realized by the Commodity Credit 
Corporation upon the sale or other disposition of the commodity pledged 
for such loan shall be recognized as income to the taxpayer, unless the 
taxpayer receives an amount in addition to that advanced to him as the 
loan, in which event such additional amount shall be included in the 
gross income of the taxpayer for the taxable year in which it is 
received, and
    (2) No deductible loss to the taxpayer shall be recognized on 
account of any deficiency realized by the Commodity Credit Corporation 
on such loan if the taxpayer was relieved from liability for such 
deficiency.

[[Page 307]]

    (b) The application of paragraph (a) of this section may be 
illustrated by the following example:

    Example. A, a taxpayer who elected for his taxable year 1952 to 
include in gross income amounts received as loans from the Commodity 
Credit Corporation, received as loans $500 in 1952, $700 in 1953, and 
$900 in 1954. In 1956 all the pledged commodity was sold by the 
Commodity Credit Corporation for an amount $100 and $200 less than the 
loans with respect to the commodity pledged in 1952 and 1953, 
respectively, and for an amount $150 greater than the loan with respect 
to the commodity pledged in 1954. A, in making his return for 1956, 
shall include in gross income the sum of $150 if it is received during 
that year, but will not be allowed a deduction for the deficiencies of 
$100 and $200 unless he is required to satisfy such deficiencies and 
does satisfy them during that year.



Sec. 1.78-1  Dividends received from certain foreign corporations 
by certain domestic corporations choosing the foreign tax credit.

    (a) Taxes deemed paid by certain domestic corporations treated as a 
section 78 dividend. Any reduction under section 907(a) of the foreign 
income taxes deemed to be paid with respect to foreign oil and gas 
extraction income does not affect the amount treated as a section 78 
dividend. If a domestic corporation chooses to have the benefits of the 
foreign tax credit under section 901 for any taxable year, an amount 
which is equal to the foreign income taxes deemed to be paid by such 
corporation for such year under section 902(a) in accordance with 
Sec. Sec. 1.902-1 and 1.902-2 and Sec. 1.902(b)(2), or under section 
960(a)(1) in accordance with Sec. 1.960-7, shall, to the extent 
provided by this section, be treated as a dividend (hereinafter referred 
to as a section 78 dividend) received by such domestic corporation from 
the foreign corporation described in section 902(a) in accordance with 
Sec. Sec. 1.902-1 and 1.902-2 or section 960(c)(1) in accordance with 
Sec. 1.960-7, as the case may be. A section 78 dividend shall be 
treated as a dividend for all purposes of the Code, except that it shall 
not be treated as a dividend under section 245, relating to dividends 
received from certain foreign corporations, or increase the earnings and 
profits of the domestic corporation. For purposes of determining the 
source of a section 78 dividend in computing the limitation on the 
foreign tax credit under section 904, see Sec. 1.902(h)(1) and the 
regulations under section 960. For special rules relating to the 
determination of the foreign tax credit under section 902 with respect 
to certain minimum distributions received from controlled foreign 
corporations and the effect of such rules upon the gross-up under 
section 78, see paragraph (c) of Sec. 1.963-4. For rules respecting the 
reduction of foreign income taxes under section 6038(b) in applying 
section 902(a) in accordance with Sec. Sec. 1.902-1 and 1.902-2 or 
section 960(c)(1) in accordance with Sec. 1.960-7, where there has been 
a failure to furnish certain information and for an illustration of the 
effect of such reduction upon the amount of a section 78 dividend, see 
paragraph (l) of Sec. 1.6038-2.
    (b) Certain taxes not treated as a section 78 dividend. Foreign 
income taxes deemed paid by a domestic corporation under section 902(a) 
in accordance with Sec. Sec. 1.902-1 and 1.902-2 or section 960(c)(1) 
in accordance with Sec. 1.960-7, shall not, to the extent provided by 
paragraph (b) of Sec. 1.960-3, be treated as a section 78 dividend 
where such taxes are imposed on certain distributions from the earnings 
and profits of a controlled foreign corporation attributable to an 
amount which is, or has been, included in gross income of the domestic 
corporation under section 951.
    (c) United Kingdom income tax included in gross income under treaty. 
Any amount of United Kingdom income tax appropriate to a dividend paid 
by a corporation which is a resident of the United Kingdom shall not be 
treated as a section 78 dividend by a domestic corporation to the extent 
that such tax is included in the gross income of such domestic 
corporation in accordance with Article XIII (1) of the income tax 
convention between the United States and the United Kingdom, as amended 
by Article II of the supplementary protocol between such Governments 
signed on August 19, 1957 (9 UST 1331). See Sec. 507.117 of this 
chapter, relating to credit against United States tax liability for 
income tax paid or deemed to have been paid to the United Kingdom.
    (d) Taxable year in which section 78 dividend is received. A section 
78 dividend shall be considered received in the

[[Page 308]]

taxable year of a domestic corporation in which--
    (1) The corporation receives the dividend by reason of which there 
are deemed paid under section 902(a) in accordance with Sec. Sec. 
1.902-1 and 1.902-2 the foreign income taxes which give rise to such 
section 78 dividend, or
    (2) The corporation includes in gross income under section 951(a) 
the amounts by reason of which there are deemed paid under section 
960(a)(1) in accordance with Sec. 1.960-7 the foreign income taxes 
which give rise to such section 78 dividend, notwithstanding that such 
foreign income taxes may be carried back or carried over to another 
taxable year under section 904(d) and are deemed to be paid or accrued 
in such other taxable year.
    (e) Effective dates for the application of section 78--(1) In 
general. This section shall apply to amounts of foreign income taxes 
deemed paid under section 902(a) in accordance with Sec. Sec. 1.902-1 
and 1.902-2, or under section 960(a)(1) in accordance with Sec. 1.960-
7, by reason of a distribution received by a domestic corporation--
    (i) After December 31, 1964, or
    (ii) Before January 1, 1965, in a taxable year of such domestic 
corporation beginning after December 31, 1962, but only to the extent 
that such distribution is made out of the accumulated profits of a 
foreign corporation for a taxable year of such foreign corporation 
beginning after December 31, 1962.

For special rules relating to determination of accumulated profits for 
such purposes, see the regulation under section 902.
    (2) Amounts under section 951 treated as distributions. For purposes 
of this paragraph, any amount attributable to the earnings and profits 
for the taxable year of a first-tier corporation (as defined in 
paragraph (b)(1) of Sec. 1.960-1) which is included in the gross income 
of a domestic corporation under section 951(a) shall be treated as a 
distribution received by such domestic corporation on the last day in 
such taxable year on which such first-tier corporation is a controlled 
foreign corporation.
    (f) Illustrations. The application of this section may be 
illustrated by the examples provided in Sec. 1.902-1, Sec. 1.904-5, 
Sec. 1.960-3, Sec. 1.960-4, and Sec. 1.963-4.

[T.D. 6805, 30 FR 3208, Mar. 9, 1965, as amended by T.D. 7120, 36 FR 
10859, June 4, 1971; 36 FR 11924, June 23, 1971; T.D. 7481, 42 FR 20130, 
Apr. 18, 1977; T.D. 7490; 42 FR 30497, June 15, 1977; 42 FR 32536, June 
27, 1977; T.D. 7649, 44 FR 60086, Oct. 18, 1979; T.D. 7961, 49 FR 26225, 
June 27, 1984]



Sec. 1.79-0  Group-term life insurance--definitions of certain terms.

    The following definitions apply for purposes of section 79, this 
section, and Sec. Sec. 1.79-1, 1.79-2, and 1.79-3.
    Carried directly or indirectly. A policy of life insurance is 
``carried directly or indirectly'' by an employer if--
    (a) The employer pays any part of the cost of the life insurance 
directly or through another person; or
    (b) The employer or two or more employers arrange for payment of the 
cost of the life insurance by their employees and charge at least one 
employee less than the cost of his or her insurance, as determined under 
Table I of Sec. 1.79-3(d)(2), and at least one other employee more than 
the cost of his or her insurance, determined in the same way.
    Employee. An ``employee'' is--
    (a) A person who performs services if his or her relationship to the 
person for whom services are performed is the legal relationship of 
employer and employee described in Sec. 31.3401(c)-1; or
    (b) A full-time life insurance salesperson described in section 
7701(a)(20); or
    (c) A person who formerly performed services as an employee.

A person who formerly performed services as an employee and currently 
performs services for the same employer as an independent contractor is 
considered an employee only with respect to insurance provided because 
of the person's former services as an employee.
    Group of employees. A ``group of employees'' is all employees of an 
employer, or less than all employees if membership in the group is 
determined solely on the basis of age, marital status, or factors 
related to employment. Examples of factors related to employment are 
membership in a union some or all of whose members are employed by the 
employer, duties performed,

[[Page 309]]

compensation received, and length of service. Ordinarily the purchase of 
something other than group-term life insurance is not a factor related 
to employment. For example, if an employer provides credit life 
insurance to all employees who purchase automobiles, these employees are 
not a ``group of employees'' because membership is not determined solely 
on the basis of age, marital status, or factors related to employment. 
On the other hand, participation in an employer's pension, profit-
sharing or accident and health plan is considered a factor related to 
employment even if employees are required to contribute to the cost of 
the plan. Ownership of stock in the employer corporation is not a factor 
related to employment. However, participation in an employer's stock 
bonus plan may be a factor related to employment and a ``group of 
employees'' may include employees who own stock in the employer 
corporation.
    Permanent benefit. A ``permanent benefit'' is an economic value 
extending beyond one policy year (for example, a paid-up or cash 
surrender value) that is provided under a life insurance policy. 
However, the following features are not permanent benefits:
    (a) A right to convert (or continue) life insurance after group life 
insurance coverage terminates;
    (b) Any other feature that provides no economic benefit (other than 
current insurance protection) to the employee; or
    (c) A feature under which term life insurance is provided at a level 
premium for a period of five years or less.
    Policy. The term ``policy'' includes two or more obligations of an 
insurer (or its affiliates) that are sold in conjunction. Obligations 
that are offered or available to members of a group of employees are 
sold in conjunction if they are offered or available because of the 
employment relationship. The actuarial sufficiency of the premium 
charged for each obligation is not taken into account in determining 
whether the obligations are sold in conjunction. In addition, 
obligations may be sold in conjunction even if the obligations are 
contained in separate documents, each document is filed with and 
approved by the applicable state insurance commission, or each 
obligation is independent of any other obligation. Thus, a group of 
individual contracts under which life insurance is provided to a group 
of employees may be a policy. Similarly, two benefits provided to a 
group of employees, one term life insurance and the other a permanent 
benefit, may be a policy, even if one of the benefits is provided only 
to employees who decline the other benefit. However, an employer may 
elect to treat two or more obligations each of which provides no 
permanent benefits as separate policies if the premiums are properly 
allocated among such policies. An employer also may elect to treat an 
obligation which provides permanent benefits as a separate policy if--
    (a) The insurer sells the obligation directly to the employee who 
pays the full cost thereof;
    (b) The participation of the employer with respect to sales of the 
obligation to employees is limited to selection of the insurer and the 
type of coverage and to sales assistance activities such as providing 
employee lists to the insurer, permitting the insurer to use the 
employer's premises for solicitation, and collecting premiums through 
payroll deduction;
    (c) The insurer sells the obligation on the same terms and in 
substantial amounts to individuals who do not purchase (and whose 
employers do not purchase) any other obligation from the insurer; and
    (d) No employer-provided benefit is conditioned on purchase of the 
obligation.

[T.D. 7623, 44 FR 28797, May 17, 1979, as amended by T.D. 7917, 48 FR 
45762, Oct. 7, 1983]



Sec. 1.79-1  Group-term life insurance--general rules.

    (a) What is group-term life insurance? Life insurance is not group-
term life insurance for purposes of section 79 unless it meets the 
following conditions:
    (1) It provides a general death benefit that is excludable from 
gross income under section 101(a).
    (2) It is provided to a group of employees.

[[Page 310]]

    (3) It is provided under a policy carried directly or indirectly by 
the employer.
    (4) The amount of insurance provided to each employee is computed 
under a formula that precludes individual selection. This formula must 
be based on factors such as age, years of service, compensation, or 
position. This condition may be satisfied even if the amount of 
insurance provided is determined under a limited number of alternative 
schedules that are based on the amount each employee elects to 
contribute. However, the amount of insurance provided under each 
schedule must be computed under a formula that precludes individual 
selection.
    (b) May group-term life insurance be combined with other benefits? 
No part of the life insurance provided under a policy that provides a 
permanent benefit is group-term life insurance unless--
    (1) The policy or the employer designates in writing the part of the 
death benefit provided to each employee that is group-term life 
insurance; and
    (2) The part of the death benefit that is provided to an employee 
and designated as the group-term life insurance benefit for any policy 
year is not less than the difference between the total death benefit 
provided under the policy and the employee's deemed death benefit (DDB) 
at the end of the policy year determined under paragraph (d)(3) of this 
section.
    (c) May a group include fewer than 10 employees? (1) As a general 
rule, life insurance provided to a group of employees cannot qualify as 
group-term life insurance for purposes of section 79 unless, at some 
time during the calendar year, it is provided to at least 10 full-time 
employees who are members of the group of employees. For purposes of 
this rule, all life insurance provided under policies carried directly 
or indirectly by the employer is taken into account in determining the 
number of employees to whom life insurance is provided.
    (2) The general rule of paragraph (c)(1) of this section does not 
apply if the following conditions are met:
    (i) The insurance is provided to all full-time employees of the 
employer or, if evidence of insurability affects eligibility, to all 
full-time employees who provide evidence of insurability satisfactory to 
the insurer.
    (ii) The amount of insurance provided is computed either as a 
uniform percentage of compensation or on the basis of coverage brackets 
established by the insurer. However, the amount computed under either 
method may be reduced in the case of employees who do not provide 
evidence of insurability satisfactory to the insurer. In general, no 
bracket may exceed 2\1/2\ times the next lower bracket and the lowest 
bracket must be at least 10 percent of the highest bracket. However, the 
insurer may establish a separate schedule of coverage brackets for 
employees who are over age 65, but no bracket in the over-65 schedule 
may exceed 2\1/2\ times the next lower bracket and the lowest bracket in 
the over-65 schedule must be at least 10 percent of the highest bracket 
in the basic schedule.
    (iii) Evidence of insurability affecting employee's eligibility for 
insurance or the amount of insurance provided to that employee is 
limited to a medical questionnaire completed by the employee that does 
not require a physical examination.
    (3) The general rule of paragraph (c)(1) of this section does not 
apply if the following conditions are met:
    (i) The insurance is provided under a common plan to the employees 
of two or more unrelated employers.
    (ii) The insurance is restricted to, but mandatory for, all 
employees of the employer who belong to or are represented by an 
organization (such as a union) that carries on substantial activities in 
addition to obtaining insurance.
    (iii) Evidence of insurability does not affect an employee's 
eligibility for insurance or the amount of insurance provided to that 
employee.
    (4) For purposes of paragraph (c) (2) and (3) of this section, 
employees are not taken into account if they are denied insurance for 
the following reasons:
    (i) They are not eligible for insurance under the terms of the 
policy because they have not been employed for a waiting period, 
specified in the policy, which does not exceed six months.

[[Page 311]]

    (ii) They are part-time employees. Employees whose customary 
employment is for not more than 20 hours in any week, or 5 months in any 
calendar year, are presumed to be part-time employees.
    (iii) They have reached the age of 65.
    (5) For purposes of paragraph (c) (1) and (2) of this section, 
insurance is considered to be provided to an employee who elects not to 
receive insurance unless, in order to receive the insurance, the 
employee is required to contribute to the cost of benefits other than 
term life insurance. Thus, if an employee could receive term life 
insurance by contributing to its cost, the employee is taken into 
account in determining whether the insurance is provided to 10 or more 
employees even if such employee elects not to receive the insurance. 
However, an employee who must contribute to the cost of permanent 
benefits to obtain term life insurance is not taken into account in 
determining whether the term life insurance is provided to 10 or more 
employees unless the term life insurance is actually provided to such 
employee.
    (d) How much must an employee receiving permanent benefits include 
in income?--(1) In general. If an insurance policy that meets the 
requirements of this section provides permanent benefits to an employee, 
the cost of the permanent benefits reduced by the amount paid for 
permanent benefits by the employee is included in the employee's income. 
The cost of the permanent benefits is determined under the formula in 
paragraph (d)(2) of this section.
    (2) Formula for determining cost of the permanent benefits. In each 
policy year the cost of the permanent benefits for any particular 
employee must be no less than:

X(DDB2-DDB1)

where

DDB2 is the employee's deemed death benefit at the end of the 
policy year:
DDB1 is the employee's deemed death benefit at the end of the 
preceding policy year; and
X is the net single premium for insurance (the premium for one dollar of 
paid-up whole-life insurance) at the employee's attained age at the 
beginning of the policy year.

    (3) Formula for determining deemed death benefit. The deemed death 
benefit (DDB) at the end of any policy year for any particular employee 
is equal to--

R/Y

Where--

R is the net level premium reserve at the end of that policy year for 
          all benefits provided to the employee by the policy or, if 
          greater, the fair market value of the policy at the end of 
          that policy year; and
Y is the net single premium for insurance (the premium for one dollar of 
          paid-up, whole life insurance) at the employee's age at the 
          end of that policy year.

    (4) Mortality tables and interest rates used. For purposes of 
paragraph (d) (2) and (3) of this section, the net level premium reserve 
(R) and the net single premium (X or Y) shall be based on the 1958 CSO 
Mortality Table and 4 percent interest.
    (5) Dividends. If an insurance policy that meets the requirements of 
this section provides permanent benefits, part or all of the dividends 
under the policy may be includible in the employee's income. If the 
employee pays nothing for the permanent benefits, all dividends under 
the policy that are actually or constructively received by the employee 
are includible in the employee's income. In all other cases, the amount 
of dividends included in the employee's income is equal to:


(D+C)-(PI+DI+AP)

where

D is the total amount of dividends actually or constructively received 
under the policy by the employee in the current and all preceding 
taxable years of the employee;
C is the total cost of the permanent benefits for the current and all 
preceding taxable years of the employee determined under the formulas in 
paragraph (d) (2) and (6) of this section:
PI is the total amount of premium included in the employee's income 
under paragraph (d)(1) of this section for the current and all preceding 
taxable years of the employee;
DI is the total amount of dividends included in the employee's income 
under this paragraph (d)(5) in all preceding taxable years of the 
employee; and
AP is the total amount paid for permanent benefits by the employee in 
the current and all preceding taxable years of the employee.


[[Page 312]]


    (6) Different policy and taxable years. (i) If a policy year begins 
in one employee taxable year and ends in another employee taxable year, 
the cost of the permanent benefits, determined under the formula in 
paragraph (d)(2) of this section, is allocated between the employee 
taxable years.
    (ii) The cost of permanent benefits for a policy year is allocated 
first to the employee taxable year in which the policy year begins. The 
cost of permanent benefits allocated to that policy year is equal to:

FxC

where

F is the fraction of the premium for that policy year that is paid on or 
before the last day of the employee taxable year; and
C is the cost of permanent benefits for the policy year determined under 
the formula in paragraph (d)(2) of this section.

    (iii) Any part of the cost of permanent benefits that is not 
allocated to the employee taxable year in which the policy year begins 
is allocated to the subsequent employee taxable year.
    (iv) The cost of permanent benefits for an employee taxable year is 
the sum of the costs of permanent benefits allocated to that year under 
paragraph (d)(6) (ii) and (iii) of this section.
    (7) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. An employer provides insurance to employee A under a policy 
that meets the requirements of this section. Under the policy, A, who is 
47 years old, received $70,000 of group-term life insurance and elects 
to receive a permanent benefit under the policy. A pays $2 for each 
$1,000 of group-term life insurance through payroll deductions and the 
employer pays the remainder of the premium for the group-term life 
insurance. The employer also pays one half of the premium specified in 
the policy for the permanent benefit. A pays the other half of the 
premium for the permanent benefit through payroll deductions. The policy 
specifies that the annual premium paid for the permanent benefit is 
$300. However, the amount of premium allocated to the permanent benefit 
by the formula in paragraph (d)(2) of this section is $350. A is a 
calendar year taxpayer; the policy year begins January 1. In year 2000, 
$200 is includible in A's income because of insurance provided by the 
employer. This amount is computed as follows:

(1) Cost of permanent benefits................................   $350
(2) Amounts considered paid by A for permanent benefits (\1/2\    150
 x $300)......................................................
(3) Line (1) minus line (2)...................................    200
(4) Cost of $70,000 of group-term life insurance under Table I    126
 of Sec.  1.79-3.............................................
(5) Cost of $50,000 of group-term life insurance under Table I     90
 of Sec.  1.79-3.............................................
(6) Cost of group-term insurance in excess of $50,000 (line        36
 (4) minus line(5))...........................................
(7) Amount considered paid by A for group-term life insurance     140
 (70 x $2)....................................................
(8) Line (6) minus line (7) (but not less than 0).............      0
(9) Amount includible in income (line (3) plus line (8))......    200
 

    (e) What is the effect of State law limits? Section 79 does not 
apply to life insurance in excess of the limits under applicable state 
law on the amount of life insurance that can be provided to an employee 
under a single contract of group-term life insurance.
    (f) Cross references. (1) See section 79(b) and Sec. 1.79-2 for 
rules relating to group-term life insurance provided to certain retired 
individuals.
    (2) See section 61(a) and the regulations thereunder for rules 
relating to life insurance not meeting the requirements of section 79, 
this section, or Sec. 1.79-2, such as insurance provided on the life of 
a non-employee (for example, an employee's spouse), insurance not 
provided as compensation for personal services performed as an employee, 
insurance not provided under a policy carried directly or indirectly by 
the employer, or permanent benefits.
    (3) See sections 106 and Sec. 1.106-1 for rules relating to certain 
insurance that does not provide general death benefits, such as travel 
insurance or accident and health insurance (including amounts payable 
under a double indemnity clause or rider).
    (g) [Reserved]
    (h) Effective date. Section 1.79-0 applies to insurance provided in 
employee taxable years beginning on or after January 1, 1977 (except as 
provided in 26 CFR 1.79-1(g) (revised as of April 1, 1983) with respect 
to insurance provided in employee taxable years beginning in 1977). 
Sections 1.79-1 through 1.79-3 apply to insurance provided in employee 
taxable years beginning after December 31, 1982. See 26 CFR 1.79-1 
through 1.79-3 (revised as of April 1, 1983) for rules applicable to 
insurance

[[Page 313]]

provided in employee taxable years beginning before January 1, 1983.

(Secs. 79(c) and 7805 of the Internal Revenue Code of 1954 (78 Stat. 36, 
26 U.S.C. 79(c); 68A Stat. 917, 26 U.S.C. 7805))

[T.D. 7623, 44 FR 28797, May 17, 1979, as amended by T.D. 7917, 48 FR 
45762, Oct. 7, 1983; T.D. 7924, 48 FR 54595, Dec. 6, 1983; T.D. 8821, 64 
FR 29790, June 3, 1999; T.D. 9223, 70 FR 50971, Aug. 29, 2005]



Sec. 1.79-2  Exceptions to the rule of inclusion.

    (a) In general. (1) Section 79(b) provides exceptions for the cost 
of group-term life insurance provided under certain policies otherwise 
described in section 79(a). The policy or policies of group-term life 
insurance which are described in section 79(a) but which qualify for one 
of the exceptions set forth in section 79(b) are described in paragraphs 
(b) through (d) of this section. Paragraph (b) of this section discusses 
the exception provided in section 79(b) (1); paragraph (c) of this 
section discusses the exception provided in section 79(b)(2); and 
paragraph (d) of this section discusses the exception provided in 
section 79(b)(3).
    (2)(i) If a policy of group-term life insurance qualifies for an 
exception provided by section 79(b), then the amount equal to the cost 
of such insurance is excluded from the application of the provisions of 
section 79(a).
    (ii) If a policy, or portion of a policy of group-term life 
insurance qualifies for an exception provided by section 79(b), the 
amount (if any) paid by the employee toward the purchase of such 
insurance is not to be taken into account as an amount referred to in 
section 79 (a)(2). In the case of a policy or policies of group-term 
life insurance which qualify for an exception provided by section 79(b) 
(1) or (3), the amount paid by the employee which is not to be taken 
into account as an amount referred to in section 79(a) (2) is the amount 
paid by the employee for the particular policy or policies of group-term 
life insurance which qualify for an exception provided under such 
section. If the exception provided in section 79(b)(2) is applicable 
only to a portion of the group-term life insurance on the employee's 
life, the amount considered to be paid by the employee toward the 
purchase of such portion is the amount equal to the excess of the cost 
of such portion of the insurance over the amount otherwise includible in 
the employee's gross income with respect to the group-term life 
insurance on his life carried directly or indirectly by such employer.
    (iii) The rules of this subparagraph may be illustrated by the 
following example:

    Example. A is an employee of X Corporation and is also an employee 
of Y Corporation, a subsidiary of X Corporation. A is provided, under a 
separate plan arranged by each of his employers, group-term life 
insurance on his life. During his taxable year, under the group-term 
life insurance plan of X Corporation, A is provided $60,000 of group-
term life insurance on his life, and A pays $360.00 toward the purchase 
of such insurance. Under the group-term life insurance plan of Y 
Corporation, A is provided $65,000 of group-term life insurance on his 
life, but does not pay any part of the cost of such insurance. At the 
beginning of his taxable year, A terminates his employment with the X 
Corporation after he has reached the retirement age with respect to such 
employer, and the policy carried by the X Corporation qualifies for the 
exception provided by section 79(b)(1). For that taxable year, the cost 
of the group-term life insurance on A's life which is provided under the 
plan of X Corporation is not taken into account in determining the 
amount includible in A's gross income under section 79(a), and A may not 
take into account as an amount described in section 79(a)(2) the $360.00 
he pays toward the purchase of such insurance.

    (b) Retired and disabled employees--(1) In general. Section 79(b)(1) 
provides an exception for the cost of group-term life insurance on the 
life of an individual which is provided under a policy or policies 
otherwise described in section 79(a) if the individual has terminated 
his employment (as defined in subparagraph (2) of this paragraph) with 
such employer and either has reached the retirement age with respect to 
such employer (as defined in subparagraph (3) of this paragraph), or has 
become disabled (as defined in subparagraph (4)(i) of this paragraph). 
If an individual who has terminated his employment attains retirement 
age or has become disabled during his taxable year, or if an employee 
who has attained retirement age or has become disabled terminates his 
employment

[[Page 314]]

during the taxable year, the exception provided by section 79(b)(1) 
applies only to the portion of the cost of group-term life insurance 
which is provided subsequent to the happening of the last event which 
qualifies the policy of insurance on the employee's life for the 
exception provided in such section.
    (2) Termination of employment. For purposes of section 79(b)(1), an 
individual has terminated his employment with an employer providing such 
individual group-term life insurance when such individual no longer 
renders services to that employer as an employee of such employer.
    (3) Retirement age. For purposes of section 79(b)(1) and this 
section, the meaning of the term ``retirement age'' is determined in 
accordance with the following rules--
    (i)(a) If the employee is covered under a written pension or annuity 
plan of the employer providing such individual group-term life insurance 
on his life (whether or not such plan is qualified under section 401(a) 
or 403(a)), then his retirement age shall be considered to be the 
earlier of--
    (1) The earliest age indicated by such plan at which an active 
employee has the right (or an inactive individual would have the right 
had he continued in employment) to retire without disability and without 
the consent of his employer and receive immediate retirement benefits 
computed at either the full rate or a rate proportionate to completed 
service as set forth in the normal retirement formula of the plan, i.e., 
without actuarial or similar reduction because of retirement before some 
later specified age, or
    (2) The age at which it has been the practice of the employer to 
terminate, due to age, the services of the class of employees to which 
he last belonged.
    (b) For purposes of (a) of this subdivision, if an employee is 
covered under more than one pension or annuity plan of the employer, his 
retirement age shall be determined with regard to that plan which covers 
that class of employees of the employer to which the employee last 
belonged. If the class of employees to which the employee last belonged 
is covered under more than one pension or annuity plan, then the 
employee's retirement age shall be determined with regard to that plan 
which covers the greatest number of the employer's employees.
    (ii) In the absence of a written employee's pension or annuity plan 
described in subdivision (i) of this subparagraph, retirement age is the 
age, if any, at which it has been the practice of the employer to 
terminate, due to age, the services of the class of employees to which 
the particular employee last belonged, provided such age is reasonable 
in view of all the pertinent facts and circumstances.
    (iii) If neither subdivision (i) or (ii) of this subparagraph 
applies, the retirement age is considered to be age 65.
    (4) Disabled. (i) For taxable years beginning after December 31, 
1966, an individual is considered disabled for purposes of section 
79(b)(1) and subparagraph (1) of this paragraph if he is disabled within 
the meaning of section 72(m)(7) and paragraph (f) of Sec. 1.72-17. For 
taxable years beginning before January 1, 1967, an individual is 
considered disabled for purposes of section 79(b)(1) and subparagraph 
(1) of this paragraph if he is disabled within the meaning of section 
213(g)(3), relating to the meaning of disabled, but the determination of 
the individual's status shall be made without regard to the provisions 
of section 213(g)(4), relating to the determination of status.
    (ii)(a) In any taxable year in which an individual seeks to apply 
the exception set forth in section 79(b)(1) by reason of his being 
disabled within the meaning of subdivision (i) of this subparagraph, and 
in which the aggregate amount of insurance on the individual's life 
subject to the rule of inclusion set forth in section 79(a), but 
determined without regard to the amount of any insurance subject to any 
exception set forth in section 79(b), is greater than $50,000 of such 
insurance, the substantiation required by (b) or (c) of this subdivision 
must be submitted with the individual's tax return.
    (b) For the first taxable year for which the individual seeks to 
apply the exception set forth in section 79(b)(1) by reason of his being 
disabled within the meaning of subdivision (i) of this subparagraph, 
there must be submitted with his income tax return a doctor's

[[Page 315]]

statement as to his impairment. There must also be submitted with the 
return a statement by the individual with respect to the effect of the 
impairment upon his substantial gainful activity, and the date such 
impairment occurred. For subsequent taxable years, the taxpayer may, in 
lieu of such statements, submit a statement declaring the continued 
existence (without substantial diminution) of the impairment and its 
continued effect upon his substantial gainful activity.
    (c) In lieu of the substantiation required to be submitted by (b) of 
this subdivision for the taxable year, the individual may submit a 
signed statement issued to him by the insurer to the effect that the 
individual is disabled within the meaning of subdivision (i) of this 
paragraph. Such statement must set forth the basis for the insurer's 
determination that the individual was so disabled, and, for the first 
taxable year in which the individual is so disabled, the date such 
disability occurred.
    (c) Employer or charity a beneficiary--(1) General rule. Section 
79(b)(2) provides an exception with respect to the amounts referred to 
in section 79 (a) for the cost of any portion of the group-term life 
insurance on the life of an employee provided during part or all of the 
taxable year of the employee under which the employer is directly or 
indirectly the beneficiary, or under which a person described in section 
170(c) (relating to definition of charitable contributions) is the sole 
beneficiary, for the entire period during such taxable year for which 
the employee receives such insurance.
    (2) Employer is a beneficiary. For purposes of section 79(b)(2) and 
subparagraph (1) of this paragraph, the determination of whether the 
employer is directly or indirectly the beneficiary under a policy or 
policies of group-term life insurance depends upon the facts and 
circumstances of the particular case. Such determination is not made 
solely with regard to whether the employer possesses all the incidents 
of ownership in the policy. Thus, for example, if the employer is the 
nominal beneficiary under a policy of group-term life insurance on the 
life of his employee but there is an arrangement whereby the employer is 
required to pay over all (or a portion) of the proceeds of such policy 
to the employee's estate or his beneficiary, the employer is not 
considered a beneficiary under such policy (or such portion of the 
policy).
    (3) Charity a beneficiary. (i) For purposes of section 79(b)(2) and 
subparagraph (1) of this paragraph, a person described in section 170(c) 
is a beneficiary under a policy providing group-term life insurance if 
such person is designated the beneficiary under the policy by any 
assignment or designation of beneficiary under the policy which, under 
the law of the jurisdiction which is applicable to the policy, has the 
effect of making such person the beneficiary under such policy (whether 
or not such designation is revocable during the taxable year). Such a 
designation may be made by the employee with respect to any portion of 
the group-term life insurance on his life. However, no deduction is 
allowed under section 170, relating to charitable, etc., contributions 
and gifts, with respect to any such assignment or designation.
    (ii) A person described in section 170(c) must be designated the 
sole beneficiary under the policy or portion of the policy. Such 
requirement is satisfied if the person described in section 170(c) is 
the beneficiary under such policy or portion of the policy, and there is 
no contingent or similar beneficiary under such policy or such portion 
other than a person described in section 170(c). A general ``preference 
beneficiary clause'' in a policy governing payment where there is no 
designated beneficiary in existence at the death of the employee will 
not of itself be considered to create a contingent or similar 
beneficiary. A person described in section 170(c) may be designated the 
beneficiary under a portion of the policy if such person is designated 
the sole beneficiary under a beneficiary designation which is expressed, 
for example, as a fraction of the amount of insurance on the insured's 
life.
    (iii) If a person described in section 170(c) is designated, before 
May 1, 1964, the beneficiary under the policy (or portion thereof) and 
such person remains the beneficiary for the period beginning May 1, 
1964, and ending with

[[Page 316]]

the close of the first taxable year of the employee ending after April 
30, 1964, such person shall be treated as the beneficiary under the 
policy (or the portion thereof) for the period beginning January 1, 
1964, and ending April 30, 1964.
    (d) Insurance contracts purchased under qualified employee plans. 
(1) Section 79(b)(3) provides an exception with respect to the cost of 
any group-term life insurance which is provided under a life insurance 
contract purchased as a part of a plan described in section 403(a), or 
purchased by a trust described in section 401(a) which is exempt from 
tax under section 501(a) if the proceeds of such contract are payable 
directly or indirectly to a participant in such trust or to a 
beneficiary of such participant. The provisions of section 72(m)(3) and 
Sec. 1.72-16 apply to the cost of such group-term life insurance, and, 
therefore, no part of such cost is excluded from the gross income of the 
employee by reason of the provisions of section 79.
    (2) Whether the life insurance protection on an employee's life is 
provided under a qualified employee plan referred to in subparagraph (1) 
of this paragraph depends upon the provisions of such plan. In 
determining whether a pension, profit-sharing, stock bonus, or annuity 
plan satisfies the requirements for qualification set forth in sections 
401(a) or 403(a), only group-term life insurance which is provided under 
such plan is taken into account.

[T.D. 6888, 31 FR 9201, July 6, 1966, as amended by T.D. 6919, 32 FR 
7390, May 18, 1967; T.D. 6985, 33 FR 19812, Dec. 27, 1968; T.D. 7623, 44 
FR 28800, May 17, 1979]



Sec. 1.79-3  Determination of amount equal to cost of group-term life 
insurance.

    (a) In general. This section prescribes the rules for determining 
the amount equal to the cost of group-term life insurance on an 
employee's life which is to be included in his gross income pursuant to 
the rule of inclusion set forth in section 79(a). Such amount is 
determined by--
    (1) Computing the cost of the portion of the group-term life 
insurance on the employee's life to be taken into account (determined in 
accordance with the rules set forth in paragraph (b) of this section) 
for each ``period of coverage'' (as defined in paragraph (c) of this 
section) and aggregating the costs so determined, then
    (2) Reducing the amount determined under subparagraph (1) of this 
paragraph by the amount determined in accordance with the rules set 
forth in paragraph (e) of this section, relating to the amount paid by 
the employee toward the purchase of group-term life insurance.
    (b) Determination of the portion of the group-term life insurance on 
the employee's life to be taken into account. (1) For each ``period of 
coverage'' (as defined in paragraph (c) of this section), the portion of 
the group-term life insurance to be taken into account in computing the 
amount includible in an employee's gross income for purposes of 
paragraph (a)(1) of this section is the sum of the proceeds payable upon 
the death of the employee under each policy, or portion of a policy, of 
group-term life insurance on such employee's life to which the rule of 
inclusion set forth in section 79(a) applies, less $50,000 of such 
insurance. Thus, the amount of any proceeds payable under a policy, or 
portion of a policy, which qualifies for one of the exceptions to the 
rule of inclusion provided by section 79(b) is not taken into account. 
For the regulations relating to such exceptions to the rule of 
inclusion, see Sec. 1.79-2.
    (2) For purposes of making the computation required by subparagraph 
(1) of this paragraph in any case in which the amount payable under the 
policy, or portion thereof, varies during the period of coverage, the 
amount payable under such policy during such period is considered to be 
the average of the amount payable under such policy at the beginning and 
the end of such period.
    (3)(i) For purposes of making the computation required by 
subparagraph (1) of this paragraph in any case in which the amount 
payable under the policy is not payable as a specific amount upon the 
death of the employee in full discharge of the liability of the insurer, 
and such form of payment is not one of alternative methods of payment, 
the amount payable under

[[Page 317]]

such policy is the present value of the agreement by the insurer under 
the policy to make the payments to the beneficiary or beneficiaries 
entitled to such amounts upon the employee's death. For each period of 
coverage, such present value is to be determined as if the first and 
last day of such period is the date of death of the employee.
    (ii) The present value of the agreement by the insurer under the 
policy to make payments shall be determined by the use of the mortality 
tables and interest rate employed by the insurer with respect to such a 
policy in calculating the amount held by the insurer (as defined in 
section 101(d)(2)), unless the Commissioner otherwise determines that a 
particular mortality table and interest rate, representative of the 
mortality table and interest rate used by commercial insurance companies 
with respect to such policies, shall be used to determine the present 
value of the policy for purposes of this subdivision.
    (iii) For purposes of making the computation required by subdivision 
(i) of this subparagraph in any case in which it is necessary to 
determine the age of an employee's beneficiary and such beneficiary 
remains the same (under the policy, or the portion of the policy, with 
respect to which the determination of the present value of the agreement 
of the insurer to pay benefits is being made) for the entire period 
during the employee's taxable year for which such policy is in effect, 
the age of such beneficiary is such beneficiary's age at his nearest 
birthday on June 30th of the calendar year.
    (iv) If the policy of group-term life insurance on the employee's 
life is such that the present value of the agreement by the insurer 
under the policy to pay benefits cannot be determined by the rules 
prescribed in this subparagraph, the taxpayer may submit with his return 
a computation of such present value, consistent with the actuarial and 
other assumptions set forth in this subparagraph, showing the 
appropriate factors applied in his case. Such computation shall be 
subject to the approval of the Commissioner upon examination of such 
return.
    (c) Period of coverage. For purposes of this section, the phrase 
``period of coverage'' means any one calendar month period, or part 
thereof, during the employee's taxable year during which the employee is 
provided group-term life insurance on his life to which the rule of 
inclusion set forth in section 79(a) applies. The phrase ``part 
thereof'' as used in the preceding sentence means any continuous period 
which is less than the one calendar month period referred to in the 
preceding sentence for which premiums are charged by the insurer.
    (d) The cost of the portion of the group-term life insurance on an 
employee's life. (1) This paragraph sets forth the rules for determining 
the cost, for each period of coverage, of the portion of the group-term 
life insurance on the employee's life to be taken into account in 
computing the amount includible in the employee's gross income for 
purposes of paragraph (a)(1) of this section. The portion of the group-
term life insurance on the employee's life to be taken into account is 
determined in accordance with the provisions of paragraph (b) of this 
section. Table I, which is set forth in subparagraph (2) of this 
paragraph, determines the cost for each $1,000 of such portion of the 
group-term life insurance on the employee's life for each one-month 
period. The cost of the portion of the group-term life insurance on the 
employee's life for each period of coverage of one month is obtained by 
multiplying the number of thousand dollars of such insurance computed to 
the nearest tenth which is provided during such period by the 
appropriate amount set forth in Table I. In any case in which group-term 
life insurance is provided for a period of coverage of less than one 
month, the amount set forth in Table I is prorated over such period of 
coverage.
    (2) For the cost of group-term life insurance provided after June 
30, 1999, the following table sets forth the cost of $1,000 of group-
term life insurance provided for one month, computed on the basis of 5-
year age brackets. See 26 CFR 1.79-3(d)(2) in effect prior to July 1, 
1999, and contained in the 26 CFR part 1 edition revised as of April 1, 
1999, for a table setting forth the cost of

[[Page 318]]

group-term life insurance provided before July 1, 1999. For purposes of 
Table I, the age of the employee is the employee's attained age on the 
last day of the employee's taxable year.

    Table I--Uniform Premiums for $1,000 of Group-Term Life Insurance
                               Protection
------------------------------------------------------------------------
                                                              Cost per
                                                              $1,000 of
                    5-year age bracket                       protection
                                                               for one
                                                                month
------------------------------------------------------------------------
Under 25..................................................         $0.05
25 to 29..................................................           .06
30 to 34..................................................           .08
35 to 39..................................................           .09
40 to 44..................................................           .10
45 to 49..................................................           .15
50 to 54..................................................           .23
55 to 59..................................................           .43
60 to 64..................................................           .66
65 to 69..................................................          1.27
70 and above..............................................          2.06
------------------------------------------------------------------------

    (3) The net premium cost of group-term life insurance as provided in 
Table I of subparagraph (2) of this paragraph applies only to the cost 
of group-term life insurance subject to the rule of inclusion set forth 
in section 79(a). Therefore, such net premium cost is not applicable to 
the determination of the cost of group-term life insurance provided 
under a policy which is not subject to such rule of inclusion.
    (e) Effective date--(1) General effective date for table. Except as 
provided in paragraph (e)(2) of this section, the table in paragraph 
(d)(2) of this section is applicable July 1, 1999. Until January 1, 
2000, an employer may calculate imputed income for all its employees 
under age 30 using the 5-year age bracket for ages 25 to 29.
    (2) Effective date for table for purposes of Sec. 1.79-0. For a 
policy of life insurance issued under a plan in existence on June 30, 
1999, which would not be treated as carried directly or indirectly by an 
employer under Sec. 1.79-0 (taking into account the Table I in effect 
on that date), until January 1, 2003, an employer may use either the 
table in paragraph (d)(2) of this section or the table in effect prior 
to July 1, 1999 (as described in paragraph (d)(2) of this section) for 
determining if the policy is carried directly or indirectly by the 
employer.
    (f) Amount paid by the employee toward the purchase of group-term 
life insurance. (1) Except as otherwise provided in subparagraph (2) of 
this paragraph, if an employee pays any amount toward the purchase of 
group-term life insurance provided for a taxable year which is subject 
to the rule of inclusion set forth in paragraph (a)(2) of Sec. 1.79-1, 
the sum of all such amounts is the amount referred to in section 
79(a)(2) and paragraph (a)(2) of this section. The rule of the preceding 
sentence applies even though the payments made by the employee are made 
with respect to a period of coverage during which no portion of the 
group-term life insurance on his life is taken into account under 
paragraph (b)(1) of this section.
    (2) In determining the amount paid by the employee for purposes of 
section 79(a)(2) and paragraph (a)(2) of this section, there is not 
taken into account any amounts paid by the employee for group-term life 
insurance provided (or to be provided) for a different taxable year 
(other than amounts applicable to regular pay periods extending into the 
next taxable year). Thus, for example, if part of an employee's payment 
during a taxable year represents a prepayment for insurance to be 
provided after his retirement, such part does not reduce the amount 
includible in his gross income for the current taxable year. 
Furthermore, in determining such amount, there is not taken into account 
any amount paid by an employee toward the purchase of group-term life 
insurance which qualifies for one of the exceptions described in section 
79(b). The amount paid by an employee toward the purchase of group-term 
life insurance which qualifies for one of the exceptions described in 
section 79(b) is determined under the rules of paragraph (a)(2) of Sec. 
1.79-2.
    (3) If payments are made by the employer and his employees to 
provide group-term life insurance which is subject to the rule of 
inclusion set forth in section 79(a) as well as to provide other 
benefits for the employees, and if the amount paid by the employee 
toward the purchase of such insurance cannot be determined by the 
provisions of the policy or plan under which such benefits are provided, 
then the determination of the portion of the cost of group-term life 
insurance (computed in accordance with the provisions of this section) 
which is attributable to the

[[Page 319]]

contributions of the employee shall be made in accordance with the 
provisions of this subparagraph. The amount paid by the employee toward 
the purchase of all the group-term life insurance on his life for his 
taxable year (or for the portion of his taxable year if such portion is 
the basis of the computation) under such group policy shall be an amount 
determined first by ascertaining the total amount paid by all employees 
who are covered for multiple benefits which is allocable toward the 
purchase of group-term life insurance on their lives for the year, and 
then by ascertaining the pro rata portion of such total amount 
attributable to the individual employee. The total amount paid by all 
employees who are covered for multiple benefits which is allocable 
toward the purchase of group-term life insurance on their lives with 
respect to such year shall be an amount which bears the same ratio to 
the total amount paid by all employees for multiple benefits with 
respect to such year as the aggregate premiums paid to the insurer for 
group-term life insurance on such employees' lives with respect to such 
year bears to the aggregate premiums paid to the insurer for such 
multiple benefits with respect to such year. The pro rata portion of 
such total amount attributable to the individual employee for the cost 
of group-term life insurance on his life shall be an amount which bears 
the same ratio to the total amount paid by all employees which is 
allocable toward the purchase of group-term insurance on their lives 
with respect to such year as the amount of group-term life insurance on 
the life of the employee at a specified time during the year, as 
determined by the employer, bears to the total amount of group-term life 
insurance on the lives of all employees insured for such multiple 
benefits at such time.
    (g) Effect of provision of other benefits--(1) In general. This 
paragraph discusses the effect of the provision of certain benefits 
other than group-term life insurance on the life of the employee if the 
provision of such benefits is contingent upon the underwriting of group-
term life insurance on the employee's life to which the rule of 
inclusion set forth in section 79(a) applies.
    (2) Dependent coverage. An amount equal to the cost of group-term 
life insurance on the life of the spouse or other family member of the 
employee which is provided under a policy of group-term life insurance 
carried directly or indirectly by his employer is not subject to the 
provisions of section 79 since it is not on the life of the employee. 
See paragraph (d)(2)(ii)(b) of Sec. 1.61-2 for rules regarding the tax 
treatment of such insurance.
    (3) Disability provisions. Payments made for disability benefits 
provided under a group-term life insurance contract are considered to 
constitute payments made for accident and health insurance. Thus, 
employer contributions to provide such benefits are excluded from gross 
income by reason of the provisions of section 106.
    (4) Cost of other benefits. If a benefit described in this paragraph 
is provided under a policy under which both the employer and his 
employees contribute, then, except as otherwise provided in this 
subparagraph, the employer and the employees will be treated as 
contributing toward the payment of such benefit at the same rate as they 
contribute toward the cost of group-term life insurance on the 
employees' lives. A separate allocation of employer and employee 
contributions for such benefits is permissible only if--
    (i) Such separate allocation is set forth in the group policy and is 
applicable to all the employees covered under such policy;
    (ii) Such separate allocation is followed in transactions between 
the insurer and the group-policyholder; and
    (iii) The allocation set forth in the policy satisfies the 
requirements of the law of the jurisdiction which is applicable to the 
contract regarding any minimum or maximum contribution rate by the 
employer or the employees.

(Secs. 79(c) and 7805 of the Internal Revenue Code of 1954 (78 Stat. 36, 
26 U.S.C. 79(c); 68A Stat. 917, 28 U.S.C. 7805))

[T.D. 6888, 31 FR 9203, July 6, 1966, as amended by T.D. 7623, 44 FR 
28800, May 17, 1979; T.D. 7924, 48 FR 54595, Dec. 6, 1983; T.D. 8273, 54 
FR 47979, Nov. 20, 1989; T.D. 8424, 57 FR 33635, July 30, 1992; T.D. 
8821, 64 FR 29790, June 3, 1999]

[[Page 320]]



Sec. 1.79-4T  Questions and answers relating to the nondiscrimination 
requirements for group-term life insurance (temporary).

    Q-1: When does section 79, as amended by the Tax Reform Act of 1984, 
become effective?
    A-1: (a) Generally, section 79, as amended, applies to taxable years 
(of the employee receiving insurance coverage) beginning after December 
31, 1983. There are, however, several exceptions to this effective date 
where there is coverage under a group-term life insurance plan of the 
employer that was in existence on January 1, 1984, or a comparable 
successor to such a plan maintained by the employer or a successor 
employer.
    (b) First, the new rules of section 79 (b) and (e), that require the 
inclusion in income of a retired employee of amounts attributable to the 
cost of group-term life insurance in excess of $50,000 and that include 
former employees within the definition of the term ``employee,'' will 
not apply to any employee who retired from employment on or before 
January 1, 1984.
    (c) Second, in the case of an individual who retires after January 
1, 1984, and before January 1, 1987, the new rules of section 79 (b) and 
(e) do not apply if (1) the individual attained age 55 on or before 
January 1, 1984, and (2) the plan was maintained by the same employer 
who employed the individual during 1983, or by a successor employer.
    (d) Third, in the case of an individual who retires after December 
31, 1986, the new rules of section 79 (b) and (e) do not apply if (1) 
the individual attained age 55 on or before January 1, 1984, (2) the 
plan was maintained by the same employer who employed the individual 
during 1983, or by a successor employer, and (3) the plan is not, after 
December 31, 1986, a discriminatory group-term life insurance plan (not 
taking into account any group-term life insurance coverage provided to 
employees who retired before January 1, 1987).
    (e) For purposes of determining whether a plan is, after December 
31, 1986, a discriminatory group-term life insurance plan, there shall 
be ignored any insurance coverage provided pursuant to a state law 
requirement that an insurer continue to provide insurance coverage for a 
period of time not in excess of two months following the termination of 
a policy.
    Q-2: What is meant by a ``group-term life insurance plan of the 
employer that was in existence on January 1, 1984''?
    A-2: A group-term life insurance plan of the employer was in 
existence on January 1, 1984, only if the group policy or policies 
providing group-term life insurance benefits under the plan were 
executed on or before January 1, 1984, and were not terminated prior to 
such date. The applicability of section 79, as amended, to an employee 
will not be affected by the transfer of the employee between employers 
treated as a single employer under section 79(d)(7) if the employee 
continues, after the transfer, to be provided with group-term life 
insurance benefits under a plan that is comparable (determined under the 
principles set forth in Q&A 3) to the plan provided by the former 
employer.
    Q-3: When is a plan of group-term life insurance a ``comparable 
successor'' to another such plan?
    A-3: A plan of group-term life insurance will be a comparable 
successor to another plan of group-term life insurance (the first plan) 
only if the plan does not differ from the first plan in any significant 
aspect with respect to individuals who are potentially eligible for 
benefits provided under the grandfather provisions in Q&A 1. These 
individuals consist of those persons who are covered under a plan of 
group-term life insurance of the employer that was in existence on 
January 1, 1984, or a comparable successor to such a plan maintained by 
the employer or a successor employer, and who either retired on or 
before January 1, 1984, or who both attained age 55 on or before January 
1, 1984, and were employed by the employer maintaining the plan (or a 
predecessor of that employer) during the year 1983. Accordingly, if 
significant additional or reduced benefits are provided only to 
individuals who are not described in the preceding sentence, the plan 
will be considered a comparable successor plan. A plan will not fail to 
be a comparable successor

[[Page 321]]

plan merely because the employer purchases a policy or policies 
identical to the employer's first plan from a different insurance 
company. If the new plan provides significant additional or reduced 
benefits (either as to the type or amount available) to employees, or 
provides benefits to a category of employees that was formerly excluded 
from participating in the plan, the plan is generally not a comparable 
successor to the first plan. However, a plan will not be considered as 
providing significant additional or reduced benefits merely because a 
participant's coverage is based on a percentage of compensation and the 
participant's compensation for the taxable year has been increased or 
decreased. Furthermore, a plan will not be considered a non-comparable 
successor plan merely because it is amended, either to decrease benefits 
provided to key employees or to increase benefits provided to non-key 
employees, solely in order to comply with the nondiscrimination 
requirements of section 79(d). Finally, a plan will not be considered a 
non-comparable successor plan merely because a policy that is part of a 
discriminatory plan is terminated in order to end discriminatory 
coverage.
    Q-4: For purposes of determining the effective date of section 79, 
as amended by the Tax Reform Act of 1984, what is a ``successor 
employer''?
    A-4: A successor employer is an employer who employs a group of 
individuals formerly employed by another employer as a result of a 
business merger, acquisition or division.
    Q-5: Under what circumstances will separate policies of group-term 
life insurance of an employer be considered to be a single plan in 
determining whether the employer's plan of group-term life insurance is 
discriminatory?
    A-5: All policies providing group-term life insurance to a common 
key employee or key employees (as defined in this Q&A) carried directly 
or indirectly by an employer (or by a group of employers described in 
section 79(d)(7)) will be considered as a single plan for purposes of 
determining whether an employer's group-term life insurance plan is 
discriminatory. For example, if a key employee receives $50,000 of 
group-term life insurance coverage under one policy and the same key 
employee receives an additional $250,000 of coverage under a separate 
group-term life insurance policy, the two policies will be treated as a 
single plan in determining whether the group-term life insurance 
provided by the employer is discriminatory. If it is discriminatory, the 
key employees covered by either policy will not receive the benefit of 
section 79(a)(1) or section 79(c) for either policy. The result is the 
same even if each policy, considered alone, would be nondiscriminatory. 
A policy that provides group-term life insurance to a key employee and a 
policy under which the same key employee is eligible to receive group-
term life insurance upon separation from service will be considered to 
provide group-term life insurance to a common key employee. In addition, 
an employer may treat two or more policies that do not provide group-
term life insurance to a common key employee as constituting a single 
plan for purposes of satisfying the nondiscrimination provisions of 
section 79(d). For example, if the employer provides group-term life 
insurance coverage for non-key employees under one policy and provides 
group-term life insurance coverage for key employees under a second 
policy, the two policies may be considered together in determining 
whether the requirements of section 79(d) are satisfied with regard to 
the second policy. For purposes of this section, the term ``key 
employee'' has the meaning given to such term by paragraph (1) of 
section 416(i), except that subparagraph (A)(iv) of such paragraph shall 
be applied by not taking into account employees described in section 
79(d)(3)(B) who are not participants in the plan. For purposes of this 
section, all references to ``plan year'' or ``plan years'' in section 
416(g)(4)(C) and section 416(i) shall be deleted and replaced with 
``taxable year of the employer'' or ``taxable years of the employer,'' 
respectively.
    Q-6: In the case of a discriminatory group-term life insurance plan, 
what amounts should be included in the gross income of a key employee?
    A-6: (a) In the case of a discriminatory group-term life insurance 
plan, each key employee must include in gross income for the taxable 
year the

[[Page 322]]

cost of his or her insurance benefit for that year provided by the 
employer under the plan.
    (b) The cost of group-term life insurance coverage provided by an 
employer for a key employee during the employee's taxable year is 
determined by apportioning the net premium (group premium less policy 
dividends, premium refunds or experience rating credits) allocable to 
the group-term life insurance coverage during the key employee's taxable 
year, less the actual cost allocated to other key employees pursuant to 
the method described in the subparagraph (d) of this answer, if 
applicable, among the covered employees. In the event that the employer 
has other forms and types of coverage with the same insurer, the 
employer must make a reasonable allocation of the total premiums paid to 
the insurer. For example, where an employer has both health insurance 
coverage and a plan of group-term life insurance with the same insurer, 
and there is no volume discount, the net premium for the plan of group-
term life insurance must include the excess, if any, of the payments the 
employer makes for the health insurance coverage over the payments the 
employer would make for such coverage if the plan of group-term life 
insurance for which this calculation is being made did not exist.
    (c) In general, the portion of the net premium for group-term life 
insurance that should be apportioned to a key employee, other than a key 
employee to whom the method in subparagraph (d) of this answer is 
applicable, is determined by: (1) Calculating a ``tabular'' premium for 
the entire group (with the exception of all key employees to whom the 
method in subparagraph (d) of this answer is applicable), in the manner 
described below, (2) determining the ratio of the total actual net 
premium (less the actual cost allocated to key employees pursuant to the 
method in the subparagraph (d) of this answer) to the total tabular 
premium and (3) multiplying the tabular premium for the key employee at 
his or her attained age by such ratio. Thus, if the total actual net 
premium is 125 percent of the total tabular premium for all covered 
employees and the tabular premium at the key employee's attained age is 
$2.00 per thousand per month, the cost for such employee would be $2.50 
per thousand per month ($2.00 times 125 percent). For these purposes the 
table used to calculate tabular premiums will be determined as follows:
    (i) If the group policy contains a reasonable table (based on 
recognized mortality assumptions) of premium rates on an attained age 
basis (which table may use age brackets not exceeding five years) with 
reference to which the group premium is determined, such table will be 
used;
    (ii) If such table is not available, the 1960 Basic Group Table 
published by the Society of Actuaries will be used.
    (d) In cases where the mortality charge for group-term life 
insurance coverage provided to a key employee is calculated separately 
by the insurer (for example, where the charge for the coverage provided 
to a key employee is based on a medical examination) and the amount of 
such mortality charge plus a proportionate share of the loading charge 
for the coverage provided to the group is higher than the amount that 
would be allocable to such employee under the allocation method in 
subparagraph (c) the cost of group-term life insurance coverage for that 
employee shall be that higher amount.
    Q-7: Must all active and former employees be considered in applying 
the coverage tests in section 79(d)(3) to determine whether or not a 
plan of group-term life insurance is discriminatory with respect to 
coverage?
    A-7: No. Generally, a plan of group-term life insurance which covers 
both active and former employees will not satisfy the nondiscrimination 
requirements of section 79(d) unless the coverage tests in section 
79(d)(3) are satisfied with respect to both the active and the former 
employees of the employer, except to the extent they are excluded from 
tests for discrimination by application of the grandfather provisions 
set forth in Q&A 1. However, for purposes of determining whether a plan 
is discriminatory with respect to coverage, the coverage tests must be 
applied separately to active and former employees. In addition, if the 
plan limits participation by former employees to employees who retired 
from employment

[[Page 323]]

with the employer, then only retired employees must be considered in 
applying the coverage tests to former employees. Also, in applying the 
coverage tests in section 79(d)(3), the employer may make reasonable 
mortality assumptions regarding former employees who are not covered 
under the plan but must be considered in applying the coverage tests. 
Furthermore, only those former employees who terminated employment on or 
after the earliest date of termination from employment for any former 
employee covered by the plan must be considered. Finally, for purposes 
of determining whether a plan of group-term life insurance of the 
employer (or a successor employer) that was in existence on January 1, 
1984 (or a comparable successor to such a plan) is discriminatory, after 
December 31, 1986, with respect to group-term life insurance coverage 
for former employees, coverage provided to employees who retired on or 
before December 31, 1986, shall not be taken into account.
    Q-8: Will a group-term life insurance plan be considered 
discriminatory if active employees receive greater benefits as a 
percentage of compensation than former employees, or vice versa?
    A-8: No. For purposes of determining whether a plan is 
discriminatory with respect to the type and amount of benefits 
available, insurance coverage for former employees must be tested 
separately from insurance coverage for active employees. For example, a 
group-term life insurance plan that provides group-term life insurance 
benefits equal to 200 percent of compensation for all active employees 
and 100 percent of final compensation (based on the average annual 
compensation for the final five years) for all former employees would 
satisfy the nondiscrimination requirements of section 79(d). However, a 
group-term life insurance plan that provides group-term life insurance 
benefits equal to 200 percent of compensation for all active employees 
and 100 percent of final compensation (based on the average annual 
compensation for the final five years) only for key employees who are no 
longer employed by the employer (or a successor employer) would not 
satisfy the nondiscrimination requirement of section 79(d)(2)(A).
    Q-9: Under what circumstances will the amount of benefits available 
under a plan of group-term life insurance be considered not to 
discriminate in favor of participants who are key employees?
    A-9: A plan of group-term life insurance will be considered not to 
discriminate in favor of participants who are key employees, as to the 
amount of benefits available, if the plan provides a fixed amount of 
insurance which is the same for all covered employees. In other 
circumstances, the determination of whether a plan is nondiscriminatory 
will be based on all of the facts and circumstances. Such plans will be 
considered not to discriminate in favor of participants who are key 
employees, as to the amount of benefits available, if the plan contains 
no group of employees described in the following sentence that, if 
tested separately, would fail to satisfy the requirements of section 
79(d)(2)(A). The group subject to separate testing under the preceding 
sentence consists of a key employee and all other participants 
(including other key employees) who receive, under the plan, an amount 
of insurance (as a multiple of compensation (either total compensation 
or the basic or regular rate of compensation)) that is equal to or 
greater than the amount of insurance received by such key employee. As 
described in Q&As 7&8, active and former employees are tested separately 
under section 79(d)(2)(A).

    Example: Assume that a plan of group-term life insurance has 500 
participants, 10 of whom are key employees. Under the plan, 400 of the 
non-key employees receive an amount of insurance equal to 100 percent of 
compensation, while all of the key employees and 90 of the non-key 
employees receive an amount of insurance equal to 200 percent of 
compensation. The plan will be considered not to discriminate in favor 
of the participants who are key employees because, tested separately, 
the group of participants receiving an amount of insurance equal to or 
greater than 200 percent of compensation would satisfy the requirements 
of section 79(d)(2)(A) (by reason of section 79(d)(3)(A)(ii)). If one of 
the key employees received an amount of insurance equal to 300 percent 
of compensation, the plan would be considered to discriminate in favor 
of participants who are key employees, because, tested separately, the 
group consisting of the single key employee receiving an amount of

[[Page 324]]

insurance equal to or greater than 300 percent of compensation would 
fail to satisfy the requirements of section 79(d)(2)(A).

    In determining the groups of employees that are tested separately 
for this purpose, allowance shall be made for reasonable differences in 
amount of insurance (as a multiple of compensation) due to rounding, the 
use of compensation brackets or other similar factors. Thus, if a plan 
bases group-term life insurance coverage on ``compensation brackets,'' 
it is not intended that any participants will be treated as receiving an 
amount of insurance (as a multiple of compensation) that is greater (or 
less) than that of any other participant merely because the first 
participant's compensation is at the lower (or higher) end of a 
compensation bracket while the second participant's compensation is at 
the higher (or lower) end of a compensation bracket. However, any 
compensation brackets utilized by a plan will be examined to determine 
if the brackets, or compensation groupings, result in discrimination in 
favor of key employees. In addition, a plan does not meet the 
requirements for nondiscrimination as to the type and amount of benefits 
available under the plan unless all types of benefits (including 
permanent benefits) and all terms and conditions with respect to such 
benefits which are available to any participant who is a key employee 
are also available on a nondiscriminatory basis to non-key employee 
participants.
    Q-10: How is additional coverage purchased by employees under a plan 
of group-term life insurance treated for purposes of determining whether 
a plan of group-term life insurance is discriminatory?
    A-10: (a) The extent to which employees purchase additional coverage 
under a plan of group-term life insurance is not taken into account for 
purposes of determining whether a plan of group-term life insurance is 
discriminatory. For example, a plan providing insurance to all employees 
of 1 times annual compensation, which gives all employees the option to 
purchase additional insurance of 1 times annual compensation at their 
own expense, would not be considered discriminatory as to the type and 
amount of benefits available, even if the group (or groups) of 
participants who purchase additional insurance, if tested separately, 
would not satisfy the requirements of section 79(d)(2)(A). Solely for 
this purpose, the choice of an amount of group-term life insurance as a 
benefit under a cafeteria plan will be treated as the purchase of group-
term life insurance by an employee. If additional insurance coverage is 
available to any key employee that is not available, on a 
nondiscriminatory basis, to non-key employees, the plan will be 
considered discriminatory, even if the full cost of such additional 
insurance coverage is paid by the employee(s) electing such benefits.
    (b) If the employer bears a part of the expense of any additional 
coverage that is purchased by an employee under a plan of group-term 
life insurance, the additional insurance shall be treated, in part, as 
an amount of insurance provided by the employer under the plan and, in 
part, as an amount of insurance purchased by the employee. Except to the 
extent provided in subparagraph (a) above, the portion of insurance 
treated as an amount of insurance purchased by the employee is not taken 
into account for purposes of determining whether the plan is 
discriminatory. Whether such insurance (together with any other 
insurance provided by the employer under the plan) will cause the plan 
to be considered to discriminate in favor of participants who are key 
employees is determined under the rules of Q&A 9.
    Q-11: What effect do the provisions of section 79(d)(1) have if a 
plan of group-term life insurance is discriminatory for only part of a 
year?
    A-11: If a plan of group-term life insurance is discriminatory at 
any time during the key employee's taxable year, then it is a 
discriminatory group-term life insurance plan for that taxable year and 
the provisions of section 79(d)(1) will be applicable with respect to 
all group-term life insurance costs allocable to that employee for that 
year.
    Q-12: Are the section 79(d) provisions independent from the 
requirements contained in Treas. Reg. Sec. 1.79-1?
    A-12: Yes. Treasury regulation Sec. 1.79-1(c)(1) provides that life 
insurance provided to a group of employees cannot

[[Page 325]]

qualify as group-term life insurance if it is provided to less than ten 
full-time employees unless certain requirements are satisfied. The 
satisfaction of these requirements does not guarantee that the plan will 
be nondiscriminatory, and vice versa. Treasury regulation Sec. 1.79-
1(a)(4) provides that life insurance is not group-term life insurance 
unless the amount of insurance provided to each employee is computed 
under a formula that precludes individual selection. The mere fact that 
a life insurance policy is nondiscriminatory is not determinative as to 
whether the policy precludes individual selection, and vice versa.

[T.D. 8073, 51 FR 4315, Feb. 4, 1986; 51 FR 7262, Mar. 3, 1986]



Sec. 1.82-1  Payments for or reimbursements of expenses of moving from 
one residence to another residence attributable to employment or self-employment.

    (a) Reimbursements in gross income--(1) In general. Any amount 
received or accrued, directly or indirectly, by an individual as a 
payment for or reimbursement of expenses of moving from one residence to 
another residence attributable to employment or self-employment is 
includible in gross income under section 82 as compensation for services 
in the taxable year received or accrued. For rules relating to the year 
a deduction may be allowed for expenses of moving from one residence to 
another residence, see section 217 and the regulations thereunder.
    (2) Amounts received or accrued as reimbursement or payment. For 
purposes of this section, amounts are considered as being received or 
accrued by an individual as reimbursement or payment whether received in 
the form of money, property, or services. A cash basis taxpayer will 
include amounts in gross income under section 82 when they are received 
or treated as received by him. Thus, for example, if an employer moves 
an employee's household goods and personal effects from the employee's 
old resident to his new residence using the employer's facilities, the 
employee is considered as having received a payment in the amount of the 
fair market value of the services furnished at the time the services are 
furnished by the employer. If the employer pays a mover for moving the 
employee's household goods and personal effects, the employee is 
considered as having received the payment at the time the employer pays 
the mover, rather than at the time the mover moves the employee's 
household goods and personal effects. Where an employee receives a loan 
or advance from an employer to enable him to pay his moving expenses, 
the employee will not be deemed to have received a reimbursement of 
moving expenses until such time as he accounts to his employer if he is 
not required to repay such loan or advance and if he makes such 
accounting within a reasonable time. Such loan or advance will be deemed 
to be a reimbursement of moving expenses at the time of such accounting 
to the extent used by the employee for such moving expenses.
    (3) Direct or indirect payments or reimbursements. For purposes of 
this section amounts are considered as being received or accrued whether 
received directly (paid or provided to an individual by an employer, a 
client, a customer, or similar person) or indirectly (paid to a third 
party on behalf of an individual by an employer, a client, a customer, 
or similar person). Thus, if an employer pays a mover for the expenses 
of moving an employee's household goods and personal effects from one 
residence to another residence, the employee has indirectly received a 
payment which is includible in his gross income under section 82.
    (4) Expenses of moving from one residence to another residence. An 
expense of moving from one residence to another residence is any 
expenditure, cost, loss, or similar item paid or incurred in connection 
with a move from one residence to another residence. Moving expenses 
include (but are not limited to) any expenditure, cost, loss, or similar 
item directly or indirectly resulting from the acquisition, sale, or 
exchange of property, the transportation of goods or property, or travel 
(by the taxpayer or any other person) in connection with a change in 
residence. Such expenses include items described in section 217(b) 
(relating to the

[[Page 326]]

definition of moving expenses), irrespective of the dollar limitations 
contained in section 217(b)(3) and the conditions contained in section 
217(c), as well as items not described in section 217 (b), such as a 
loss sustained on the sale or exchange of personal property, storage 
charges, taxes, or expenses of refitting rugs or draperies.
    (5) Attributable to employment or self-employment. Any amount 
received or accrued from an employer, a client, a customer, or similar 
person in connection with the performance of services for such employer, 
client, customer, or similar person, is attributable to employment or 
self-employment. Thus, for example, if an employer reimburses an 
employee for a loss incurred on the sale of the employee's house, 
reimbursement is attributable to the performance of services if made 
because of the employer-employee relationship. Similarly, if an employer 
in order to prevent an employee's sustaining a loss on a sale of a house 
acquires the property from the employee at a price in excess of fair 
market value, the employee is considered to have received a payment 
attributable to employment to the extent that such payment exceeds the 
fair market value of the property.
    (b) Effective date--(1) In general. Except as provided in 
subparagraph (2) of this paragraph, paragraph (a) of this section is 
applicable only to amounts received or accrued in taxable years 
beginning after December 31, 1969.
    (2) Election with respect to payments or reimbursements for expenses 
paid or incurred before January 1, 1971. Paragraph (a) of this section 
does not apply with respect to moving expenses paid or incurred before 
January 1, 1971, in connection with the commencement of work by an 
employee at a new principal place of work where such employee had been 
notified by his employer on or before December 19, 1969, of such move 
and the employee makes an election under paragraph (h) of Sec. 1.217-2.

[T.D. 7195, 37 FR 13533, July 11, 1972, as amended by T.D. 7578, 43 FR 
59355, Dec. 20, 1978]



Sec. 1.83-1  Property transferred in connection with the performance 
of services.

    (a) Inclusion in gross income--(1) General rule. Section 83 provides 
rules for the taxation of property transferred to an employee or 
independent contractor (or beneficiary thereof) in connection with the 
performance of services by such employee or independent contractor. In 
general, such property is not taxable under section 83(a) until it has 
been transferred (as defined in Sec. 1.83-3(a)) to such person and 
become substantially vested (as defined in Sec. 1.83-3(b)) in such 
person. In that case, the excess of--
    (i) The fair market value of such property (determined without 
regard to any lapse restriction, as defined in Sec. 1.83-3(i)) at the 
time that the property becomes substantially vested, over
    (ii) The amount (if any) paid for such property,

shall be included as compensation in the gross income of such employee 
or independent contractor for the taxable year in which the property 
becomes substantially vested. Until such property becomes substantially 
vested, the transferor shall be regarded as the owner of such property, 
and any income from such property received by the employee or 
independent contractor (or beneficiary thereof) or the right to the use 
of such property by the employee or independent contractor constitutes 
additional compensation and shall be included in the gross income of 
such employee or independent contractor for the taxable year in which 
such income is received or such use is made available. This paragraph 
applies to a transfer of property in connection with the performance of 
services even though the transferor is not the person for whom such 
services are performed.
    (2) Life insurance. The cost of life insurance protection under a 
life insurance contract, retirement income contract, endowment contract, 
or other contract providing life insurance protection is taxable 
generally under section 61 and the regulations thereunder during the 
period such contract remains substantially nonvested (as defined in 
Sec. 1.83-3(b)). For the taxation of life insurance protection under a 
split-

[[Page 327]]

dollar life insurance arrangement (as defined in Sec. 1.61-22(b)(1) or 
(2)), see Sec. 1.61-22.
    (3) Cross references. For rules concerning the treatment of 
employers and other transferors of property in connection with the 
performance of services, see section 83(h) and Sec. 1.83-6. For rules 
concerning the taxation of beneficiaries of an employees' trust that is 
not exempt under section 501(a), see section 402(b) and the regulations 
thereunder.
    (b) Subsequent sale, forfeiture, or other disposition of nonvested 
property. (1) If substantially nonvested property (that has been 
transferred in connection with the performance of services) is 
subsequently sold or otherwise disposed of to a third party in an arm's 
length transaction while still substantially nonvested, the person who 
performed such services shall realize compensation in an amount equal to 
the excess of--
    (i) The amount realized on such sale or other disposition, over
    (ii) The amount (if any) paid for such property.

Such amount of compensation is includible in his gross income in 
accordance with his method of accounting. Two preceding sentences also 
apply when the person disposing of the property has received it in a 
non-arm's length transaction described in paragraph (c) of this section. 
In addition, section 83(a) and paragraph (a) of this section shall 
thereafter cease to apply with respect to such property.
    (2) If substantially nonvested property that has been transferred in 
connection with the performance of services to the person performing 
such services is forfeited while still substantially nonvested and held 
by such person, the difference between the amount paid (if any) and the 
amount received upon forfeiture (if any) shall be treated as an ordinary 
gain or loss. This paragraph (b)(2) does not apply to property to which 
Sec. 1.83-2(a) applies.
    (3) This paragraph (b) shall not apply to, and no gain shall be 
recognized on, any sale, forfeiture, or other disposition described in 
this paragraph to the extent that any property received in exchange 
therefor is substantially nonvested. Instead, section 83 and this 
section shall apply with respect to such property received (as if it 
were substituted for the property disposed of).
    (c) Dispositions of nonvested property not at arm's length. If 
substantially nonvested property (that has been transferred in 
connection with the performance of services) is disposed of in a 
transaction which is not at arm's length and the property remains 
substantially nonvested, the person who performed such services realizes 
compensation equal in amount to the sum of any money and the fair market 
value of any substantially vested property received in such disposition. 
Such amount of compensation is includible in his gross income in 
accordance with his method of accounting. However, such amount of 
compensation shall not exceed the fair market value of the property 
disposed of at the time of disposition (determined without regard to any 
lapse restriction), reduced by the amount paid for such property. In 
addition, section 83 and these regulations shall continue to apply with 
respect to such property, except that any amount previously includible 
in gross income under this paragraph (c) shall thereafter be treated as 
an amount paid for such property. For example, if in 1971 an employee 
pays $50 for a share of stock which has a fair market value of $100 and 
is substantially monvested at that time and later in 1971 (at a time 
when the property still has a fair market value of $100 and is still 
substantially nonvested) the employee disposes of, in a transaction not 
at arm's length, the share of stock to his wife for $10, the employee 
realizes compensation of $10 in 1971. If in 1972, when the share of 
stock has a fair market value of $120, it becomes substantially vested, 
the employee realizes additional compensation in 1972 in the amount of 
$60 (the $120 fair market value of the stock less both the $50 price 
paid for the stock and the $10 taxed as compensation in 1971). For 
purposes of this paragraph, if substantially nonvested property has been 
transferred to a person other than the person who performed the 
services, and the transferee dies holding the property while the 
property is still substantially nonvested and while the person who 
performed the services is alive, the

[[Page 328]]

transfer which results by reason of the death of such transferee is a 
transfer not at arm's length.
    (d) Certain transfers upon death. If substantially nonvested 
property has been transferred in connection with the performance of 
services and the person who performed such services dies while the 
property is still substantially nonvested, any income realized on or 
after such death with respect to such property under this section is 
income in respect of a decedent to which the rules of section 691 apply. 
In such a case the income in respect of such property shall be taxable 
under section 691 (except to the extent not includible under section 
101(b)) to the estate or beneficiary of the person who performed the 
services, in accordance with section 83 and the regulations thereunder. 
However, if an item of income is realized upon such death before July 
21, 1978, because the property became substantially vested upon death, 
the person responsible for filing decedent's income tax return for 
decedent's last taxable year may elect to treat such item as includible 
in gross income for decedent's last taxable year by including such item 
in gross income on the return or amended return filed for decedent's 
last taxable year.
    (e) Forfeiture after substantial vesting. If a person is taxable 
under section 83(a) when the property transferred becomes substantially 
vested and thereafter the person's beneficial interest in such property 
is nevertheless forfeited pursuant to a lapse restriction, any loss 
incurred by such person (but not by a beneficiary of such person) upon 
such forfeiture shall be an ordinary loss to the extent the basis in 
such property has been increased as a result of the recognition of 
income by such person under section 83(a) with respect to such property.
    (f) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example (1). On November 1, 1978, X corporation sells to E, an 
employee, 100 shares of X corporation stock at $10 per share. At the 
time of such sale the fair market value of the X corporation stock is 
$100 per share. Under the terms of the sale each share of stock is 
subject to a substantial risk of forfeiture which will not lapse until 
November 1, 1988. Evidence of this restriction is stamped on the face of 
E's stock certificates, which are therefore nontransferable (within the 
meaning of Sec. 1.83-3(d)). Since in 1978 E's stock is substantially 
nonvested, E does not include any of such amount in his gross income as 
compensation in 1978. On November 1, 1988, the fair market value of the 
X corporation stock is $250 per share. Since the X corporation stock 
becomes substantially vested in 1988, E must include $24,000 (100 shares 
of X corporation stock x $250 fair market value per share less $10 price 
paid by E for each share) as compensation for 1988. Dividends paid by X 
to E on E's stock after it was transferred to E on November 1, 1973, are 
taxable to E as additional compensation during the period E's stock is 
substantially nonvested and are deductible as such by X.
    Example (2). Assume the facts are the same as in example (1), except 
that on November 1, 1985, each share of stock of X corporation in E's 
hands could as a matter of law be transferred to a bona fide purchaser 
who would not be required to forfeit the stock if the risk of forfeiture 
materialized. In the event, however, that the risk materializes, E would 
be liable in damages to X. On November 1, 1985, the fair market value of 
the X corporation stock is $230 per share. Since E's stock is 
transferable within the meaning of Sec. 1.83-3(d) in 1985, the stock is 
substantially vested and E must include $22,000 (100 shares of X 
corporation stock x $230 fair market value per share less $10 price paid 
by E for each share) as compensation for 1985.
    Example (3). Assume the facts are the same as in example (1) except 
that, in 1984 E sells his 100 shares of X corporation stock in an arm's 
length sale to I, an investment company, for $120 per share. At the time 
of this sale each share of X corporation's stock has a fair market value 
of $200. Under paragraph (b) of this section, E must include $11,000 
(100 shares of X corporation stock x $120 amount realized per share less 
$10 price paid by E per share) as compensation for 1984 notwithstanding 
that the stock remains nontransferable and is still subject to a 
substantial risk of forfeiture at the time of such sale. Under Sec. 
1.83-4(b)(2), I's basis in the X corporation stock is $120 per share.

[T.D. 7554, 43 FR 31913, July 24, 1978, as amended by T.D. 9092, 68 FR 
54351, Sept. 17, 2003]



Sec. 1.83-2  Election to include in gross income in year of transfer.

    (a) In general. If property is transferred (within the meaning of 
Sec. 1.83-3(a)) in connection with the performance of services, the 
person performing such services may elect to include in gross income 
under section 83(b) the excess (if any) of the fair market value of the 
property at the time of transfer

[[Page 329]]

(determined without regard to any lapse restriction, as defined in Sec. 
1.83-3(i)) over the amount (if any) paid for such property, as 
compensation for services. The fact that the transferee has paid full 
value for the property transferred, realizing no bargain element in the 
transaction, does not preclude the use of the election as provided for 
in this section. If this election is made, the substantial vesting rules 
of section 83(a) and the regulations thereunder do not apply with 
respect to such property, and except as otherwise provided in section 
83(d)(2) and the regulations thereunder (relating to the cancellation of 
a nonlapse restriction), any subsequent appreciation in the value of the 
property is not taxable as compensation to the person who performed the 
services. Thus, property with respect to which this election is made 
shall be includible in gross income as of the time of transfer, even 
though such property is substantially nonvested (as defined in Sec. 
1.83-3(b)) at the time of transfer, and no compensation will be 
includible in gross income when such property becomes substantially 
vested (as defined in Sec. 1.83-3(b)). In computing the gain or loss 
from the subsequent sale or exchange of such property, its basis shall 
be the amount paid for the property increased by the amount included in 
gross income under section 83(b). If property for which a section 83(b) 
election is in effect is forfeited while substantially nonvested, such 
forfeiture shall be treated as a sale or exchange upon which there is 
realized a loss equal to the excess (if any) of--
    (1) The amount paid (if any) for such property, over,
    (2) The amount realized (if any) upon such forfeiture.

If such property is a capital asset in the hands of the taxpayer, such 
loss shall be a capital loss. A sale or other disposition of the 
property that is in substance a forfeiture, or is made in contemplation 
of a forfeiture, shall be treated as a forfeiture under the two 
immediately preceding sentences.
    (b) Time for making election. Except as provided in the following 
sentence, the election referred to in paragraph (a) of this section 
shall be filed not later than 30 days after the date the property was 
transferred (or, if later, January 29, 1970) and may be filed prior to 
the date of transfer. Any statement filed before February 15, 1970, 
which was amended not later than February 16, 1970, in order to make it 
conform to the requirements of paragraph (e) of this section, shall be 
deemed a proper election under section 83(b).
    (c) Manner of making election. The election referred to in paragraph 
(a) of this section is made by filing one copy of a written statement 
with the internal revenue office with whom the person who performed the 
services files his return. In addition, one copy of such statement shall 
be submitted with this income tax return for the taxable year in which 
such property was transferred.
    (d) Additional copies. The person who performed the services shall 
also submit a copy of the statement referred to in paragraph (c) of this 
section to the person for whom the services are performed. In addition, 
if the person who performs the services and the transferee of such 
property are not the same person, the person who performs the services 
shall submit a copy of such statement to the transferee of the property.
    (e) Content of statement. The statement shall be signed by the 
person making the election and shall indicate that it is being made 
under section 83(b) of the Code, and shall contain the following 
information:
    (1) The name, address and taxpayer identification number of the 
taxpayer;
    (2) A description of each property with respect to which the 
election is being made;
    (3) The date or dates on which the property is tansferred and the 
taxable year (for example, ``calendar year 1970'' or ``fiscal year 
ending May 31, 1970'') for which such election was made;
    (4) The nature of the restriction or restrictions to which the 
property is subject;
    (5) The fair market value at the time of transfer (determined 
without regard to any lapse restriction, as defined in Sec. 1.83-3(i)) 
of each property with respect to which the election is being made;
    (6) The amount (if any) paid for such property; and

[[Page 330]]

    (7) With respect to elections made after July 21, 1978, a statement 
to the effect that copies have been furnished to other persons as 
provided in paragraph (d) of this section.
    (f) Revocability of election. An election under section 83(b) may 
not be revoked except with the consent of the Commissioner. Consent will 
be granted only in the case where the transferee is under a mistake of 
fact as to the underlying transaction and must be requested within 60 
days of the date on which the mistake of fact first became known to the 
person who made the election. In any event, a mistake as to the value, 
or decline in the value, of the property with respect to which an 
election under section 83(b) has been made or a failure to perform an 
act contemplated at the time of transfer of such property does not 
constitute a mistake of fact.

[T.D. 7554, 43 FR 31915, July 24, 1978]



Sec. 1.83-3  Meaning and use of certain terms.

    (a) Transfer--(1) In general. For purposes of section 83 and the 
regulations thereunder, a transfer of property occurs when a person 
acquires a beneficial ownership interest in such property (disregarding 
any lapse restriction, as defined in Sec. 1.83-3(i)). For special rules 
applying to the transfer of a life insurance contract (or an undivided 
interest therein) that is part of a split-dollar life insurance 
arrangement (as defined in Sec. 1.61-22(b)(1) or (2)), see Sec. 1.61-
22(g).
    (2) Option. The grant of an option to purchase certain property does 
not constitute a transfer of such property. However, see Sec. 1.83-7 
for the extent to which the grant of the option itself is subject to 
section 83. In addition, if the amount paid for the transfer of property 
is an indebtedness secured by the transferred property, on which there 
is no personal liability to pay all or a substantial part of such 
indebtedness, such transaction may be in substance the same as the grant 
of an option. The determination of the substance of the transaction 
shall be based upon all the facts and circumstances. The factors to be 
taken into account include the type of property involved, the extent to 
which the risk that the property will decline in value has been 
transferred, and the likelihood that the purchase price will, in fact, 
be paid. See also Sec. 1.83-4(c) for the treatment of forgiveness of 
indebtedness that has constituted an amount paid.
    (3) Requirement that property be returned. Similarly, no transfer 
may have occurred where property is transferred under conditions that 
require its return upon the happening of an event that is certain to 
occur, such as the termination of employment. In such a case, whether 
there is, in fact, a transfer depends upon all the facts and 
circumstances. Factors which indicate that no transfer has occurred are 
described in paragraph (a) (4), (5), and (6) of this section.
    (4) Similarity to option. An indication that no transfer has 
occurred is the extent to which the conditions relating to a transfer 
are similar to an option.
    (5) Relationship to fair market value. An indication that no 
transfer has occurred is the extent to which the consideration to be 
paid the transferee upon surrendering the property does not approach the 
fair market value of the property at the time of surrender. For purposes 
of paragraph (a) (5) and (6) of this section, fair market value includes 
fair market value determined under the rules of Sec. 1.83-5(a)(1), 
relating to the valuation of property subject to nonlapse restrictions. 
Therefore, the existence of a nonlapse restriction referred to in Sec. 
1.83-5(a)(1) is not a factor indicating no transfer has occurred.
    (6) Risk of loss. An indication that no transfer has occurred is the 
extent to which the transferee does not incur the risk of a beneficial 
owner that the value of the property at the time of transfer will 
decline substantially. Therefore, for purposes of this (6), risk of 
decline in property value is not limited to the risk that any amount 
paid for the property may be lost.
    (7) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example (1). On January 3, 1971, X corporation sells for $500 to S, 
a salesman of X, 10 shares of stock in X corporation with a fair market 
value of $1,000. The stock is nontransferable and subject to return to 
the corporation (for $500) if S's sales do not reach a certain level by 
December 31, 1971. Disregarding the restriction concerning S's

[[Page 331]]

sales (since the restrictions is a lapse restriction), S's interest in 
the stock is that of a beneficial owner and therefore a transfer occurs 
on January 3, 1971.
    Example (2). On November 17, 1972, W sells to E 100 shares of stock 
in W corporation with a fair market value of $10,000 in exchange for a 
$10,000 note without personal liability. The note requires E to make 
yearly payments of $2,000 commencing in 1973. E collects the dividends, 
votes the stock and pays the interest on the note. However, he makes no 
payments toward the face amount of the note. Because E has no personal 
liability on the note, and since E is making no payments towards the 
face amount of the note, the likelihood of E paying the full purchase 
price is in substantial doubt. As a result E has not incurred the risks 
of a beneficial owner that the value of the stock will decline. 
Therefore, no transfer of the stock has occurred on November 17, 1972, 
but an option to purchase the stock has been granted to E.
    Example (3). On January 3, 1971, X corporation purports to transfer 
to E, an employee, 100 shares of stock in X corporation. The X stock is 
subject to the sole restriction that E must sell such stock to X on 
termination of employment for any reason for an amount which is equal to 
the excess (if any) of the book value of the X stock at termination of 
employment over book value on January 3, 1971. The stock is not 
transferable by E and the restrictions on transfer are stamped on the 
certificate. Under these facts and circumstances, there is no transfer 
of the X stock within the meeting of section 83.
    Example (4). Assume the same facts as in example (3) except that E 
paid $3,000 for the stock and that the restriction required E upon 
termination of employment to sell the stock to M for the total amount of 
dividends that have been declared on the stock since September 2, 1971, 
or $3,000 whichever is higher. Again, under the facts and circumstances, 
no transfer of the X stock has occurred.
    Example (5). On July 4, 1971, X corporation purports to transfer to 
G, an employee, 100 shares of X stock. The stock is subject to the sole 
restriction that upon termination of employment G must sell the stock to 
X for the greater of its fair market value at such time or $100, the 
amount G paid for the stock. On July 4, 1971 the X stock has a fair 
market value of $100. Therefore, G does not incur the risk of a 
beneficial owner that the value of the stock at the time of transfer 
($100) will decline substantially. Under these facts and circumstances, 
no transfer has occurred.

    (b) Substantially vested and substantially nonvested property. For 
purposes of section 83 and the regulations thereunder, property is 
substantially nonvested when it is subject to a substantial risk of 
forfeiture, within the meaning of paragraph (c) of this section, and is 
nontransferable, within the meaning of paragraph (d) of this section. 
Property is substantially vested for such purposes when it is either 
transferable or not subject to a substantial risk of forfeiture.
    (c) Substantial risk of forfeiture--(1) In general. For purposes of 
section 83 and the regulations thereunder, whether a risk of forfeiture 
is substantial or not depends upon the facts and circumstances. A 
substantial risk of forfeiture exists where rights in property that are 
transferred are conditioned, directly or indirectly, upon the future 
performance (or refraining from performance) of substantial services by 
any person, or the occurrence of a condition related to a purpose of the 
transfer, and the possibility of forfeiture is substantial if such 
condition is not satisfied.


Property is not transferred subject to a substantial risk of forfeiture 
to the extent that the employer is required to pay the fair market value 
of a portion of such property to the employee upon the return of such 
property. The risk that the value of property will decline during a 
certain period of time does not constitute a substantial risk of 
forfeiture. A nonlapse restriction, standing by itself, will not result 
in a substantial risk of forfeiture.
    (2) Illustrations of substantial risks of forfeiture. The regularity 
of the performance of services and the time spent in performing such 
services tend to indicate whether services required by a condition are 
substantial. The fact that the person performing services has the right 
to decline to perform such services without forfeiture may tend to 
establish that services are insubstantial. Where stock is transferred to 
an underwriter prior to a public offering and the full enjoyment of such 
stock is expressly or impliedly conditioned upon the successful 
completion of the underwriting, the stock is subject to a substantial 
risk of forfeiture. Where an employee receives property from an employer 
subject to a requirement that it be returned if the total earnings of 
the employer do not increase, such property is subject to a substantial 
risk of forfeiture. On the other hand,

[[Page 332]]

requirements that the property be returned to the employer if the 
employee is discharged for cause or for committing a crime will not be 
considered to result in a substantial risk of forfeiture. An enforceable 
requirement that the property be returned to the employer if the 
employee accepts a job with a competing firm will not ordinarily be 
considered to result in a substantial risk of forfeiture unless the 
particular facts and circumstances indicate to the contrary. Factors 
which may be taken into account in determining whether a convenant not 
to compete constitutes a substantial risk of forfeiture are the age of 
the employee, the availability of alternative employment opportunities, 
the likelihood of the employee's obtaining such other employment, the 
degree of skill possessed by the employee, the employee's health, and 
the practice (if any) of the employer to enforce such covenants. 
Similarly, rights in property transferred to a retiring employee subject 
to the sole requirement that it be returned unless he renders consulting 
services upon the request of his former employer will not be considered 
subject to a substantial risk of forfeiture unless he is in fact 
expected to perform substantial services.
    (3) Enforcement of forfeiture condition. In determining whether the 
possibility of forfeiture is substantial in the case of rights in 
property transferred to an employee of a corporation who owns a 
significant amount of the total combined voting power or value of all 
classes of stock of the employer corporation or of its parent 
corporation, there will be taken into account (i) the employee's 
relationship to other stockholders and the extent of their control, 
potential control and possible loss of control of the corporation, (ii) 
the position of the employee in the corporation and the extent to which 
he is subordinate to other employees, (iii) the employee's relationship 
to the officers and directors of the corporation, (iv) the person or 
persons who must approve the employee's discharge, and (v) past actions 
of the employer in enforcing the provisions of the restrictions. For 
example, if an employee would be considered as having received rights in 
property subject to a substantial risk of forfeiture, but for the fact 
that the employee owns 20 percent of the single class of stock in the 
transferor corporation, and if the remaining 80 percent of the class of 
stock is owned by an unrelated individual (or members of such an 
individual's family) so that the possibility of the corporation 
enforcing a restriction on such rights is substantial, then such rights 
are subject to a substantial risk of forfeiture. On the other hand, if 4 
percent of the voting power of all the stock of a corporation is owned 
by the president of such corporation and the remaining stock is so 
diversely held by the public that the president, in effect, controls the 
corporation, then the possibility of the corporation enforcing a 
restriction on rights in property transferred to the president is not 
substantial, and such rights are not subject to a substantial risk of 
forfeiture.
    (4) Examples. The rules contained in paragraph (c)(1) of this 
section may be illustrated by the following examples. In each example it 
is assumed that, if the conditions on transfer are not satisfied, the 
forfeiture provision will be enforced.

    Example (1). On November 1, 1971, corporation X transfers in 
connection with the performance of services to E, an employee, 100 
shares of corporation X stock for $90 per share. Under the terms of the 
transfer, E will be subject to a binding commitment to resell the stock 
to corporation X at $90 per share if he leaves the employment of 
corporation X for any reason prior to the expiration of a 2-year period 
from the date of such transfer. Since E must perform substantial 
services for corporation X and will not be paid more than $90 for the 
stock, regardless of its value, if he fails to perform such services 
during such 2-year period, E's rights in the stock are subject to a 
substantial risk of forfeiture during such period.
    Example (2). On November 10, 1971, corporation X transfers in 
connection with the performance of services to a trust for the benefit 
of employees, $100x. Under the terms of the trust any child of an 
employee who is an enrolled full-time student at an accredited 
educational institution as a candidate for a degree will receive an 
annual grant of cash for each academic year the student completes as a 
student in good standing, up to a maximum of four years. E, an employee, 
has a child who is enrolled as a full-time student at an accredited 
college as a candidate for a degree. Therefore, E has a beneficial 
interest in the assets of the trust equalling the value

[[Page 333]]

of four cash grants. Since E's child must complete one year of college 
in order to receive a cash grant, E's interest in the trust assets are 
subject to a substantial risk of forfeiture to the extent E's child has 
not become entitled to any grants.
    Example (3). On November 25, 1971, corporation X gives to E, an 
employee, in connection with his performance of services to corporation 
X, a bonus of 100 shares of corporation X stock. Under the terms of the 
bonus arrangement E is obligated to return the corporation X stock to 
corporation X if he terminates his employment for any reason. However, 
for each year occurring after November 25, 1971, during which E remains 
employed with corporation X, E ceases to be obligated to return 10 
shares of the corporation X stock. Since in each year occurring after 
November 25, 1971, for which E remains employed he is not required to 
return 10 shares of corporation X's stock, E's rights in 10 shares each 
year for 10 years cease to be subject to a substantial risk of 
forfeiture for each year he remains so employed.
    Example (4). (a) Assume the same facts as in example (3) except that 
for each year occurring after November 25, 1971, for which E remains 
employed with corporation X, X agrees to pay, in redemption of the bonus 
shares given to E if he terminates employment for any reason, 10 percent 
of the fair market value of each share of stock on the date of such 
termination of employment. Since corporation X will pay E 10 percent of 
the value of his bonus stock for each of the 10 years after November 25, 
1971, in which he remains employed by X, and the risk of a decline in 
value is not a substantial risk of forfeiture, E's interest in 10 
percent of such bonus stock becomes substantially vested in each of 
those years.
    (b) The following chart illustrates the fair market value of the 
bonus stock and the fair market value of the portion of bonus stock that 
becomes substantially vested on November 25, for the following years:

------------------------------------------------------------------------
                                                   Fair market value of
                                                 -----------------------
                                                              Portion of
                      Year                                    stock that
                                                   All stock    becomes
                                                                vested
------------------------------------------------------------------------
1972............................................        $200         $20
1973............................................         300          30
1974............................................         150          15
1975............................................         150          15
1976............................................         100          10
------------------------------------------------------------------------


If E terminates his employment on July 1, 1977, when the fair market 
value of the bonus stock is $100, E must return the bonus stock to X, 
and X must pay, in redemption of the bonus stock, $50 (50 percent of the 
value of the bonus stock on the date of termination of employment). E 
has recognized income under section 83(a) and Sec. 1.83-1(a) with 
respect to 50 percent of the bonus stock, and E's basis in that portion 
of the stock equals the amount of income recognized, $90. Under Sec. 
1.83-1(e), the $40 loss E incurred upon forfeiture ($90 basis less $50 
redemption payment) is an ordinary loss.
    Example (5). On January 7, 1971, corporation X, a computer service 
company, transfers to E, 100 shares of corporation X stock for $50. E is 
a highly compensated salesman who sold X's products in a three-state 
area since 1960. At the time of transfer each share of X stock has a 
fair market value of $100. The stock is transferred to E in connection 
with his termination of employment with X. Each share of X stock is 
subject to the sole condition that E can keep such share only if he does 
not engage in competition with X for a 5-year period in the three-state 
area where E had previously sold X's products. E, who is 45 years old, 
has no intention of retiring from the work force. In order to earn a 
salary comparable to his current compensation, while preventing the risk 
of forfeiture from arising, E will have to expend a substantial amount 
of time and effort in another industry or market to establish the 
necessary business contacts. Thus, under these facts and circumstances 
E's rights in the stock are subject to a substantial risk of forfeiture.

    (d) Transferability of property. For purposes of section 83 and the 
regulations thereunder, the rights of a person in property are 
transferable if such person can transfer any interest in the property to 
any person other than the transferor of the property, but only if the 
rights in such property of such transferee are not subject to a 
substantial risk of forfeiture. Accordingly, property is transferable if 
the person performing the services or receiving the property can sell, 
assign, or pledge (as collateral for a loan, or as security for the 
performance of an obligation, or for any other purpose) his interest in 
the property to any person other than the transferor of such property 
and if the transferee is not required to give up the property or its 
value in the event the substantial risk of forfeiture materializes. On 
the other hand, property is not considered to be transferable merely 
because the person performing the services or receiving the property may 
designate a beneficiary to receive the property in the event of his 
death.
    (e) Property. For purposes of section 83 and the regulations 
thereunder, the term ``property'' includes real and personal property 
other than either

[[Page 334]]

money or an unfunded and unsecured promise to pay money or property in 
the future. The term also includes a beneficial interest in assets 
(including money) which are transferred or set aside from the claims of 
creditors of the transferor, for example, in a trust or escrow account. 
See, however, Sec. 1.83-8(a) with respect to employee trusts and 
annuity plans subject to section 402(b) and section 403(c). In the case 
of a transfer of a life insurance contract, retirement income contract, 
endowment contract, or other contract providing life insurance 
protection, or any undivided interest therein, the policy cash value and 
all other rights under such contract (including any supplemental 
agreements thereto and whether or not guaranteed), other than current 
life insurance protection, are treated as property for purposes of this 
section. However, in the case of the transfer of a life insurance 
contract, retirement income contract, endowment contract, or other 
contract providing life insurance protection, which was part of a split-
dollar arrangement (as defined in Sec. 1.61-22(b)) entered into (as 
defined in Sec. 1.61-22(j)) on or before September 17, 2003, and which 
is not materially modified (as defined in Sec. 1.61-22(j)(2)) after 
September 17, 2003, only the cash surrender value of the contract is 
considered to be property. Where rights in a contract providing life 
insurance protection are substantially nonvested, see Sec. 1.83-1(a)(2) 
for rules relating to taxation of the cost of life insurance protection.
    (f) Property transferred in connection with the performance of 
services. Property transferred to an employee or an independent 
contractor (or beneficiary thereof) in recognition of the performance 
of, or the refraining from performance of, services is considered 
transferred in connection with the performance of services within the 
meaning of section 83. The existence of other persons entitled to buy 
stock on the same terms and conditions as an employee, whether pursuant 
to a public or private offering may, however, indicate that in such 
circumstances a transfer to the employee is not in recognition of the 
performance of, or the refraining from performance of, services. The 
transfer of property is subject to section 83 whether such transfer is 
in respect of past, present, or future services.
    (g) Amount paid. For purposes of section 83 and the regulations 
thereunder, the term ``amount paid'' refers to the value of any money or 
property paid for the transfer of property to which section 83 applies, 
and does not refer to any amount paid for the right to use such property 
or to receive the income therefrom. Such value does not include any 
stated or unstated interest payments. For rules regarding the 
calculation of the amount of unstated interest payments, see Sec. 
1.483-1(c). When section 83 applies to the transfer of property pursuant 
to the exercise of an option, the term ``amount paid'' refers to any 
amount paid for the grant of the option plus any amount paid as the 
exercise price of the option. For rules regarding the forgiveness of 
indebtedness treated as an amount paid, see Sec. 1.83-4(c).
    (h) Nonlapse restriction. For purposes of section 83 and the 
regulations thereunder, a restriction which by its terms will never 
lapse (also referred to as a ``nonlapse restriction'') is a permanent 
limitation on the transferability of property--
    (1) Which will require the transferee of the property to sell, or 
offer to sell, such property at a price determined under a formula, and
    (2) Which will continue to apply to and be enforced against the 
transferee or any subsequent holder (other than the transferor).

A limitation subjecting the property to a permanent right of first 
refusal in a particular person at a price determined under a formula is 
a permanent nonlapse restriction. Limitations imposed by registration 
requirements of State or Federal security laws or similar laws imposed 
with respect to sales or other dispositions of stock or securities are 
not nonlapse restrictions. An obligation to resell or to offer to sell 
property transferred in connection with the performance of services to a 
specific person or persons at its fair market value at the time of such 
sale is not a nonlapse restriction. See Sec. 1.83-5(c) for examples of 
nonlapse restrictions.

[[Page 335]]

    (i) Lapse restriction. For purposes of section 83 and the 
regulations thereunder, the term ``lapse restriction'' means a 
restriction other than a nonlapse restriction as defined in paragraph 
(h) of this section, and includes (but is not limited to) a restriction 
that carries a substantial risk of forfeiture.
    (j) Sales which may give rise to suit under section 16(b) of the 
Securities Exchange Act of 1934--(1) In general. For purposes of section 
83 and the regulations thereunder if the sale of property at a profit 
within six months after the purchase of the property could subject a 
person to suit under section 16(b) of the Securities Exchange Act of 
1934, the person's rights in the property are treated as subject to a 
substantial risk of forfeiture and as not transferable until the earlier 
of (i) the expiration of such six-month period, or (ii) the first day on 
which the sale of such property at a profit will not subject the person 
to suit under section 16(b) of the Securities Exchange Act of 1934. 
However, whether an option is ``transferable by the optionee'' for 
purposes of Sec. 1.83-7(b)(2)(i) is determined without regard to 
section 83(c)(3) and this paragraph (j).
    (2) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example (1). On January 1, 1983, X corporation sells to P, a 
beneficial owner of 12% of X corporation stock, in connection with P's 
performance of services, 100 shares of X corporation stock at $10 per 
share. At the time of the sale the fair market value of the X 
corporation stock is $100 per share. P, as a beneficial owner of more 
10% of X corporation stock, is liable to suit under section 16(b) of the 
Securities Exchange Act of 1934 for recovery of any profit from any sale 
and purchase or purchase and sale of X corporation stock within a six-
month period, but no other restrictions apply to the stock. Because the 
section 16(b) restriction is applicable to P, P's rights in the 100 
shares of stock purchased on January 1, 1983, are treated as subject to 
a substantial risk of forfeiture and as not transferable through June 
29, 1983. P chooses not to make an election under section 83 (b) and 
therefore does not include any amount with respect to the stock purchase 
in gross income as compensation on the date of purchase. On June 30, 
1983, the fair market value of X corporation stock is $250 per share. P 
must include $24,000 (100 shares of X corporation stock x $240 ($250 
fair market value per share less $10 price paid by P for each share)) in 
gross income as compensation on June 30, 1983. If, in this example, 
restrictions other than section 16(b) applied to the stock, such other 
restrictions (but not section 16(b)) would be taken into account in 
determining whether the stock is subject to a substantial risk of 
foreiture and is nontransferable for periods after June 29, 1983.
    Example (2). Assume the same facts as in example (1) except that P 
is not an insider on or after May 1, 1983, and the section 16(b) 
restriction does not apply beginning on that date. On May 1, 1983, P 
must include in gross income as compensation the difference between the 
fair market value of the stock on that date and the amount paid for the 
stock.
    Example (3). Assume the same facts as in example (1) except that on 
June 1, 1983, X corporation sells to P an additional 100 shares of X 
corporation stock at $20 per share. At the time of the sale the fair 
market value of the X corporation stock is $150 per share. On June 30, 
1983, P must include $24,000 in gross income as compensation with 
respect to the January 1, 1983 purchase. On November 30, 1983, the fair 
market value of X corporation stock is $200 per share. Accordingly, on 
that date P must include $18,000 (100 shares of X corporation stock x 
$180 ($200 fair market value per share less $20 price paid by P for each 
share)) in gross income as compensation with respect to the June 1, 1983 
purchase.

    (3) Effective date. This paragraph applies property transferred 
after December 31, 1981.
    (k) Special rule for certain accounting rules. (1) For purposes of 
section 83 and the regualtions thereunder, property is subject to 
substantial risk of forfeiture and is not transferable so long as the 
property is subject to a restriction on transfer to comply with the 
``Pooling-of-Interests Accounting'' rules set forth in Accounting Series 
Release Numbered 130 ((10/5/72) 37 FR 20937; 17 CFR 211.130) and 
Accounting Series Release Numbered 135 ((1/18/73) 38 FR 1734; 17 CFR 
211.135).
    (2) Effective date. This paragraph applies to property transferred 
after December 31, 1981.

[T.D. 7554, 43 FR 31916, July 24, 1978, as amended by T.D. 8042, 50 FR 
31713, Aug. 6, 1985; 50 FR 39664, Sept. 30, 1985; T.D. 9092, 68 FR 
54351, Sept. 17, 2003; T.D. 9223, 70 FR 50971, Aug. 29, 2005]

[[Page 336]]



Sec. 1.83-4  Special rules.

    (a) Holding period. Under section 83(f), the holding period of 
transferred property to which section 83(a) applies shall begin just 
after such property is substantially vested. However, if the person who 
has performed the services in connection with which property is 
transferred has made an election under section 83(b), the holding period 
of such property shall begin just after the date such property is 
transferred. If property to which section 83 and the regulations 
thereunder apply is transferred at arm's length, the holding period of 
such property in the hands of the transferee shall be determined in 
accordance with the rules provided in section 1223.
    (b) Basis. (1) Except as provided in paragraph (b)(2) of this 
section, if property to which section 83 and the regulations thereunder 
apply is acquired by any person (including a person who acquires such 
property in a subsequent transfer which is not at arm's length), while 
such property is still substantially nonvested, such person's basis for 
the property shall reflect any amount paid for such property and any 
amount includible in the gross income of the person who performed the 
services (including any amount so includible as a result of a 
disposition by the person who acquired such property.) Such basis shall 
also reflect any adjustments to basis provided under sections 1015 and 
1016.
    (2) If property to which Sec. 1.83-1 applies is transferred at 
arm's length, the basis of the property in the hands of the transferee 
shall be determined under section 1012 and the regulations thereunder.
    (c) Forgiveness of indebtedness treated as an amount paid. If an 
indebtedness that has been treated as an amount paid under Sec. 1.83-
1(a)(1)(ii) is subsequently cancelled, forgiven or satisfied for an 
amount less than the amount of such indebtedness, the amount that is 
not, in fact, paid shall be includible in the gross income of the 
service provider in the taxable year in which such cancellation, 
forgiveness or satisfaction occurs.

[T.D. 7554, 43 FR 31918, July 24, 1978]



Sec. 1.83-5  Restrictions that will never lapse.

    (a) Valuation. For purposes of section 83 and the regulations 
thereunder, in the case of property subject to a nonlapse restriction 
(as defined in Sec. 1.83-3(h)), the price determined under the formula 
price will be considered to be the fair market value of the property 
unless established to the contrary by the Commissioner, and the burden 
of proof shall be on the commissioner with respect to such value. If 
stock in a corporation is subject to a nonlapse restriction which 
requires the transferee to sell such stock only at a formula price based 
on book value, a reasonable multiple of earnings or a reasonable 
combination thereof, the price so determined will ordinarily be regarded 
as determinative of the fair market value of such property for purposes 
of section 83. However, in certain circumstances the formula price will 
not be considered to be the fair market value of property subject to 
such a formula price restriction, even though the formula price 
restriction is a substantial factor in determining such value. For 
example, where the formula price is the current book value of stock, the 
book value of the stock at some time in the future may be a more 
accurate measure of the value of the stock than the current book value 
of the stock for purposes of determining the fair market value of the 
stock at the time the stock becomes substantially vested.
    (b) Cancellation--(1) In general. Under section 83(d)(2), if a 
nonlapse restriction imposed on property that is subject to section 83 
is cancelled, then, unless the taxpayer establishes--
    (i) That such cancellation was not compensatory, and
    (ii) That the person who would be allowed a deduction, if any, if 
the cancellation were treated as compensatory, will treat the 
transaction as not compensatory, as provided in paragraph (c)(2) of this 
section, the excess of the fair market value of such property (computed 
without regard to such restriction) at the time of cancellation, over 
the sum of--
    (iii) The fair market value of such property (computed by taking the 
restriction into account) immediately before the cancellation, and

[[Page 337]]

    (iv) The amount, if any, paid for the cancellation, shall be treated 
as compensation for the taxable year in which such cancellation occurs. 
Whether there has been a noncompensatory cancellation of a nonlapse 
restriction under section 83(d)(2) depends upon the particular facts and 
circumstances. Ordinarily the fact that the employee or independent 
contractor is required to perform additional services or that the salary 
or payment of such a person is adjusted to take the cancellation into 
account indicates that such cancellation has a compensatory purpose. On 
the other hand, the fact that the original purpose of a restriction no 
longer exists may indicate that the purpose of such cancellation is 
noncompensatory. Thus, for example, if a so-called ``buy-sell'' 
restriction was imposed on a corporation's stock to limit ownership of 
such stock and is being cancelled in connection with a public offering 
of the stock, such cancellation will generally be regarded as 
noncompensatory. However, the mere fact that the employer is willing to 
forego a deduction under section 83(h) is insufficient evidence to 
establish a noncompensatory cancellation of a nonlapse restriction. The 
refusal by a corporation or shareholder to repurchase stock of the 
corporation which is subject to a permanent right of first refusal will 
generally be treated as a cancellation of a nonlapse restriction. The 
preceding sentence shall not apply where there is no nonlapse 
restriction, for example, where the price to be paid for the stock 
subject to the right of first refusal is the fair market value of the 
stock. Section 83(d)(2) and this (1) do not apply where immediately 
after the cancellation of a nonlapse restriction the property is still 
substantially nonvested and no section 83(b) election has been made with 
respect to such property. In such a case the rules of section 83(a) and 
Sec. 1.83-1 shall apply to such property.
    (2) Evidence of noncompensatory cancellation. In addition to the 
information necessary to establish the factors described in paragraph 
(b)(1) of this section, the taxpayer shall request the employer to 
furnish the taxpayer with a written statement indicating that the 
employer will not treat the cancellation of the nonlapse restriction as 
a compensatory event, and that no deduction will be taken with respect 
to such cancellation. The taxpayer shall file such written statement 
with his income tax return for the taxable year in which or with which 
such cancellation occurs.
    (c) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example (1). On November 1, 1971, X corporation whose shares are 
closely held and not regularly traded, transfers to E, an employee, 100 
shares of X corporation stock subject to the condition that, if he 
desires to dispose of such stock during the period of his employment, he 
must resell the stock to his employer at its then existing book value. 
In addition, E or E's estate is obligated to offer to sell the stock at 
his retirement or death to his employer at its then existing book value. 
Under these facts and circumstances, the restriction to which the shares 
of X corporation stock are subject is a nonlapse restriction. 
Consequently, the fair market value of the X stock is includible in E's 
gross income as compensation for taxable year 1971. However, in 
determining the fair market value of the X stock, the book value formula 
price will ordinarily be regarded as being determinative of such value.
    Example (2). Assume the facts are the same as in example (1), except 
that the X stock is subject to the condition that if E desires to 
dispose of the stock during the period of his employment he must resell 
the stock to his employer at a multiple of earnings per share that is in 
this case a reasonable approximation of value at the time of transfer to 
E. In addition, E or E's estate is obligated to offer to sell the stock 
at his retirement or death to his employer at the same multiple of 
earnings. Under these facts and circumstances, the restriction to which 
the X corporation stock is subject is a nonlapse restriction. 
Consequently, the fair market value of the X stock is includible in E's 
gross income for taxable year 1971. However, in determining the fair 
market value of the X stock, the multiple-of-earnings formula price will 
ordinarily be regarded as determinative of such value.
    Example (3). On January 4, 1971, X corporation transfers to E, an 
employee, 100 shares of stock in X corporation. Each such share of stock 
is subject to an agreement between X and E whereby E agrees that such 
shares are to be held solely for investment purposes and not for resale 
(a so-called investment letter restriction). E's rights in such stock 
are substantially vested upon transfer, causing the fair market value of 
each share of X corporation stock to be includible in E's gross income 
as compensation for taxable year 1971. Since such an investment letter 
restriction

[[Page 338]]

does not constitute a nonlapse restriction, in determining the fair 
market value of each share, the investment letter restriction is 
disregarded.
    Example (4). On September 1, 1971, X corporation transfers to B, an 
independent contractor, 500 shares of common stock in X corporation in 
exchange for B's agreement to provide services in the construction of an 
office building on property owned by X corporation. X corporation has 
100 shares of preferred stock outstanding and an additional 500 shares 
of common stock outstanding. The preferred stock has a liquidation value 
of $1,000x, which is equal to the value of all assets owned by X. 
Therefore, the book value of the common stock in X corporation is $0. 
Under the terms of the transfer, if B wishes to dispose of the stock, B 
must offer to sell the stock to X for 150 percent of the then existing 
book value of B's common stock. The stock is also subject to a 
substantial risk of forfeiture until B performs the agreed-upon 
services. B makes a timely election under section 83(b) to include the 
value of the stock in gross income in 1971. Under these facts and 
circumstances, the restriction to which the shares of X corporation 
common stock are subject is a nonlapse restriction. In determining the 
fair market value of the X common stock at the time of transfer, the 
book value formula price would ordinarily be regarded as determinative 
of such value. However, the fair market value of X common stock at the 
time of transfer, subject to the book value restriction, is greater than 
$0 since B was willing to agree to provide valuable personal services in 
exchange for the stock. In determining the fair market value of the 
stock, the expected book value after construction of the office building 
would be given great weight. The likelihood of completion of 
construction would be a factor in determining the expected book value 
after completion of construction.

[T.D. 7554, 43 FR 31918, July 24, 1978]



Sec. 1.83-6  Deduction by employer.

    (a) Allowance of deduction--(1) General rule. In the case of a 
transfer of property in connection with the performance of services, or 
a compensatory cancellation of a nonlapse restriction described in 
section 83(d) and Sec. 1.83-5, a deduction is allowable under section 
162 or 212 to the person for whom the services were performed. The 
amount of the deduction is equal to the amount included as compensation 
in the gross income of the service provider under section 83 (a), (b), 
or (d)(2), but only to the extent the amount meets the requirements of 
section 162 or 212 and the regulations thereunder. The deduction is 
allowed only for the taxable year of that person in which or with which 
ends the taxable year of the service provider in which the amount is 
included as compensation. For purposes of this paragraph, any amount 
excluded from gross income under section 79 or section 101(b) or 
subchapter N is considered to have been included in gross income.
    (2) Special Rule. For purposes of paragraph (a)(1) of this section, 
the service provider is deemed to have included the amount as 
compensation in gross income if the person for whom the services were 
performed satisfies in a timely manner all requirements of section 6041 
or section 6041A, and the regulations thereunder, with respect to that 
amount of compensation. For purposes of the preceding sentence, whether 
a person for whom services were performed satisfies all requirements of 
section 6041 or section 6041A, and the regulations thereunder, is 
determined without regard to Sec. 1.6041-3(c) (exception for payments 
to corporations). In the case of a disqualifying disposition of stock 
described in section 421(b), an employer that otherwise satisfies all 
requirements of section 6041 and the regulations thereunder will be 
considered to have done so timely for purposes of this paragraph (a)(2) 
if Form W-2 or Form W-2c, as appropriate, is furnished to the employee 
or former employee, and is filed with the federal government, on or 
before the date on which the employer files the tax return claiming the 
deduction relating to the disqualifying disposition.
    (3) Exceptions. Where property is substantially vested upon 
transfer, the deduction shall be allowed to such person in accordance 
with his method of accounting (in conformity with sections 446 and 461). 
In the case of a transfer to an employee benefit plan described in Sec. 
1.162-10(a) or a transfer to an employees' trust or annuity plan 
described in section 404(a)(5) and the regulations thereunder, section 
83(h) and this section do not apply.
    (4) Capital expenditure, etc. No deduction is allowed under section 
83(h) to the extent that the transfer of property constitutes a capital 
expenditure, an item of deferred expense, or an amount

[[Page 339]]

properly includible in the value of inventory items. In the case of a 
capital expenditure, for example, the basis of the property to which 
such capital expenditure relates shall be increased at the same time and 
to the same extent as any amount includible in the employee's gross 
income in respect of such transfer. Thus, for example, no deduction is 
allowed to a corporation in respect of a transfer of its stock to a 
promoter upon its organization, notwithstanding that such promoter must 
include the value of such stock in his gross income in accordance with 
the rules under section 83.
    (5) Transfer of life insurance contract (or an undivided interest 
therein)--(i) General rule. In the case of a transfer of a life 
insurance contract (or an undivided interest therein) described in Sec. 
1.61-22(c)(3) in connection with the performance of services, a 
deduction is allowable under paragraph (a)(1) of this section to the 
person for whom the services were performed. The amount of the 
deduction, if allowable, is equal to the sum of the amount included as 
compensation in the gross income of the service provider under Sec. 
1.61-22(g)(1) and the amount determined under Sec. 1.61-22(g)(1)(ii).
    (ii) Effective date--(A) General rule. Paragraph (a)(5)(i) of this 
section applies to any split-dollar life insurance arrangement (as 
defined in Sec. 1.61-22(b)(1) or (2)) entered into after September 17, 
2003. For purposes of this paragraph (a)(5), an arrangement is entered 
into as determined under Sec. 1.61-22(j)(1)(ii).
    (B) Modified arrangements treated as new arrangements. If an 
arrangement entered into on or before September 17, 2003 is materially 
modified (within the meaning of Sec. 1.61-22(j)(2)) after September 17, 
2003, the arrangement is treated as a new arrangement entered into on 
the date of the modification.
    (6) Effective date. Paragraphs (a)(1) and (2) of this section apply 
to deductions for taxable years beginning on or after January 1, 1995. 
However, taxpayers may also apply paragraphs (a)(1) and (2) of this 
section when claiming deductions for taxable years beginning before that 
date if the claims are not barred by the statute of limitations. 
Paragraphs (a) (3) and (4) of this section are effective as set forth in 
Sec. 1.83-8(b).
    (b) Recognition of gain or loss. Except as provided in section 1032, 
at the time of a transfer of property in connection with the performance 
of services the transferor recognizes gain to the extent that the 
transferor receives an amount that exceeds the transferor's basis in the 
property. In addition, at the time a deduction is allowed under section 
83(h) and paragraph (a) of this section, gain or loss is recognized to 
the extent of the difference between (1) the sum of the amount paid plus 
the amount allowed as a deduction under section 83(h), and (2) the sum 
of the taxpayer's basis in the property plus any amount recognized 
pursuant to the previous sentence.
    (c) Forfeitures. If, under section 83(h) and paragraph (a) of this 
section, a deduction, an increase in basis, or a reduction of gross 
income was allowable (disregarding the reasonableness of the amount of 
compensation) in respect of a transfer of property and such property is 
subsequently forfeited, the amount of such deduction, increase in basis 
or reduction of gross income shall be includible in the gross income of 
the person to whom it was allowable for the taxable year of forfeiture. 
The basis of such property in the hands of the person to whom it is 
forfeited shall include any such amount includible in the gross income 
of such person, as well as any amount such person pays upon forfeiture.
    (d) Special rules for transfers by shareholders--(1) Transfers. If a 
shareholder of a corporation transfers property to an employee of such 
corporation or to an independent contractor (or to a beneficiary 
thereof), in consideration of services performed for the corporation, 
the transaction shall be considered to be a contribution of such 
property to the capital of such corporation by the shareholder, and 
immediately thereafter a transfer of such property by the corporation to 
the employee or independent contractor under paragraphs (a) and (b) of 
this section. For purposes of this (1), such a transfer will be 
considered to be in consideration for services performed for the 
corporation if either the property transferred is substantially 
nonvested at the time of

[[Page 340]]

transfer or an amount is includible in the gross income of the employee 
or independent contractor at the time of transfer under Sec. 1.83-
1(a)(1) or Sec. 1.83-2(a). In the case of such a transfer, any money or 
other property paid to the shareholder for such stock shall be 
considered to be paid to the corporation and transferred immediately 
thereafter by the corporation to the shareholder as a distribution to 
which section 302 applies. For special rules that may applyto a 
corporation's transfer of its own stock to any person in consideration 
of services performed for another corporation or partnership, see Sec. 
1.1032-3. The preceding sentence applies to transfers of stock and 
amounts paid for such stock occurring on or after May 16, 2000.
    (2) Forfeiture. If, following a transaction described in paragraph 
(d)(1) of this section, the transferred property is forfeited to the 
shareholder, paragraph (c) of this section shall apply both with respect 
to the shareholder and with respect to the corporation. In addition, the 
corporation shall in the taxable year of forfeiture be allowed a loss 
(or realize a gain) to offset any gain (or loss) realized under 
paragraph (b) of this section. For example, if a shareholder transfers 
property to an employee of the corporation as compensation, and as a 
result the shareholder's basis of $200x in such property is allocated to 
his stock in such corporation and such corporation recognizes a short-
term capital gain of $800x, and is allowed a deduction of $1,000x on 
such transfer, upon a subsequent forfeiture of the property to the 
shareholder, the shareholder shall take $200x into gross income, and the 
corporation shall take $1,000x into gross income and be allowed a short-
term capital loss of $800x.
    (e) Options. [Reserved]
    (f) Reporting requirements. [Reserved]

[T.D. 7554, 43 FR 31919, July 24, 1978, as amended by T.D. 8599, July 
19, 1995; T.D. 8883, 65 FR 31076, May 16, 2000; T.D. 9092, 68 FR 54352, 
Sept. 17, 2003]



Sec. 1.83-7  Taxation of nonqualified stock options.

    (a) In general. If there is granted to an employee or independent 
contractor (or beneficiary thereof) in connection with the performance 
of services, an option to which section 421 (relating generally to 
certain qualified and other options) does not apply, section 83(a) shall 
apply to such grant if the option has a readily ascertainable fair 
market value (determined in accordance with paragraph (b) of this 
section) at the time the option is granted. The person who performed 
such services realizes compensation upon such grant at the time and in 
the amount determined under section 83(a). If section 83(a) does not 
apply to the grant of such an option because the option does not have a 
readily ascertainable fair market value at the time of grant, sections 
83(a) and 83(b) shall apply at the time the option is exercised or 
otherwise disposed of, even though the fair market value of such option 
may have become readily ascertainable before such time. If the option is 
exercised, sections 83(a) and 83(b) apply to the transfer of property 
pursuant to such exercise, and the employee or independent contractor 
realizes compensation upon such transfer at the time and in the amount 
determined under section 83(a) or 83(b). If the option is sold or 
otherwise disposed of in an arm's length transaction, sections 83(a) and 
83(b) apply to the transfer of money or other property received in the 
same manner as sections 83(a) and 83(b) would have applied to the 
transfer of property pursuant to an exercise of the option. The 
preceding sentence does not apply to a sale or other disposition of the 
option to a person related to the service provider that occurs on or 
after July 2, 2003. For this purpose, a person is related to the service 
provider if--
    (1) The person and the service provider bear a relationship to each 
other that is specified in section 267(b) or 707(b)(1), subject to the 
modifications that the language ``20 percent'' is used instead of ``50 
percent'' each place it appears in sections 267(b) and 707(b)(1), and 
section 267(c)(4) is applied as if the family of an individual includes 
the spouse of any member of the family; or
    (2) The person and the service provider are engaged in trades or 
businesses under common control (within the meaning of section 52(a) and 
(b)); provided that a person is not related to the service provider if 
the person is the

[[Page 341]]

service recipient with respect to the option or the grantor of the 
option.
    (b) Readily ascertainable defined--(1) Actively traded on an 
established market. Options have a value at the time they are granted, 
but that value is ordinarily not readily ascertainable unless the option 
is actively traded on an established market. If an option is actively 
traded on an established market, the fair market value of such option is 
readily ascertainable for purposes of this section by applying the rules 
of valuation set forth in Sec. 20.2031-2.
    (2) Not actively traded on an established market. When an option is 
not actively traded on an established market, it does not have a readily 
ascertainable fair market value unless its fair market value can 
otherwise be measured with reasonable accuracy. For purposes of this 
section, if an option is not actively traded on an established market, 
the option does not have a readily ascertainable fair market value when 
granted unless the taxpayer can show that all of the following 
conditions exist:
    (i) The option is transferable by the optionee;
    (ii) The option is exerciseable immediately in full by the optionee;
    (iii) The option or the property subject to the option is not 
subject to any restriction or condition (other than a lien or other 
condition to secure the payment of the purchase price) which has a 
significant effect upon the fair market value of the option; and
    (iv) The fair market value of the option privilege is readily 
ascertainable in accordance with paragraph (b)(3) of this section.
    (3) Option privilege. The option privilege in the case of an option 
to buy is the opportunity to benefit during the option's exercise period 
from any increase in the value of property subject to the option during 
such period, without risking any capital. Similarly, the option 
privilege in the case of an option to sell is the opportunity to benefit 
during the exercise period from a decrease in the value of property 
subject to the option. For example, if at some time during the exercise 
period of an option to buy, the fair market value of the property 
subject to the option is greater than the option's exercise price, a 
profit may be realized by exercising the option and immediately selling 
the property so acquired for its higher fair market value. Irrespective 
of whether any such gain may be realized immediately at the time an 
option is granted, the fair market value of an option to buy includes 
the value of the right to benefit from any future increase in the value 
of the property subject to the option (relative to the option exercise 
price), without risking any capital. Therefore, the fair market value of 
an option is not merely the difference that may exist at a particular 
time between the option's exercise price and the value of the property 
subject to the option, but also includes the value of the option 
privilege for the remainder of the exercise period. Accordingly, for 
purposes of this section, in determining whether the fair market value 
of an option is readily ascertainable, it is necessary to consider 
whether the value of the entire option privilege can be measured with 
reasonable accuracy. In determining whether the value of the option 
privilege is readily ascertainable, and in determining the amount of 
such value when such value is readily ascertainable, it is necessary to 
consider--
    (i) Whether the value of the property subject to the option can be 
ascertained;
    (ii) The probability of any ascertainable value of such property 
increasing or decreasing; and
    (iii) The length of the period during which the option can be 
exercised.
    (c) Reporting requirements. [Reserved]
    (d) This section applies on and after July 2, 2003. For transactions 
prior to that date, see Sec. 1.83-7 as published in 26 CFR part 1 
(revised as of April 1, 2003).

[T.D. 7554, 43 FR 31920, July 24, 1978, as amended by T.D. 9067, 68 FR 
39454, July 2, 2003; T.D. 9148, 69 FR 48392, Aug. 10, 2004]



Sec. 1.83-8  Applicability of section and transitional rules.

    (a) Scope of section 83. Section 83 is not applicable to--
    (1) A transaction concerning an option to which section 421 applies;
    (2) A transfer to or from a trust described in section 401(a) for 
the benefit of employees or their beneficiaries, or a transfer under an 
annuity plan that

[[Page 342]]

meets the requirements of section 404(a)(2) for the benefit of employees 
or their beneficiaries;
    (3) The transfer of an option without a readily ascertainable fair 
market value (as defined in Sec. 1.83-7(b)(1)); or
    (4) The transfer of property pursuant to the exercise of an option 
with a readily ascertainable fair market value at the date of grant. 
Section 83 applies to a transfer to or from a trust or under an annuity 
plan for the benefit of employees, independent contractors, or their 
beneficiaries (except as provided in paragraph (a)(2) of this section), 
but to the extent a transfer is subject to section 402(b) or 403(c), 
section 83 applies to such a transfer only as provided for in section 
402(b) or 403(c).
    (b) Transitional rules--(1) In general. Except as otherwise provided 
in this paragraph, section 83 and the regulations thereunder shall apply 
to property transferred after June 30, 1969.
    (2) Binding written contracts. Section 83 and the regulations 
thereunder shall not apply to property transferred pursuant to a binding 
written contract entered into before April 22, 1969. For purposes of 
this paragraph, a binding written contract means only a written contract 
under which the employee or independent contractor has an enforceable 
right to compel the transfer of property or to obtain damages upon the 
breach of such contract. A contract which provides that a person's right 
to such property is contingent upon the happening of an event (including 
the passage of time) may satisfy the requirements of this paragraph. 
However, if the event itself, or the determination of whether the event 
has occurred, rests with the board of directors or any other individual 
or group acting on behalf of the employer (other than an arbitrator), 
the contract will not be treated as giving the person an enforceable 
right for purposes of this paragraph.

The fact that the board of directors has the power (either expressly or 
impliedly) to terminate employment of an officer pursuant to a contract 
that contemplates the completion of services over a fixed or 
ascertainable period does not negate the existence of a binding written 
contract. Nor will the binding nature of the contract be negated by a 
provision in such contract which allows the employee or independent 
contractor to terminate the contract for any year and receive cash 
instead of property if such election would cause a substantial penalty, 
such as a forfeiture of part or all of the property received in 
connection with the performance of services in an earlier year.
    (3) Options granted before April 22, 1969. Section 83 shall not 
apply to property received upon the exercise of an option granted before 
April 22, 1969.
    (4) Certain written plans. Section 83 shall not apply to property 
transferred (whether or not by the exercise of an option) before May 1, 
1970, pursuant to a written plan adopted and approved before July 1, 
1969. A plan is to be considered as having been adopted and approved 
before July 1, 1969, only if prior to such date the transferor of the 
property undertook an ascertainable course of conduct which under 
applicable State law does not require further approval by the board of 
directors or the stockholders of any corporation. For example, if a 
corporation transfers property to an employee in connection with the 
performance of services pursuant to a plan adopted and approved before 
July 1, 1969, by the board of directors of such corporation, it is not 
necessary that the stockholders have adopted or approved such plan if 
State law does not require such approval. However, such approval is 
necessary if required by the articles of incorporation or the bylaws or 
if, by its terms, such plan will not become effective without such 
approval.
    (5) Certain options granted pursuant to a binding written contract. 
Section 83 shall not apply to property transferred before January 1, 
1973, upon the exercise of an option granted pursuant to a binding 
written contract (as defined in paragraph (b)(2) of this section) 
entered into before April 22, 1969, between a corporation and the 
transferor of such property requiring the transferor to grant options to 
employees of such corporation (or a subsidiary of such corporation) to 
purchase a determinable number of shares of stock of such corporation, 
but only if the transferee was an employee of such corporation (or a

[[Page 343]]

subsidiary of such corporation) on or before April 22, 1969.
    (6) Certain tax free exchanges. Section 83 shall not apply to 
property transferred in exchange for (or pursuant to the exercise of a 
conversion privilege contained in) property transferred before July 1, 
1969, or in exchange for property to which section 83 does not apply (by 
reason of paragraphs (1), (2), (3), or (4) of section 83(i)), if section 
354, 355, 356, or 1036 (or so much of section 1031 as relates to section 
1036) applies, or if gain or loss is not otherwise required to be 
recognized upon the exercise of such conversion privilege, and if the 
property received in such exchange is subject to restrictions and 
conditions substantially similar to those to which the property given in 
such exchange was subject.

[T.D. 7554, 43 FR 31921, July 24, 1978]



Sec. 1.84-1  Transfer of appreciated property to political organizations.

    (a) Transfer defined. A transfer after May 7, 1974, of property to a 
political organization (as defined in section 527(e)(1), and including a 
newsletter fund to the extent provided under section 527(g)) is treated 
as a sale of the property to the political organization if the fair 
market value of the property exceeds its adjusted basis. The transferor 
is treated as having realized an amount equal to the fair market value 
of the property on the date of the transfer. For purposes of this 
section, a transfer is any assignment, conveyance, or delivery of 
property other than a bona fide sale for an adequate and full 
consideration in money or money's worth, whether the transfer is in 
trust or otherwise, whether the transfer is direct or indirect and 
whether the property is real or personal, tangible or intangible. Thus, 
for example, a sale at less than fair market value (other than an 
ordinary trade discount), or a receipt of property by a political 
organization under an agency agreement entitling the organization to 
sell the property and retain all or a portion of the proceeds of the 
sale, is a transfer within the meaning, of this section. The term 
``transfer'' also includes an illegal contribution of property.
    (b) Amount realized. A transferor to whom this section applies 
realizes an amount equal to the fair market value of the property on the 
date of the transfer. For purposes of this section, the definition of 
fair market value set forth in Sec. 1.170A-1(c) (2) and (3) is 
incorporated by reference.
    (c) Amount recognized. A transferor to whom this section applies is 
treated as having sold the property to the political organization on the 
date of the transfer. Therefore, the rules of chapter 1 of subtitle A 
(relating to income tax) apply to the gain realized under this section 
as if this gain were an amount realized upon the sale of the property. 
These rules include those of section 55 and section 56 (relating to 
minimum tax for tax preference), section 306 (relating to disposition of 
certain stock), section 1201 (relating to the alternative tax on certain 
capital gains), section 1245 (relating to gain from dispositions of 
certain depreciable property), and section 1250 (relating to gain from 
dispositions of certain depreciable realty).
    (d) Holding period. The holding period of property transferred to a 
political organization to which this section applies begins on the day 
after the date of acquisition of the property by the political 
organization.

[T.D. 7671, 45 FR 8003, Feb. 6, 1980]



Sec. 1.85-1  Unemployment compensation.

    (a) Introduction. Section 85 prescribes rules relating to the 
inclusion in gross income of unemployment compensation (as defined in 
paragraph (b)(1) of this section) paid in taxable years beginning after 
December 31, 1978, pursuant to governmental programs. In general, these 
rules provide that unemployment compensation paid pursuant to 
governmental programs is includible in the gross income of a taxpayer if 
the taxpayer's modified adjusted gross income (as defined in paragraph 
(b)(2) of this section) exceeds a statutory base amount (as defined in 
paragraph (b)(3) of this section). If there is such an excess, however, 
the amount included in gross income is limited under paragraph (c)(1) of 
this section to the lesser of one-half of such excess or the amount of 
the unemployment compensation. If such taxpayer's modified

[[Page 344]]

adjusted gross income does not exceed the applicable statutory base 
amount, none of the unemployment compensation is included in the 
taxpayer's gross income.
    (b) Definitions--(1) Unemployment compensation--(i) General rule. 
Except as provided in paragraph (b)(1)(iii) of this section, the term 
``unemployment compensation'' means any amount received under a law of 
the United States, or of a State, which is in the nature of unemployment 
compensation. Thus, section 85 applies only to unemployment compensation 
paid pursuant to governmental programs and does not apply to amounts 
paid pursuant to private nongovernmental unemployment compensation plans 
(which are includible in income without regard to section 85). 
Generally, unemployment compensation programs are those designed to 
protect taxpayers against the loss of income caused by involuntary 
layoff. Ordinarily, unemployment compensation is paid in cash and on a 
periodic basis. The amount of the payments is usually computed in 
accordance with formula based on the taxpayer's length of prior 
employment and wages. Such payments, however, may be made in a lump sum 
or other than in cash or on some other basis.
    (ii) Disability and worker's compensation payments. Amounts in the 
nature of unemployment compensation also include cash disability 
payments made pursuant to a governmental program as a substitute for 
case unemployment payments to an unemployed taxpayer who is ineligible 
for such payments solely because of the disability. Usually these 
disability payments are paid in the same weekly amount and for the same 
period as the unemployment compensation benefits to which the unemployed 
taxpayer otherwise would have been entitled. Amounts received under 
workmen's compensation acts as compensation for personal injuries or 
sickness are not amounts in the nature of unemployment compensation. See 
section 104(a)(1) relating to the exclusion from gross income of such 
amounts.
    (iii) Employee contributions to a governmental plan. If a 
governmental unemployment compensation program is funded in part by an 
employee's contribution which is not deductible by the employee, an 
amount paid to such employee under the program is not to be considered 
unemployment compensation until an amount equal to the total 
nondeductible contributions paid by the employee to such program has 
been paid to such employee.
    (iv) Examples of governmental unemployment compensation programs. 
Governmental unemployment compensation programs include (but are not 
limited to) programs established under:
    (A) A State law approved by the Secretary of Labor pursuant to 
section 3304 of the Internal Revenue Code of 1954.
    (B) Chapter 85 of title 5, United States Code, relating to 
unemployment compensation for Federal employees generally and for ex-
servicemen.
    (C) Trade Act of 1974, sections 231 and 232 (19 U.S.C. 2291 and 
2292).
    (D) Disaster Relief Act of 1974, section 407 (42 U.S.C. 5177).
    (E) The Airline Deregulation Act of 1978 (49 U.S.C. 1552(b)).
    (F) The Railroad Unemployment Insurance Act, section 2 (45 U.S.C. 
352).
    (2) Modified adjusted gross income. The term ``modified adjusted 
gross income'' means the sum of the following amounts:
    (i) Adjusted gross income (as defined in section 62);
    (ii) All disability payments of the type that are eligible for 
exclusion from gross income under section 105(d); and
    (iii) All amounts of unemployment compensation (as defined in 
paragraph (b)(1) of this section).
    (3) Base amount. The term ``base amount'' means--
    (i) $25,000 in the case of a joint return under section 6013.
    (ii) Zero in the case of a taxpayer who--
    (A) Is married (within the meaning of section 143) at the close of 
the taxable year,
    (B) Does not file a joint return for such taxable year, and
    (C) Does not live apart (as defined in paragraph (b)(4) of this 
section) from his or her spouse at all times during the taxable year.
    (iii) $20,000 in the case of all other taxpayers.

[[Page 345]]

    (4) Living apart. A taxpayer does not ``live apart'' from his or her 
spouse at all times during a taxable year if for any period during the 
taxable year the taxpayer is a member of the same household as such 
taxpayer's spouse. A taxpayer is a member of a household for any period, 
including temporary absences due to special circumstances, during which 
the household is the taxpayer's place of abode. A temporary absence due 
to special circumstances includes a nonpermanent absence caused by 
illness, education, business, vacation, or military service.
    (c) Limitations--(1) General rule. If for a taxable year, a 
taxpayer's modified adjusted gross income does not exceed the applicable 
statutory base amount, no amount of unemployment compensation is 
included in gross income for the taxable year. If there is such an 
excess, the taxpayer includes in gross income for the taxable year the 
lesser of the following:
    (i) One-half of the excess of the taxpayer's modified adjusted gross 
income over such taxpayer's base amount, or
    (ii) The amount of unemployment compensation.
    (2) Exception for fraudulently received unemployment compensation. 
If a taxpayer fraudulently receives unemployment compensation under any 
governmental unemployment compensation program, then the entire amount 
of such fraudulently received unemployment compensation must be included 
in the taxpayer's gross income for the taxable year in which the 
benefits were received. Thus, the limitation in section 85 and in 
paragraph (c)(1) of this section, does not apply to such amounts.
    (3) Examples. The application of this paragraph may be illustrated 
by the following examples:

    Example (1). H and W are married taxpayers who for calendar year 
1979 file a joint income tax return. During 1979 H receives $4,500 of 
disability income that is eligible for an exclusion under section 
105(d). W works for part of 1979 and receives $20,000 as compensation 
and also receives $5,000 of unemployment compensation in 1979. Assume 
that H and W's adjusted gross income is $20,000. The modified adjusted 
gross income of H and W is $29,500 ($4,500 + $20,000 + $5,000). Since 
their modified adjusted gross income ($29,500) is greater than their 
base amount ($25,000), some of the unemployment compensation received by 
W must be included in their gross income on their 1979 joint income tax 
return. Under paragraph (c)(1) of this section, of the $5,000 which is 
unemployment compensation, the lesser of $2,250 (($29,500--$25,000)/2) 
or $5,000 must be included in their gross income. Thus, $2,250 of the 
$5,000 received by W in 1979 is included in the gross income of H and W 
on their joint income tax return for 1979.
    Example (2). Assume the same facts in example (1) except H received 
$5,000 of disability income that is eligible for an exclusion under 
section 105(d) and W receives $28,000 as compensation, and $4,000 which 
is unemployment compensation. Assume that H and W's adjusted gross 
income is $28,000. The modified adjusted gross income of H and W is 
$37,000 ($4,000 + $28,000 + $5,000). Since their modified adjusted gross 
income ($37,000) is greater than their base amount ($25,000), all of the 
unemployment compensation received by W must be included in their gross 
income on their 1979 joint income tax return. Under paragraph (c)(1) of 
this section, of the $4,000 which is unemployment compensation, the 
lesser of $6,000 (($37,000--$25,000)/2) or $4,000 must be included in 
their gross income. Thus, all of the $4,000 unemployment compensation 
received by W is included in the gross income of H and W on their joint 
income tax return for 1979.

    (d) Cross reference. See section 6050B, relating to the requirement 
that every person who makes payments of unemployment compensation 
aggregating $10 or more to any individual during any calendar year file 
an information return with the Internal Revenue Service.

[T.D. 7705, 45 FR 46069, July 9, 1980]



Sec. 1.88-1  Nuclear decommissioning costs.

    (a) In general. Section 88 provides that the amount of nuclear 
decommissioning costs directly or indirectly charged to the customers of 
a taxpayer that is engaged in the furnishing or sale of electric energy 
generated by a nuclear power plant must be included in the gross income 
of such taxpayer in the same manner as amounts charged for electric 
energy. For this purpose, decommissioning costs directly or indirectly 
charged to the customers of a taxpayer include all decommissioning costs 
that consumers are liable to pay by reason of electric energy furnished 
by the taxpayer during the taxable year, whether payable to the 
taxpayer,

[[Page 346]]

a trust, State government, or other entity, and even though the taxpayer 
may not control the investment or current expenditure of the amount and 
the amount may not be paid to the taxpayer at the time decommissioning 
costs are incurred. However, decommissioning costs payable to a taxpayer 
holding a qualified leasehold interest (as described in paragraph 
(b)(2)(ii) of Sec. 1.468A-1) are included in the gross income of such 
taxpayer, and not in the gross income of the lessor.
    (b) Examples. The following examples illustrate the application of 
the principles of paragraph (a) of this section:

    Example (1). X corporation, an accrual method taxpayer engaged in 
the sale of electric energy generated by a nuclear power plant owned by 
X, is authorized by the public utility commission of State A to collect 
nuclear decommissioning costs from ratepayers residing in State A. With 
respect to the sale of electric energy, X includes in income amounts 
that have been billed to customers as well as estimated unbilled amounts 
that relate to energy provided by X after the previous billing but 
before the end of the taxable year (``accrued unbilled amounts''). The 
decommissioning costs are included in the monthly bills provided by X to 
its ratepayers and the entire amount billed is remitted directly to X. 
Under paragraph (a) of this section, the decommissioning costs must be 
included in the gross income of X in the same manner as amounts charged 
for electric energy (i.e., by including in income decommissioning costs 
that relate to amounts billed as well as decommissioning costs that 
relate to accrued unbilled amounts). The same rule would apply if the 
decommissioning costs charged to ratepayers were separately billed and 
the amounts billed were remitted to State A to be held in trust for the 
purpose of decommissioning the nuclear power plant owned by X. In that 
case, X must include in gross income decommissioning costs that relate 
to amounts billed as well as decommissioning costs that relate to 
accrued unbilled amounts.
    Example (2). Assume the same facts as in Example (1), except that X 
and M, a municipality located in State A, have entered into a life-of-
unit contract pursuant to which (i) M is entitled to 20 percent of the 
electric energy generated by the nuclear power plant owned by X, and 
(ii) M is obligated to pay 20 percent of the plant operating costs, 
including decommissioning costs, incurred by X. Under paragraph (a) of 
this section, the decommissioning costs that relate to electric energy 
consumed or distributed by M during any taxable year must be included in 
the gross income of X for such taxable year. The result contained in 
this example would be the same if M was a State or an agency or 
instrumentality of a State or a political subdivision thereof.

    (c) Cross reference. For special rules relating to the deduction for 
amounts paid to a nuclear decommissioning fund, see Sec. 1.468A-1 
through Sec. 1.468A-5, 1.468A-7, 1.468A-8.
    (d) Effective date. (1) Section 88 and this section apply to nuclear 
decommissioning costs directly or indirectly charged to the customers of 
a taxpayer on or after July 18, 1984, and with respect to taxable years 
ending on or after such date.
    (2) If the amount of nuclear decommissioning costs directly or 
indirectly charged to the customers of a taxpayer before July 18, 1984, 
was includible in gross income in a different manner than amounts 
charged for electric energy, such amount must be included in gross 
income for the taxable year in which includible in gross income under 
the method of accounting of the taxpayer that was in effect when such 
amount was charged to customers.

[T.D. 8184, 53 FR 6804, Mar. 3, 1988]

              Items Specifically Excluded From Gross Income



Sec. 1.101-1  Exclusion from gross income of proceeds of life insurance 
contracts payable by reason of death.

    (a)(1) In general. Section 101(a)(1) states the general rule that 
the proceeds of life insurance policies, if paid by reason of the death 
of the insured, are excluded from the gross income of the recipient. 
Death benefit payments having the characteristics of life insurance 
proceeds payable by reason of death under contracts, such as workmen's 
compensation insurance contracts, endowment contracts, or accident and 
health insurance contracts, are covered by this provision. For 
provisions relating to death benefits paid by or on behalf of employers, 
see section 101(b) and Sec. 1.101-2. The exclusion from gross income 
allowed by section 101(a) applies whether payment is made to the estate 
of the insured or to any beneficiary (individual, corporation, or 
partnership) and whether it is made directly or in trust. The extent to 
which this exclusion applies in cases where

[[Page 347]]

life insurance policies have been transferred for a valuable 
consideration is stated in section 101(a)(2) and in paragraph (b) of 
this section. In cases where the proceeds of a life insurance policy, 
payable by reason of the death of the insured, are paid other than in a 
single sum at the time of such death, the amounts to be excluded from 
gross income may be affected by the provisions of section 101 (c) 
(relating to amounts held under agreements to pay interest) or section 
101(d) (relating to amounts payable at a date later than death). See 
Sec. Sec. 1.101-3 and 1.101-4. However, neither section 101(c) nor 
section 101(d) applies to a single sum payment which does not exceed the 
amount payable at the time of death even though such amount is actually 
paid at a date later than death.
    (2) Cross references. For rules governing the taxability of 
insurance proceeds constituting benefits payable on the death of an 
employee--
    (i) Under pension, profit-sharing, or stock bonus plans described in 
section 401(a) and exempt from tax under section 501(a), or under 
annuity plans described in section 403(a), see section 72 (m)(3) and 
paragraph (c) of Sec. 1.72-16;
    (ii) Under annuity contracts to which paragraph (a) or (b) of Sec. 
1.403(b)-1 applies, see paragraph (c)(3) of Sec. 1.403(b)-1; or
    (iii) Under eligible State deferred compensation plans described in 
section 457(b), see paragraph (c) of Sec. 1.457-1.

For the definition of a life insurance company, see section 801.
    (b) Transfers of life insurance policies. (1) In the case of a 
transfer, by assignment or otherwise, of a life insurance policy or any 
interest therein for a valuable consideration, the amount of the 
proceeds attributable to such policy or interest which is excludable 
from the transferee's gross income is generally limited to the sum of 
(i) the actual value of the consideration for such transfer, and (ii) 
the premiums and other amounts subsequently paid by the transferee (see 
section 101(a)(2) and example (1) of subparagraph (5) of this 
paragraph). However, this limitation on the amount excludable from the 
transferee's gross income does not apply (except in certain special 
cases involving a series of transfers), where the basis of the policy or 
interest transferred, for the purpose of determining gain or loss with 
respect to the transferee, is determinable, in whole or in part, by 
reference to the basis of such policy or interest in the hands of the 
transferor (see section 101(a)(2)(A) and examples (2) and (4) of 
subparagraph (5) of this paragraph). Neither does the limitation apply 
where the policy or interest therein is transferred to the insured, to a 
partner of the insured, to a partnership in which the insured is a 
partner, or to a corporation in which the insured is a shareholder or 
officer (see section 101(a)(2)(B)). For rules relating to gratuitous 
transfers, see subparagraph (2) of this paragraph. For special rules 
with respect to certain cases where a series of transfers is involved, 
see subparagraph (3) of this paragraph.
    (2) In the case of a gratuitous transfer, by assignment or 
otherwise, of a life insurance policy or any interest therein, as a 
general rule the amount of the proceeds attributable to such policy or 
interest which is excludable from the transferee's gross income under 
section 101(a) is limited to the sum of (i) the amount which would have 
been excludable by the transferor (in accordance with this section) if 
no such transfer had taken place, and (ii) any premiums and other 
amounts subsequently paid by the transferee. See example (6) of 
subparagraph (5) of this paragraph. However, where the gratuitous 
transfer in question is made by or to the insured, a partner of the 
insured, a partnership in which the insured is a partner, or a 
corporation in which the insured is a shareholder or officer, the entire 
amount of the proceeds attributable to the policy or interest 
transferred shall be excludable from the transferee's gross income (see 
section 101(a)(2)(B) and example (7) of subparagraph (5) of this 
paragraph).
    (3) In the case of a series of transfers, if the last transfer of a 
life insurance policy or an interest therein is for a valuable 
consideration--
    (i) The general rule is that the final transferee shall exclude from 
gross income, with respect to the proceeds of such policy or interest 
therein, only the sum of--

[[Page 348]]

    (a) The actual value of the consideration paid by him, and
    (b) The premiums and other amounts subsequently paid by him;
    (ii) If the final transfer is to the insured, to a partner of the 
insured, to a partnership in which the insured is a partner, or to a 
corporation in which the insured is a shareholder or officer, the final 
transferee shall exclude the entire amount of the proceeds from gross 
income;
    (iii) Except where subdivision (ii) of this subparagraph applies, if 
the basis of the policy or interest transferred, for the purpose of 
determining gain or loss with respect to the final transferee, is 
determinable, in whole or in part, by reference to the basis of such 
policy or interest therein in the hands of the transferor, the amount of 
the proceeds which is excludable by the final transferee is limited to 
the sum of--
    (a) The amount which would have been excludable by his transferor if 
no such transfer had taken place, and
    (b) Any premiums and other amounts subsequently paid by the final 
transferee himself.
    (4) For the purposes of section 101(a)(2) and subparagraphs (1) and 
(3) of this paragraph, a ``transfer for a valuable consideration'' is 
any absolute transfer for value of a right to receive all or a part of 
the proceeds of a life insurance policy. Thus, the creation, for value, 
of an enforceable contractual right to receive all or a part of the 
proceeds of a policy may constitute a transfer for a valuable 
consideration of the policy or an interest therein. On the other hand, 
the pledging or assignment of a policy as collateral security is not a 
transfer for a valuable consideration of such policy or an interest 
therein, and section 101 is inapplicable to any amounts received by the 
pledgee or assignee.
    (5) The application of this paragraph may be illustrated by the 
following examples:

    Example (1). A pays premiums of $500 for an insurance policy in the 
face amount of $1,000 upon the life of B, and subsequently transfers the 
policy to C for $600. C receives the proceeds of $1,000 upon the death 
of B. The amount which C can exclude from his gross income is limited to 
$600 plus any premiums paid by C subsequent to the transfer.
    Example (2). The X Corporation purchases for a single premium of 
$500 an insurance policy in the face amount of $1,000 upon the life of 
A, one of its employees, naming the X Corporation as beneficiary. The X 
Corporation transfers the policy to the Y Corporation in a tax-free 
reorganization (the policy having a basis for determining gain or loss 
in the hands of the Y Corporation determined by reference to its basis 
in the hands of the X Corporation). The Y Corporation receives the 
proceeds of $1,000 upon the death of A. The entire $1,000 is to be 
excluded from the gross income of the Y Corporation.
    Example (3). The facts are the same as in example (2) except that, 
prior to the death of A, the Y Corporation transfers the policy to the Z 
Corporation for $600. The Z Corporation receives the proceeds of $1,000 
upon the death of A. The amount which the Z Corporation can exclude from 
its gross income is limited to $600 plus any premiums paid by the Z 
Corporation subsequent to the transfer of the policy to it.
    Example (4). The facts are the same as in example (3) except that, 
prior to the death of A, the Z Corporation transfers the policy to the M 
Corporation in a tax-free reorganization (the policy having a basis for 
determining gain or loss in the hands of the M Corporation determined by 
reference to its basis in the hands of the Z Corporation). The M 
Corporation receives the proceeds of $1,000 upon the death of A. The 
amount which the M Corporation can exclude from its gross income is 
limited to $600 plus any premiums paid by the Z Corporation and the M 
Corporation subsequent to the transfer of the policy to the Z 
Corporation.
    Example (5). The facts are the same as in example (3) except that, 
prior to the death of A, the Z Corporation transfers the policy to the N 
Corporation, in which A is a shareholder. The N Corporation receives the 
proceeds of $1,000 upon the death of A. The entire $1,000 is to be 
excluded from the gross income of the N Corporation.
    Example (6). A pays premiums of $500 for an insurance policy in the 
face amount of $1,000 upon his own life, and subsequently transfers the 
policy to his wife B for $600. B later transfers the policy without 
consideration to C, who is the son of A and B. C receives the proceeds 
of $1,000 upon the death of A. The amount which C can exclude from his 
gross income is limited to $600 plus any premiums paid by B and C 
subsequent to the transfer of the policy to B.
    Example (7). The facts are the same as in example (6) except that, 
prior to the death of A, C transfers the policy without consideration to 
A, the insured. A's estate receives the proceeds of $1,000 upon the 
death of A.

[[Page 349]]

The entire $1,000 is to be excluded from the gross income of A's estate.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6783, 29 FR 
18356, Dec. 24, 1964; T.D. 7836, 47 FR 42337, Sept. 27, 1982]



Sec. 1.101-2  Employees' death benefits.

    (a) In general. (1) Section 101(b) states the general rule that 
amounts up to $5,000 which are paid to the beneficiaries or the estate 
of an employee, or former employee, by or on behalf of an employer and 
by reason of the death of the employee shall be excluded from the gross 
income of the recipient. This exclusion from gross income applies 
whether payment is made to the estate of the employee or to any 
beneficiary (individual, corporation, or partnership), whether it is 
made directly or in trust, and whether or not it is made pursuant to a 
contractual obligation of the employer. The exclusion applies whether 
payment is made in a single sum or otherwise, subject to the provisions 
of section 101 (c), relating to amounts held under an agreement to pay 
interest thereon (see Sec. 1.101-3). The exclusion from gross income 
also applies to any amount not actually paid which is otherwise taxable 
to a beneficiary of an employee because it was made available as a 
distribution from an employee's trust.
    (2) The exclusion does not apply to amounts constituting income 
payable to the employee during his life as compensation for his 
services, such as bonuses or payments for unused leave or uncollected 
salary, nor to certain other amounts with respect to which the deceased 
employee possessed, immediately before his death, a nonforfeitable right 
to receive the amounts while living (see section 101(b)(2)(B) and 
paragraph (d) of this section). Further, the exclusion does not apply to 
amounts received as an annuity under a joint and survivor annuity 
obligation where the employee was the primary annuitant and the annuity 
starting date occurred before the death of the employee (see section 101 
(b)(2)(C) and paragraph (e)(1)(ii) of this section). In the case of 
amounts received by a beneficiary as an annuity (but not as a survivor 
under a joint and survivor annuity with respect to which the employee 
was the primary annuitant), the exclusion is applied indirectly by means 
of the provisions of section 72 and the regulations thereunder (see 
section 101(b)(2)(D) and paragraph (e)(1) (iii) and (iv) of this 
section). Thus, for example, the exclusion applies to amounts which are 
received by a survivor of an employee retired on disability under the 
provisions of the Civil Service retirement law (5 U.S.C. 8301 or any 
former corresponding provisions of law) or the Retired Serviceman's 
Family Protection Plan or Survivor Benefit Plan (10 U.S.C. 1431 et 
seq.), provided such employee dies before attaining mandatory retirement 
age (as defined in Sec. 1.105-4 (a)(3)(i)(B)).
    (3) The total amount excludable with respect to any employee may not 
exceed $5,000, regardless of the number of employers or the number of 
beneficiaries. For allocation of the exclusion among beneficiaries, see 
paragraph (c) of this section. For rules governing the taxability of 
benefits payable on the death of an employee under pension, 
profitsharing, or stock bonus plans described in section 401(a) and 
exempt under section 501(a), under annuity plans described in section 
403(a), or under annuity contracts to which paragraph (a) or (b) of 
Sec. 1.403(b)-1 applies, see sections 72(m)(3), 402(a), and 403 and the 
regulations thereunder.
    (b) Payments under certain employee benefit plans--(1) In general. 
Where a payment is made by reason of the death of an employee by an 
employer-provided welfare fund or a trust, including a stock bonus, 
pension, or profitsharing trust described in section 401 (a), or by an 
insurance company (if such payment does not constitute ``life 
insurance'' within the purview of section 101(a), the payment shall be 
considered to have been made by or on behalf of the employer to the 
extent that it exceeds amounts contributed by, or deemed contributed by, 
the deceased employee.
    (2) Cross references. For provisions governing the taxability of 
distributions payable on the death of an employee participant--
    (i) Under a trust described in section 401(a) and exempt from tax 
under section 501(a), see paragraph (c) of Sec. 1.72-16 and paragraph 
(a)(5) of Sec. 1.402 (a)-1;

[[Page 350]]

    (ii) Under an annuity plan described in section 403(a), see 
paragraph (c) of Sec. 1.72-16 and paragraph (c) of Sec. 1.403 (a)-1;
    (iii) Under annuity contracts to which paragraph (a) or (b) of Sec. 
1.403 (b)-1 applies, see paragraph (c) (2) and (3) of Sec. 1.403(b)-1;
    (iv) Under eligible State deferred compensation plans described in 
section 457 (b), see paragraph (c) of Sec. 1.457-1.
    (c) Allocation of the exclusion. (1) Where the aggregate payments by 
or on behalf of an employer or employers as death benefits to the 
beneficiaries or the estate of a deceased employee exceed $5,000, the 
$5,000 exclusion shall be apportioned among them in the same proportion 
as the amount received by or the present value of the amount payable to 
each bears to the total death benefits paid or payable by or on behalf 
of the employer or employers.
    (2) The application of the rule in subparagraph (1) of this 
paragraph may be illustrated by the following example:

    Example. The M Corporation, the employer of A, a deceased employee 
who died November 30, 1954, makes payments in 1955 to the beneficiaries 
of A as follows: $5,000 to W, A's widow, $2,000 to B, the son of A, and 
$3,000 to C, the daughter of A. No other amounts are paid by any other 
employer of A to his estate or beneficiaries. By application of the 
apportionment rule stated above, W, the widow, will exclude $2,500 
($5,000/$10,000, or one-half, of $5,000); B, the son, will exclude 
$1,000 ($2,000/$10,000, or one-fifth, of $5,000); and C, the daughter, 
will exclude $1,500 ($3,000/$10,000, or three-tenths, of $5,000).

    (d) Nonforfeitable rights. (1) Except as provided in subparagraphs 
(3) and (4) of this paragraph, the exclusion provided by section 101(b) 
does not apply to amounts with respect to which the deceased employee 
possessed, immediately before his death, a nonforfeitable right to 
receive the amounts while living. Section 101(b)(2)(B). For the purpose 
of section 101(b) and this paragraph, an employee shall be considered to 
have had a nonforfeitable right with respect to--
    (i) Any amount to which he would have been entitled--
    (a) If he had made an appropriate election or demand, or
    (b) Upon termination of his employment (see examples (5) and (6) of 
subparagraph (2) of this paragraph); or
    (ii) The present value (immediately before his death) of--
    (a) Amounts payable as an annuity (as defined in paragraph (b) of 
Sec. 1.72-2, whether immediate or deferred) by or on behalf of the 
employer (see example (1) of subparagraph (2) of this paragraph), or
    (b) Amounts which would have been so payable if the employee had 
terminated his employment and continued to live;

or
    (iii) Any amount to the extent it is paid in lieu of amounts 
described in either subdivision (i) or (ii) of this subparagraph. See 
examples (2), (3), and (4) of subparagraph (2) of this paragraph.

For purposes of subdivision (iii) of this subparagraph, any amount paid 
in discharge of an obligation which arose solely because of the 
existence of a particular fact or circumstance subsequent to the 
employee's death shall not be considered an amount paid in lieu of 
amounts described in subdivision (i) or (ii) of this subparagraph. 
Subdivision (iii) of this subparagraph shall apply, however, to the 
extent indicated therein, to amounts payable without regard to any such 
contingency (to the extent that such amounts are equal to or less than 
those described in subdivision (i) and (ii) of this subparagraph which 
are not paid). See paragraph (e)(1)(iii)(b) of this section for rules 
with respect to finding the present value of an annuity immediately 
before the employee's death.
    (2) The application of paragraph (d)(1) of this section may be 
illustrated by the following examples, in which it is assumed that the 
plans are not ``qualified plans'' and that no employer is an 
organization referred to in section 170(b)(1)(A) (ii) or (vi) or a 
religious organization (other than a trust) which is exempt from tax 
under section 501(a):

    Example (1). A, who was a participant under the X Company pension 
plan, retired on December 31, 1953. He had made no contributions to the 
plan. Upon his retirement, he became entitled to monthly payments of 
$100 payable for life, or 120 months certain. A died on October 31, 
1954, having received 10

[[Page 351]]

monthly payments of $100 each. After his death, the monthly payments 
became payable to his estate for the remaining 110 months certain. No 
exclusion from gross income is allowed to A's estate (or any beneficiary 
who receives the right to such payments from the estate), since the 
employee's right to the monthly payments was nonforfeitable at the date 
of his death. It will be noted that in this example it is unnecessary to 
consider the present value of the annuity to A just before his death 
since the payments to be made include only those certain to be made in 
any event under the plan whether or not A continued to live.
    Example (2). C, a participant under the Y Company pension plan, died 
on December 15, 1954, while actively in the employment of the company, 
survived by a widow and minor children. Because of his years of service, 
he would have been entitled to an annuity for life, his own 
contributions to the plan and interest thereon being guaranteed, if he 
had retired or terminated his employment at a time immediately before 
his death. The plan further provides that--(a) if, but only if, an 
employee is survived by a widow and minor children, his widow is to 
receive an annuity for her life without regard to whether or not the 
employee had begun his annuity; (b) any payments made with respect to 
his widow's annuity are to reduce the guaranteed amount to an equal 
extent; and (c) if the employee is not so survived, the guaranteed 
amount is payable to his beneficiary or estate, but no amount is payable 
to anyone with respect to what would have been the widow's annuity. In 
view of these provisions, that portion of the present value of the 
annuity payable to C's widow which exceeds the guaranteed amount shall 
be considered paid neither as an amount, nor in lieu of an amount, which 
C had a nonforfeitable right to receive while living. The reason for 
this result is that the payment of such excess is contingent upon C's 
being survived by a widow and minor children, a circumstance existing 
subsequent to his death. Conversely, to the extent that the present 
value of the annuity payable to C's widow does not exceed the guaranteed 
amount, annuity payments attributable to such present value shall be 
considered paid in lieu of an amount which C had a nonforfeitable right 
to receive while living.
    Example (3). D, a participant under the Y Company pension plan, died 
on January 1, 1955, while actively in the employment of the company. The 
Y Company plan provides that where an employee dies in service, the 
present value of the accumulated credits which he could have obtained at 
that time if he had instead separated from the service shall be paid in 
a single sum to his surviving spouse or to his estate if no widow 
survives him. The present value of D's accumulated credits, at the time 
of his death, was $10,000. However, the plan also provides that a 
surviving spouse may elect to take, in lieu of a single sum, an annuity 
the present value of which exceeds such sum by $2,500. D's widow elects 
to receive an annuity (the present value of which is $12,500). 
Therefore, $2,500 is an amount to which the exclusion of section 101(b) 
and this section shall apply.
    Example (4). A, an employee of the X Company, continues to work 
after reaching the normal retirement age of 60 years, although he could 
have retired at that age and obtained an annuity of $3,000 per year for 
his life. A is not entitled to any part of the annuity while he is 
employed and receiving compensation. A dies at the age of 67 while still 
in active employment. Since he had passed normal retirement age, his 
additional years of service did not entitle him to a larger annuity at 
age 67 than that which he could have obtained at age 60. However, the 
plan of the X Company provides that in the event of an employee's death 
prior to separation from the service, his widow is to be paid an annuity 
for her life in the same amount per year as that which the employee 
could have obtained if he had instead retired; but if no widow survives 
him, the present value of the annuity which the employee could have 
obtained at a time just before his death is to be paid to a named 
beneficiary or the estate of the employee. Assuming that the present 
value of the annuity to A's widow, whose age is 61, is $36,000 and the 
present value of the annuity which would have been payable to A at age 
67 if he had then retired is $23,500, the present value of the widow's 
annuity, to the extent of $23,500, is an amount which is payable in lieu 
of amounts which the employee had a nonforfeitable right to receive 
while living because it does not exceed the value of his nonforfeitable 
rights and is not otherwise paid. On the other hand, the $12,500 excess 
of the value of the widow's annuity ($36,000) over the value of the 
employee's annuity ($23,500) is an amount to which section 101(b) 
applies since the employee had no right to any part of it. If no other 
death benefits are payable, a $5,000 exclusion is available (see section 
101(b)(2)(D) and paragraph (e) of this section).
    Example (5). The trustee of the X Corporation noncontributory 
profit-sharing plan is required under the provisions of the plan to pay 
to the beneficiary of B, an employee of the X Corporation who died on 
July 1, 1955, the benefit due on account of the death of B. The 
provisions of the profit-sharing plan give each participating employee 
in case of termination of employment a 10-percent vested interest in the 
amount accumulated in his account for each year of participation in the 
plan. In case of death, the entire credit in the participant's account 
is to be paid to his beneficiary. At the time of B's death, he had been 
a participant for three years and the accumulation in his account was 
$8,000. After

[[Page 352]]

his death this amount is paid to his beneficiary. At the time of B's 
death, the amount distributable to him on account of termination of 
employment would have been $2,400 (30 percent of $8,000). The difference 
of $5,600 ($8,000 minus $2,400), payable to the beneficiary of B, is an 
amount payable solely by reason of B's death. Accordingly, $5,000 of the 
$5,600 may be excluded from the gross income of the beneficiary 
receiving such payment (assuming no other death benefits are involved). 
However, if it is assumed that the facts are the same as above, except 
that at the time of his death B has been a participant for 6 years, the 
amount distributable to him on account of termination of employment 
would have been $4,800 (60 percent of $8,000). The difference of $3,200 
($8,000 minus $4,800), payable to B's beneficiary, is an amount payable 
solely by reason of B's death. Accordingly, only $3,200 may be excluded 
from the gross income of the beneficiary receiving such payment 
(assuming no other death benefits are involved).
    Example (6). The X Corporation instituted a trust, forming part of a 
pension plan, for its employees, the cost thereof being borne entirely 
by the corporation. The plan provides, in part, that after 10 or more 
years of service and attaining the age of 55, an employee can elect to 
retire and receive benefits before the normal retirement date contingent 
upon the employer's approval. If he retires without the employer's 
consent, or voluntarily leaves the company, no benefits are or will be 
payable. The plan further provides that if the employee is involuntarily 
separated or dies before retirement, he or his beneficiary, 
respectively, will receive a percentage of the reserve provided for the 
employee in the trust fund on the following basis: 10 to 15 years of 
service, 25 percent; 15 to 20 years of service, 50 percent; 20 to 25 
years of service, 75 percent; 25 or more years of service, 100 percent. 
A, an employee of the X Corporation for 17 years, died at the age of 56 
while in the employ of the corporation. At the time of his death, 
$15,000 was the reserve provided for him in the trust. His beneficiary 
receives $7,500, an amount equal to 50 percent of the reserve provided 
for A's retirement; accordingly, $5,000 of the $7,500 may be excluded 
from the gross income of the beneficiary receiving such payment 
(assuming no other death benefits are involved) since A, prior to his 
death, had only a forfeitable right to receive $7,500.

    (3)(i) Notwithstanding the rule stated in subparagraph (1) of this 
paragraph and illustrated in subparagraph (2) of this paragraph, the 
exclusion from gross income provided by section 101(b) applies to the 
receipt of certain amounts, paid under ``qualified'' plans, with respect 
to which the deceased employee possessed, immediately before his death, 
a nonforfeitable right to receive the amounts while living (see section 
101(b)(2)(B) (i) and (ii)). The payments to which this exclusion applies 
are--
    (a) ``Total distributions payable'' by a stock bonus, pension, or 
profit-sharing trust described in section 401(a) which is exempt from 
tax under section 501(a), and
    (b) ``Total amounts'' paid under an annuity contract under a plan 
described in section 403(a), provided such distributions or amounts are 
paid in full within one taxable year of the distributee (see example (3) 
of subdivision (ii) of this subparagraph). For the purposes of applying 
section 101(b), ``Total distributions payable'' means the balance to the 
credit of an employee which becomes payable to a distributee on account 
of the employee's death, either before or after separation from the 
service (see section 402(a)(3)(C), the regulations thereunder, and 
examples (2) and (4) of subdivision (ii) of this subparagraph); and 
``total amounts'' means the balance to the credit of an employee which 
becomes payable to the payee by reason of the employee's death, either 
before or after separation from the service (see section 403(a)(2)(B), 
the regulations thereunder, and example (1) of subdivision (ii) of this 
subparagraph). See subparagraph (4) of this paragraph relating to the 
exclusion of amounts which are received under annuity contracts 
purchased by certain exempt organizations and with respect to which the 
deceased employee possessed, immediately before his death, a 
nonforfeitable right to receive the amounts while living.
    (ii) The application of the provisions of subdivision (i) of this 
subparagraph may be illustrated by the following examples:

    Example (1). The widow of an employee elects, under a 
noncontributory ``qualified'' plan, to receive in a lump sum the present 
value of the annuity which C, the deceased employee, could have obtained 
at a time just before his death if he had retired at that time. Such 
present value is $6,000. Of this amount, $5,000 is excludable from the 
widow's gross income despite the fact that C had a nonforfeitable right 
to the amount in lieu of which the payment is made, since such payment 
is an amount to which subdivision

[[Page 353]]

(i) of this subparagraph applies (assuming no other death benefits are 
involved).
    Example (2). The trustee of the X Corporation noncontributory, 
``qualified'', profit- sharing plan is required under the provisions of 
the plan to pay to the beneficiary of B, an employee of the X 
Corporation who died on July 1, 1955, the benefit due on account of the 
death of B. The provisions of the profit-sharing plan give each 
participating employee, in case of termination of employment, a 10 
percent vested interest in the amount accumulated in his account for 
each year of participation in the plan, but, in case of death, the 
entire credit to the participant's account is to be paid to his 
beneficiary. At the time of B's death, he had been a participant for 
five years. The accumulation in his account was $8,000, and the amount 
which would have been distributable to him in the event of termination 
of employment was $4,000 (50 percent of $8,000). After his death, $8,000 
is paid to his beneficiary in a lump sum. (It may be noted that these 
are the same facts as in example (5) of subparagraph (2) of this 
paragraph except that the employee has been a participant for five years 
instead of three and the plan is a ``qualified'' plan.) It is immaterial 
that the employee had a nonforfeitable right to $4,000, because the 
payment of the $8,000 to the beneficiary is the payment of the ``total 
distributions payable'' within one taxable year of the distributee to 
which subdivision (i) of this subparagraph applies. Assuming no other 
death benefits are involved, the beneficiary may exclude $5,000 of the 
$8,000 payment from gross income.
    Example (3). The facts are the same as in example (2) except that 
the beneficiary is entitled to receive only the $4,000 to which the 
employee had a nonforfeitable right and elects, 30 days after B's death, 
to receive it over a period of ten years. Since the ``total 
distributions payable'' are not paid within one taxable year of the 
distributee, no exclusion from gross income is allowable with respect to 
the $4,000.
    Example (4). The X Corporation instituted a trust, forming part of a 
``qualified'' profit-sharing plan for its employees, the cost thereof 
being borne entirely by the corporation. The plan provides, in part, 
that if, after 10 or more years of service, an employee leaves the 
employ of the corporation, either voluntarily or involuntarily, before 
retirement, a percentage of the reserve provided for the employee in the 
trust fund will be paid to the employee as follows: 10 to 15 years of 
service, 25 percent; 15 to 20 years of service, 50 percent; 20 to 25 
years of service, 75 percent; 25 or more years of service, 100 percent. 
The plan further provides that if an employee dies before reaching 
retirement age, his beneficiary will receive a percentage of the reserve 
provided for the employee in the trust fund, on the same basis as shown 
in the preceding sentence. A, an employee of the X Corporation for 17 
years, died before attaining retirement age while in the employ of the 
corporation. At the time of his death, $15,000 was the reserve provided 
for him in the trust fund. His beneficiary receives $7,500 in a lump 
sum, an amount equal to 50 percent of the reserve provided for A's 
retirement. The beneficiary may exclude from gross income (assuming no 
other death benefits are involved) $5,000 of the $7,500, since the 
latter amount constitutes ``total distributions payable'' paid within 
one taxable year of the distributee, to which subdivision (i) of this 
subparagraph applies.

    (4)(i) Notwithstanding the rule stated in subparagraph (1) of this 
paragraph and illustrated in subparagraph (2) of this paragraph, the 
exclusion from gross income under section 101(b) also applies (but only 
to the extent provided in the next sentence) to amounts with respect to 
which the deceased employee possessed, immediately before his death, a 
nonforfeitable right to receive the amounts while living--
    (a) If such amounts are paid under an annuity contract purchased by 
an employer which is an organization referred to in section 170(b)(1)(A) 
(ii) or (vi) or which is a religious organization (other than a trust) 
and which is exempt from tax under section 501(a).
    (b) If such amounts are paid as part of a ``total payment'' with 
respect to the deceased employee; and
    (c) If such ``total payment'' is paid in full within one taxable 
year of the payee beginning after December 31, 1957.

However, the amount that is excludable under section 101(b) by reason of 
this subparagraph shall not exceed an amount which bears the same ratio 
to the amount which would be includible in the payee's gross income if 
it were not for the second sentence of section 101(b)(2)(B) and this 
subparagraph, as the amount contributed by the employer for the annuity 
contract that was excludable from the deceased employee's gross income 
under paragraph (b) of Sec. 1.403(b)-1 bears to the total amount 
contributed by the employer for the annuity contract. See section 
101(b)(2)(B)(iii). For purposes of this subparagraph, a ``total 
payment'' means a payment of the balance to the credit of an employee 
with respect to all ``section 403(b) annuities'' purchased by the 
employer which becomes

[[Page 354]]

payable to the payee by reason of the employee's death, either before or 
after separation from the service. An annuity contract will be regarded 
as a ``section 403(b) annuity'' if any amount contributed (or considered 
as contributed under paragraph (b)(2) of Sec. 1.403(b)-1) by the 
employer for such contract was excludable from the employee's gross 
income under paragraph (b) of Sec. 1.403(b)-1. Under this definition, 
therefore, an annuity contract may be regarded as a ``section 403(b) 
annuity'' even though some of the employer's contributions for the 
contract were not excludable from the employee's gross income under 
paragraph (b) of Sec. 1.403(b)-1 because, for example, the employer was 
not an exempt organization when such contributions were paid. For 
purposes of computing the ratio described in this subdivision in such a 
case, the total amount contributed by the employer for the contract 
includes the amounts contributed by the employer when it was not an 
exempt organization.
    (ii) This subparagraph does not relate to any amounts with respect 
to which the deceased employee did not possess, immediately before his 
death, a nonforfeitable right to receive the amounts while living. Such 
amounts are excludable under the provisions of section 101(b) without 
regard to section 101(b)(2)(B) and this subparagraph. Thus, if a ``total 
payment'' received by a beneficiary of a deceased employee under an 
annuity contract purchased by an organization described in subdivision 
(i)(a) of this subparagraph consists both of amounts with respect to 
which the deceased employee possessed, immediately before his death, a 
nonforfeitable right to receive the amounts while living and of amounts 
with respect to which the deceased employee did not possess such a 
nonforfeitable right, only those amounts with respect to which the 
deceased employee possessed such a nonforfeitable right are amounts to 
which this subparagraph applies. Therefore, for purposes of computing 
the ratio described in subdivision (i) of this subparagraph in such a 
case, there shall be taken into account only the employer contributions 
attributable to those amounts with respect to which the deceased 
employee possessed, immediately before his death, a nonforfeitable right 
to receive the amounts while living. See example (3) of subdivision (v) 
of this subparagraph. In no event, however, may the total amount 
excludable under section 101(b) with respect to any employee exceed 
$5,000 (See paragraph (a)(3) of this section).
    (iii)(a) In any case when the deceased employee's interest in the 
employer's contributions for an annuity contract was forfeitable at the 
time the contributions were made but, at a subsequent date prior to his 
death, such interest changed to a nonforfeitable interest, then, for 
purposes of computing the ratio described in subdivision (i) of this 
subparagraph, the cash surrender value of the contract on the date of 
the change (except to the extent attributable to employee contributions) 
shall be considered as the amount contributed by the employer for the 
contract. In such a case, if only part of the deceased employee's 
interest in the annuity changed from a forfeitable to a nonforfeitable 
interest, then only the corresponding part of the cash surrender value 
of the contract on the date of the change shall be considered as the 
amount contributed by the employer for the contract. Similarly, if part 
of the deceased employee's interest in the annuity contract changed from 
a forfeitable to a nonforfeitable interest on a particular date and 
another part of his interest so changed on a subsequent date, it is 
necessary, in order to compute the amount contributed by the employer 
for the contract, to first determine (under the rules in the preceding 
sentence) the amount that is considered as the amount contributed by the 
employer with respect to each change, and then to add these amounts 
together. For purposes of computing the ratio described in subdivision 
(i) of this subparagraph in all of the above cases, the amount 
contributed by the employer that was excludable from the employee's 
gross income under paragraph (b) of Sec. 1.403(b)-1 is that amount 
which, under paragraph (b)(2) of such section, was considered as 
employer contributions and which, under such paragraph (b) of Sec. 
1.403(b)-1, was excludable from the deceased employee's

[[Page 355]]

gross income for the taxable year in which the change occurred.
    (b) This subdivision (iii) may be illustrated by the following 
examples:

    Example (1). X Organization contributed $4,000 toward the purchase 
of an annuity contract for A, an employee who died in 1970. At the time 
they were made, A's interest in such contributions was forfeitable. A 
made no contributions toward the purchase of the annuity contract. On 
January 1, 1960, A's entire interest in the annuity contract changed to 
a nonforfeitable interest. At the time of such change, the cash 
surrender value of the contract was $5,000. For purposes of the ratio 
described in subdivision (i) of this subparagraph, the total amount 
contributed by X Organization for the annuity contract is $5,000. If any 
part of such $5,000 was excludable under paragraph (b) of Sec. 
1.403(b)-1 from A's gross income for his taxable year in which the 
change occurred, the amount so excludable shall be considered as the 
amount contributed for the contract by the employer that was excludable 
from the employee's gross income under paragraph (b) of Sec. 1.403(b)-
1.
    Example (2). Assume the same facts as in example (1) except that 
only one-half of A's interest in the annuity contract changed to a 
nonforfeitable interest on January 1, 1960, and that no other part of 
his interest so changed during his lifetime. For purposes of the ratio 
described in subdivision (i) of this subparagraph, the total amount 
contributed by X Organization for the annuity contract is $2,500 (\1/2\ 
of the cash surrender value of the annuity contract on the date of the 
change). To the extent such $2,500 was, under paragraph (b) of Sec. 
1.403(b)-1, excludable from A's gross income for the taxable year of the 
change, it is considered as the amount contributed by the employer that 
was excludable under paragraph (b) of Sec. 1.403(b)-1.
    Example (3). Assume the same facts as in example (1) except that 
one-half of A's interest in the annuity contract changed to a 
nonforfeitable interest on January 1, 1960, and the other half of his 
interest changed to a nonforfeitable interest on January 1, 1965. On 
January 1, 1965, the cash surrender value of the annuity contract was 
$6,000. For purposes of the ratio described in subdivision (i) of this 
subparagraph, the total amount contributed by X organization for the 
annuity contract is $5,500 (i.e., \1/2\x$5,000 plus \1/2\x$6,000). The 
amount contributed by the employer that was excludable from A's gross 
income under paragraph (b) of Sec. 1.403(b)-1 is an amount equal to the 
sum of the amount that was, under such paragraph, excludable from A's 
gross income for the taxable year during which the first change occurred 
and the amount that was, under such paragraph, excludable from A's gross 
income for the taxable year in which the second change occurred.

    (iv) For purposes of this subparagraph, an annuity contract will be 
considered to have been purchased by an employer which is an 
organization referred to in section 170(b)(1)(A) (ii) or (vi) or which 
is a religious organization (other than a trust) and which is exempt 
from tax under section 501(a), if any of the contributions paid toward 
the purchase price of such contract by the employer were paid at a time 
when the employer was such an organization. Thus an annuity contract may 
be regarded as purchased by such an organization even though part of the 
organization's contributions for such annuity contract were paid at a 
time when the organization was not such an exempt organization.
    (v) The application of this subparagraph may be illustrated by the 
following examples:

    Example (1). The widow of A, a deceased employee, elects, under an 
annuity contract purchased for A by X Organization, to receive in a lump 
sum the present value of such annuity contract as of the date of A's 
death. Such present value is $6,000 and is received by the widow in a 
taxable year beginning after December 31, 1957. X Organization 
contributed $3,000 toward the purchase of the annuity contract and A 
contributed $2,000 toward such purchase. A's interest in X 
Organization's contributions was nonforfeitable at the time such 
contributions were made. Thus, just before his death, A's entire 
interest in the annuity contract was a nonforfeitable interest and, if 
he had retired at that time, he could have received the present value of 
$6,000. The whole amount of the $3,000 contributed by X Organization for 
the annuity contract was excludable from A's gross income under 
paragraph (b) of Sec. 1.403(b)-1. This annuity contract was the only 
annuity contract purchased by X Organization for A and was not purchased 
as part of a qualified plan. However, all the contributions paid by X 
Organization were paid at a time when X Organization was an organization 
referred to in section 170(b)(1)(A)(ii) and exempt from tax under 
section 501(a). The amount that A's widow may exclude from gross income 
(assuming no other death benefits) is computed in the following manner:

(a) Amount includible in gross income without regard to second    $4,000
 sentence of section 101(b)(2)(B) ($6,000 minus $2,000
 contributed for contract by A)...............................
(b) Total employer contributions for the contract.............    $3,000

[[Page 356]]

 
(c) Amount of employer contributions for the contract that was    $3,000
 excludable under paragraph (b) of Sec.  1.403(b)-1..........
(d) Percent of total employer contributions for the contract        100%
 that were excludable under paragraph (b) of Sec.  1.403(b)-1
 ((c) / (b))..................................................
(e) Amount to which section 101(b) exclusion applies ((d) x       $4,000
 (a)).........................................................
 

    Example (2). The facts are the same as in example (1) except that 
only $2,000 of X Organization's contributions for the annuity contract 
was excludable from A's gross income under paragraph (b) of Sec. 
1.403(b)-1 and that the remaining $1,000 was includible in A's gross 
income for the taxable years during which such amounts were contributed 
by X Organization. The amount that A's widow may exclude from gross 
income (assuming no other death benefits) is computed in the following 
manner:

(a) Amount includible in gross income without regard to second    $3,000
 sentence of section 101(b)(2)(B) ($6,000 minus $2,000
 contributed for contract by A and $1,000 of X Organization's
 contributions includible in A's gross income)................
(b) Total employer contributions for the contract.............    $3,000
(c) Amount of employer contributions for the contract that was    $2,000
 excludable under paragraph (b) of Sec.  1.403(b)-1..........
(d) Percent of total employer contributions for the contract         67%
 that were excludable under paragraph (b) of Sec.  1.403(b)-1
 ((c) /(b))...................................................
(e) Amount to which section 101(b) exclusion applies ((d) x       $2,000
 (a)).........................................................
 

    Example (3). The widow of B, a deceased employee, elects, under an 
annuity contract purchased for B by Y Organization, to receive in a lump 
sum the present value of such annuity contract as of the date of B's 
death. Such present value is $6,000 and is received by the widow in a 
taxable year beginning after December 31, 1957. Y Organization 
contributed $4,000 toward the purchase of the contract; whereas B made 
no contributions toward the purchase of the contract. This annuity 
contract was the only annuity contract purchased by Y Organization for B 
and was not purchased as part of a ``qualified'' plan. However, all the 
contributions paid by Y Organization were paid at a time when it was an 
organization referred to in section 170(b)(1)(A)(ii) and exempt from tax 
under section 501(a). B's interest in Y Organization's contributions 
was, at the time they were paid, forfeitable. However, prior to his 
death, one-half of B's interest in the annuity contract changed from a 
forfeitable to a nonforfeitable interest. Therefore, just before his 
death, B could have obtained $3,000 under the annuity contract if he had 
retired at that time. On the date of the change, the cash surrender 
value of the annuity contract was $5,000. As a result of the change, 
$1,500 was, under paragraph (b) of Sec. 1.403(b)-1, excludable from B's 
gross income, and $600 was includible in his gross income for the 
taxable year in which the change occurred. Part of the value of the 
annuity contract on the date of the change was attributable to 
contributions made by Y Organization prior to January 1, 1958, and, 
consequently, was neither excludable from B's gross income under 
paragraph (b) of Sec. 1.403(b)-1 nor includible in B's gross income 
(see paragraph (b) of Sec. 1.403(d)-1). The amount that B's widow may 
exclude from gross income (assuming no other death benefits) is computed 
in the following manner:

(a) Amount of ``total payment'' with respect to which A had a     $3,000
 forfeitable right at time of death. (\1/2\x$6,000)...........
(b) Amount includible in gross income without regard to second    $2,400
 sentence of section 101(b)(2)(B) (\1/2\x$6,000 less $600
 includible in B's gross income for year when his rights
 changed to nonforfeitable rights)............................
(c) Total employer contributions for the contract (\1/2\ of       $2,500
 cash surrender value of contract on date B's rights changed
 to nonforfeitable rights)....................................
(d) Amount of employer contributions for the contract that was    $1,500
 excludable under paragraph (b) of Sec.  1.403(b)-1..........
(e) Percent of total employer contributions for the contract         60%
 that were excludable under paragraph (b) of Sec.  1.403(b)-1
 ((d) / (c))..................................................
(f) Amount to which section 101(b) exclusion applies by reason    $1,440
 of the second sentence of section 101(b)(2)(B) ((e)x(b)).....
(g) Total amount to which section 101(b) exclusion applies        $4,440
 ((a)+(f))....................................................
 


    (e) Annuity payments. (1) Where death benefits are paid in the form 
of annuity payments, the following rules shall govern for purposes of 
the exclusion provided in section 101(b):
    (i) The exclusion from gross income provided by section 101(b) does 
not apply to amounts, paid as an annuity, with respect to which the 
employee possessed, immediately before his death, a nonforfeitable right 
to receive the amounts while living, or to amounts paid as an annuity in 
lieu thereof. See paragraph (d) of this section.
    (ii) Under section 101(b)(2)(C), no exclusion is allowable for 
amounts received by a surviving annuitant under a joint and survivor's 
annuity contract if the annuity starting date (as defined in section 
72(c)(4) and paragraph (b) of Sec. 1.72-4) occurs before the death of 
the employee. If the annuity starting date occurs after the death of the 
employee, the joint and survivor's annuity contract shall be treated as 
an annuity to which section 101(b)(2)(D) applies. See subdivision (iii) 
of this subparagraph.
    (iii)(a) Subject to the other limitations stated in section 101(b) 
and in this section (see section 101(b)(2)(D)), the amount to which the 
exclusion of section 101(b) shall apply, with respect

[[Page 357]]

to ``amounts received as an annuity'' (as defined in paragraph (b) of 
Sec. 1.72-2) shall be the amount by which the present value of the 
annuity to be paid to the beneficiary, computed as of the date of the 
employee's death, exceeds the value (if any) of whichever of the 
following is the larger:
    (1) Amounts contributed by the employee (determined in accordance 
with the provisions of section 72 and the regulations thereunder), or
    (2) Amounts with respect to which the employee possessed, 
immediately before his death, a nonforfeitable right to receive the 
amounts while living, or amounts paid in lieu thereof (see paragraph (d) 
of this section).
    (b) The present value of an annuity (immediately before the death of 
the employee), to the employee, or (immediately after the death of the 
employee), to his estate or beneficiary, shall be determined as follows:
    (1) In the case of an annuity paid by an insurance company or by an 
organization (other than an insurance company) regularly engaged in 
issuing annuity contracts with an insurance company as the coinsurer or 
reinsurer of the obligations under the contract, by use of the discount 
interest rates and mortality tables used by the insurance company 
involved to determine the installment benefits; and
    (2) In the case of an annuity issued after November 23, 1984, to 
which paragraph (e)(1)(iii)(b)(1) of this section is not applicable, by 
use of the appropriate tables in Sec. 20.2031-7 of this chapter (Estate 
Tax Regulations).
    (iv) Any amount subject to section 101(b)(2)(D) which is excludable 
under section 101(b) (see subdivision (iii) of this subparagraph) shall, 
for purposes of section 72, be treated as additional consideration paid 
by the employee. See paragraph (b) of Sec. 1.72-8.
    (v) Where more than one beneficiary, or more than one death benefit, 
is involved, the exclusion provided by section 101(b) shall be 
apportioned to the various beneficiaries and benefits in accordance with 
the proportion that the present value of each benefit bears to the total 
present value of all the benefits.
    (2) The application of the principles of this paragraph may be 
illustrated by the following examples:

    Example (1). (i) A died on January 1, 1969. Under the plan of the X 
Corporation, W, who is the widow of employee A, and who is 55 years old 
at the time of A's death, is entitled to an immediate annuity of $2,000 
per year during her life and C, the minor child of A, is entitled to 
receive $1,000 per year for 15 years. A made no contributions under the 
plan and died while still employed by the X Corporation. At the time of 
A's death, the amount in his account is $18,000. Under the terms of the 
plan, this amount would have been distributable to him on account of 
voluntary termination of employment, but would not have been payable 
after his death except in the form of the annuities just described. This 
amount, accordingly, constitutes a nonforfeitable interest in lieu of 
which the annuities are paid. The exclusion does not apply, except to 
the extent that the present value of the annuities exceeds $18,000, 
whether or not the plan is ``qualified'', since the total of the amount 
in A's account will not be paid within one taxable year of the 
distributees. See subparagraph (1)(i) of this paragraph.
    (ii) The computation of the exclusion applicable to the interests of 
W and C (assuming that the payments will not be made by an insurance 
company or some other organization regularly engaged in issuing annuity 
contracts) is, by application of the tables in Sec. 20.2031-7 of this 
chapter (Estate Tax Regulations), as follows: The present value of W's 
interest is $26,243.60, determined by multiplying the annual payment of 
$2,000 by 13.1218 (the factor in Table I for a person aged 55); the 
present value of C's interest is $11,517.40, determined by multiplying 
the yearly payment of $1,000 by 11.5174 (the factor in Table II for 
payments for a term certain of 15 years). The present value of both 
annuities is $37,761 and (assuming no other death benefits are 
involved), the total amount excludable is $5,000, because the total 
present value of the annuities exceeds the employee's nonforfeitable 
interest by more than $5,000 ($37,761 minus $18,000 equal $19,761). The 
exclusion allocable to W's interest is $26,243.60/$37,761 times $5,000, 
or $3,474.96; the exclusion allocable to C's interest is $11,517.40/
$37,761 times $5,000, or $1,525.04. That portion of the death benefit 
exclusion as so determined for each beneficiary is to be treated as 
consideration paid by the employee for purposes of section 72.
    Example (2). The facts are the same as in example (1), except that 
the nonforfeitable interest of A, at the time of his death, amounted to 
$33,761. Since the present value of both annuities ($37,761) exceeds the 
value of such nonforfeitable interest by only $4,000,

[[Page 358]]

the latter amount is the total amount excludable from the gross income 
of the beneficiaries. This $4,000 exclusion is to be divided in the same 
proportions as those indicated in example (1). Thus, the exclusion 
allocable to W's interest is $26,243.60/$37,761 times $4,000, or 
$2,779.97; and the exclusion allocable to the interest of C is 
$11,517.40/$37,761 times $4,000, or $1,220.03. That portion of the death 
benefit exclusion as so determined for each beneficiary is to be treated 
as consideration paid by the employee for purposes of section 72.

    (f) Distributions on behalf of a self- employed individual. (1) 
Under sections 401(c)(1) and 403(a)(3), certain self-employed 
individuals may be covered by a pension or profit-sharing plan described 
in section 401(a) and exempt under section 501(a) or under an annuity 
plan described in section 403(a). However, a payment pursuant to the 
provisions of any such plan by reason of the death of an individual who 
participated in such a plan as a self-employed individual immediately 
before his retirement or death to the beneficiary or estate of such 
individual does not qualify for the exclusion provided by section 
101(b).
    (2) The application of this paragraph may be illustrated by the 
following examples:

    Example (1). From 1950 to 1965, A was an employee of B, a sole 
proprietor. In 1963, B established a qualified pension plan covering A 
and all other persons who had been employed by B for more than 3 years. 
In 1965, A acquired from B a 40-percent interest in the capital and 
profits of the business. A continued to participate in the pension plan 
as a self-employed individual. In 1970, A died and his widow, in 
compliance with one of the provisions of the pension plan, elected to 
receive all of the benefits accrued to A prior to his death in a lump-
sum distribution. As A participated in the plan as a self-employed 
individual immediately prior to his death, A's widow may not exclude any 
portion of such distribution from her gross income under section 101(b).
    Example (2). A, an attorney, is employed by the X Company in their 
legal department. He is covered by the pension plan that X has 
established for its employees. Under the terms of A's contract of 
employment with X, A is permitted to carry on the private practice of 
law in his off-duty hours. A establishes his own pension plan with 
respect to his earnings from his private practice. On A's death, his 
widow elected to receive a lump-sum distribution with respect to any 
benefits accrued to A under both X's pension plan and A's own pension 
plan. To the extent that such payment otherwise complies with the 
requirements of section 101(b), up to $5,000 of the amount paid by X may 
be excluded from her gross income. No part of the distribution from A's 
own pension plan may be excluded from her gross income under section 
101(b) because A participated in the plan as a self-employed individual 
immediately before his death.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6722, 29 FR 
5070, Apr. 14, 1964; T.D. 6783, 29 FR 18357, Dec. 24, 1964; T.D. 7352, 
40 FR 16666, Apr. 14, 1975; T.D. 7428, 41 FR 34619, Aug. 16, 1976; T.D. 
7836, 47 FR 42337, Sept. 27, 1982; T.D. 7955, 49 FR 19975, May 11, 1984; 
T.D. 8540, 59 FR 30102, 30103, June 10, 1994]



Sec. 1.101-3  Interest payments.

    (a) Applicability of section 101(c). Section 101(c) provides that if 
any amount excluded from gross income by section 101(a) (relating to 
life insurance proceeds) or section 101(b) (relating to employees' death 
benefits) is held under an agreement to pay interest thereon, the 
interest payments shall be included in gross income. This provision 
applies to payments made (either by an insurer or by or on behalf of an 
employer) of interest earned on any amount so excluded from gross income 
which is held without substantial diminution of the principal amount 
during the period when such interest payments are being made or credited 
to the beneficiaries or estate of the insured or the employee. For 
example, if a monthly payment is $100, of which $99 represents interests 
and $1 represents diminution of the principal amount, the principal 
amount shall be considered held under an agreement to pay interest 
thereon and the interest payment shall be included in the gross income 
of the recipient. Section 101(c) applies whether the election to have an 
amount held under an agreement to pay interest thereon is made by the 
insured or employee or by his beneficiaries or estate, and whether or 
not an interest rate is explicitly stated in the agreement. Section 
101(d), relating to the payment of life insurance proceeds at a date 
later than death, shall not apply to any amount to which section 101(c) 
applies. See section 101(d)(4). However, both section 101(c) and section 
101(d) may apply to payments received under a

[[Page 359]]

single life insurance contract. For provisions relating to the 
application of this rule to payments received under a permanent life 
insurance policy with a family income rider attached, see paragraph (h) 
of Sec. 1.101-4.
    (b) Determination of ``present value''. For the purpose of 
determining whether section 101(c) or section 101(d) applies, the 
present value (at the time of the insured's death) of any amount which 
is to be paid at a date later than death shall be determined by the use 
of the interest rate and mortality tables used by the insurer in 
determining the size of the payments to be made.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6577, 26 FR 
10127, Oct. 28, 1961]



Sec. 1.101-4  Payment of life insurance proceeds at a date later than 
death.

    (a) In general. (1)(i) Section 101(d) states the provisions 
governing the exclusion from gross income of amounts (other than those 
to which section 101(c) applies) received under a life insurance 
contract and paid by reason of the death of the insured which are paid 
to a beneficiary on a date or dates later than the death of the insured. 
However, if the amounts payable as proceeds of life insurance to which 
section 101(a)(1) applies cannot in any event exceed the amount payable 
at the time of the insured's death, such amounts are fully excludable 
from the gross income of the recipient (or recipients) without regard to 
the actual time of payment and no further determination need be made 
under this section. Section 101(d)(1)(A) provides an exclusion from 
gross income of any amount determined by a proration, under applicable 
regulations, of ``an amount held by an insurer with respect to any 
beneficiary''. The quoted phrase is defined in section 101(d)(2). For 
the regulations governing the method of computation of this proration, 
see paragraphs (c) through (f) of this section. The prorated amounts are 
to be excluded from the gross income of the beneficiary regardless of 
the taxable year in which they are actually received (see example (2) of 
subparagraph (2) of this paragraph).
    (ii) Section 101(d)(1)(B) provides an additional exclusion where 
life insurance proceeds are paid to the surviving spouse of an insured. 
For purposes of this exclusion, the term ``surviving spouse'' means the 
spouse of the insured as of the date of death, including a spouse 
legally separated, but not under a decree of absolute divorce (section 
101(d)(3)). To the extent that the total payments, under one or more 
agreements, made in excess of the amounts determined by proration under 
section 101(d)(1)(A) do not exceed $1,000 in the taxable year of 
receipt, they shall be excluded from the gross income of the surviving 
spouse (whether or not payment of any part of such amounts is guaranteed 
by the insurer). Amounts excludable under section 101(d)(1)(B) are not 
``prorated'' amounts.
    (2) The principles of this paragraph may be illustrated by the 
following examples:

    Example (1). A surviving spouse elects to receive all of the life 
insurance proceeds with respect to one insured, amounting to $150,000, 
in ten annual installments of $16,500 each, based on a certain 
guaranteed interest rate. The prorated amount is $15,000 ($150,000/10). 
As the second payment, the insurer pays $17,850, which exceeds the 
guaranteed payment by $1,350 as the result of earnings of the insurer in 
excess of those required to pay the guaranteed installments. The 
surviving spouse shall include $1,850 in gross income and exclude 
$16,000--determined in the following manner:

Fixed payment (including guaranteed interest).................   $16,500
Excess interest...............................................     1,350
                                                               ---------
    Total payment.............................................    17,850
Prorated amount...............................................    15,000
                                                               ---------
    Excess over prorated amount...............................     2,850
Annual excess over prorated amount excludable under section        1,000
 101(d)(1)(B).................................................
                                                               ---------
    Amount includible in gross income.........................     1,850
 

    Example (2). Assume the same facts as in example (1), except that 
the third and fourth annual installments, totalling $33,000 (2x$16,500), 
are received in a single subsequent taxable year of the surviving 
spouse. The prorated amount of $15,000 of each annual installment, 
totalling $30,000, shall be excluded even though the spouse receives 
more than one annual installment in the single subsequent taxable year. 
However, the surviving spouse is entitled to only one exclusion of 
$1,000 under section 101(d)(1)(B) for each taxable year of receipt. The 
surviving spouse shall include $2,000 in her gross income for the 
taxable year with respect to the above installment payments ($33,000 
less the sum of $30,000 plus $1,000).

[[Page 360]]

    Example (3). Assume the same facts as in example (1), except that 
the surviving spouse dies before receiving all ten annual installments 
and the remaining installments are paid to her estate or beneficiary. In 
such a case, $15,000 of each installment would continue to be excludable 
from the gross income of the recipient, but any amounts received in 
excess thereof would be fully includible.

    (b) Amount held by an insurer. (1) For the purpose of the proration 
referred to in section 101(d)(1), an ``amount held by an insurer with 
respect to any beneficiary'' means an amount equal to the present value 
to such beneficiary (as of the date of death of the insured) of an 
agreement by the insurer under a life insurance policy (whether as an 
option or otherwise) to pay such beneficiary an amount or amounts at a 
date or dates later than the death of the insured (section 101(d)(2)). 
The present value of such agreement is to be computed as if the 
agreement under the life insurance policy had been entered into on the 
date of death of the insured, except that such value shall be determined 
by the use of the mortality table and interest rate used by the insurer 
in calculating payments to be made to the beneficiary under such 
agreement. Where an insurance policy provides an option for the payment 
of a specific amount upon the death of the insured in full discharge of 
the contract, such lump sum is the amount held by the insurer with 
respect to all beneficiaries (or their beneficiaries) under the 
contract. See, however, paragraph (e) of this section.
    (2) In the case of two or more beneficiaries, the ``amount held by 
the insurer'' with respect to each beneficiary depends on the 
relationship of the different benefits payable to such beneficiaries. 
Where the amounts payable to two or more beneficiaries are independent 
of each other, the ``amount held by the insurer with respect to each 
beneficiary'' shall be determined and prorated over the periods involved 
independently. Thus, if a certain amount per month is to be paid to A 
for his life, and, concurrently, another amount per month is to be paid 
to B for his life, the ``amount held by the insurer'' shall be 
determined and prorated for both A and B independently, but the 
aggregate shall not exceed the total present value of such payments to 
both. On the other hand, if the obligation to pay B was contingent on 
his surviving A, the ``amount held by the insurer'' shall be considered 
an amount held with respect to both beneficiaries simultaneously. 
Furthermore, it is immaterial whether B is a named beneficiary or merely 
the ultimate recipient of payments for a term of years. For the special 
rules governing the computation of the proration of the ``amount held by 
an insurer'' in determining amounts excludable under the provisions of 
section 101(d), see paragraphs (c) to (f), inclusive, of this section.
    (3) Notwithstanding any other provision of this section, if the 
policy was transferred for a valuable consideration, the total ``amount 
held by an insurer'' cannot exceed the sum of the consideration paid 
plus any premiums or other consideration paid subsequent to the transfer 
if the provisions of section 101(a)(2) and paragraph (b) of Sec. 1.101-
1 limit the excludability of the proceeds to such total.
    (c) Treatment of payments for life to a sole beneficiary. If the 
contract provides for the payment of a specified lump sum, but, pursuant 
to an agreement between the beneficiary and the insurer, payments are to 
be made during the life of the beneficiary in lieu of such lump sum, the 
lump sum shall be divided by the life expectancy of the beneficiary 
determined in accordance with the mortality table used by the insurer in 
determining the benefits to be paid. However, if payments are to be made 
to the estate or beneficiary of the primary beneficiary in the event 
that the primary beneficiary dies before receiving a certain number of 
payments or a specified total amount, such lump sum shall be reduced by 
the present value (at the time of the insured's death) of amounts which 
may be paid by reason of the guarantee, in accordance with the 
provisions of paragraph (e) of this section, before making this 
calculation. To the extent that payments received in each taxable year 
do not exceed the amount found from the above calculation, they are 
``prorated amounts'' of the ``amount held by an insurer'' and are 
excludable from the gross income of the beneficiary without regard to 
whether he lives beyond

[[Page 361]]

the life expectancy used in making the calculation. If the contract in 
question does not provide for the payment of a specific lump sum upon 
the death of the insured as one of the alternative methods of payment, 
the present value (at the time of the death of the insured) of the 
payments to be made the beneficiary, determined in accordance with the 
interest rate and mortality table used by the insurer in determining the 
benefits to be paid, shall be used in the above calculation in lieu of a 
lump sum.
    (d) Treatment of payments to two or more beneficiaries--(1) 
Unrelated payments. If payments are to be made to two or more 
beneficiaries, but the payments to be made to each are to be made 
without regard to whether or not payments are made or continue to be 
made to the other beneficiaries, the present value (at the time of the 
insured's death) of such payments to each beneficiary shall be 
determined independently for each such beneficiary. The present value so 
determined shall then be divided by the term for which the payments are 
to be made. If the payments are to be made for the life of the 
beneficiary, the divisor shall be the life expectancy of the 
beneficiary. To the extent that payments received by a beneficiary do 
not exceed the amount found from the above calculation, they are 
``prorated amounts'' of the ``amount held by an insurer'' with respect 
to such beneficiary and are excludable from the gross income of the 
beneficiary without regard to whether he lives beyond any life 
expectancy used in making the calculation. For the purpose of the 
calculation described above, both the ``present value'' of the payments 
to be made periodically and the ``life expectancy'' of the beneficiary 
shall be determined in accordance with the interest rate and mortality 
table used by the insurer in determining the benefits to be paid. If 
payments are to be made to the estate or beneficiary of a primary 
beneficiary in the event that such beneficiary dies before receiving a 
certain number of payments or a specified total amount, the ``present 
value'' of payments to such beneficiary shall not include the present 
value (at the time of the insured's death) of amounts which may be paid 
by reason of such a guarantee. See paragraph (e) of this section.
    (2) Related payments. If payments to be made to two or more 
beneficiaries are in the nature of a joint and survivor annuity (as 
described in paragraph (b) of Sec. 1.72-5), the present value (at the 
time of the insured's death) of the payments to be made to all such 
beneficiaries shall be divided by the life expectancy of such 
beneficiaries as a group. To the extent that the payments received by a 
beneficiary do not exceed the amount found from the above calculation, 
they are ``prorated amounts'' of the ``amount held by an insurer'' with 
respect to such beneficiary and are excludable from the gross income of 
the beneficiary without regard to whether all the beneficiaries involved 
live beyond the life expectancy used in making the calculation. For the 
purpose of the calculation described above, both the ``present value'' 
of the payments to be made periodically and the ``life expectancy'' of 
all the beneficiaries as a group shall be determined in accordance with 
the interest rate and mortality table used by the insurer in determining 
the benefits to be paid. If the contract provides that certain payments 
are to be made in the event that all the beneficiaries of the group die 
before a specified number of payments or a specified total amount is 
received by them, the present value of payments to be made to the group 
shall not include the present value (at the time of the insured's death) 
of amounts which may be paid by reason of such a guarantee. See 
paragraph (e) of this section.
    (3) Payments to secondary beneficiaries. Payments made by reason of 
the death of a beneficiary (or beneficiaries) under a contract providing 
that such payments shall be made in the event that the beneficiary (or 
beneficiaries) die before receiving a specified number of payments or a 
specified total amount shall be excluded from the gross income of the 
recipient to the extent that such payments are made solely by reason of 
such guarantee.
    (e) Treatment of present value of guaranteed payments. In the case 
of payments which are to be made for a life or lives under a contract 
providing

[[Page 362]]

that further amounts shall be paid upon the death of the primary 
beneficiary (or beneficiaries) in the event that such beneficiary (or 
beneficiaries) die before receiving a specified number of payments or a 
specified total amount, the present value (at the time of the insured's 
death) of all payments to be made under the contract shall not include, 
for purposes of prorating the amount held by the insurer, the present 
value of the payments which may be made to the estate or beneficiary of 
the primary beneficiary. In such a case, any lump sum amount used to 
measure the value of the amount held by an insurer with respect to the 
primary beneficiary must be reduced by the value at the time of the 
insured's death of any amounts which may be paid by reason of the 
guarantee provided for a secondary beneficiary or the estate of the 
primary beneficiary before prorating such lump sum over the life or 
lives of the primary beneficiaries. Such present value (of the 
guaranteed payment) shall be determined by the use of the interest rate 
and mortality tables used by the insurer in determining the benefits to 
be paid.
    (f) Treatment of payments not paid periodically. Payments made to 
beneficiaries other than periodically shall be included in the gross 
income of the recipients, but only to the extent that they exceed 
amounts payable at the time of the death of the insured to each such 
beneficiary or, where no such amounts are specified, the present value 
of such payments at that time.
    (g) Examples. The principles of this section may be illustrated by 
the following examples:

    Example (1). A life insurance policy provides for the payment of 
$20,000 in a lump sum to the beneficiary at the death of the insured. 
Upon the death of the insured, the beneficiary elects an option to leave 
the proceeds with the company for five years and then receive payment of 
$24,000, having no claim of right to any part of such sum before the 
entire five years have passed. Upon the payment of the larger sum, 
$24,000, the beneficiary shall include $4,000 in gross income and 
exclude $20,000 therefrom. If it is assumed that the same insurer has 
determined the benefits to be paid, the same result would obtain if no 
lump sum amount were provided for at the death of the insured and the 
beneficiary were to be paid $24,000 five years later. In neither of 
these cases would the surviving spouse be able to exclude any additional 
amount from gross income since both cases involve an amount held by an 
insurer under an agreement to pay interest thereon to which section 
101(c) applies, rather than an amount to be paid periodically after the 
death of the insured to which section 101(d) applies.
    Example (2). A life insurance policy provides that $1,200 per year 
shall be paid the sole beneficiary (other than a surviving spouse) until 
a fund of $20,000 and interest which accrues on the remaining balance is 
exhausted. A guaranteed rate of interest is specified, but excess 
interest may be credited according to the earnings of the insurer. 
Assuming that the fund will be exhausted in 20 years if only the 
guaranteed interest is actually credited, the beneficiary shall exclude 
$1,000 of each installment received ($20,000 divided by 20) and any 
installments received, whether by the beneficiary or his estate or 
beneficiary, in excess of 20 shall be fully included in the gross income 
of the recipient. If, instead, the excess interest were to be paid each 
year, any portion of each installment representing an excess over $1,000 
would be fully includible in the recipient's gross income. Thus, if an 
installment of $1,350 were received, $350 of it would be included in 
gross income.
    Example (3). Assume that the sole life insurance policy of a 
decedent provides only for the payment of $5,000 per year for the life 
of his surviving spouse, beginning with the insured's death. If the 
present value of the proceeds, determined by reference to the interest 
rate and the mortality table used by the insurance company, is $60,000, 
and such beneficiary's life expectancy is 20 years, $3,000 of each 
$5,000 payment ($60,000 divided by 20) is excludable as the prorated 
portion of the ``amount held by an insurer''. For each taxable year in 
which a payment is made, an additional $1,000 is excludable from the 
gross income of the surviving spouse. Hence, if she receives only one 
$5,000 payment in her taxable year, only $1,000 is includible in her 
gross income in that year with respect to such payment ($5,000 less the 
total amount excludable, $4,000). Assuming that the policy also provides 
for payments of $2,000 per year for 10 years to the daughter of the 
insured, the present value of the payments to the daughter is to be 
computed separately for the purpose of determining the excludable 
portion of each payment to her. Assuming that such present value is 
$15,000, $1,500 of each payment of $2,000 received by the daughter is 
excludable from her gross income ($15,000 divided by 10). The remaining 
$500 shall be included in the gross income of the daughter.
    Example (4). Beneficiaries A and B, neither of whom is the surviving 
spouse of the insured, are each to receive annual payments

[[Page 363]]

of $1,800 for each of their respective lives upon the death of the 
insured. The contract does not provide for payments to be made in any 
other manner. Assuming that the present value of the payments to be made 
to A, whose life expectancy according to the insurer's mortality table 
is 30 years, is $36,000, A shall exclude $1,200 of each payment received 
($36,000 divided by 30). Assuming that the present value of the payments 
to be made to B, whose life expectancy according to the insurer's 
mortality table is 20 years, is $27,000, B shall exclude $1,350 of each 
payment received ($27,000 divided by 20).
    Example (5). A life insurance policy provides for the payment of 
$76,500 in a lump sum to the beneficiary, A, at the death of the 
insured. Upon the insured's death, however, A selects an option for the 
payment of $2,000 per year for her life and for the same amount to be 
paid after her death to B, her daughter, for her life. Assuming that 
since A is 51 years of age and her daughter is 28 years of age, the 
insurer determined the amount of the payments by reference to a 
mortality table under which the life expectancy for the lives of both A 
and B, joint and survivor, is 51 years, $1,500 of each $2,000 payment to 
either A or B ($76,500 divided by 51, or $1,500) shall be excluded from 
the gross income of the recipient. However, if A is the surviving spouse 
of the insured and no other contracts of insurance whose proceeds are to 
be paid to her at a date later than death are involved, A shall exclude 
the entire payment of $2,000 in any taxable year in which she receives 
but one such payment because of the additional exclusion under section 
101(d)(1)(B).
    Example (6). Beneficiaries A and B, neither of whom is the surviving 
spouse of the insured, are each to receive annual payments of $1,800 for 
each of their respective lives upon the death of the insured, but after 
the death of either, the survivor is to receive the payments formerly 
made to the deceased beneficiary until the survivor dies. Assuming that 
the life expectancy, joint and survivor, of A and B in accordance with 
the mortality table used by the insurer is 32 years and assuming that 
the total present value of the benefits to both (determined in 
accordance with the interest rate used by the insurer) is $80,000, A and 
B shall each exclude $1,250 of each installment of $1,800 ($80,000 
divided by the life expectancy, 32, multiplied by the fraction of the 
annual payment payable to each, one-half) until the death of either. 
Thereafter, the survivor shall exclude $2,500 of each installment of 
$3,600 ($80,000 divided by 32).
    Example (7). A life insurance policy provides for the payment of 
$75,000 in a lump sum to the beneficiary, A, at the death of the 
insured. A, upon the insured's death, however, selects an option for the 
payment of $4,000 per year for life, with a guarantee that any part of 
the $75,000 lump sum not paid to A before his death shall be paid to B 
(or his estate). A's beneficiary. Assuming that, under the criteria used 
by the insurer in determining the benefits to be paid, the present value 
of the guaranteed amount to B is $13,500 and that A's life expectancy is 
25 years, the lump sum shall be reduced by the present value of the 
guarantee to B ($75,000 less $13,500, or $61,500) and divided by A's 
life expectancy ($61,500 divided by 25, or $2,460). Hence, $2,460 of 
each $4,000 payment is excludable from A's gross income. If A is the 
surviving spouse of the insured and no other contracts of insurance 
whose proceeds are to be paid to her at a date later than death are 
involved, A shall exclude $3,460 of each $4,000 payment from gross 
income in any taxable year in which but one such payment is received. 
Under these facts, if any amount is paid to B by reason of the fact that 
A dies before receiving a total of $75,000, the residue of the lump sum 
paid to B shall be excluded from B's gross income since it is wholly in 
lieu of the present value of such guarantee plus the present value of 
the payments to be made to the first beneficiary, and is therefore 
entirely an ``amount held by an insurer'' paid at a date later than 
death (see paragraph (d)(3) of this section).
    Example (8). Assume that an insurance policy does not provide for 
the payment of a lump sum, but provides for the payment of $1,200 per 
year for a beneficiary's life upon the death of the insured, and also 
provides that if ten payments are not made to the beneficiary before 
death a secondary beneficiary (whether named by the insured or by the 
first beneficiary) shall receive the remainder of the ten payments in 
similar installments. If, according to the criteria used by the 
insurance company in determining the benefits, the present value of the 
payments to the first beneficiary is $12,000 and the life expectancy of 
such beneficiary is 15 years, $800 of each payment received by the first 
beneficiary is excludable from gross income. Assuming that the same 
figures obtain even though the payments are to be made at the rate of 
$100 per month, the yearly exclusion remains the same unless more or 
less than twelve months' installments are received by the beneficiary in 
a particular taxable year. In such a case two-thirds of the total 
received in the particular taxable year with respect to such beneficiary 
shall be excluded from gross income. Under either of the above 
alternatives, any amount received by the second beneficiary by reason of 
the guarantee of ten payments is fully excludable from the beneficiary's 
gross income since it is wholly in lieu of the present value of such 
guarantee plus the present value of the payments to be made to the first 
beneficiary and is therefore entirely an ``amount held by an insurer'' 
paid at a date later than death (see paragraph (d)(3) of this section).


[[Page 364]]


    (h) Applicability of both section 101(c) and 101(d) to payments 
under a single life insurance contract--(1) In general. Section 101(d) 
shall not apply to interest payments on any amount held by an insurer 
under an agreement to pay interest thereon (see sections 101(c) and 
101(d)(4) and Sec. 1.101-3). On the other hand, both section 101(c) and 
section 101(d) may be applicable to payments received under a single 
life insurance contract, if such payments consist both of interest on an 
amount held by an insurer under an agreement to pay interest thereon and 
of amounts held by the insurer and paid on a date or dates later than 
the death of the insured. One instance when both section 101(c) and 
section 101(d) may be applicable to payments received under a single 
life insurance contract is in the case of a permanent life insurance 
policy with a family income rider attached. A typical family income 
rider is one which provides additional term insurance coverage for a 
specified number of years from the register date of the basic policy. 
Under the policy with such a rider, if the insured dies at any time 
during the term period, the beneficiary is entitled to receive (i) 
monthly payments of a specified amount commencing as of the date of 
death and continuing for the balance of the term period, and (ii) a lump 
sum payment of the proceeds under the basic policy to be paid at the end 
of the term period. If the insured dies after the expiration of the term 
period, the beneficiary receives only the proceeds under the basic 
policy. If the insured dies before the expiration of the term period, 
part of each monthly payment received by the beneficiary during the term 
period consists of interest on the proceeds of the basic policy (such 
proceeds being retained by the insurer until the end of the term 
period). The remaining part consists of an installment (principal plus 
interest) of the proceeds of the terms insurance purchased under the 
family income rider. The amount of term insurance which is provided 
under the family income rider is, therefore, that amount which, at the 
date of the insured's death, will provide proceeds sufficient to fund 
such remaining part of each monthly payment. Since the proceeds under 
the basic policy are held by the insurer until the end of the term 
period, that portion of each monthly payment which consists of interest 
on such proceeds is interest on an amount held by an insurer under an 
agreement to pay interest thereon and is includible in gross income 
under section 101(c). On the other hand, since the remaining portion of 
each monthly payment consists of an installment payment (principal plus 
interest) of the proceeds of the term insurance, it is a payment of an 
amount held by the insurer and paid on a date later than the death of 
the insured to which section 101(d) and this section applies (including 
the $1,000 exclusion allowed the surviving spouse under section 
101(d)(1)(B)). The proceeds of the basic policy, when received in a lump 
sum at the end of the term period, are excludable from gross income 
under section 101(a).
    (2) Example of tax treatment of amounts received under a family 
income rider. The following example illustrates the application of the 
principles contained in subparagraph (1) of this paragraph to payments 
received under a permanent life insurance policy with a family income 
rider attached:

    Example. The sole life insurance policy of the insured provides for 
the payment of $100,000 to the beneficiary (the insured's spouse) on his 
death. In addition, there is attached to the policy a family income 
rider which provides that, if the insured dies before the 20th 
anniversary of the basic policy, the beneficiary shall receive (i) 
monthly payments of $1,000 commencing on the date of the insured's death 
and ending with the payment prior to the 20th anniversary of the basic 
policy, and (ii) a single payment of $100,000 payable on the 20th 
anniversary of the basic policy. On the date of the insured's death, the 
beneficiary (surviving spouse of the insured) is entitled to 36 monthly 
payments of $1,000 and to the single payment of $100,000 on the 20th 
anniversary of the basic policy. The value of the proceeds of the term 
insurance at the date of the insured's death is $28,409.00 (the present 
value of the portion of the monthly payments to which section 101(d) 
applies computed on the basis that the interest rate used by the insurer 
in determining the benefits to be paid under the contract is 2\1/4\ 
percent). The amount of each monthly payment of $1,000 which is 
includible in the beneficiary's gross income is determined in the 
following manner:

(a) Total amount of monthly payment.........................   $1,000.00

[[Page 365]]

 
(b) Amount includible in gross income under section 101(c)        185.00
 as interest on the $100,000 proceeds under the basic policy
 held by the insurer until 20th anniversary of the basic
 policy (computed on the basis that the interest rate used
 by the insurer in determining the benefits to be paid under
 the contract is 2\1/4\ percent)............................
(c) Amount to which section 101(d) applies ((a) minus (b))..      815.00
(d) Amount excludable from gross income under section 101(d)      789.14
 ($28,409/36)...............................................
(e) Amount includible in gross income under section 101(d)         25.86
 without taking into account the $1,000 exclusion allowed
 the beneficiary as the surviving spouse ((c) minus (d))....
 


The beneficiary, as the surviving spouse of the insured, is entitled to 
exclude the amounts otherwise includible in gross income under section 
101(d) (item (e)) to the extent such amounts do not exceed $1,000 in the 
taxable year of receipt. This exclusion is not applicable, however, with 
respect to the amount of each payment which is includible in gross 
income under section 101(c) (item (b)). In this example, therefore, the 
beneficiary must include $185 of each monthly payment in gross income 
(amount includible under section 101(c)), but may exclude the $25.86 
which is otherwise includible under section 101(d). The payment of 
$100,000 which is payable to the beneficiary on the 20th anniversary of 
the basic policy will be entirely excludable from gross income under 
section 101(a).

    (3) Limitation on amount considered to be an ``amount held by an 
insurer''. See paragraph (b)(3) of this section for a limitation on the 
amount which shall be considered an ``amount held by an insurer'' in the 
case of proceeds of life insurance which are paid subsequent to the 
transfer of the policy for a valuable consideration.
    (4) Effective date. The provisions of this paragraph are applicable 
only with respect to amounts received during taxable years beginning 
after October 28, 1961, irrespective of the date of the death of the 
insured.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6577, 26 FR 
10127, Oct. 28, 1961; 26 FR 10275, Nov. 2, 1961]



Sec. 1.101-5  Alimony, etc., payments.

    Proceeds of life insurance policies paid by reason of the death of 
the insured to his separated wife, or payment excludable as death 
benefits under section 101(b) paid to a deceased employee's separated 
wife, if paid to discharge legal obligations imposed by a decree of 
divorce or separate maintenance, by a written separation agreement 
executed after August 16, 1954, or by a decree of support entered after 
March 1, 1954, shall be included in the gross income of the separated 
wife if section 71 or 682 is applicable to the payments made. For 
definition of ``wife'', see section 7701(a)(17) and the regulations 
thereunder.



Sec. 1.101-6  Effective date.

    (a) Except as otherwise provided in paragraph (h)(4) of Sec. 1.101-
4, the provisions of section 101 of the Internal Revenue Code of 1954 
and Sec. Sec. 1.101-1, 1.101-2, 1.101-3, 1.101-4, and 1.101-5 are 
applicable only with respect to amounts received by reason of the death 
of an insured or an employee occurring after August 16, 1954. In the 
case of such amounts, these sections are applicable even though the 
receipt of such amounts occurred in a taxable year beginning before 
January 1, 1954, to which the Internal Revenue Code of 1939 applies.
    (b) Section 22(b)(1) of the Internal Revenue Code of 1939 and the 
regulations pertaining thereto shall apply to amounts received by reason 
of the death of an insured or an employee occurring before August 17, 
1954, regardless of the date of receipt.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6577, 26 FR 
10128, Oct. 28, 1961]



Sec. 1.101-7  Mortality table used to determine exclusion for deferred 
payments of life insurance proceeds.

    (a) Mortality table. Notwithstanding any provision of Sec. 1.101-4 
that otherwise would permit the use of a mortality table not described 
in this section, the mortality table set forth in Sec. 1.72-7(c)(1) 
must be used to determine--
    (1) The amount held by an insurer with respect to a beneficiary for 
purposes of section 101(d)(2) and Sec. 1.101-4; and
    (2) The period or periods with respect to which payments are to be 
made for purposes of section 101(d)(1) and Sec. 1.101-4.
    (b) Examples. The principles of this section may be illustrated by 
the following examples:

    Example (1). A life insurance policy provides only for the payment 
of $5,000 per year

[[Page 366]]

for the life of the beneficiary, A, beginning with the insured's death. 
If A is 59 years of age at the time of the insured's death, the period 
with respect to which the payments are to be made is 25 years. This 
period is determined by using the mortality table set forth in Sec. 
1.72-7(c)(1), and is shown in Table V of Sec. 1.72-9 (which contains 
life expectancy tables determined using this mortality table). If the 
present value of the proceeds, determined by reference to the interest 
rate used by the insurance company and the mortality table set forth in 
Sec. 1.72-7(c)(1), is $75,000, $3,000 of each $5,000 payment ($75,000 
divided by 25) is excluded from the gross income of A.
    Example (2). A life insurance policy provides for the payment of 
$82,500 in a lump sum to the beneficiary, A, at the death of the 
insured. Upon the insured's death, however, A selects an option for the 
payment of $2,000 per year for life and for the same amount to be paid 
after A's death to B for B's life. If A is 51 years of age and B is 28 
years of age at the death of the insured, the period with respect to 
which the payments are to be made is 55 years. This period is determined 
by using the mortality table set forth in Sec. 1.72-7(c)(1), and is 
shown in Table VI of Sec. 1.72-9 (which contains life expectancy tables 
determined using this mortality table). Accordingly $1,500 of each 
$2,000 payment ($82,500 divided by 55) is excluded from the gross income 
of the recipient.

    (c) Effective date. This section applies to amounts received with 
respect to deaths occurring after October 22, 1986, in taxable years 
ending after October 22, 1986.

[T.D. 8161, 52 FR 35415, Sept. 21, 1987. Redesignated and amended by 
T.D. 8272, 54 FR 47980, Nov. 20, 1989]



Sec. 1.102-1  Gifts and inheritances.

    (a) General rule. Property received as a gift, or received under a 
will or under statutes of descent and distribution, is not includible in 
gross income, although the income from such property is includible in 
gross income. An amount of principal paid under a marriage settlement is 
a gift. However, see section 71 and the regulations thereunder for rules 
relating to alimony or allowances paid upon divorce or separation. 
Section 102 does not apply to prizes and awards (see section 74 and 
Sec. 1.74-1) nor to scholarships and fellowship grants (see section 117 
and the regulations thereunder).
    (b) Income from gifts and inheritances. The income from any property 
received as a gift, or under a will or statute of descent and 
distribution shall not be excluded from gross income under paragraph (a) 
of this section.
    (c) Gifts and inheritances of income. If the gift, bequest, devise, 
or inheritance is of income from property, it shall not be excluded from 
gross income under paragraph (a) of this section. Section 102 provides a 
special rule for the treatment of certain gifts, bequests, devises, or 
inheritances which by their terms are to be paid, credited, or 
distributed at intervals. Except as provided in section 663(a)(1) and 
paragraph (d) of this section, to the extent any such gift, bequest, 
devise, or inheritance is paid, credited, or to be distributed out of 
income from property, it shall be considered a gift, bequest, devise, or 
inheritance of income from property. Section 102 provides the same 
treatment for amounts of income from property which is paid, credited, 
or to be distributed under a gift or bequest whether the gift or bequest 
is in terms of a right to payments at intervals (regardless of income) 
or is in terms of a right to income. To the extent the amounts in either 
case are paid, credited, or to be distributed at intervals out of 
income, they are not to be excluded under section 102 from the 
taxpayer's gross income.
    (d) Effect of Subchapter J. Any amount required to be included in 
the gross income of a beneficiary under sections 652, 662, or 668 shall 
be treated for purposes of this section as a gift, bequest, devise, or 
inheritance of income from property. On the other hand, any amount 
excluded from the gross income of a beneficiary under section 663(a)(1) 
shall be treated for purposes of this section as property acquired by 
gift, bequest, devise, or inheritance.
    (e) Income taxed to grantor or assignor. Section 102 is not intended 
to tax a donee upon the same income which is taxed to the grantor of a 
trust or assignor of income under section 61 or sections 671 through 
677, inclusive.



Sec. 1.103-1  Interest upon obligations of a State, territory, etc.

    (a) Interest upon obligations of a State, territory, a possession of 
the United States, the District of Columbia, or any political 
subdivision thereof

[[Page 367]]

(hereinafter collectively or individually referred to as ``State or 
local governmental unit'') is not includable in gross income, except as 
provided under section 103 (c) and (d) and the regulations thereunder.
    (b) Obligations issued by or on behalf of any State or local 
governmental unit by constituted authorities empowered to issue such 
obligations are the obligations of such a unit. However, section 
103(a)(1) and this section do not apply to industrial development bonds 
except as otherwise provided in section 103(c). See section 103(c) and 
Sec. Sec. 1.103-7 through 1.103-12 for the rules concerning interest 
paid on industrial development bonds. See section 103(d) for rules 
concerning interest paid on arbitrage bonds. Certificates issued by a 
political subdivision for public improvements (such as sewers, 
sidewalks, streets, etc.) which are evidence of special assessments 
against specific property, which assessments become a lien against such 
property and which the political subdivision is required to enforce, 
are, for purposes of this section, obligations of the political 
subdivision even though the obligations are to be satisfied out of 
special funds and not out of general funds or taxes. The term 
``political subdivision'', for purposes of this section denotes any 
division of any State or local governmental unit which is a municipal 
corporation or which has been delegated the right to exercise part of 
the sovereign power of the unit. As thus defined, a political 
subdivision of any State or local governmental unit may or may not, for 
purposes of this section, include special assessment districts so 
created, such as road, water, sewer, gas, light, reclamation, drainage, 
irrigation, levee, school, harbor, port improvement, and similar 
districts and divisions of any such unit.

[T.D. 7199, 37 FR 15486, Aug. 3, 1972]



Sec. 1.103-2  Dividends from shares and stock of Federal agencies or 
instrumentalities.

    (a) Issued before March 28, 1942. (1) Section 26 of the Federal Farm 
Loan Act of July 17, 1916 (12 U.S.C. 931), provides that Federal land 
banks and Federal land bank associations, including the capital and 
reserve or surplus therein and the income derived therefrom, shall be 
exempt from taxation, except taxes upon real estate. Section 7 of the 
Federal Reserve Act of December 23, 1913 (12 U.S.C. 531), provides that 
Federal reserve banks, including the capital stock and surplus therein 
and the income derived therefrom, shall be exempt from taxation, except 
taxes upon real estate. Section 13 of the Federal Home Loan Bank Act (12 
U.S.C. 1433) provides that the Federal Home Loan Bank including its 
franchise, its capital, reserves, and surplus, its advances, and its 
income shall be exempt from all taxation, except taxes upon real estate. 
Section 5(h) of the Home Owners' Loan Act of 1933 (12 U.S.C. 1464(h)) 
provides that shares of Federal savings and loan associations shall, 
both as to their value and the income therefrom, be exempt from all 
taxation (except surtaxes, estate, inheritance, and gift taxes) imposed 
by the United States. Under the above-mentioned provisions, income 
consisting of dividends on stock of Federal land banks, Federal land 
bank associations, Federal home loan banks, and Federal reserve banks is 
not, in the case of stock issued before March 28, 1942, includable in 
gross income. Income consisting of dividends on share accounts of 
Federal savings and loan associations is includable in gross income but, 
in the case of shares issued before March 28, 1942, is not subject to 
the normal tax on income. For taxability of such income in the case of 
such stock or shares issued on or after March 28, 1942, see section 6 of 
the Public Debt Act of 1942 (31 U.S.C. 742a) and paragraph (b) of this 
section. For the time at which a stock or share is issued within the 
meaning of this section, see paragraph (b) of this section.
    (2) Regardless of the exemption from income tax of dividends paid on 
the stock of Federal reserve banks, dividends paid by member banks are 
treated like dividends of ordinary corporations.
    (3) Dividends on the stock of the central bank for cooperatives, the 
production credit corporations, production credit associations, and 
banks for cooperatives, organized under the provisions of the Farm 
Credit Act of 1933 (12 U.S.C. 1138), constitute income to the 
recipients, subject to both the normal

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tax and surtax (see section 63 of the Farm Credit Act of 1933 (12 U.S.C. 
1138c)).
    (b) Issued on or after March 28, 1942. (1) By virtue of the 
provisions of section 6 of the Public Debt Act of 1942 (31 U.S.C. 742a), 
the tax exemption provisions set forth in paragraph (a) of this section 
with respect to income consisting of dividends on stock of the Federal 
land banks, Federal land bank associations, and Federal reserve banks, 
or on share accounts of Federal savings and loan associations, are not 
applicable in the case of dividends on such stock or shares issued on or 
after March 28, 1942.
    (2) For the purposes of this section, a stock or share is deemed to 
be issued at the time and to the extent that payment therefor is made to 
the agency or instrumentality. The date of issuance of the certificate 
or other evidence of ownership of such stock or share is not 
determinative if payment is made at an earlier or later date. Where old 
stock is retired in exchange for new stock of a different character or 
preference, the new stock shall be deemed to have been issued at the 
time of the exchange rather than when the old stock was paid for. These 
rules may be illustrated by the following examples:

    Example (1). A, the owner of an investment share account, consisting 
of 10 shares, in a Federal savings and loan association, has a single 
certificate issued before March 28, 1942, evidencing such ownership. In 
order that A may dispose of half of such shares, the association at his 
request issues, after March 27, 1942, two 5-share certificates in 
substitution for the 10-share certificate. The shares evidenced by the 
two new certificates are deemed to have been issued before March 28, 
1942, the shares having been paid for before such date.
    Example (2). The X Bank, a member of a Federal reserve bank, owns 50 
shares of Federal reserve bank stock, evidenced by a single stock 
certificate issued before March 28, 1942. On December 31, 1942, the X 
Bank reduces the amount of its capital stock, as a result of which it is 
required to reduce the amount of its Federal reserve bank stock to 40 
shares. It surrenders the 50-share certificate to the Federal reserve 
bank and receives a new 40-share certificate. The 40 shares evidenced by 
such certificate are deemed to have been issued before March 28, 1942. 
On December 31, 1943, the X Bank increases the amount of its capital 
stock, as a result of which it is required to purchase 10 additional 
shares of the Federal reserve bank stock. The Federal reserve bank 
issues a 10-share certificate evidencing ownership of the new shares. Of 
the 50 shares then owned by the X Bank, 40 were issued prior to March 
28, 1942, and 10 were issued after March 27, 1942.
    Example (3). A, the owner of a savings share account in the amount 
of $100 in a Federal savings and loan association, has a passbook 
containing a certificate issued prior to March 28, 1942, evidencing such 
ownership. Subsequent to March 27, 1942, A deposits $10,000 in the 
account. With respect to the $10,000 deposit, the share is deemed to 
have been issued after March 27, 1942.



Sec. 1.103-3  Interest upon notes secured by mortgages executed to 
Federal agencies or instrumentalities.

    Section 26 of the Federal Farm Loan Act (12 U.S.C. 931), and section 
210 of such act, as added by section 2 of the act of March 4, 1923 (12 
U.S.C. 1111), provide that first mortgages executed to Federal land 
banks, joint-stock land banks, or Federal intermediate credit banks, and 
the income derived therefrom, shall be exempt from taxation. 
Accordingly, income consisting of interest on promissory notes held by 
such banks and secured by such first mortgages is not subject to the 
income tax.



Sec. 1.103-4  Interest upon United States obligations.

    (a) Issued before March 1, 1941. (1) Interest upon obligations of 
the United States issued on or before September 1, 1917, is exempt from 
tax. In the case of obligations issued by the United States after 
September 1, 1917, and in the case of obligations of a corporation 
organized under act of Congress, if such corporation is an 
instrumentality of the United States, the interest is exempt from tax 
only if and to the extent provided in the acts authorizing the issue 
thereof, as amended and supplemented.
    (2) Interest on Treasury bonds issued before March 1, 1941, is 
exempt from Federal income taxes except surtaxes imposed upon the income 
or profits of individuals, associations, or corporations. However, 
interest on an aggregate of not exceeding $5,000 principal amount of 
such bonds is also exempt from surtaxes. Interest in excess of the 
interest on an aggregate of not exceeding $5,000 principal amount of 
such

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bonds is subject to surtax and must be included in gross income.
    (3) Interest credited to postal savings accounts upon moneys 
deposited before March 1, 1941, in postal savings banks is wholly exempt 
from income tax.
    (b) Issued on or after March 1, 1941. (1) Under the provisions of 
sections 4 and 5 of the Public Debt Act of 1941 (31 U.S.C. 742a), 
interest upon obligations issued on or after March 1, 1941, by the 
United States, or any agency or instrumentality thereof, shall not have 
any exemption, as such, from Federal income tax except in respect of any 
such obligations which the Federal Maritime Board and Maritime 
Administration (formerly United States Maritime Commission) or the 
Federal Housing Administration has, before March 1, 1941, contracted to 
issue at a future date. The interest on such obligations so contracted 
to be issued shall bear such tax-exemption privileges as were at the 
time of such contract provided in the law authorizing their issuance. 
For the purposes hereof, under section 4(a) of the Public Debt Act of 
1941, a Territory and a possession of the United States (or any 
political subdivisions thereof), and the District of Columbia, and any 
agency or instrumentality of any one or more of the foregoing, shall not 
be considered as an agency or instrumentality of the United States.
    (2) In the case of obligations issued as the result of a refunding 
operation, as, for example, where a corporation exchanges bonds for 
previously issued bonds, the refunding obligations are deemed, for the 
purposes of this section, to have been issued at the time of the 
exchange rather than at the time the original bonds were issued.



Sec. 1.103-5  Treasury bond exemption in the case of trusts or 
partnerships.

    (a) When the income of a trust is taxable to beneficiaries, as in 
the case of a trust the income of which is to be distributed to the 
beneficiaries currently, each beneficiary is entitled to exemption as if 
he owned directly a proportionate part of the Treasury bonds held in 
trust. When, on the other hand, income is taxable to the trustee, as in 
the case of a trust the income of which is accumulated for the benefit 
of unborn or unascertained persons, the trust, as the owner of the bonds 
held in trust, is entitled to the exemption on account of such 
ownership. In general, see sections 652(b) and 662(b) and the 
regulations thereunder.
    (b) As the income of a partnership is taxable to the individual 
partners, each partner is entitled to exemption as if he owned directly 
a proportionate part of the bonds held by the partnership. For rules 
relating to partially tax-exempt interest see section 702(a)(7) and the 
regulations thereunder.



Sec. 1.103-6  Interest upon United States obligations in the case of 
nonresident aliens and foreign corporations, not engaged in business 
in the United States.

    By virtue of section 4 of the Victory Liberty Loan Act of March 3, 
1919 (31 U.S.C. 750), amending section 3 of the Fourth Liberty Bond Act 
of July 9, 1918 (31 U.S.C. 750), the interest received on and after 
March 3, 1919, on bonds, notes, and certificates of indebtedness of the 
United States while beneficially owned by a nonresident alien 
individual, or a foreign corporation, partnership, or association, if 
such individual, corporation, partnership, or association is not engaged 
in business in the United States, is exempt from income taxes. Such 
exemption applies only to such bonds, notes, or certificates as have 
been issued before March 1, 1941. Interest derived by a nonresident 
alien individual, or by a foreign corporation, partnership, or 
association on such bonds, notes, or certificates issued on or after 
March 1, 1941, is subject to tax as in the case of taxpayers generally 
as provided in paragraph (b) of Sec. 1.103-4.



Sec. 1.103-7  Industrial development bonds.

    (a) In general. Under section 103(c)(1) and this section, an 
industrial development bond issued after April 30, 1968, shall be 
treated as an obligation not described in section 103(a)(1) and Sec. 
1.103-1. Accordingly, interest paid on such a bond is includable in 
gross income unless the bond was issued by a State, or local 
governmental unit to finance certain exempt facilities (see section 
103(c)(4) and Sec. 1.103-8), to finance an industrial park (see section 
103(c)(5) and

[[Page 370]]

Sec. 1.103-9), or as part of an exempt small issue (see section 
103(c)(6) and Sec. 1.103-10). For applicable rules when an industrial 
development bond is held by a substantial user (or a person related to a 
substantial user) of such an exempt facility, or an industrial park, or 
a facility financed with the proceeds of such an exempt small issue, see 
section 103(c)(7) and Sec. 1.103-11. See also Sec. 1.103-12 for the 
transitional provisions concerning the interest paid on certain 
industrial development bonds issued before January 1, 1969, and certain 
other industrial development bonds. Even if section 103(c) does not 
prevent a bond from being treated as an obligation described in section 
103(a)(1) and Sec. 1.103-1, such bond shall nevertheless be treated as 
an obligation which is not described in section 103(a)(1) and Sec. 
1.103-1 if under section 103(d) it is an arbitrage bond. For purposes of 
section 103(c), the term ``issue'' includes a single obligation such as 
a single note issued in connection with a bank loan as well as a series 
of notes or bonds.
    (b) Industrial development bonds--(1) Definition. For purposes of 
this section, the term ``industrial development bond'' means any 
obligation--
    (i) Which is issued as part of an issue all or a major portion of 
the proceeds of which are to be used directly or indirectly in any trade 
or business carried on by any person who is not an exempt person (as 
defined in subparagraph (2) of this paragraph), and
    (ii) The payment of the principal or interest on which, under the 
terms of such obligation or any underlying arrangement (as described in 
subparagraph (4) of this paragraph), is in whole or in major part (i.e., 
major portion)--
    (a) Secured by any interest in property used or to be used in a 
trade or business,
    (b) Secured by any interest in payments in respect of property used 
or to be used in a trade or business, or
    (c) To be derived from payments in respect of property, or borrowed 
money, used or to be used in a trade or business.

See subparagraphs (3) and (4) of this paragraph for the trade or 
business test and the security interest test respectively. See Sec. 
1.103-8(a)(6) to determine the amount of proceeds of an issue for which 
the amount payable during each annual period over the term of the issue 
is less than the amount of interest accruing thereon in such period, 
e.g., in the case of an issue sold by the issuer for less than its face 
amount.
    (2) Exempt person. The term ``exempt person'' means a governmental 
unit as defined in this subparagraph, or an organization which is 
described in section 501(c)(3) and this subparagraph and is exempt from 
taxation under section 501(a). For purposes of this subparagraph, the 
term ``governmental unit'' means a State or local governmental unit (as 
defined in Sec. 1.103-1). For purposes of this subparagraph, the term 
``governmental unit'' also includes the United States of America (or an 
agency or instrumentality of the United States of America), but only in 
the case of obligations (i) issued on or before August 3, 1972, or (ii) 
issued after August 3, 1972, with respect to which a bond resolution or 
any other official action was taken and in reliance on such action 
either (a) construction of such facility to be financed with such 
obligations commenced or (b) a binding contract was entered into, or an 
irrevocable bid was submitted, prior to August 3, 1972, or (iii) issued 
after August 3, 1972, with respect to a program approved by Congress 
prior to such date but only if (a) a portion of such program has been 
financed by obligations issued prior to such date, to which section 
103(a) applied pursuant to a ruling issued by the Commissioner or his 
delegate prior to such date and (b) construction of one or more 
facilities comprising a part of such program commenced prior to such 
date. For purposes of this subparagraph, a tax-exempt organization is an 
exempt person only with respect to a trade or business it carries on 
which is not an unrelated trade or business. Whether a particular trade 
or business carried on by a tax-exempt organization is an unrelated 
trade or business is determined by applying the rules of section 513(a) 
(relating to general rule for unrelated trade or business) and the 
regulations thereunder to the tax-exempt organization without regard to 
whether the organization is an organization subject to the tax imposed 
by section 511 (relating to imposition of tax on unrelated business

[[Page 371]]

income of charitable, etc., organizations).
    (3) Trade or business test. (i) The trade or business test relates 
to the use of the proceeds of a bond issue. The test is met if all or a 
major portion of the proceeds of a bond issue is used in a trade or 
business carried on by a nonexempt person. For example, if all or a 
major portion of the proceeds of a bond issue is to be loaned to one or 
more private business users, or is to be used to acquire, construct, or 
reconstruct facilities to be leased or sold to such private business 
users, and such proceeds or facilities are to be used in trades or 
businesses carried on by them, such proceeds are to be used in a trade 
or business carried on by persons who are not exempt persons, and the 
debt obligations comprising the bond issue satisfy the trade or business 
test. If, however, less than a major portion of the proceeds of an issue 
is to be loaned to nonexempt persons or is to be used to acquire or 
construct facilities which will be used in a trade or business carried 
on by a nonexempt person, the debt obligations will not be industrial 
development bonds. Also, when publicly-owned facilities which are 
intended for general public use, such as toll roads or bridges, are 
constructed with the proceeds of a bond issue and used by nonexempt 
persons in their trades or businesses on the same basis as other members 
of the public, such use does not constitute a use in the trade or 
business of a nonexempt person for purposes of the trade or business 
test.
    (ii) In determining whether a debt obligation meets the trade or 
business test, the indirect, as well as the direct, use of the proceeds 
is to be taken into account. For example, the debt obligations 
comprising a bond issue do not fail to satisfy the trade or business 
test merely because the State or local governmental unit uses the 
proceeds to engage in a series of financing transactions for property to 
be used by private business users in trades or businesses carried on by 
them. Similarly, if such proceeds are to be used to construct facilities 
to be leased or sold to any nonexempt person for use in a trade or 
business it carries on, such proceeds are to be used in a trade or 
business carried on by a nonexempt person and the debt obligations 
comprising such issue satisfy the trade or business test. If such 
proceeds are to be used to construct facilities to be leased or sold to 
an exempt person who will, in turn, lease or sell the facilities to a 
nonexempt person for use in a trade or business, such proceeds are to be 
used in a trade or business carried on by a nonexempt person and the 
debt obligations comprising such issue satisfy the trade or business 
test. In addition, proceeds will be treated as being used in the trade 
or business of a nonexempt person in situations involving other 
arrangements, whether in a single transaction or in a series of 
transactions, whereby a nonexempt person uses property acquired with the 
proceeds of a bond issue in its trade or business.
    (iii) The use of more than 25 percent of the proceeds of an issue of 
obligations in the trades or businesses of nonexempt persons will 
constitute the use of a major portion of such proceeds in such manner. 
In the case of the direct or indirect use of the proceeds of an issue of 
obligations or the direct or indirect use of a facility constructed, 
reconstructed, or acquired with such proceeds, the use by all nonexempt 
persons in their trades or businesses must be aggregated to determine 
whether the trade or business test is satisfied. If more than 25 percent 
of the proceeds of a bond issue is used in the trades or businesses of 
nonexempt persons, the trade or business test is satisfied. For special 
rules with respect to the acquisition of the output of facilities, see 
subparagraph (5) of this paragraph.
    (4) Security interest test. The security interest test relates to 
the nature of the security for, and the source of, the payment of either 
the principal or interest on a bond issue. The nature of the security 
for, and the source of, the payment may be determined from the terms of 
the bond indenture or on the basis of an underlying arrangement. An 
underlying arrangement to provide security for, or the source of, the 
payment of the principal or interest on an obligation may result from 
separate agreements between the parties or may be determined on the 
basis of all the facts and circumstances surrounding the issuance of the 
bonds. The property which is the security for, or the source

[[Page 372]]

of, the payment of either the principal or interest on a debt obligation 
need not be property acquired with bond proceeds. The security interest 
test is satisfied if, for example, a debt obligation is secured by 
unimproved land or investment securities used, directly or indirectly, 
in any trade or business carried on by any private business user. A 
pledge of the full faith and credit of a State or local governmental 
unit will not prevent a debt obligation from otherwise satisfying the 
security interest test. For example, if the payment of either the 
principal or interest on a bond issue is secured by both a pledge of the 
full faith and credit of a State or local governmental unit and any 
interest in property used or to be used in a trade or business, the bond 
issue satisfies the security interest test. For rules with respect to 
the acquisition of the output of facilities see subparagraph (5) of this 
paragraph.
    (5) Trade or business test and security interest test with respect 
to certain output contracts. (i) The use by one or more nonexempt 
persons of a major portion of the subparagraph (5) output of facilities 
such as electric energy, gas, or water facilities constructed, 
reconstructed, or acquired with the proceeds of an issue satisfies the 
trade or business test and the security interest test if such use has 
the effect of transferring to nonexempt persons the benefits of 
ownership of such facilities, and the burdens of paying the debt service 
on governmental obligations used directly or indirectly to finance such 
facilities, so as to constitute the indirect use by them of a major 
portion of such proceeds. Such benefits and burdens are transferred and 
a major portion of the proceeds of an issue is used indirectly by the 
users of the subparagraph (5) output of such a facility which is owned 
and operated by an exempt person where--
    (a)(1) One nonexempt person agrees pursuant to a contract to take, 
or to take or pay for, a major portion (more than 25 percent) of the 
subparagraph (5) output (within the meaning of subdivision (ii) of this 
subparagraph) of such a facility (whether or not conditional upon the 
production of such output) or (2) two or more nonexempt persons, each of 
which pays annually a guaranteed minimum payment exceeding 3 percent of 
the average annual debt service with respect to the obligations in 
question, agree, pursuant to contracts, to take, or to take or pay for, 
a major portion (more than 25 percent) of the subparagraph (5) output of 
such a facility (whether or not conditioned upon the production of such 
output), and
    (b) Payment made or to be made with respect to such contract or 
contracts by such nonexempt person or persons exceeds a major part (more 
than 25 percent) of the total debt service with respect to such issue of 
obligations.
    (ii) For purposes of this subparagraph--
    (a) Where a contract described in subdivision (i) of this 
subparagraph may be extended by the issuer of obligations described 
therein, the term of the contract shall be considered to include the 
period for which such contract may be so extended.
    (b) The subparagraph (5) output of a facility shall be determined by 
multiplying the number of units produced or to be produced by the 
facility in 1 year by the number of years in the contract term of the 
issue of obligations issued to provide such facility. The number of 
units produced or to be produced by a facility in 1 year shall be 
determined by reference to its nameplate capacity (or where there is no 
nameplate capacity, its maximum capacity) without any reduction for 
reserves or other unutilized capacity. The contract term of an issue 
begins on the date the output of a facility is first taken, pursuant to 
a take or a take or pay contract, by a nonexempt person and ends on the 
latest maturity date of any obligation of the issue (determined without 
regard to any optional redemption dates). If, however, on or before the 
date of issue of a prior issue of governmental obligations issued to 
provide a facility, the issuer makes a commitment in the bond indenture 
or related document to refinance such prior issue with one or more 
subsequent issues of governmental obligations, then the contract term of 
the issue shall be determined with regard to the latest redemption date 
of any obligation of the last such refinancing issue with respect to 
such facility (determined without regard to

[[Page 373]]

any optional redemption dates). Where it appears that the term of an 
issue (or the terms of two or more issues) is extended for purposes of 
extending the contract term of an issue and thereby increasing the 
subparagraph (5) output of the facility provided by such issue, the 
subparagraph (5) output of such facility shall be determined by the 
Commissioner without regard to the provisions of this subdivision (b).
    (c) The total debt service with respect to an issue of obligations 
shall be the total dollar amount (excluding any penalties) payable with 
respect to such issue over its entire term. The entire term of an issue 
begins on its date of issue and ends on the latest maturity date of any 
obligation of the issue (determined without regard to any optional 
redemption dates). If, however, on or before the date of issue of a 
prior issue of governmental obligations the issuer makes a commitment in 
the bond indenture or related document to refinance such prior issue 
with one or more subsequent issues of governmental obligations, the 
entire term of the issue shall be determined with regard to the latest 
redemption date of any obligation of the last such refinancing issue 
(determined without regard to any optional redemption dates).
    (d) Two or more nonexempt persons who are related persons (within 
the meaning of section 103(c)(6)(C)) shall be treated as one nonexempt 
person.
    (c) Examples. The application of the rules contained in section 
103(c) (2) and (3) and paragraph (b) of this section are illustrated by 
the following examples:

    Example (1). State A and corporation X enter into an arrangement 
under which A is to provide a factory which X will lease for 20 years. 
The arrangement provides (1) that A will issue $10 million of bonds, (2) 
that the proceeds of the bond issue will be used to purchase land and to 
construct and equip a factory in accordance with X's specifications, (3) 
that X will rent the facility (land, factory, and equipment) for 20 
years at an annual rental equal to the amount necessary to amortize the 
principal and pay the interest on the outstanding bonds, and (4) that 
such payments by X and the facility itself will be the security for the 
bonds. The bonds are industrial development bonds since they are part of 
an issue of obligations (1) all of the proceeds of which are to be used 
(by purchasing land and constructing and equipping the factory) in a 
trade or business by a nonexempt person, and (2) the payment of the 
principal and interest on which is secured by the facility and payments 
to be made with respect thereto.
    Example (2). The facts are the same as in example (1) except that 
(1) X will purchase the facility, and (2) annual payments equal to the 
amount necessary to amortize the principal and pay the interest on the 
outstanding bonds will be made by X. The bonds are industrial 
development bonds for the reasons set forth in example (1).
    Example (3). State B and corporation X enter into an arrangement 
under which B is to loan $10 million to X. The arrangement provides (1) 
that B will issue $10 million of bonds, (2) that the proceeds of the 
bond issue will be loaned to X to provide additional working capital and 
to finance the acquisition of certain new machinery, (3) that X will 
repay the loan in annual installments equal to the amount necessary to 
amortize the principal and pay the interest on the outstanding bonds, 
and (4) that the payments on the loan and the machinery will be the 
security for only the payment of the principal on the bonds. The bonds 
are industrial development bonds since they are part of an issue of 
obligations (1) all of the proceeds of which are to be used in a trade 
or business by a nonexempt person, and (2) the payment of the principal 
on which is secured by payments to be made in respect of property to be 
used in a trade or business. The result would be the same if only the 
payment of the interest on the bonds were secured by payments on the 
loan and machinery.
    Example (4). The facts are the same as in example (1), (2), or (3) 
except that the annual payments required to be made by corporation X 
exceed the amount necessary to amortize the principal and pay the 
interest on the outstanding bonds. The bonds are industrial development 
bonds for the reasons set forth in such examples. The fact that 
corporation X is required to pay an amount in excess of the amount 
necessary to pay the principal and interest on the bonds does not affect 
their status as industrial development bonds. Similarly, if the annual 
payments required to be made by corporation X were sufficient to pay 
only a major portion of either the principal or the interest on the 
outstanding bonds, the bonds would be industrial development bonds for 
the reasons set forth in such examples.
    Example (5). The facts are the same as in example (1), (2), (3), or 
(4) except that the issuer is a political subdivision which has taxing 
power and the bonds are general obligation bonds. Since both the trade 
or business and the security interest tests are met, the bonds are 
industrial development bonds notwithstanding the fact that they 
constitute an unconditional obligation of the issuer payable from its 
general revenues.

[[Page 374]]

    Example (6). (a) State C issues its general obligation bonds to 
purchase land and construct a hotel for use by the general public (i.e., 
tourists, visitors, travelers on business, etc.). The bond indenture 
provides (1) that C will own and operate the project for the period 
required to redeem the bonds, and (2) that the project itself and the 
revenues derived therefrom are the security for the bonds. The bonds are 
not industrial development bonds since (1) the proceeds are to be used 
by an exempt person in a trade or business carried on by such person, 
and (2) a major portion of such proceeds is not to be used, directly or 
indirectly, in a trade or business carried on by a nonexempt person. Use 
of the hotel by hotel guests who are travelling in connection with 
trades or businesses of nonexempt persons is not an indirect use of the 
hotel by such nonexempt persons for purposes of section 103(c).
    (b) The facts are the same as in paragraph (a) of this example 
except that corporation Y enters into a long-term agreement with C that 
Y will rent more than one-fourth of the rooms on an annual basis for a 
period approximately equal to one half of the term of the bonds. The 
bonds are industrial development bonds because (1) a major portion of 
the proceeds used to construct the hotel is to be used in the trade or 
business of corporation Y (a nonexempt person) and (2) a major portion 
of the principal and interest on such issue will be derived from 
payments in respect of the property used in the trade or business of Y.
    Example (7). (a) State D and corporation Y enter into an agreement 
under which Y will lease for 20 years three floors of a 12- story office 
building to be constructed by D on land which it will acquire. D will 
occupy the grade floor and the remaining eight floors of the building. 
The portion of the costs of acquiring the land and constructing the 
building which are allocated to the space to be leased by Y is not in 
excess of 25 percent of the total costs of acquiring the land and 
constructing the building. Such costs, whether attributable to the 
acquisition of land or the construction of the building, were allocated 
to leased space in the same proportion that the reasonable rental value 
of such leased space bears to the reasonable rental value of the entire 
building. From the facts and circumstances presented, it is determined 
that such allocation was reasonable. The arrangement between D and Y 
provides that D will issue $10 million of bonds, that the proceeds of 
the bond issue will be used to purchase land and construct an office 
building, that Y will lease the designated floor space for 20 years at 
its reasonable rental value, and that such rental payments and the 
building itself shall be security for the bonds. The bonds are not 
industrial development bonds since a major portion of the proceeds is 
not to be used, directly or indirectly, in the trade or business of a 
nonexempt person.
    (b) The facts are the same as in paragraph (a) of this example 
except that corporation Y will lease four floors, and the costs 
allocated to these floors are in excess of 25 percent of D's investment 
in the land and building. The bonds are industrial development bonds 
because (1) a major portion of the building is to be used in the trade 
or business of a nonexempt person, and (2) a major portion of the 
principal and interest on such issue is secured by the rental payments 
on the building.
    Example (8). The facts are the same as in paragraph (b) of example 
(7) except that, instead of leasing any space to corporation Y, State D 
will lease the four floors to numerous unrelated private business users 
to be used in their trades or businesses. No lease will have a term 
exceeding 2 years. A major portion of the principal and interest will be 
paid from the revenues that D will derive from such leases. The fact 
that the activities of D, an exempt person, may amount to a trade or 
business of leasing property is not material, and the bonds are 
industrial development bonds for the reasons set forth in paragraph (b) 
of example (7). The result would be the same in the case of long-term 
leases.
    Example (9). State E issues its obligations to finance the 
construction of dormitories for educational institution Z which is an 
organization described in section 501(c)(3) and exempt from tax under 
section 501(a). The dormitories are to be owned and operated by Z and 
their operation does not constitute an unrelated trade or business. The 
bonds are not industrial development bonds since the proceeds are to be 
used by an exempt person in a trade or business carried on by such 
person which is not an unrelated trade or business, as determined by 
applying section 513(a) to Z.
    Example (10). State F issues its obligations to finance the 
construction of a toll road and the cost of erecting related facilities 
such as gasoline service stations and restaurants. Such related 
facilities represent less than 25 percent of the total cost of the 
project and are to be leased or sold to nonexempt persons. The toll road 
is to be owned and operated by F. The revenues from the toll road and 
from the rental of related facilities are the security for the bonds. 
The bonds are not industrial development bonds since a major portion of 
the proceeds is not to be used, directly or indirectly, in the trades or 
businesses of nonexempt persons. The fact that vehicles owned by 
nonexempt persons engaged in their trades or businesses may use the road 
in common with, or as a part of, the general public is not material.
    Example (11). City G issues its obligations to finance the 
construction of a municipal auditorium which it will own and operate.

[[Page 375]]

The use of the auditorium will be open to anyone who wishes to use it 
for a short period of time on a rate-scale basis. The rights of such a 
user are only those of a transient occupant rather than the full legal 
possessory interests of a lessee. It is anticipated that the auditorium 
will be used by schools, church groups, and fraternities, and numerous 
commercial organizations. The revenues from the rentals of the 
auditorium and the auditorium building itself will be the security for 
the bonds. The bonds are not industrial development bonds because such 
use is not a use in the trade or business of a nonexempt person.
    Example (12). The facts are the same as in example (11) except that 
one nonexempt person will have a 20-year rental agreement providing for 
exclusive use of the entire auditorium for more than 3 months of each 
year at a rental comparable to that charged short-term users. The bonds 
are industrial development bonds since such use is a use in the trade or 
business of a nonexempt person and, therefore, a major portion of the 
proceeds of the issue will be used in the trade or business of a 
nonexempt person and a major portion of the principal or interest on 
such issue will be secured by a facility used in such trade or business 
and by payments with respect to such facility.
    Example (13). In order to construct an electric generating facility 
of a size sufficient to take advantage of the economies of scale: (1) 
City H will issue $50 million of its 25-year bonds and Z (a privately 
owned electric utility) will use $100 million of its funds for 
construction of a facility they will jointly own as tenants in common. 
(2) Each of the participants will share in the ownership, output, and 
operating expenses of the facility in proportion to its contribution to 
the cost of the facility, that is, one-third by H and two-thirds by Z. 
(3) H's bonds will be secured by H's ownership in the facility and by 
revenues to be derived from the sale of H's share of the annual output 
of the facility. (4) Because H will need only 50 percent of its share of 
the annual output of the facility, it agrees to sell to Z 25 percent of 
its share of such annual output for a period of 20 years pursuant to a 
contract under which Z agrees to take or pay for such power in all 
events. The facility will begin operation, and Z will begin to receive 
power, 4 years after the City H obligations are issued. The contract 
term of the issue will, therefore, be 21 years. (5) H also agrees to 
sell the remaining 25 percent of its share of the annual output to 
numerous other private utilities under a prevailing rate schedule 
including demand charges. (6) No contracts will be executed obligating 
any person other than Z to purchase any specified amount of the power 
for any specified period of time and no one such person (other than Z) 
will pay a demand charge or other minimum payment under conditions 
which, under paragraph (b)(5) of this section, result in a transfer of 
the benefits of ownership and the burdens of paying the debt service on 
obligations used directly or indirectly to provide such facilities. The 
bonds are not industrial development bonds because H's one-third 
interest in the facility (financed with bond proceeds) shall be treated 
as a separate property interest and, although 25 percent of H's interest 
in the annual output of the facility will be used directly or indirectly 
in the trade or business of Z, a nonexempt person, under the rule of 
paragraph (b)(5) of this section, such portion constitutes less than a 
major portion of the subparagraph (5) output of the facility. If more 
than 25 percent of the subparagraph (5) output of the facility were to 
be sold to Z pursuant to the take or pay contract, the bonds would be 
industrial development bonds since they would be secured by H's 
ownership in the facility and revenues therefrom, and under the rules of 
paragraph (b)(5) of this section a major portion of the proceeds of the 
bond issue would be used in the trade or business of Z, a nonexempt 
person.
    Example (14). J, a political subdivision of a State, will issue 
several series of bonds from time to time and will use the proceeds to 
rehabilitate urban areas. More than 25 percent of the proceeds of each 
issue will be used for the rehabilitation and construction of buildings 
which will be leased or sold to nonexempt persons for use in their 
trades or businesses. There is no limitation either on the number of 
issues or the aggregate amount of bonds which may be outstanding. No 
group of bondholders has any legal claim prior to any other bondholders 
or creditors with respect to specific revenues of J, and there is no 
arrangement whereby revenues from a particular project are paid into a 
trust or constructive trust, or sinking fund, or are otherwise 
segregated or restricted for the benefit of any group of bondholders. 
There is, however, an unconditional obligation by J to pay the principal 
and interest on each issue of bonds. Further, it is apparent that J 
requires the revenues from the lease or sale of buildings to nonexempt 
persons in order to pay in full the principal and interest on the bonds 
in question. The bonds are industrial development bonds because a major 
portion of the proceeds will be used in the trades or businesses of 
nonexempt persons and, pursuant to an underlying arrangement, payment of 
the principal and interest is, in major part, to be derived from 
payments in respect of property or borrowed money used in the trades or 
businesses of nonexempt persons.
    Example (15). Power Authority K, a political subdivision created by 
the legislature in State X to own and operate certain power generating 
facilities, sells all of the power from its existing facilities to four 
private utility systems under contracts executed in

[[Page 376]]

1970, whereby such four systems are required to take or pay for 
specified portions of the total power output until the year 2000. 
Currently, existing facilities supply all of the present needs of the 
four utility systems but their future power requirements are expected to 
increase substantially. K issues 20-year general obligation bonds to 
construct a large nuclear generating facility. A fifth private utility 
system contracts with K to take or pay for 30 percent of the 
subparagraph (5) output of the new facility. The balance of the power 
output of the new facility will be available for sale as required, but 
initially it is not anticipated there will be any need for such power. 
The revenues from the contract with the fifth private utility system 
will be sufficient to pay less than 25 percent of the principal or 
interest on the bonds. The balance, which will exceed 25 percent of the 
principal or interest on such bonds, will be paid from revenues from the 
contracts with the four systems from sale of power produced by the old 
facilities. The bonds will be industrial development bonds because a 
major portion of the proceeds will be used in the trade or business of a 
nonexempt person, and payment of the principal and interest, pursuant to 
an underlying arrangement, will be derived in major part from payments 
in respect of property used in the trades or businesses of nonexempt 
persons.

    (d) Certain refunding issues--(1) General rule. In the case of an 
issue of obligations issued to refund the outstanding face amount of an 
issue of obligations, the proceeds of the refunding issue will be 
considered to be used for the purpose for which the proceeds of the 
issue to be refunded were used. The rules of this subparagraph shall 
apply regardless of the date of issuance of the issue to be refunded and 
shall apply to refunding issues to be issued to refund prior refunding 
issues.
    (2) Obligations issued prior to effective date. In the case of an 
issue of obligations issued to refund the outstanding face amount of an 
issue of obligations issued on or before April 30, 1968 (or before 
January 1, 1969, if the transitional rules of Sec. 1.103-12 are 
applicable) which would have been industrial development bonds within 
the meaning of section 103(c)(2) had they been issued after such date, 
the refunding issue shall not be considered to be an issue of industrial 
development bonds if it does not make funds available for any purpose 
other than the debt service on the obligations. For rules as to 
arbitrage bonds, see section 103(d).
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example (1). In 1969, State A issued $20 million of 20-year revenue 
bonds the proceeds of which were used to contruct a sports facility 
which qualifies as an exempt facility described in section 103(c)(4)(B) 
and paragraph (c) of Sec. 1.103-8. The sports facility will be owned 
and operated by X, a nonexempt person, for the use of the general 
public. In 1975, A issues $15 million of revenue bonds in order to 
refund the outstanding face amount of the 1969 issue. Since the proceeds 
of the 1969 issue were used for an exempt facility, the proceeds of the 
1975 refunding issue will be considered to be used for the same purposes 
and section 103(c)(1) shall not apply to the 1975 refunding issue. The 
result would have been the same if the original issue had been issued in 
1965. For rules as to a refunding obligation held by substantial users 
of facilities constructed with the proceeds of the issue refunded, see 
section 103(c)(7) and Sec. 1.103-11.
    Example (2). In 1967, prior to the effective date of section 103(c), 
city B issued $10 million of revenue bonds the proceeds of which were 
used to construct a manufacturing facility for corporation Y, a 
nonexempt person. Lease payments by Y were security for the bonds. In 
1975, B issue $7 million of revenue bonds in order to retire the 
outstanding face amount of the 1967 issue. The interest rate of the 1975 
issue is one and one-half percentage points lower than the interest rate 
on the 1967 issue. Both issues sold at par. All of the terms of the 1975 
issue are the same as the terms of the 1967 issue with the exception of 
the interest rate. The 1975 refunding issue will not be considered to be 
an issue of industrial development bonds since the refunding issue will 
not make funds available for any purpose other than the debt service on 
the outstanding obligations.
    Example (3). The facts are the same as in example (2) except that 
the interest rate on the refunding issue is the same as the interest 
rate on the issue to be refunded. Assume further that city B issued the 
1975 refunding issue in order to extend the term of the obligations 
issued in 1967 as the result of its inability to pay such obligations 
due to insufficient revenues. The results will be the same as in example 
(2) for the reasons stated therein.

[T.D. 7199, 37 FR 15486, Aug. 3, 1972; 37 FR 16177, Aug. 11, 1972, as 
amended by T.D. 7869, 48 FR 1708, Jan. 14, 1983]



Sec. 1.103-8  Interest on bonds to finance certain exempt facilities.

    (a) In general--(1) General rule. (i) Under section 103(b)(4), 
interest paid on

[[Page 377]]

an issue of obligations issued by a State or local governmental unit (as 
defined in Sec. 1.103-1) is not includable in gross income if 
substantially all of the proceeds of such issue is to be used to provide 
one or more of the exempt facilities listed in subparagraphs (A) through 
(J) of section 103(b)(4) and in this section. However, interest on an 
obligation of such issue is includable in gross income if the obligation 
is held by a substantial user or a related person (as described in 
section 103(b)(13) and Sec. 1.103-11). If substantially all of the 
proceeds of a bond issue is to be used to provide such exempt 
facilities, the debt obligations are treated as obligations described in 
section 103(a)(1) and Sec. 1.103-1 even though such obligations are 
industrial development bonds as defined in section 103(b)(2) and Sec. 
1.103-7. Substantially all of the proceeds of an issue of governmental 
obligations are used to provide an exempt facility if 90 percent or more 
of such proceeds are so used. For purposes of this ``substantially all'' 
test, two rules apply. First, proceeds are reduced by amounts properly 
allocable on a pro rata basis between providing the exempt facility and 
other uses of the proceeds. Second, amounts used to provide an exempt 
facility include amounts paid or incurred which are chargeable to the 
facility's capital account or would be so chargeable either with a 
proper election by a taxpayer (for example, under section 266) or but 
for a proper election by a taxpayer to deduct such amounts. In the event 
the amount payable with respect to an issue during each annual period 
over its term is less than the amount of interest accruing thereon in 
such period, e.g., in the case of an issue sold by the issuer for less 
than its face amount, see paragraph (a)(6) of this section to determine 
the amount of proceeds of the issue.
    (ii) The provisions of subdivision (i) of this subparagraph shall 
also apply to an issue of obligations substantially all of the proceeds 
of which is to be used to provide exempt facilities described in this 
section and for either or both of the following purposes: (a) To acquire 
or develop land as the site for an industrial park described in section 
103(b)(5) and Sec. 1.103-9, (b) to provide facilities to be used by an 
exempt person.
    (iii) Section 103(b)(4) only becomes applicable where the bond issue 
meets both the trade or business and the security interest tests so that 
obligations are industrial development bonds within the meaning of 
section 103(b)(2). For rules as to exempt facilities including property 
functionally related and subordinate to such facilities, see 
subparagraph (3) of this paragraph. For rules with respect to the 
ultimate use of proceeds of obligations, see subparagraph (4) of this 
paragraph. For rules which limit the application of the provisions of 
this section see subparagraph (5) of this paragraph. For the 
interrelationship of the rules provided in this section and the 
exemption for certain small issues provided in section 103(b)(6), see 
Sec. 1.103-10.
    (2) Public use requirement. To qualify under section 103(b)(4) and 
this section as an exempt facility, a facility must serve or be 
available on a regular basis for general public use, or be a part of a 
facility so used, as contrasted with similar types of facilities which 
are constructed for the exclusive use of a limited number of nonexempt 
persons in their trades or businesses. For example, a private dock or 
wharf owned by or leased to, and serving only a single manufacturing 
plant would not qualify as a facility for general public use, but a 
hangar or repair facility at a municipal airport, or a dock or a wharf, 
would qualify even if it is owned by, or leased or permanently assigned 
to, a nonexempt person provided that such nonexempt person directly 
serves the general public, such as a common passenger carrier or freight 
carrier. Similarly, an airport owned or operated by a nonexempt person 
for general public use is a facility for public use, as is a dock or 
wharf which is a part of a public port. However, a landing strip which, 
by reason of a formal or informal agreement or by reason of geographic 
location, will not be available for general public use does not satisfy 
the public use requirement. Sewage or solid waste disposal facilities 
and air or water pollution control facilities, described in sections 
103(b)(4) (E) and (F) and paragraphs (f) and (g) of this section, will 
be treated in all events as serving a general public use although

[[Page 378]]

they may be part of a nonpublic facility such as a manufacturing 
facility used in the trade or business of a nonexempt user.
    (3) Functionally related and subordinate. An exempt facility 
includes any land, building, or other property functionally related and 
subordinate to such facility. Property is not functionally related and 
subordinate to a facility if it is not of a character and size 
commensurate with the character and size of such facility. Since 
substantially all of the proceeds of a bond issue must be used for the 
exempt facility (or for any combination of exempt facilities, industrial 
parks, and facilities to be used by exempt persons), including property 
functionally related and subordinate thereto, an insubstantial amount of 
the proceeds of a bond issue may be used for facilities which are 
neither exempt facilities (or a combination of exempt facilities, 
industrial parks and facilities to be used by exempt persons) nor 
functionally related and subordinate to exempt facilities. Thus, for 
example, where substantially all of the proceeds of an urban 
redevelopment bond issue are to be used by a State urban redevelopment 
agency for residential real property for family units within the meaning 
of section 103(b)(4)(A) and paragraph (b) of this section, an 
insubstantial amount may be used for an industrial or commercial project 
or for any other purpose that is not functionally related and 
subordinate to the residential real property for family units.
    (4) Ultimate use of proceeds. The question whether substantially all 
of the proceeds of an issue of obligations are to be used to provide one 
or more of the exempt facilities listed in subparagraphs (A) through (J) 
of section 103(b)(4) and in this section is to be resolved by reference 
to the ultimate use of such proceeds. For example, such proceeds will be 
treated as used to provide residential rental property whether the State 
or local governmental unit (i) constructs such property and leases or 
sells it to any person who is not an exempt person for use in such 
person's trade or business of leasing such property; (ii) lends the 
proceeds to any such person for such purpose; or (iii) lends the 
proceeds to banks or other financial institutions in order to increase 
the supply of funds for mortgage lending under conditions requiring such 
banks or other financial institutions to use such proceeds only for 
further lending for residential rental property.
    (5) Limitation. (i) A facility qualifies under this section only to 
the extent that there is a valid reimbursement allocation under Sec. 
1.150-2 with respect to expenditures that are incurred before the issue 
date of the bonds to provide the facility and that are to be paid with 
the proceeds of the issue. In addition, if the original use of the 
facility begins before the issue date of the bonds, the facility does 
not qualify under this section if any person that was a substantial user 
of the facility at any time during the 5-year period before the issue 
date or any related person to that user receives (directly or 
indirectly) 5 percent or more of the proceeds of the issue for the 
user's interest in the facility and is a substantial user of the 
facility at any time during the 5-year period after the issue date, 
unless--
    (A) An official intent for the facility is adopted under Sec. 
1.150-2 within 60 days after the date on which acquisition, 
construction, or reconstruction of that facility commenced; and
    (B) For an acquisition, no person that is a substantial user or 
related person after the acquisition date was also a substantial user 
more than 60 days before the date on which the official intent was 
adopted.
    (ii) A facility, the original use of which commences (or the 
acquisition of which occurs) on or after the issue date of bonds to 
provide that facility, qualifies under this section only to the extent 
that an official intent for the facility is adopted under Sec. 1.150-2 
by the issuer of the bonds within 60 days after the commencement of the 
construction, reconstruction, or acquisition of that facility. Temporary 
construction or other financing of a facility prior to the issuance of 
the bonds to provide that facility will not cause that facility to be 
one that does not qualify under this paragraph (a)(5)(ii).
    (iii) For purposes of paragraph (a)(5)(i) of this section, 
substantial user has the meaning used in section 147(a)(1), related 
person has the meaning

[[Page 379]]

used in section 144(a)(3), and a user that is a governmental unit within 
the meaning of Sec. 1.103-1 is disregarded.
    (iv) Except to the extent provided in Sec. Sec. 1.142-4(d), 1.148-
11A(i), and 1.150-2(j), this paragraph (a)(5) applies to bonds issued 
after June 30, 1993, and sold before July 8, 1997. See Sec. 1.142-4(d) 
for rules relating to bonds sold on or after July 8, 1997.
    (6) Deep discount obligations. (i) Except as otherwise provided in 
paragraph (a)(7) of this section, the proceeds of any issue of 
obligations sold by the issuer after June 4, 1982, shall include any 
imputed proceeds of the issue. The imputed proceeds of an issue equal 
the sum of the amounts of imputed proceeds for each annual period 
(hereinafter, bond year) over the term of the issue.
    (ii) The amount of imputed proceeds for a bond year equals--
    (a) The sum of the amounts of interest that will accrue with respect 
to each obligation that is part of the issue in such year, reduced (but 
not below zero) by
    (b) The sum of the amounts of principal and interest that become 
payable with respect to the issue in that bond year.
    (iii) Interest will be deemed to accrue with respect to an 
obligation on an amount that, as of the commencement of that year, is 
equal to the sum of--
    (a) The purchase price (as defined in Sec. 1.103-13(d)(2)) 
allocable to the obligation and
    (b) The aggregate of the amounts of interest accruing in each prior 
bond year with respect to the obligation, reduced by all amounts that 
became payable with respect to the obligation in prior bond years. Any 
amount that becomes payable during the 30 day period following any bond 
year will be deemed to have become payable in such bond year. Thus, to 
the extent interest on an obligation accruing during a bond year does 
not become payable within 30 days from the end of such year, it is 
treated as reinvested under the same terms as the obligation. For 
purposes of this subparagraph (6), the rate at which such interest 
accrues is equal to the yield of the obligation. Yield is computed in 
the same manner as set forth in Sec. 1.103-13(c)(1)(ii) for computing 
yield on governmental obligations (assuming annual compounding of 
interest). Such computations shall be made without regard to optional 
call dates.
    (7) Deep discount obligations; special rules. (i) There are no 
imputed proceeds with respect to an obligation if--
    (a) The obligation does not have a stated interest rate 
(determinable at the date of issue) that increases over the term of the 
obligation, and
    (b) The purchase price of the obligation is at least 95 percent of 
its face amount.

At the option of the issuer, any obligation described in the preceding 
sentence may be disregarded in computing the imputed proceeds of the 
issue. Payments with respect to such obligations are also disregarded in 
determining the amount payable with respect to the issue in that bond 
year. If each obligation which is part of an issue is described in this 
subdivision (i), there are no imputed proceeds with respect to the 
issue.
    (ii) If the actual rate at which interest is to accrue over the term 
of an obligation is indeterminable at the date of issue then, in 
computing the yield of the obligation for purposes of this paragraph, 
such rate shall be determined as if the conditions as of the date of 
issue will not change over the term of the obligation. Thus, for 
example, if interest on an obligation is to be paid semiannually at a 
rate equal to 80 percent of the yield on six month Treasury bills at the 
most recent public sale immediately prior to the corresponding interest 
payment date and the yield on six month Treasury bills sold immediately 
preceding the issue date is 10 percent, then the six month Treasury bill 
rate is deemed to be a constant 10 percent for purposes of determining 
the amount of imputed proceeds of the issue. Therefore, all interest 
payments on the obligation would be deemed to be made at a rate of 8 
percent.
    (8) Examples. The principles of this paragraph may be illustrated by 
the following examples:

    Example (1). State A issues its bonds and plans to use substantially 
all of the proceeds from such bond issue to purchase land and build a 
facility which will be used for one of the purposes described in section 
103(b)(4)

[[Page 380]]

and this section. The arrangement provides that (1) A will issue bonds 
with a face amount of $21 million and with all accrued interest payable 
annually, the proceeds of which (after deducting bond election costs, 
costs of publishing notices, attorneys' fees, printing costs, trustees' 
fees for fiscal agents, and similar expenses) will be $20 million; (2) 
$18 million of the proceeds of the bond issue will be used to purchase 
land and to construct such facility; (3) $2 million of the proceeds will 
be used for an unrelated facility which will be used by X, a nonexempt 
person, in a separate trade or business and for a purpose not described 
in section 103(b) (4) or (5); (4) X will rent both facilities for 20 
years at an annual rental equal to the amount necessary to amortize the 
principal and pay the interest annually on the outstanding bonds; and 
(5) such payments by X and the facilities will be the security for the 
bonds. On these facts, substantially all of the proceeds will be used in 
connection with an exempt facility described in section 103(b)(4) and 
this section. Accordingly, section 103(b)(1) does not apply to the bonds 
unless such bonds are thereafter held by a person who is a substantial 
user of the facilities or a related person within the meaning of section 
103(b)(13) and Sec. 1.103-11.
    Example (2). On July 1, 1982, State B sells an issue of its 
obligations to an underwriter in anticipation of a public offering. The 
initial offering price is $18,627,639.69 of which $17,000,000 is to be 
used to construct a pollution control facility described in section 
103(b)(4)(F). X Corporation, a nonexempt person, is to use the facility 
and, in exchange, is obligated to pay an amount equal to the face amount 
of the issue when it becomes due. The obligations are issued on August 
1, 1982. The face amount of the issue is $30,000,000. The issue is a 
term issue with all obligations maturing on August 1, 1987. The issue 
bears no stated rate of interest; there are no interest coupons on the 
obligations. The bonds are industrial development bonds with a yield 
(based upon annual compounding) of ten percent. Based on these facts, 
the amount of imputed proceeds with respect to the issue is determined 
as follows:

----------------------------------------------------------------------------------------------------------------
                                                                  Purchase price
                                                                       plus                           Imputed
                              Date                                 accumulated       Interest        proceeds
                                                                     interest
----------------------------------------------------------------------------------------------------------------
Aug. 1, 1983...................................................   $18,627,639.69   $1,862,763.97   $1,862,763.97
Aug. 1, 1984...................................................    20,490,403.68    2,049,040.37    2,049,040.37
Aug. 1, 1985...................................................    22,539,444.03    2,253,944.40    2,253,944.40
Aug. 1, 1986...................................................    24,793,388.43    2,479,338.84    2,479,338.84
Aug. 1, 1987...................................................    27,272,727.27    2,727,272.73               0
                                                                ------------------------------------------------
  Total imputed proceeds.......................................  ...............  ..............    8,645,087.58
----------------------------------------------------------------------------------------------------------------


Therefore, proceeds of the issue equal $27,272,727.27 less issuance 
costs. Substantially all of the bond proceeds are not used to provide an 
exempt facility, and section 103(b)(1) applies to the issue.
    Example (3). The facts are the same as example (2) except that the 
issue has a face amount and purchase price of $18,500,000. The issue 
also provides for one payment in addition to the redemption payment, in 
the amount of $10,267,668 payable on or after August 1, 1986, one year 
before maturity. Section 103(b)(1) applies to the issue.
    Example (4). On July 1, 1982, City E sells an issue of industrial 
development bonds to provide for a convention facility, as described in 
section 103(b)(4)(C). Assume that the bonds are issued on that date as 
well. The issue has a face amount of $15,240,000 and a purchase price of 
$11,929,382.53. The estimated cost of the facility is $11,000,000. The 
bonds are ``zero coupon'' bonds, i.e., there are no interest coupons. 
Each series is initially offered for less than 95 percent of its face 
amount. The issue matures serially over a five year period, with each 
series being allocated a part of the purchase price of the issue. The 
following chart indicates the purchase price and yield for each series 
and debt service for the issue:

[[Page 381]]



                                                            [Amount allocable to each series]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                             1984 series   1985 series   1986 series   1987 series    Interest
                    Date                       1983 series     at 8.5        at 8.75       at 9.25       at 9.75     accruing on   Amount due    Imputed
                                              at 8 percent     percent       percent       percent       percent       issue*                   proceeds
--------------------------------------------------------------------------------------------------------------------------------------------------------
July 1, 1983................................  2,939,814.82  2,697,020.54  2,468,629.60  2,228.732.51  1,595,185.06  ............  ............      0
                                                235,185.18    229,246.75    216,005.09    206,157.76    155,530.54  1,042,125.32     3,175,000
July 1, 1984................................  ............  2,926,267.29  2,684,634.69  2,434,890.27  1,750,715.60  ............  ............      0
                                              ............    248,732.71    234,905.54    225,227.35    170,694.77    879,560.37     3,175,000
July 1, 1985................................  ............  ............  2,919,540.23  2,660,117.62  1,921,410.37  ............  ............      0
                                              ............  ............    255,459.77    246,060.88    187,337.51    688,858.16     3,175,000
July 1, 1986................................  ............  ............  ............  2,906,178.50  2,108,747.88  ............  ............      0
                                              ............  ............  ............    268,821.50    205,602.92    474,424.42     3,175,000
July 1, 1987................................  ............  ............  ............  ............  2,314,350.80  ............  ............      0
                                              ............  ............  ............  ............    225,649.20    225,649.20     2,540,000
                                             -----------------------------------------------------------------------------------------------------------
  Total.....................................  ............  ............  ............  ............  ............  ............    15,240,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
*This column (interest accruing on the issue) contains the sums of the interest that accrues on each series in each bond year. The amount of interest
  accruing on the issue is computed by adding the amount of interest accruing on each series outstanding for that bond year (the bottom number in the
  line for each bond year). The amount of interest annually accruing on each series also is added to the purchase price of the series to determine the
  amount of interest accruing in subsequent years, inasmuch as there are no payments with respect to the outstanding series prior to maturity. Thus, the
  ``principal'' amount, of the top of the two numbers given in such line for each bond year, is the purchase price allocable to that series plus the
  amount of interest that accrued on that series in prior years.


[[Page 382]]


There are no imputed proceeds because the amount payable on the issue in 
each bond year exceeds the total amount of interest accruing on the 
issue during such bond year. Section 103(b)(1) does not apply to the 
bonds unless such bonds are held by a person who is a substantial user 
of the facility or a related person within the meaning of section 
103(b)(13) and Sec. 1.103-11.
    Example (5). On July 1, 1982, City C issues industrial development 
bonds in the face amount of $30 million to construct a sports facility 
described in section 103(b)(4)(B) to be leased to D, a nonexempt person, 
with payments on the bonds secured by the lease. C receives $30 million 
in exchange for the bonds which will be used to provide the facility. 
The bonds mature on July 1, 2002. Each bond provides for an annual 
interest payment equal to ten percent of the face amount of the bond, 
with the last payment thereon (on July 1, 2002) including a return of 
the principal amount of the bond. The proceeds of the issue are $30 
million. Section 103(b)(1) does not apply to the bonds unless such bonds 
are held by a person who is a substantial user of the facility or a 
related person within the meaning of section 103(b)(13) and Sec. 1.103-
11.
    Example (6). The facts are the same as example (5) except that each 
bond provides for an annual interest payment equal to nine percent of 
its face amount and is sold with the option to tender the bond to D for 
purchase at par 5 years after the sale date of July 1, 1982 (i.e., the 
bonds are sold with a ``put'' option). Such bonds also provide a put 
option annually thereafter. There are no imputed proceeds (without 
regard to Sec. 1.103-8(a)(7)), and the result is the same as example 
(5).
    Example (7). On July 1, 1982, City F sells an issue of industrial 
development bonds in the face amount of $20 million to acquire a parking 
facility as described in section 103(b)(4)(D). The estimated cost of the 
facility is $17,800,000. The issue is issued on the same date and will 
mature serially over the following ten years. Each bond that is part of 
the issue bears annual interest coupons, each of which is in an amount 
equal to ten percent of the face amount of the bond. Each maturity has a 
face amount of $2,000,000. The issue is initially offered to the public 
for $19,700,000, allocable to each maturity as follows:

------------------------------------------------------------------------
                                                               Purchase
                          Maturity                              price
------------------------------------------------------------------------
July 1, 1983...............................................   $1,990,000
July 1, 1984...............................................   $1,980,000
July 1, 1985...............................................   $1,980,000
July 1, 1986...............................................   $1,970,000
July 1, 1987...............................................   $1,970,000
July 1, 1988...............................................   $1,970,000
July 1, 1989...............................................   $1,960,000
July 1, 1990...............................................   $1,960,000
July 1, 1991...............................................   $1,960,000
July 1, 1992...............................................   $1,960,000
------------------------------------------------------------------------


Based on the foregoing issue proceeds equal $19,700,000 less issuance 
costs. There are no imputed proceeds with respect to this issue inasmuch 
as each bond pays interest at a constant rate in each bond year and the 
purchase price of each bond is at least 95 percent of its face amount. 
Substantially all of the proceeds are to be used to provide the exempt 
facility. Accordingly, section 103(b)(1) does not apply to the bonds 
unless such bonds are thereafter held by a person who is a substantial 
user of the facility or a related person within the meaning of section 
103(b)(13) and Sec. 1.103-11.

    (b) Residential rental property--(1) General rule for obligations 
issued after April 24, 1979. Section 103(b)(1) shall not apply to any 
obligation which is issued after April 24, 1979, and is part of an issue 
substantially all of the proceeds of which are to be used to provide a 
residential rental project in which 20 percent or more of the units are 
to be occupied by individuals or families of low or moderate income (as 
defined in paragraph (b)(8)(v) of this section). In the case of a 
targeted area project, the minimum percentage of units which are to be 
occupied by individuals of low or moderate income is 15 percent. See 
generally Sec. 1.103-7 for rules relating to refunding issues.
    (2) Registration requirement. Any obligation (including any 
refunding obligation) issued after December 31, 1981, to provide a 
residential rental project must be issued as part of an issue, each 
obligation of which is in registered form (as defined in paragraph 
(b)(8)(ii) of this section).
    (3) Transitional rule. For purposes of this section, obligations 
issued after April 24, 1979, may be treated as issued before April 25, 
1979, if the transitional requirements of section 1104 of the Mortgage 
Subsidy Bond Tax Act of 1980 (94 Stat. 2670) are satisfied.
    (4) Residential rental project. (i) In general. A residential rental 
project is a building or structure, together with any functionally 
related and subordinate facilities, containing one or more similarly 
constructed units--
    (a) Which are used on other than a transient basis, and

[[Page 383]]

    (b) Which satisfy the requirements of paragraph (b)(5)(i) of this 
section and are available to members of the general public in accordance 
with the requirement of paragraph (a)(2) of this section.

Substantially all of each project must contain such units and 
functionally related and subordinate facilities. Hotels, motels, 
dormitories, fraternity and sorority houses, rooming houses, hospitals, 
nursing homes, sanitariums, rest homes, and trailer parks and courts for 
use on a transient basis are not residential rental projects.
    (ii) Multiple buildings. (a) Proximate buildings or structures 
(hereinafter ``buildings'') which have similarly constructed units are 
treated as part of the same project if they are owned for Federal tax 
purposes by the same person and if the buildings are financed pursuant 
to a common plan.
    (b) Buildings are proximate if they are located on a single tract of 
land. The term ``tract'' means any parcel or parcels of land which are 
contiguous except for the interposition of a road, street, stream or 
similar property. Otherwise, parcels are contiguous if their boundaries 
meet at one or more points.
    (c) A common plan of financing exists if, for example, all such 
buildings are provided by the same issue or several issues subject to a 
common indenture.
    (iii) Functionally related and subordinate facilities. Under 
paragraph (a)(3) of this section, facilities that are functionally 
related and subordinate to residential rental projects include 
facilities for use by the tenants, for example, swimming pools, other 
recreational facilities, parking areas, and other facilities which are 
reasonably required for the project, for example, heating and cooling 
equipment, trash disposal equipment or units for resident managers or 
maintenance personnel.
    (iv) Owner-occupied residences. For purposes of section 103 
(b)(4)(A) and this paragraph (b), the term ``residential rental 
project'' does not include any building or structure which contains 
fewer than five units, one unit of which is occupied by an owner of the 
units.
    (5) Requirement must be continuously satisfied--(i) Rental 
requirement. Once available for occupancy, each unit (as defined in 
paragraph (b)(8)(i) of this section) in a residential rental project 
must be rented or available for rental on a continuous basis during the 
longer of--
    (a) The remaining term of the obligation, or
    (b) The qualified project period (as defined in paragraph (b)(7) of 
this section).
    (ii) Low or moderate income occupancy requirement. Individuals or 
families of low or moderate income must occupy that percentage of 
completed units in such project applicable to the project under 
paragraph (b)(1) of this section continuously during the qualified 
project period. For this purpose, a unit occupied by an individual or 
family who at the commencement of the occupancy is of low or moderate 
income is treated as occupied by such an individual or family during 
their tenancy in such unit, even though they subsequently cease to be of 
low or moderate income. Moreover, such unit is treated as occupied by an 
individual or family of low or moderate income until reoccupied, other 
than for a temporary period, at which time the character of the unit 
shall be redetermined. In no event shall such temporary period exceed 31 
days.
    (6) Effect of post-issuance noncompliance--(i) In general. Unless 
corrected within a reasonable period, noncompliance with the 
requirements of this paragraph (b) shall cause the project to be treated 
as other than a project described in section 103 (b)(4)(A) and this 
paragraph (b) as of the date of issue. After an issue to provide such 
project ceases to qualify, subsequent conformity with the requirements 
will not alter the taxable status of such issue.
    (ii) Correction of noncompliance. If the issuer corrects any 
noncompliance arising from events occurring after the issuance of the 
obligation within a reasonable period, such noncompliance (e.g., an 
unauthorized sublease) shall not cause the project to be a project not 
described in this paragraph (b). A reasonable period is at least 60 days 
after such error is first discovered or would have been discovered by 
the exercise of reasonable diligence.

[[Page 384]]

    (iii) Involuntary loss. (a) The requirements of paragraph (b) shall 
cease to apply to a project in the event of involuntary noncompliance 
caused by fire, seizure, requisition, foreclosure, transfer of title by 
deed in lieu of foreclosure, change in a Federal law or an action of a 
Federal agency after the date of issue which prevents an issuer from 
enforcing the requirements of this paragraph, or condemnation or similar 
event but only if, within a reasonable period, either the obligation 
used to provide such project is retired or amounts received as a 
consequence of such event are used to provide a project which meets the 
requirement of section 103 (b)(4)(A) and this paragraph (b).
    (b) The provisions of paragraph (b)(6)(iii)(a) of this section shall 
cease to apply to a project subject to foreclosure, transfer of title by 
deed in lieu of foreclosure or similar event if, at anytime during that 
part of the qualified project period subsequent to such event, the 
obligor on the acquired purpose obligation (as defined in Sec. 1.103-
13(b)(4)(iv)(a)) or a related person (as defined in Sec. 1.103-10(e)) 
obtains an ownership interest in such project for tax purposes.
    (7) Qualified project period. The term ``qualified project period'' 
means--
    (i) For obligations issued after April 24, 1979, and prior to 
September 4, 1982, a period of 20 years commencing on the later of the 
date that the project becomes available for occupancy or the date of 
issue of the obligations. The requirement of paragraph (b)(5)(ii) of 
this section shall be deemed met if the owner of the project contracts 
with a Federal or state agency to maintain at least 20 percent (or 15 
percent in the case of targeted areas) of the units for low or moderate 
income individuals or families (as defined in paragraph (b)(8)(v) of 
this section) for 20 years in consideration for rent subsidies for such 
individuals or families for such period.
    (ii) For obligations issued after September 3, 1982, a period 
beginning on the later of the first day on which at least 10 percent of 
the units in the project are first occupied or the date of issue of an 
obligation described in section 103(b)(4)(A) and this paragraph and 
ending on the later of the date--
    (a) Which is 10 years after the date on which at least 50 percent of 
the units in the project are first occupied,
    (b) Which is a qualified number of days after the date on which any 
of the units in the project is first occupied, or
    (c) On which any assistance provided with respect to the project 
under section 8 of the United States Housing Act of 1937 terminates.

For purposes of this paragraph (b)(7)(ii), the term ``qualified number 
of days'' means 50 percent of the total number of days comprising the 
term of the obligation with the longest maturity in the issue used to 
provide the project. In the case of a refunding of such an issue, the 
longest maturity is equal to the sum of the period the prior issue was 
outstanding and the longest term of any refunding obligations.
    (8) Other definitions. For purposes of this paragraph--
    (i) Unit. The term ``unit'' means any accommodation containing 
separate and complete facilities for living, sleeping, eating, cooking, 
and sanitation. Such accommodations may be served by centrally located 
equipment, such as air conditioning or heating. Thus, for example, an 
apartment containing a living area, a sleeping area, bathing and 
sanitation facilities, and cooking facilities equipped with a cooking 
range, refrigerator, and sink, all of which are separate and distinct 
from other apartments, would constitute a unit.
    (ii) In registered form. The term ``in registered form'' has the 
same meaning as in section 6049. With respect to obligations issued 
after December 31, 1982, such term shall have the same meaning as 
prescribed in section 103(j) (including the regulations thereunder).
    (iii) Targeted area project. The term ``targeted area project'' 
means a project located in a qualified census tract (as defined in Sec. 
6a.103A-2(b)(4)) or an area of chronic economic distress (as defined in 
Sec. 6a.103A-2(b)(5)).
    (iv) Building or structure. The term ``building or structure'' 
generally means a discrete edifice or other man-made construction 
consisting of an independent foundation, outer walls, and roof. A single 
unit which is not an

[[Page 385]]

entire building but is merely a part of a building is not a building or 
structure within the meaning of this section. As such, while single 
townhouses are not buildings if their foundation, outer walls, and roof 
are not independent, detached houses and rowhouses are buildings.
    (v) Low or moderate income. Individuals and families of low or 
moderate income shall be determined in a manner consistent with 
determinations of lower income families under section 8 of the United 
States Housing Act of 1937, as amended, except that the percentage of 
median gross income which qualifies as low or moderate income shall be 
80 percent. Therefore, occupants of a unit are considered individuals or 
families of low or moderate income only if their adjusted income 
(computed in the manner prescribed with Sec. 1.167(k)-3(b)(3)) does not 
exceed 80 percent of the median gross income for the area. 
Notwithstanding the foregoing, the occupants of a unit shall not be 
considered to be of low or moderate income if all the occupants are 
students (as defined in section 151(e)(4)), no one of whom is entitled 
to file a joint return under section 6013. The method of determining low 
or moderate income in effect on the date of issue will be determinative 
for such issue, even if such method is subsequently changed. In the 
event programs under section 8(f) of the Housing Act of 1937, as 
amended, are terminated prior to the date of issue, the applicable 
method shall be that in effect immediately prior to the date of such 
termination.
    (9) Examples. The following examples illustrate the application of 
this paragraph (b).

    Example (1). In August 1982, City X issues $10 million of registered 
bonds with a term of 20 years to be used to finance the construction of 
an apartment building to be available to members of the general public. 
X loans the proceeds of the bonds to Corporation M, the tax owner of the 
project. The loan is secured by a promissory note from M and a mortgage 
on the project. The mortgage requires annual payments sufficient to 
amortize the principal and interest on the bonds. Corporation M 
maintains 20 percent of the units in the project for low or moderate 
income individuals and meets all of the requirements of this section 
until 2002, at which time M converts the project to offices. The bonds 
are industrial development bonds, but because the proceeds are used for 
construction of residential rental property, which is an exempt facility 
under section 103(b)(4)(A) and paragraph (b) of this section, section 
103(b)(1) does not apply.
    Example (2). The facts are the same as in example (1), except that 
the building is constructed adjacent to a factory, and the factory 
employees are to be given preference in selecting tenants. The bonds are 
industrial development bonds and the facility is not an exempt facility 
under section 103(b)(4)(A) and paragraph (b) of this section because it 
is not a facility constructed for use by the general public.
    Example (3). The facts are the same as in example (1), except that 
the proceeds of the obligation are provided to N, a cooperative housing 
corporation, to finance the construction of a cooperative housing 
project. N sells stock in such cooperative to shareholders, some of whom 
occupy the units in the cooperative and some of whom rent the units to 
other persons. Such project is not a residential rental project within 
the meaning of section 103(b)(4)(A) and Sec. 1.103-8(b) because less 
than all of the units in the building are used for rental. Further, the 
bonds are mortgage subsidy bonds under section 103A because more than a 
significant portion of the proceeds are used to provide financing for 
residences, some of which are owner-occupied and some of which are used 
in the trade or business of rental.
    Example (4). On February 1, 1984, County Z issues registered 
obligations with a term of 3 years and loans the proceeds to Corporation 
V to construct a garden apartment project for tenants who are 65 years 
or older. The mortgage on the project secures the loan. At the end of 3 
years, V obtains permanent financing for the project from a commercial 
lender. The project is not a targeted area project. V has not contracted 
with any Federal or State agency to provide rental assistance under 
section 8 of the United States Housing Act of 1937. As a condition for 
providing financing for construction, Z requires that the deed to the 
project contain a covenant that requires the project be used for elderly 
tenants and restricts occupancy of 20 percent of the units in the 
project to individuals or families of low or moderate income. Further, 
the deed provides that ``Such covenant shall run with and bind the land, 
from the date that ten percent of the units in the project are first 
occupied until ten years after the date that at least half the units are 
first occupied. The right to enforce these restrictions is vested in 
County Z.'' In 1990, however, less than 20 percent of the units are 
occupied by families or individuals of low or moderate incomes, and 
three months after learning of this condition County Z had not

[[Page 386]]

commenced enforcement of the covenant. Although on the date of issue the 
proceeds of the obligation were used to provide a residential rental 
project, the obligation will not be treated as providing a residential 
rental project within the meaning of section 103(b)(4)(A) as of February 
1, 1984, because the project did not meet the requirements of this 
paragraph for at least 10 years after at least 50 percent of the units 
are first occupied.
    Example (5). On January 15, 1983, State X issues registered 
obligations with a term of 15 years, the proceeds of which are loaned to 
Corporation P to construct an apartment building. The project will be a 
``targeted area project'', within the meaning of Sec. 1.103-
8(b)(8)(iii). Corporation P intends to rent all the units to individuals 
for their residences, maintaining 15 percent of the units in the project 
for individuals having low or moderate incomes, for 15 years. In 1988, 
however, Corporation P converts 80 percent of the units to condominiums. 
Corporation P repays the loan to State X which, in turn, redeems the 
obligations. The obligations are not used to provide a residential 
rental project within the meaning of section 103(b)(4)(A), and all the 
interest paid or to be paid on such obligations will be includable in 
gross income.
    Example (6). On January 15, 1984, State Z issues registered 
obligations with a term of 15 years the proceeds of which will be used 
to acquire and renovate a residential apartment building. Z sells the 
project to Corporation U and receives a 30-year mortgage. On June 1, 
1985, the first occupants of the project commence their tenancies. At 
least 50 percent of the units in the project are occupied on July 1, 
1985. On January 15, 1988, Z issues 35-year refunding bonds the proceeds 
of which are used to retire the obligations issued in 1984. The prior 
issue will be discharged by March 15, 1988. In order to meet the 
requirement of Sec. 1.103-8(b)(5)(ii), at least 20 percent of such 
units must be occupied by individuals of low or moderate income until 
January 1, 2005.
    Example (7). The facts are the same as in example (6) except that in 
1987, the apartment building is substantially destroyed by fire. The 
building was insured at its fair market value. U does not intend to 
reconstruct the building but uses a portion of the insurance proceeds to 
repay the unpaid balance of the mortgage. Z uses this amount to redeem 
the outstanding bonds at the first available call date. Since the 
project was substantially destroyed by fire and the outstanding bonds 
are retired at the first available call date, the requirements of 
section 103(b)(4)(A) and this paragraph (b) are satisfied with respect 
to the obligations.
    Example (8). The facts are the same as in example (6) except that in 
1987 U defaults on the mortgage, and Z obtains title to the project 
without instituting foreclosure proceedings. Z sells the project to S 
and uses the proceeds to retire the outstanding bonds. Since S did not 
obtain the project with obligations described in section 103(b)(4), S is 
not required to meet the requirements of section 103(b)(4)(A) and this 
paragraph. Further, the 1984 obligations are obligations described in 
section 103(b)(4)(A).
    Example (9). In September 1983, State W issues $10 million of 
registered bonds with a term of 3 years, the proceeds of which are to be 
loaned to Corporation V to finance the construction of an apartment 
building in a rural community. At the end of 3 years, V obtains 
permanent financing from Federal Agency T. Agency T will not allow the 
deed to contain any restrictive covenant relating to the use of the 
project. Under Federal law, however, T requires that V maintain all of 
the units in the project for rental to low-income farmworkers for the 
term of the mortgage, which is 20 years. Further, the mortgage between T 
and V provides that if T determines that low-income housing is no longer 
required in the community in which the project is constructed then the 
repayment of the mortgage may be accelerated. T determines as of the 
date of issue that low-income housing will be needed in the community 
for at least 20 years. In 1987, the project fails to meet the 
requirements of section 1.103-8(b)(5)(ii), relating to occupancy by 
individuals or families of low or moderate income. Further, T does not 
require V to correct the failure. Based on the foregoing, the bonds 
issued by W will be treated as described in section 103(b)(4)(A).
    Example (10). The facts are the same as in example (9) except that 
in 1987, the Federal law is amended to provide that Agency T may not 
enforce its low-income occupancy requirement. The result is the same.
    Example (11). The facts are the same as in example (9) except that 
in 1987 Agency T determines that due to a change in circumstances in the 
community in which the project is located low-income rental housing is 
no longer required. As such, T requires V to repay the mortgage. Since 
the obligations have been repaid, W has no legal right to enforce the 
requirements of paragraph (b) with respect to the project. Subsequent 
nonconformity of the project with the requirements of Sec. 1.103-8(b) 
under these circumstances will not cause the obligations issued by W to 
be industrial development bonds within the meaning of section 103(b)(1).

    (10) Obligations issued before April 25, 1979--(i) General rules. 
Section 103(b)(1) shall not apply to obligations issued before April 25, 
1979, which are part of an issue substantially all of the proceeds of 
which are to be used to provide residential real property for family 
units. In order to qualify under this

[[Page 387]]

paragraph (b) as an exempt facility, the facility must satisfy the 
public use requirement of paragraph (a)(2) of this section by being 
available for use by members of the general public.
    (ii) Family units defined. For purposes of this paragraph (b) the 
term ``family unit'' means a building or any portion thereof which 
contains complete living facilities which are to be used on other than a 
transient basis by one or more persons, and facilities functionally 
related and subordinate thereto. Thus, an apartment which is to be used 
on other than a transient basis as a residence by a single person or by 
a family and which contains complete facilities for living, sleeping, 
eating, cooking, and sanitation, constitutes a family unit. Such a unit 
may be served by centrally located machinery and equipment as in a 
typical apartment building. To qualify as a family unit, the living 
facilities must be a separate, self-contained building or constitute one 
unit in a building substantially all of which consists of similar units, 
together with functionally related and subordinate facilities and areas. 
Hotels, motels, dormitories, fraternity and sorority houses, rooming 
houses, hospitals, sanitariums, rest homes, and trailer parks and courts 
for use on a transient basis do not constitute residential real property 
for family units.
    (iii) Functionally related and subordinate facilities. Under 
paragraph (a)(3) of this section, facilities which are functionally 
related and subordinate to residential real property actually used for 
family units include, for example, facilities for use by the occupants 
such as a swimming pool, a parking area, and recreational facilities.
    (c) Sports facilities--(1) General rule. Section 103(b)(4)(B) 
provides that section 103(b)(1) shall not apply to obligations issued by 
a State or local governmental unit which are part of an issue 
substantially all of the proceeds of which are to be used to provide 
sports facilities. In order to qualify as an exempt facility under 
section 103(b)(4)(B) and this paragraph, the facility must satisfy the 
public use requirement of paragraph (a)(2) of this section by being 
available for use by members of the general public either as 
participants or as spectators.
    (2) Sports facility defined. (i) For purposes of section 
103(b)(4)(B) and this paragraph, the term ``sports facilities'' includes 
both outdoor and indoor facilities. The facility may be designed either 
as a spectator or as a participation facility. For example, the term 
includes both indoor and outdoor stadiums for baseball, football, ice 
hockey, or other sports events, as well as facilities for the 
participation of the general public in sports activities, such as golf 
courses, ski slopes, swimming pools, tennis courts, and gymnasiums. The 
term does not include, however, facilities such as a golf course, 
swimming pool, or tennis court, which are constructed for use by members 
of a private club or as integral or subordinate parts of a hotel or 
motel, or the use of which will be restricted to a special class or 
group or to guests of a particular hotel or motel, since they are not 
facilities for the use of the general public as required by paragraph 
(a)(2) of this section.
    (ii) Under paragraph (a)(3) of this section, facilities which are 
functionally related and subordinate to a sports facility, such as a 
parking lot, clubhouse, ski slope warming house, bath house, or ski tow, 
are considered to be part of a sports facility. A ski lodge which 
consists primarily of overnight accommodations is not functionally 
related and subordinate to a sports facility.
    (d) Convention or trade show facilities--(1) General rule. Section 
103(b)(4)(C) provides that section 103(b)(1) shall not apply to 
obligations issued by a State or local governmental unit which are a 
part of an issue substantially all of the proceeds of which are to be 
used to provide convention or trade show facilities. In order to qualify 
under section 103(b)(4)(C) and this paragraph as an exempt facility, the 
facility must satisfy the public use requirement of paragraph (a)(2) of 
this section by being available for an appropriate charge or rental, on 
a rate scale basis, for use by members of the general public. The public 
use requirement is not satisfied if the use of a convention or trade 
show facility is limited by long-term leases to a single user or group 
of users.
    (2) Convention or trade show facilities defined. For purposes of 
section 103(b)(4)(C) and this paragraph, the

[[Page 388]]

term ``convention or trade show facilities'' means special-purpose 
buildings or structures, such as meeting halls and display areas, which 
are generally used to house a convention or trade show, including, under 
paragraph (a)(3) of this section, facilities functionally related and 
subordinate to such facilities such as parking lots or railroad sidings. 
A hotel or motel which is available to the general public, whether or 
not it is intended primarily to house persons attending or participating 
in a convention or trade show, is neither a convention or trade show 
facility nor functionally related and subordinate thereto.
    (e) Certain transportation facilities--(1) General rule. Section 
103(b)(4)(D) provides that section 103(b)(1) shall not apply to 
obligations issued by a State or local governmental unit which are part 
of an issue substantially all of the proceeds of which are to be used to 
provide (i) airports, docks, wharves, mass commuting facilities, or 
public parking facilities, or (ii) storage or training facilities 
directly related to any such facility. In order to qualify under section 
103(b)(4)(D) and this paragraph as an exempt facility, the facility must 
satisfy the public use requirement of paragraph (a)(2) of this section 
by being available for use by members of the general public or for use 
by common carriers or charter carriers which serve members of the 
general public. A dock or wharf which is part of a public port (or a 
public port to be constructed in accordance with a plan which has been 
finally adopted on the date the obligations in question are issued) 
satisfies the public use test. A parking lot will be available for use 
by the general public unless more than an insubstantial portion thereof 
will be used exclusively by or for the benefit of a nonexempt person by 
reason of a formal or informal agreement or by reason of the remote 
geographic location of the facility.
    (2) Definitions. For purposes of section 103(b)(4)(D) and this 
paragraph--
    (i) With respect to bonds sold at or before 5:00 p.m. EST on 
December 29, 1978, an airport includes service accommodations for the 
public such as terminals, retail stores in such terminals, runways, 
hangars, loading facilities, repair shops, parking areas, and facilities 
which, under paragraph (a)(3) of this section, are functionally related 
and subordinate to the airport, such as facilities for the preparation 
of in-flight meals, restaurants, and accommodations for temporary or 
overnight use by passengers, and other facilities functionally related 
to the needs or convenience of passengers, shipping companies, and 
airlines. The term ``airport'' does not include a landing strip which, 
by reason of a formal or informal agreement, or by reason of geographic 
location, will not be available for general public use.
    (ii) With respect to bonds sold after 5:00 p.m. EST on December 29, 
1978--
    (a) An airport includes facilities which are directly related and 
essential to--
    (1) Servicing aircraft or enabling aircraft to take off and land, or
    (2) Transferring passengers or cargo to or from aircraft.

A facility does not satisfy either of the foregoing requirements if the 
facility need not be located at, or in close proximity to, the take-off 
and landing area in order to perform its function. Examples of 
facilities which satisfy those requirements are terminals, runways, 
hangars, loading facilities, repair shops, and land-based navigation 
aids such as radar installation.
    (b) Under paragraph (a)(3) of this section, an airport includes 
facilities other than those described in paragraph (e)(2)(ii)(a) only if 
they are functionally related and subordinate to an airport (as defined 
in paragraph (e)(2)(ii)(a)). A facility (or part thereof) is not 
functionally related and subordinate to an airport if the facility (or 
part thereof)--
    (1) Is not of a character and size commensurate with the character 
and size of the airport at or adjacent to which the facility is located, 
or
    (2) Is not located at or adjacent to that airport.

A facility may satisfy the character and size requirement although it 
provides minimal benefits to other airports. For example, a facility for 
the preparation of in-flight meals which has capacity sufficient to 
prepare all in-flight meals for aircraft departing the airport where the 
facility is located

[[Page 389]]

qualifies although some meals may be consumed in transit between other 
airports. Other examples of facilities functionally related and 
subordinate to an airport are restaurants and retail stores located in 
terminals, ground transportation parking areas, and accommodations for 
temporary or overnight use by passengers. Unimproved land (including 
agricultural land) that is adjacent to an airport and that is impaired 
by a significant level of airport noise is functionally related and 
subordinate to the airport if after its acquisition that land will not 
be converted to a use that is incompatible with the level of airport 
noise. Adjacent land with existing improvements also may be functionally 
related and subordinate to an airport by reason of impairment by a 
significant level of airport noise but only if the use of such land 
before its acquisition is incompatible with the airport noise level, its 
use after acquisition is to be compatible, and the post-acquisition use 
will be essentially different from the pre-acquisition use. 
Notwithstanding the foregoing, an interest in such improved land 
acquired solely to mitigate damages attributable to airport noise is 
treated as functionally related and subordinate to the airport. Thus, 
for example, amounts allocated to imposing a servitude on improved land 
adjacent to an airport restricting its future use to uses compatible 
with airport noise are treated as amounts allocated to property 
functionally related and subordinate to an airport. For the purpose of 
determining whether land is impaired by a significant level of airport 
noise, any generally accepted noise estimating methodology may be used. 
For example, a Noise Exposure Forecast (NEF), a method for composite 
noise rating recommended by the Federal Aviation Administration to 
measure the impact of airport noise, may be used for this purpose. 
Compatibility may be determined by reference to regulations or general 
guidelines published by the Federal Aviation Administration under 
section 102 of the Aviation Safety and Noise Abatement Act of 1979 (49 
U.S.C. 2102), or sections 11(3)(C) and 18(a)(4) of the Airport and 
Airway Development Act of 1970, as amended (49 U.S.C. 1711(3)(C) and 
1718(a)(4)), concerning uses of land impaired by a significant level of 
airport noise, or, where available, by reference to the airport 
compatibility plan specifically addressing what constitutes a compatible 
use of that land.
    (c) As an illustration of the rules of this paragraph (e)(2)(ii), an 
office building (or office space within a building) or a computer 
facility, either of which serves a system-wide or regional function of 
an airline, is not considered part of an airport since that facility is 
not described in either paragraph (e)(2)(ii)(a) or (b). However, a 
maintenance or overhaul facility which services aircraft is considered 
part of an airport under paragraph (e)(2)(ii)(a) since that facility is 
directly related and essential to servicing aircraft and must be located 
where aircraft take off and land in order to perform its function.
    (d) A hotel located at or adjacent to an airport satisfies the 
requirements of paragraph (e)(2)(ii)(b), that is, it is of a character 
and size commensurate with the character and size of the airport at or 
adjacent to which it is located, if the number of guest rooms in the 
hotel is reasonable for the size of the airport, taking into account the 
current and projected passenger usage of the terminal facility. If the 
hotel contains meeting rooms, the number and size of these rooms must be 
in reasonable proportion to the number of guest rooms in the hotel. 
Limited recreational facilities will not prevent the hotel from being of 
a character and size commensurate with the character and size of the 
airport.
    (iii) A dock or wharf includes property which, under paragraph 
(a)(3) of this section, is functionally related and subordinate to a 
dock or wharf such as the structure alongside which a vessel docks, the 
equipment needed to receive and to discharge cargo and passengers from 
the vessel, such as cranes and conveyors, related storage, handling, 
office, and passenger areas, and similar facilities.
    (iv) A mass commuting facility includes real property together with 
improvements and personal property used therein, such as machinery, 
equipment, and furniture, serving the general public commuting on a day-
to-day basis by

[[Page 390]]

bus, subway, rail, ferry, or other conveyance which moves over 
prescribed routes. Such property also includes terminals and facilities 
which, under paragraph (a)(3) of this section, are functionally related 
and subordinate to the mass commuting facility, such as parking garages, 
car barns, and repair shops. Use of mass commuting facilities by 
noncommuters in common with commuters is immaterial. Thus, a terminal 
leased to a common carrier bus line which serves both commuters and long 
distance travelers would qualify as an exempt facility.
    (3) Related storage or training facility. Section 103 (b)(4)(D) 
includes only those storage and training facilities which are both (i) 
directly related to a facility to which subparagraph (1)(i) or (ii) of 
this paragraph applies and (ii) physically located on or adjacent to 
such a facility. For example, a storage facility would include a grain 
elevator, silo, warehouse, or oil and gas storage tank used in 
connection with a dock or wharf and located on or adjacent to such dock 
or wharf. Similarly, a training facility would include a building 
located at or adjacent to an airport for the training of flight 
personnel or a paved area immediately adjoining a bus garage used to 
train bus drivers.
    (4) Examples. The principles of this paragraph may be illustrated by 
the following examples:

    Example (1). B Airport Authority, a political subdivision of State 
A, owns and operates B Airport. B Airport Authority adds several 
runways. In view of the expanded area impaired by significant levels of 
airport noise, the Authority proposes to issue bonds the proceeds of 
which are to be used to acquire a hospital located adjacent to the 
airport. The noise level on the acquired property is 40 NEF. By 
reference to a noise exposure map setting forth noncompatible land uses 
and by reference to guidelines published by the Federal Aviation 
Administration, it is established that continued use of the land for a 
hospital is not compatible with the noise level. Prior to issuing the 
bonds, B contracts to lease the property to Corporation C to be used for 
warehouse space. Within 18 months of the bonds' issuance C will remodel 
the hospital (previously owned by D, who is unrelated to C) with its own 
funds and rent the facility as a warehouse. Use as a warehouse is 
determined to be compatible with the level of airport noise impairing 
the land. The improved land and prospective revenues from the facility's 
rental are security for the proposed issuance. Based on the foregoing, 
the acquired land satisfies the public use test. Furthermore, it is 
functionally related and subordinate to the airport because the 
improvements are to be used in an essentially different manner than 
prior to the land's acquisition. The bonds are industrial development 
bonds. However, section 103(b)(1) does not apply unless the provisions 
of section 103(b)(13) and Sec. 1.103-11 apply.
    Example (2). The facts are the same as in Example (1) except that a 
substantial portion of the proceeds of the bond issue is allocated to 
the acquisition of a limited interest in an additional tract of land 
(also impaired by airport noise measured at 40 NEF) on which an office 
building stands. The limited interest holds B harmless for damages 
caused by airport noise and restricts uses of the tract after the 
building is retired to those compatible with noise levels caused by the 
airport. Based on the foregoing, such interest satisfies the public use 
test. Furthermore, the interest is functionally related and subordinate 
to the airport because it is solely to mitigate damage attributable to 
airport noise, in part by restricting future land uses. The bonds are 
industrial development bonds. However, section 103(b)(1) does not apply 
unless the provisions of section 103(b)(13) or Sec. 1.103-11 apply.
    Example (3). On June 1, 1982, M Airport Authority, a political 
subdivision of State O, issues obligations, the proceeds of which are 
loaned to X Corporation, a nonexempt person. X uses the proceeds to 
construct a hotel adjacent to the main terminal building at M Airport. X 
will be unconditionally liable for repayment of the proposed 
obligations. The hotel will be used to provide temporary and overnight 
accommodations for airline passengers using M Airport. The number of 
rooms in the hotel is reasonable for an airport of M's size, taking into 
account the current and projected passenger usage of the terminal 
facility. In addition to guest rooms, the hotel will contain a 
restaurant, small retail stores (such as a gift shop and newstand), and 
limited recreation facilities (such as a swimming pool). The hotel will 
also contain several multipurpose rooms suitable for use as meeting 
rooms. The number and size of these rooms will be in reasonable 
proportion to the number and size of the guest rooms in the hotel. Use 
of the guest rooms, restaurant and stores, recreational facilities, and 
meeting rooms by air passengers arriving at or departing from M Airport 
will be incidental to the use of the hotel by air passengers for 
temporary and overnight accommodations. The hotel is of a character and 
size commensurate with the character and size of M Airport. 
Consequently, applying the provisions of Sec. 1.103-8(e)(2), the hotel 
is functionally related and subordinate to M Airport. The obligations 
are industrial development bonds. Section

[[Page 391]]

103(b)(1) does not apply to the obligations, however, unless the 
provisions of section 103(b)(10) and Sec. 1.103-11 apply.
    Example (4). On June 1, 1982, N Airport Authority, a political 
subdivision of State P, issues obligations the proceeds of which are 
loaned to Y Corporation, a nonexempt person. Y uses the proceeds to 
construct a hotel adjacent to the main terminal building at N Airport. Y 
Corporation will be unconditionally liable for repayment of the proposed 
obligations. The hotel will contain extensive recreational facilities, 
including a large roof-top swimming pool, tennis courts, and a health 
club. In addition, facilities for conferences consisting of a ballroom-
sized meeting room capable of being partitioned by movable panels and 
several smaller meeting rooms will be constructed. The number of rooms 
in the hotel will substantially exceed the number which is reasonably 
based on the current and projected passenger usage of the terminal 
facility. Because of the presence of extensive recreational and 
conference facilities, as well as the presence of on excessive number of 
rooms at the hotel, the hotel fails to be of a character and size 
commensurate with the character and size of N Airport. The result would 
be the same if the hotel did not have extensive recreational facilities. 
Consequently, the hotel is not functionally related and subordinate to N 
Airport under Sec. 1.103-8(e)(2). The obligations are industrial 
development bonds and interest thereon is not excluded from gross income 
by reason of subsection (a)(1) or (b)(4) of section 103.

    (f) Certain public utility facilities--(1) General rule. (i) Section 
103(b)(4)(E) provides that section 103(b)(1) shall not apply to 
obligations issued by a State or local governmental unit which are part 
of an issue substantially all of the proceeds of which are to be used to 
provide sewage disposal facilities, solid waste disposal facilities, or 
facilities for the local furnishing of electric energy or gas. In order 
to qualify under section 103(b)(4)(E) as an exempt facility, the 
facility must satisfy the public use requirement of paragraph (a)(2) of 
this section. A public utility facility described in this subparagraph 
(with the exception of sewage and solid waste disposal facilities which 
will be treated in all events as serving the general public) will 
satisfy the public use requirement only if such facility, or the output 
thereof, is available for use by members of the general public.
    (ii) A facility for the local furnishing of electric energy or gas 
is, for purposes of applying the public use test in paragraph (a)(2) of 
this section, available for use by members of the general public if (a) 
the owner or operator of the facility is obligated, by a legislative 
enactment, local ordinance, regulation, or the equivalent thereof, to 
furnish electric energy or gas to all persons who desire such services 
and who are within the service area of the owner or operator of such 
facility, and (b) it is reasonably expected that such facility will 
serve or be available to a large segment of the general public in such 
service area. For rules with respect to facilities for the furnishing of 
water, see paragraph (h) of this section.
    (2) Definitions. For purposes of section 103(b)(4)(E) and this 
paragraph--
    (i) The term ``sewage disposal facilities'' means any property used 
for the collection, storage, treatment, utilization, processing, or 
final disposal of sewage.
    (ii)(a) The term ``solid waste disposal facilities'' means any 
property or portion thereof used for the collection, storage, treatment, 
utilization, processing, or final disposal of solid waste. Only 
expenditures for that portion of property which is a solid waste 
disposal facility qualify as expenditures for solid waste disposal 
facilities. The fact that a facility which otherwise qualifies as a 
solid waste disposal facility operates at a profit will not, of itself, 
disqualify the facility as an exempt facility. However, whether a 
collection or storage facility qualifies as a solid waste disposal 
facility depends upon all of the facts and circumstances. Thus, land and 
facilities for the collection of materials to form a slag heap which is 
not preliminary to the recycling or other final disposal of such 
materials within a reasonable period of time will not qualify. The term 
does not include facilities for collection, storage, or disposal of 
liquid or gaseous waste except where such facilities are facilities 
which, under paragraph (a)(3) of this section, are functionally related 
and subordinate to a solid waste disposal facility.
    (b) The term ``solid waste'' shall have the same meaning as in 
section 203(4) of the Solid Waste Disposal Act (42 U.S.C. 3252(4)), 
except that for purposes of this paragraph, material will not qualify as 
solid waste unless, on the date of issue of the obligations issued

[[Page 392]]

to provide the facility to dispose of such waste material, it is 
property which is useless, unused, unwanted, or discarded solid 
material, which has no market or other value at the place where it is 
located. Thus, where any person is willing to purchase such property, at 
any price, such material is not waste. Where any person is willing to 
remove such property at his own expense but is not willing to purchase 
such property at any price, such material is waste. Section 203(4) of 
the Solid Waste Disposal Act provides that:

    (4) The term ``solid waste'' means garbage, refuse, and other 
discarded solid materials, including solid-waste materials resulting 
from industrial, commercial, and agricultural operations, and from 
community activities, but does not include solids or dissolved material 
in domestic sewage or other significant pollutants in water resources, 
such as silt, dissolved or suspended solids in industrial waste water 
effluents, dissolved materials in irrigation return flows or other 
common water pollutants.

    (c) A facility which disposes of solid waste by reconstituting, 
converting, or otherwise recycling it into material which is not waste 
shall also qualify as a solid waste disposal facility if solid waste 
(within the meaning of (b) of this subdivision (ii) constitutes at least 
65 percent, by weight or volume, of the total materials introduced into 
the recycling process. Such a recycling facility shall not fail to 
qualify as a solid waste disposal facility solely because it operates at 
a profit.
    (d) For rules relating to property which has both a solid waste 
disposal function and a function other than the disposal of solid waste, 
see Sec. 17.1 of this chapter.
    (iii) The term ``facilities for the local furnishing of electric 
energy or gas'' means property which--
    (a) Is either property of a character subject to the allowance for 
depreciation provided in section 167 or land,
    (b) Is used to produce, collect, generate, transmit, store, 
distribute, or convey electric energy or gas.
    (c) Is used in the trade or business of furnishing electric energy 
or gas, and
    (d) Is a part of a system providing service to the general populace 
of one or more communities or municipalities, but in no event more than 
2 contiguous counties (or a political equivalent) whether or not such 
counties are located in one State.

For purposes of this subdivision, a city which is not within, or does 
not consist of, one or more counties (or a political equivalent) shall 
be treated as a county (or a political equivalent). A facility for the 
generation of electric energy otherwise qualifying under this 
subdivision will not be disqualified because it is connected to a system 
for interconnection with other public utility systems for the emergency 
transfer of electric energy. The facilities need not be located in the 
area served by them. Also, the term ``facilities for the local 
furnishing of electric energy or gas'' does not include coal, oil, gas, 
nuclear cores, or other materials performing a similar function.
    (g) Air or water pollution control facilities--(1) General rule. 
Section 103(b)(4)(F) provides that section 103(b)(1) shall not apply to 
obligations issued by a State or local governmental unit which are part 
of an issue substantially all of the proceeds of which are to be used to 
provide air or water pollution control facilities. Such facilities are 
in all events treated as serving the general public and, thus, satisfy 
the public use requirement of paragraph (a)(2) of this section.
    (2) Definitions. (i) For purposes of section 103(b)(4)(F) and this 
paragraph, property is a pollution control facility to the extent that 
the test of either subdivision (iii) or (iv) of this subparagraph is 
satisfied, but only if--
    (a) It is property which is described in subdivision (ii) of this 
subparagraph and is either of a character subject to the allowance for 
depreciation provided in section 167 or land, and
    (b) Either (1) a Federal, State, or local agency exercising 
jurisdiction has certified that the facility, as designed, is in 
furtherance of the purpose of abating or controlling atmospheric 
pollutants or contaminants, or water pollution, as the case may be, or 
(2) the facility is designed to meet or exceed applicable Federal, 
State, and local requirements for the control of atmospheric pollutants 
or contaminants, or water pollution, as the case may be, in effect at 
the time the obligations, the proceeds of which are to be used to 
provide such facilities, are issued.

[[Page 393]]

    (ii) Property is described in this subdivision if it is property to 
be used, in whole or in part, to abate or control water or atmospheric 
pollution or contamination by removing, altering, disposing, or storing 
pollutants, contaminants, wastes, or heat. In the case of property to be 
used to control water pollution, such property includes the necessary 
intercepting sewers, pumping, power, and other equipment, and their 
appurtenances. For rules relating to facilities which remove pollutants 
from fuel or certain other items, see subdivision (vi) of this 
subparagraph.
    (iii) In the case of an expenditure for property which is designed 
for no significant purpose other than the control of pollution, the 
total expenditure for such property satisfies the test of this 
subdivision. Thus, where property which is to serve no function other 
than the control of pollution is to be added to an existing 
manufacturing or production facility, the total expenditure for such 
property satisfies the test of this subdivision. Also, if an expenditure 
for property would not be made but for the purpose of controlling 
pollution, and if the expenditure has no significant purpose other than 
the purpose of pollution control, the total expenditure for such 
property satisfies the test of this subdivision even though such 
property serves one or more functions in addition to its function as a 
pollution control facility.
    (iv) In the case of property to be placed in service for the purpose 
of controlling pollution and for a significant purpose other than 
controlling pollution, only the incremental cost of such facility 
satisfies the test of this subdivision. The ``incremental cost'' of 
property is the excess of its total cost over that portion of its cost 
expended for a purpose other than the control of pollution.
    (v) An expenditure has a significant purpose other than the control 
of pollution if it results in an increase in production or capacity, or 
in a material extension of the useful life of a manufacturing or 
production facility or a part thereof.
    (h) Water facilities--(1) General rule. Section 103(b)(4)(G) 
provides that section 103(b)(1) shall not apply to obligations issued by 
a State or local governmental unit which are part of an issue 
substantially all of the proceeds of which are to be used to provide 
facilities for the furnishing of water which are available, on 
reasonable demand, to members of the general public. A water facility 
will satisfy the public use test of paragraph (a)(2) of this section if 
it will provide water, on reasonable demand, to any member of the 
general public within the service area of the water system of which such 
facility is a part.
    (2) Definition. For purposes of section 103(b)(4)(G) and this 
paragraph, the ``water facilities'' include artesian wells, reservoirs, 
dams, related equipment and pipelines, and other facilities used to 
furnish water for domestic, industrial, irrigation, or other purposes.
    (3) Effective date. The provisions of this paragraph apply in the 
case of facilities provided by obligations issued after January 1, 1969. 
In the case of facilities provided by obligations issued on or before 
such date to which section 103(b) is applicable, the provisions of 
paragraph (f) of this section shall apply. For such purposes, wherever 
the term ``local furnishing of electric energy or gas'' appears in 
paragraph (f) of this section, such term shall be deemed to read ``local 
furnishing of electric energy, gas, or water.''
    (i) Examples. The application of section 103(b)(4) and this section 
are illustrated by the following examples:

    Example (1). City B plans to issue $10 million of bonds to be used 
to construct a sports stadium. The revenues from the facility and the 
facility itself will be the security for the bonds. A professional 
football team rents the facility on a long-term leasee for part of the 
year and a professional baseball team rents the sports facility for the 
remainder of the year. Tickets are sold by the teams to the general 
public. The bonds are industrial development bonds, but since the 
proceeds are used for a spectator facility for general public use, which 
is an exempt facility under section 103(b)(4)(B) and paragraph (c) of 
this section, section 103(b)(1) does not apply unless the provisions of 
section 103(b)(13) and Sec. 1.103-11 apply.
    Example (2). City C plans to issue $10 million of bonds to be used 
to construct a convention hall which it will own. City C plans to lease 
the convention hall for 25 years to corporation Y, a nonexempt person, 
which will operate and maintain it. The terms of the lease obligate Y to 
make the convention

[[Page 394]]

hall generally available for civic, business, and recreational shows, 
meetings, performances, and similar activities serving or benefiting the 
community. Lease payments from Y and the facility will be security for 
the bonds. The bonds are industrial development bonds, but since the 
proceeds are to be used for a facility for general public use, which is 
an exempt facility under section 103(b)(4)(C) and paragraph (d) of this 
section, section 103(b)(1) does not apply unless the provisions of 
section 103(b)(13) and Sec. 1.103-11 apply.
    Example (3). City D issues $100 million of its bonds and uses the 
proceeds to finance construction of an airport for the use of the 
general public. D will own and operate the airport. A major portion of 
the rentable space in the terminal building is leased on a long-term 
basis to common carrier and non-scheduled airlines. The bonds will be 
secured by the airport landing and runway charges and by payments with 
respect to such long-term leases from such commercial airlines. Such 
commercial airline payments are expected to constitute more than 50 
percent of the total revenues from the airport. The bonds are industrial 
development bonds, but since the proceeds are to be used for an airport 
for use by the general public and by carriers serving the general 
public, which is an exempt facility under section 103(b)(4)(D) and 
paragraph (e) of this section, section 103(b)(1) does not apply unless 
the provisions of section 103(b)(13) and Sec. 1.103-11 apply. The 
result would be the same if D hired an airport management firm to 
operate the airport.
    Example (4). City E issues $6 million of its bonds and uses the 
proceeds to finance construction of a landing strip for airplanes to be 
located adjacent to the factories of corporations Y and Z. The landing 
strip will be used in the trades or businesses of Y and Z and by any 
member of the general public wishing to use it. However, due to its 
location, general public use will be negligible. The lease payments by Y 
and Z for the use of the facility are the security for the bonds. The 
bonds are industrial development bonds and the facility is not an exempt 
facility under section 103(b)(4)(D) and paragraph (c) of this section 
because it is not a facility constructed for general public use.
    Example (5). State F and corporation Z enter into an arrangement 
which provides that F will issue $10 million of its bonds and use the 
proceeds to construct a facility for Z the only purpose of which is to 
control air and water pollution at Z's plant. The principal and interest 
on the bonds will be secured by the charges which F will impose on Z. 
The bonds are industrial development bonds, but since the proceeds are 
to be used for air and water pollution facilities designed to abate 
pollution by private persons, such facilities are for the benefit of the 
general public and are exempt facilities under section 103(b)(4)(F) and 
paragraph (g) of this section. Accordingly, section 103(b)(1) does not 
apply unless the provisions of section 103(b)(13) and Sec. 1.103-11 
apply.
    Example (6). City G issues $20 million of its bonds and will use $6 
million to finance residential rental property which qualifies as an 
exempt facility under section 103(b)(4)(A) and paragraph (b) of this 
section, $9 million to finance construction of a stadium which qualifies 
as an exempt facility under section 103(b)(4)(B) and paragraph (c) of 
this section, and $5 million for convention facilities which qualify as 
exempt facilities under section 103(b)(4)(C) and paragraph (d) of this 
section. The facilities will be used in the trades or businesses of 
nonexempt persons and rental payments with respect to such facilities 
and the facilities themselves will be the security for the bonds. The 
bonds are industrial development bonds, but since all the proceeds are 
to be used for facilities which are exempt facilities under section 
103(b)(4), section 103(b)(1) does not apply unless the provisions of 
section 103(b)(10) and Sec. 1.103-11 apply. The result would be the 
same, if; instead of using $9 million to finance construction of a 
stadium, the $9 million were used to finance construction of a capitol 
building. [Reg. Sec. 1.103-8].

[T.D. 7199, 37 FR 15490, Aug. 3, 1972]

    Editorial Note: For Federal Register citations affecting Sec. 
1.103-8, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and on GPO Access.



Sec. 1.103-9  Interest on bonds to finance industrial parks.

    (a) General rule. (1) Under section 103(c)(5), interest paid on an 
issue of obligations issued by a State or local governmental unit (as 
defined in Sec. 1.103-1) is not includable in gross income if 
substantially all of the proceeds of such issue is to be used to finance 
the acquisition or development of land as the site for an industrial 
park (referred to in this section as ``industrial park bonds''). 
However, interest on an obligation of such an issue is includable in 
gross income if the obligation is held by a substantial user or a 
related person (as described in section 103(c)(7) and Sec. 1.103-11). 
If substantially all of the proceeds of a bond issue is to be so used to 
finance an industrial park, the debt obligations are treated as 
obligations described in section 103(a)(1) and Sec. 1.103-1 even though

[[Page 395]]

such obligations are industrial development bonds within the meaning of 
section 103(c)(2) and Sec. 1.103-7. Whether substantially all of the 
proceeds of an issue of governmental obligations are used to finance an 
industrial park is determined consistently with the rules for exempt 
facilities in Sec. 1.103-8(a)(1)(i).
    (2) The provisions of subparagraph (1) of this paragraph shall also 
apply to an issue of obligations substantially all of the proceeds of 
which is to be used to acquire or develop land as the site for an 
industrial park described in section 103(c)(5) and this section and for 
either or both of the following purposes: (i) To finance exempt 
facilities described in section 103(c)(4) and Sec. 1.103-8, (ii) to 
finance facilities to be used by an exempt person.
    (3) Section 103(c)(5) only becomes applicable where the bond issue 
meets both the trade or business and the security interest tests so that 
the obligations are industrial development bonds within the meaning of 
section 103(c)(2). For the interrelationship of the rules provided in 
this section and the exemption for certain small issues provided in 
section 103(c)(6), see Sec. 1.103-10.
    (b) Definition of an industrial park. For purposes of section 
103(c)(5) and this section, the term ``industrial park'' means a tract 
of land, other than a tract of land intended for use by a single 
enterprise, suitable primarily for use as building sites by a group of 
enterprises engaged in industrial, distribution, or wholesale businesses 
if either--
    (1) The control and administration of the tract is vested in an 
exempt person (within the meaning of paragraph (b)(2) of Sec. 1.103-7), 
or
    (2) The uses of the tract are normally (i) regulated by protective 
minimum restrictions, ordinarily including the size of individual sites, 
parking and loading regulations, and building setback lines, and (ii) 
designed to be compatible, under a comprehensive plan, with the 
community in which the industrial park is located and with the uses of 
the surrounding land.
    (c) Development of land defined. For purposes of section 103(c)(5) 
and this section, the term ``development of land'' includes the 
provision of certain improvements to an industrial park site if such 
improvements are incidental to the use of the land as an industrial 
park. Such incidental improvements include the building or installation 
of incidental water, sewer, sewage and waste disposal, drainage, or 
similar facilities (whether surface, subsurface, or both). Such 
incidental improvements include the provision of incidental 
transportation facilities, such as hard-surface roads (including curbs 
and gutters) and railroad spurs and sidings; power distribution 
facilities, such as gas and electric lines; and communication 
facilities. The provision of structures or buildings of any kind is not 
included within the meaning of the term ``development of land,'' except 
for those structures or buildings which are necessary in connection with 
the incidental improvements encompassed by the term, such as, for 
example, a water pumphouse and storage tank needed in connection with 
the incidental provision of water facilities in an industrial park.
    (d) Examples. The application of the rules contained in section 
103(c)(5) and this section are illustrated by the following examples:

    Example (1). City A and corporations X, Y, and Z (unrelated 
companies) enter into an arrangement under which A is to acquire a tract 
of land suitable for use as an industrial park. The arrangement provides 
that: (1) A will issue $10 million of bonds to be used for the 
acquisition and development of a suitable tract of land; (2) the tract 
will be controlled and administered by A, pursuant to a comprehensive 
zoning plan, for the use of a group of enterprises; (3) A will install 
necessary water, sewer, and drainage facilities on the tract; (4) A will 
sell substantial portions of the developed tract to X for use as a 
factory site and to Y for use as a warehouse site; (5) A will lease a 
sizeable portion of the tract to Z for 20 years as a distribution center 
site; and (6) the developed tract and the proceeds from the sale or 
lease of parts of the tract will be the security for the bonds. The 
bonds are industrial development bonds. Since, however, the proceeds of 
the issue are to be used for the acquisition and development of a tract 
of land as the site for an industrial park under section 103(c)(5), 
section 103(c)(1) does not apply unless the provisions of section 
103(c)(7) and Sec. 1.103-11 apply.
    Example (2). The facts are the same as in example (1) except that $1 
million of the proceeds of the $10 million issue are to be used

[[Page 396]]

for the construction of a factory by corporation W or X. The bonds are 
industrial development bonds. Under these circumstances, substantially 
all of the proceeds are treated as used or to be used for the 
acquisition and development of a tract of land as the site for an 
industrial park described in section 103(c)(5). Accordingly, section 
103(c)(1) does not apply unless the provisions of section 103(c)(7) and 
Sec. 1.103-11 apply.

[T.D. 7199, 37 FR 15494, Aug. 3, 1972, as amended by T.D. 7511, 42 FR 
54285, Oct. 5, 1977]



Sec. 1.103-10  Exemption for certain small issues of industrial 
development bonds.

    (a) In general. Section 103(b)(6) applies to certain industrial 
development bond issues (referred to in this section as ``exempt small 
issues'') and bonds issued to refund certain issues (referred to in this 
section as ``exempt small refunding issues''). If an issue is an exempt 
small issue or an exempt small refunding issue, then under the 
requirements of section 103(b)(6) and this section the interest paid on 
the debt obligations is not includable in gross income, and the 
obligations are treated as obligations described in section 103(a)(1) 
and Sec. 1.103-1, even though such obligations are industrial 
development bonds as defined in section 103(b)(2) and Sec. 1.103-7. 
However, interest on an obligation of such an issue is includable in 
gross income if the obligation is held by a substantial user of the 
financed facilities or a related person (as described in section 
103(b)(7) and Sec. 1.103-11). Section 103(b)(6) only becomes applicable 
where the bond issue meets both the trade or business and the security 
interest tests so that the obligations are industrial development bonds 
within the meaning of section 103(b)(2). For bonds issued before January 
1, 1979, in taxable years ending before such date, and for capital 
expenditures made before January 1, 1979, with respect to such bonds, 
paragraphs (b), (c), and (d) of this section shall be applied by 
substituting $5 million for $10 million.
    (b) Small issue exemption--(1) $1 million or less. Section 
103(b)(6)(A) provides that section 103(b)(1) shall not apply to any debt 
obligation issued by a State or local governmental unit as part of an 
issue where--
    (i) The aggregate authorized face amount of such issue (determined 
by aggregating the outstanding face amount of any prior exempt small 
issues described in paragraph (d) of this section and the face amount of 
the issue of obligations in question) is $1 million or less; and
    (ii) Substantially all of the proceeds of such issue is to be used 
for the acquisition, construction, reconstruction, or improvement of 
land or property of a character subject to the allowance for 
depreciation under section 167. Proceeds which are loaned to a borrower 
for use as working capital or to finance inventory are not used in the 
manner described in the preceding sentence. Whether substantially all of 
the proceeds of an issue of governmental obligations are used in such 
manner is determined consistently with the rules for exempt facilities 
in Sec. 1.103-8(a)(1)(i). Any obligation which is an industrial 
development bond within the meaning of section 103(b)(2) and which 
satisfies the $1 million small issue exemption requirements is an exempt 
small issue. See paragraph (c)(1) of this section for the treatment of 
refunding issues of $1 million or less.
    (2) $10 million or less. (i) Under section 103(b)(6)(D), the issuing 
State or local governmental unit may elect to have an aggregate 
authorized face amount of $10 million or less, in lieu of the $1 million 
exemption otherwise provided for in section 103(b)(6)(A), with respect 
to issues of obligations that are industrial development bonds (within 
the meaning of section 103(b)(2)) issued after October 24, 1968. If the 
election is made in a timely manner, the bonds will be treated as 
obligations of a State or local governmental unit described in section 
103(a)(1) and Sec. 1.103-1 if the sum of--
    (a) The aggregate face amount of the issue including the aggregate 
outstanding face amount of any prior $1 million or $10 million exempt 
small issues taken into account under section 103(b)(6)(B) and paragraph 
(d) of this section, and
    (b) The aggregate amount of ``section 103(b)(6)(D) capital 
expenditures'' (within the meaning of paragraph (b)(2)(ii) of this 
section),

is $10 million or less. In the case of an issue of obligations that 
qualified for exemption under section 103(b)(6)(A)

[[Page 397]]

and this paragraph, if a section 103(b)(6)(D) capital expenditure made 
after the date of issue has the effect of making taxable the interest on 
the issue, under section 103(b)(6)(G) the loss of tax exemption for the 
interest shall begin only with the date on which the expenditure that 
caused the issue to cease to qualify under the $10 million limit was 
paid or incurred. See paragraph (b)(2)(vi) of this section for the time 
and manner in which the issuer may elect the $10 million exemption. See 
section 103(b)(6)(H) and paragraph (c)(2) of this section for the 
treatment of certain refinancing issues of $10 million of less.
    (ii) The term ``section 103(b)(6)(D) capital expenditure'' is 
defined in this subdivision. Special rules for applying such definition 
in the case of certain expenditures paid or incurred by a State or local 
governmental unit are prescribed in subdivision (iii) of this 
subparagraph. Except as excluded by subdivision (iv) or (v) of this 
subparagraph, an expenditure (regardless of how paid, whether in cash, 
notes, or stock in a taxable or nontaxable transaction) is a section 
103(b)(6)(D) capital expenditure if--
    (a) The capital expenditure was financed other than out of the 
proceeds of issues to the extent such issues are taken into account 
under paragraph (b)(2)(i)(a) of this section.
    (b) The capital expenditures were paid or incurred during the 6-year 
period which begins 3 years before the date of issuance of the issue in 
question and ends 3 years after such date,
    (c) The principal user of the facility in connection with which the 
property resulting from the capital expenditures is used and the 
principal user of the facility financed by the proceeds of the issue in 
question is the same person or are two or more related persons (as 
defined in section 103(b)(6)(C) and paragraph (e) of this section),
    (d) Both facilities referred to in (c) of this subdivision were 
(during the period described in (b) of this subdivision or a part 
thereof) located in the same incorporated municipality or in the same 
county outside of the incorporated municipalities in such county), and
    (e) The capital expenditures were properly chargeable to the capital 
account of any person or State or local governmental unit (whether or 
not such person is the principal user of the facility or a related 
person) determined, for this purpose, without regard to any rule of the 
Code which permits expenditures properly chargeable to capital account 
to be treated as current expenses. With respect to obligations issued on 
or after August 8, 1972, determinations under the preceding sentence 
shall be made by including any expenditure which may, under any rule or 
election under the Code, be treated as a capital expenditure (whether or 
not such expenditure is so treated). With respect to obligations issued 
on or after August 8, 1972, for purposes of this subparagraph, capital 
expenditures made with respect to a contiguous or integrated facility 
which is located on both sides of a border between two or more political 
jurisdictions are made with respect to a facility located in all such 
jurisdictions and, therefore, shall be treated as if they were made in 
each such political jurisdiction.
    (iii) Amounts properly chargeable to capital account under 
subdivision (ii) (e) of this subparagraph include capital expenditures 
made by a State or local governmental unit with respect to an exempt 
facility or an industrial park, within the 6-year period described in 
subdivision (ii)(b) of this subparagraph, out of the proceeds of bond 
issues to which section 103(b)(1) did not apply by reason of section 
103(b) (4) or (5) (relating to certain exempt activities and industrial 
parks). Thus, for example, the cost to the lessor of a leased plantsite 
financed out of the proceeds of an issue for an exempt air pollution 
control facility under section 103(b)(4)(F) and paragraph (g) of Sec. 
1.103-8 would constitute a section 103(b)(6)(D) capital expenditure. 
However, in the case of an industrial park, only the land costs 
allocated on an area basis to the plantsite and the actual cost of any 
improvements made on the plantsite, or to be used principally in 
connection with the actual plantsite occupied by a principal user or a 
related person, shall be taken into account as capital expenditures. 
Where the actual amount

[[Page 398]]

of capital expenditures made with respect to a facility by a person 
(including a State or local governmental unit) other than the user of 
such facility (or a related person) cannot be ascertained, the fair 
market value of the property with respect to which the capital 
expenditures were made, at the time of such capital expenditures, shall 
be deemed to be the amount of such capital expenditures. In the case of 
a transaction which is not in form a purchase but which is treated as a 
purchase for Federal income tax purposes, the purchase price for Federal 
income tax purposes shall constitute a capital expenditure.
    (iv) A section 103(b)(6)(D) capital expenditure shall not include 
any ``excluded expenditure'' described in (a) through (e) of this 
subdivision (iv).
    (a) A capital expenditure is an excluded expenditure if either it is 
made by a public utility company which is not the principal user of the 
facility financed by the proceeds of the issue in question (or a related 
person) with respect to property of such company, or it is made by a 
State or local governmental unit with respect to property of such unit, 
and if in either case it meets all of the following three conditions: 
Such property of such company or unit (as the case may be) must be used 
to provide gas, water, sewage disposal services, electric energy, or 
telephone service. Such property must be installed in, or connected to, 
the facility but must not consist of property which is such an integral 
part of the facility that the cost of such property is ordinarily 
included as part of the acquisition, construction, or reconstruction 
cost of such facility. Such property must be of a type normally paid for 
by the user (or a related person) in the form of periodic fees based 
upon time or use.
    (b) A capital expenditure is an excluded expenditure if it is made 
by a person other than the user, a related person, or a State or local 
governmental unit and if it is made with respect to tangible personal 
property (within the meaning of paragraph (c) of Sec. 1.48-1), or 
intangible personal property, leased to the user (or a related person) 
of a facility. However, the preceding sentence shall apply only if such 
personal property is leased by the manufacturer of such tangible or 
intangible personal property, or by a person in the trade or business of 
leasing property the same as, or similar to, such personal property, and 
only if, pursuant to general business practice, property of such type is 
ordinarily the subject of a lease.
    (c) A capital expenditure is an excluded expenditure if it is made 
to replace property damaged or destroyed by fire, storm, or other 
casualty, to the extent that these expenditures do not exceed in dollar 
amount the fair market value (determined immediately before the 
casualty) of the property replaced.
    (d) A capital expenditure is an excluded expenditure if it is 
required by a change made after the date of issue in a Federal or State 
law, or a local ordinance which has general application, or if it is 
required by a change made after such date in rules and regulations of 
general application issued under such law or ordinance.
    (e) A capital expenditure is an excluded expenditure if it is 
required by or arises out of circumstances which could not reasonably be 
foreseen on the date of issue or which arise out of a mistake of law or 
fact. However, the aggregate dollar amount taken into account under this 
subdivision (e) with respect to any issue may not exceed $1 million. 
With respect to expenditures incurred prior to December 11, 1971, the 
dollar amount specified in the preceding sentence shall be $250,000.
    (v)(a) If the assets of a corporation are acquired by another 
corporation in a transaction to which section 381(a) (relating to 
carryovers in certain corporate acquisitions) applies, the exchange of 
consideration by the acquiring corporation for such assets is not a 
section 103(b)(6)(D) capital expenditure by such acquiring corporation.
    (b) However, if an exchange referred to in (a) of this subdivision 
occurs during the 6-year period beginning 3 years before the date of 
issuance of an issue of obligations and ending 3 years after such date, 
the transferor and transferee shall be treated as having been related 
persons for the portion of such 6-year period preceding the date of the 
exchange for purposes of determining

[[Page 399]]

whether section 103(b)(6)(D) capital expenditures have been made. For 
purposes of this subdivision (b), the date of an exchange to which 
section 381 applies shall be the date of distribution or transfer within 
the meaning of paragraph (b) of Sec. 1.381(b)-1.
    (c) If section 351(a) applies to a transfer of property to a 
corporation solely in exchange for its stock or securities, the issuance 
of such stock or securities in such exchange is not a section 
103(b)(6)(D) capital expenditure by such corporation.
    (d) However, if such a transfer referred to in (c) of this 
subdivision occurs during the 6-year period beginning 3 years before the 
date of issuance of an issue of obligations and ending 3 years after 
such date, and if, with respect to the property transferred, 
expenditures made within such period would have been section 
103(b)(6)(D) capital expenditures if the transferor and transferee had 
been related persons for such period, then such expenditures shall be 
considered to be section 103(b)(6)(D) capital expenditures made by the 
transferee. In addition, if a transferor and transferee are related 
persons immediately following such transfer, such transferor and 
transferee shall also be treated as having been related persons for the 
portion of such 6-year period preceding the date of such transfer.
    (e) For purposes of this subdivision (v), the term ``issue of 
obligations'' means an issue being tested for purposes of qualifying or 
continuing to qualify under an election pursuant to section 103(b)(6)(D) 
as to which an amount which would be a section 103(b)(6)(D) capital 
expenditure solely by reason of (b) or (d) of this subdivision must be 
taken into account.
    (f) If with respect to an issue of obligations an expenditure would 
not have been a section 103(b)(6)(D) capital expenditure but for the 
application of (b) or (d) of this subdivision, and if such section 
103(b)(6)(D) capital expenditure has the effect of making taxable the 
interest on an issue of obligations which qualified for exemption under 
section 103(b)(6)(A) and this paragraph, the loss of tax exemption for 
such interest shall begin not earlier than the date of such exchange or 
transfer referred to in this subdivision (v).
    (vi) The issuer may make the election provided by section 
103(b)(6)(D) and this paragraph (b)(2) (assuming that the bonds 
otherwise qualify under section 103(b)(6) by noting the election 
affirmatively at or before the time of issuance of the issue in question 
on its books or records with respect to the issue. The term ``books or 
records'' includes the bond resolution or other similar legislation for 
the issue in question as well as the bond transcript or other 
compilation of bond and bond-related documents. If the issuer fails to 
make an election at the time and in the manner prescribed in this 
paragraph (b)(2), the issue will not be treated as described in section 
103(b)(6)(D), and interest thereon will be includible in gross income.
    (c) Refunding or refinancing issue exemption--(1) $1 million or less 
refunding issue. Section 103(b)(6)(A) also provides that section 
103(b)(1) shall not apply to any debt obligation issued by a State or 
local governmental unit as part of an issue the aggregate authorized 
face amount of which is $1 million or less, if substantially all of the 
proceeds of such issue are to be used--
    (i) To redeem part of all of a prior issue substantially all of the 
proceeds of which were used to acquire, construct, reconstruct, or 
improve land or property of a character subject to the allowance for 
depreciation, or
    (ii) To redeem part or all of a prior exempt small refunding issue.
    (2) 10 million or less refinancing issue. Section 103(b)(6)(H) 
provides that section 103(b)(1) shall not apply to any debt obligation 
issued by a governmental unit as part of an issue which is $10 million 
or less if the condition of section 103(b)(6)(H) is met and if 
substantially all of the proceeds are to be used--
    (i) To redeem part or all of one or more prior exempt small issues, 
or
    (ii) To redeem part or all of one or more prior exempt small 
refunding issues.

The condition of section 103(b)(6)(H) is that an election by the issuer 
of the $10 million exemption in lieu of the $1 million limit for a 
refunding issue may be

[[Page 400]]

made only if each prior issue being redeemed is an issue which qualified 
either for the $1 million exemption or, by reason of an election under 
section 103(b)(6)(D), for the $10 million exemption. In addition, in 
applying the capital expenditures test under section 103(b)(6)(D)(ii) 
and paragraph (b)(2)(i)(b) of this section to refinancing issues, 
section 103(b)(6)(D) capital expenditures are taken into account only 
for purposes of determining whether prior issues which were made under 
the section 103(b)(6)(D) election qualified under section 103(b)(6)(A) 
and would have continued to qualify under that section but for the 
redemption.
    (d) Certain prior issues taken into account--(1) In general. Section 
103(b)(6)(B) provides, in effect, that if (i) a prior issue specified in 
subparagraph (2) of this paragraph is an exempt small issue (including 
for this purpose an exempt small refunding issue) under section 
103(b)(6)(A) and this section, and (ii) such prior issue is outstanding 
at the time of issuance of a subsequent issue, then in determining the 
aggregate face amount of such subsequent issue (for purposes of 
determining whether such issue is a $1 million or $10 million exempt 
small issue under section 103(b)(6)(A) and this section) there shall be 
taken into account the outstanding face amount of such prior exempt 
small issue. For purposes of this paragraph, the outstanding face amount 
of a prior exempt small issue does not include the face amount of any 
obligation which is to be redeemed from the proceeds of such subsequent 
issue.
    (2) Prior issues specified. The face amount of an outstanding prior 
exempt small issue is taken into account under subparagraph (1) of this 
paragraph if--
    (i) The proceeds of both the prior exempt small issue and of the 
subsequent issue (whether or not the State or local governmental unit 
issuing such obligation is the same unit for each such issue) are or 
will be used primarily with respect to facilities located or to be 
located in the same incorporated municipality or located or to be 
located in the same county outside of an incorporated municipality in 
such county (and, for purposes of this subdivision, on or after August 
8, 1972, a contiguous or integrated facility which is located on both 
sides of a border between two or more political jurisdictions shall be 
treated as if it is entirely within each such political jurisdiction), 
and
    (ii) The principal user of the financed facilities referred to in 
subdivision (i) of this subparagraph is or will be the same person or 
two or more related persons (as defined in section 103(b)(6)(C) and 
paragraph (e) of this section).
    (3) Rules of application. The rules of this paragraph shall apply--
    (i) Only in the case of outstanding prior exempt small issues which 
are industrial development bonds to which section 103(b)(1) would have 
applied but for the provisions of section 103(b)(6). Thus, for example, 
the provisions of this paragraph do not apply in respect of a prior 
issue of obligations issued on or before April 30, 1968. In addition, 
the provisions of this paragraph do not apply in respect of a prior 
issue for an exempt facility under section 103(b)(4) and Sec. 1.103-8, 
or for an industrial park under section 103(b)(5) and Sec. 1.103-9, 
whether or not the issue might also have qualified as an exempt small 
issue under section 103(b)(6)(A) and this section.
    (ii) To all prior exempt small issues which meet the requirements of 
this paragraph. Thus, for example, in determining the aggregate face 
amount of an issue under section 103(b)(6)(A), the outstanding face 
amount of prior $1 million or $10 million exempt small issues which meet 
the requirements of this paragraph shall be taken into account in 
determining the aggregate face amount of a subsequent issue being tested 
for the $1 million small issue exemption. Similarly, in determining the 
aggregate face amount of an issue under section 103(b)(6)(A) and (D), 
the outstanding face amount of prior $1 million or $10 million exempt 
small issues which meet the requirements of this paragraph shall be 
taken into account in determining the aggregate face amount of a 
subsequent issue being tested for the $10 million small issue exemption.
    (e) Related persons. For purposes of section 103(b) and Sec. Sec. 
1.103-7 through 1.103-11, the term ``related person''

[[Page 401]]

means a person who is related to another person if, on the date of issue 
of an issue of obligations--
    (1) The relationship between such persons would result in a 
disallowance of losses under section 267 (relating to disallowance of 
losses, etc., between related taxpayers) and section 707(b) (relating to 
losses disallowed, etc., between partners and controlled partnerships) 
and the regulations thereunder, or
    (2) Such persons are members of the same controlled group of 
corporations, as defined in section 1563(a), relating to definition of 
controlled group of corporations (except that ``more than 50 percent'' 
shall be substituted for ``at least 80 percent'' each place it appears 
in section 1563(a)) and the regulations thereunder.
    (f) Disqualification of certain small issues. (1) Section 103(b)(6) 
shall not apply to any obligation issued after April 24, 1979, which is 
part of an issue, a significant portion of the proceeds of which are to 
be used directly or indirectly to provide residential real property for 
family units. For purposes of the preceding sentence, the term 
``residential real property for family units'' means residential rental 
projects (within the meaning of Sec. 1.103-8(b)) and owner-occupied 
residences (within the meaning of section 103A).
    (2) For purposes of paragraph (f)(1), a significant portion of the 
proceeds of an issue are used to provide residential real property for 
family units if 5 percent or more of the proceeds are so used.
    (g) Examples. The application of the rules contained in section 
103(b)(6) and this section are illustrated by the following examples:

    Example (1). County A and corporation X enter into an arrangement 
under which the county will provide a factory which X will lease for 25 
years. The arrangement provides (1) that A will issue $1 million of 
bonds on March 1, 1970, (2) that the proceeds of the bond issue will be 
used to acquire land in County A (but not in an incorporated 
municipality) and to construct and equip a factory on such land in 
accordance with X's specifications, (3) that X will rent the facility 
for 25 years at an annual rental equal to the amount necessary to 
amortize the principal and pay the interest on the outstanding bonds, 
and (4) that such payments by X and the facility itself shall be the 
security for the bonds. Although the bonds issued are industrial 
development bonds, the bonds are an exempt small issue under section 
103(b)(6)(A) and this section since the aggregate authorized face amount 
of the bond issue is $1 million or less and all of the proceeds of the 
bond issue are to be used to acquire and improve land and acquire and 
construct depreciable property. The result would be the same if the 
arrangement provided that X would purchase the facility from A.
    Example (2). The facts are the same as in example (1) except that, 
instead of acquiring land and constructing a new factory, the 
arrangement provides that A will acquire a vacant existing factory 
building and rebuild and equip the building in accordance with X's 
specifications. The bonds are an exempt small issue for the same reasons 
as in example (1).
    Example (3). The facts are the same as in example (1) or (2) except 
that the financed facilities are additions to facilities which were 
financed by an issue of bonds to which section 103(b)(1) does not apply 
because such bonds were issued prior to May 1, 1968, or were subject to 
the transitional provisions of Sec. 1.103-12. The bonds are an exempt 
small issue since neither of the prior bond issues are taken into 
account under section 103(b)(6)(B) and this section in determining the 
status of industrial development bonds which are issued after April 30, 
1968, and which are not subject to the transitional provisions of Sec. 
1.103-12.
    Example (4). The facts are the same as in example (1) except that, 
subsequently, corporation X proposes to County A that A build a $400,000 
warehouse located in Town M (an unincorporated town located in County A) 
for X under terms similar to the factory arrangement described in 
example (1). On the proposed issue date of the subsequent bond issue, 
$600,000 of the first exempt small issue will be outstanding. If A 
issues $400,000 of bonds for such purposes, the bonds will be an exempt 
small issue under section 103(b)(6) and this section since, under the 
rules of section 103(b)(6)(B) and paragraph (d) of this section, if the 
aggregate authorized face amount of the new issue and the outstanding 
prior exempt small issue will be $1 million or less, the new issue will 
be an exempt small issue. If, however, the aggregate authorized face 
amount of the prior issue outstanding on the date of the subsequent 
issue were in excess of $600,000, the subsequent issue would not qualify 
as an exempt small issue because (1) the combined aggregate face amount 
of the outstanding prior issue and the new issue would be in excess of 
$1 million, (2) the facilities financed by both issues are to be located 
in unincorporated areas in the same county, (3) the same taxpayer will 
be the principal user of both facilities, and (4) but

[[Page 402]]

for the rules of section 103(b)(6)(B) and paragraph (d) of this section 
the prior issue would be an exempt small issue.
    Example (5). The facts are the same as in example (1) except that 
subsequently corporation X proposes to City P and City R (incorporated 
municipalities located in County A) that P and R each issue bonds and 
each build $1 million facilities to be located in Cities P and R for the 
use of X under terms similar to the arrangement in example (1). Each of 
the $1 million issues will be an exempt small issue because each 
proposed facility is located within a different incorporated 
municipality and the proceeds of the prior outstanding exempt small 
issue were used to construct facilities outside of an incorporated area.
    Example (6). The facts are the same as in example (1) except that 
$95,000 of the $1 million will be used by the corporation as working 
capital. The bonds are an exempt small issue for the same reason as in 
example (1) since substantially all of the proceeds will be used for the 
acquisition of land and the construction of depreciable property.
    Example (7). The facts are the same as in example (1) except that on 
November 1, 1969, County A issued $10 million of industrial development 
bonds, all of the proceeds of which were issued for the acquisition of 
land as the site for an industrial park within the meaning of section 
103(b)(5) and Sec. 1.103-9. The proceeds of the $1 million of bonds 
issued in 1970 will be used to construct a factory for corporation X to 
be located in the industrial park. The bonds issued in 1970 are 
industrial development bonds within the meaning of section 103(b)(2) and 
Sec. 1.103-7. Since, however, the prior 1969 issue is not an issue to 
which section 103(b)(6)(A) applied (see paragraph (d)(3)(i) of this 
section), the bonds issued in 1970 are an exempt small issue for the 
reasons stated in example (1).
    Example (8). County B enters into three separate arrangements with 
three unrelated corporations whereby the county will provide separate 
storage facilities for each corporation. The arrangement provides (1) 
that the county will issue bonds and loan to each corporation $250,000 
of the proceeds which will be used to acquire land in the county and to 
construct the facilities, (2) that the rental payments by the 
corporations will be equal to the amount necessary to amortize the 
principal and pay the interest on any outstanding bonds issued by the 
county, and (3) that the payments by the corporations and the facilities 
themselves shall be the security for the industrial development bonds. 
For convenience, the county issues one series of bonds in the face 
amount of $750,000 rather than three separate series of bonds of 
$250,000 each. The issue is an exempt small issue under section 
103(b)(6)(A) and paragraph (b)(1) of this section since the aggregate 
authorized face amount of the bond issue is $1 million or less, and all 
of the proceeds of the bond issue are to be used to acquire and improve 
land and acquire and construct depreciable property.
    Example (9). City C and corporation Y enter into an arrangement 
under which C will provide a factory which Y will lease for 25 years. 
The arrangement provides (1) that C will issue $4 million of bonds on 
March 1, 1969, after making the election under section 103(b)(6)(D) and 
paragraph (b)(2) of this section, (2) that the proceeds of the bond 
issue will be used to acquire land in the city and to construct and 
equip a factory on such land in accordance with Y's specifications, (3) 
that Y will rent the facilities for 25 years at an annual rental equal 
to the amount necessary to amortize the principal and pay the interest 
on the outstanding bonds, (4) that such payments by Y and the facility 
itself shall be the security for the bonds, and (5) that, if corporation 
Y pays or incurs capital expenditures in excess of $1 million within 3 
years from the date of issue which disqualify the bonds as an exempt 
small issue under section 103(b)(6)(D), it will either furnish funds to 
C to redeem such bonds at par or at a premium, or increase the rental 
payments to C in an amount sufficient to pay a premium interest rate. 
Although the bonds issued are industrial development bonds, they are an 
exempt small issue under section 103(b)(6)(A) by reason of the election 
under section 103(b)(6)(D) and paragraph (b)(2) of this section, since 
the aggregate authorized face amount of the bond issue is $5 million or 
less and all of the proceeds of the bond issue are to be used to acquire 
and improve land and acquire and construct depreciable property. The 
provisions for redemption of the bonds or an increase in rental if the 
bonds are disqualified as an exempt small issue under section 
103(b)(6)(A) will not disqualify an otherwise valid election under 
section 103(b)(6)(D) and paragraph (b)(2) of this section.
    Example (10). The facts are the same as in example (9) except that 
corporation Y subsequently proposed to the city that it build a $1 
million warehouse next to the plant for the use of Y under terms similar 
to the factory arrangement. Assume further that the factory building was 
completed by March 1, 1970, and that on January 15, 1972, the proposed 
issue date of the subsequent bond issue, $2 million of the first exempt 
small issue will be outstanding. In determining the aggregate authorized 
face amount of the new issue, the original face amount of a prior 
outstanding issue must be reduced by that portion which is to be 
redeemed before it is added to the face amount of the new issue. 
Therefore, if the city issues $3 million of bonds to redeem the 
remaining $2 million of bonds and to construct the warehouse the bonds 
will be an exempt small issue under section 103(b)(6)(A) if an election 
is made

[[Page 403]]

under section 103(b)(6)(D) and paragraph (b)(2) of this section since 
(1) the face amount of the new issue ($3 million), plus (2) the face 
amount of the prior outstanding exempt small issue minus the amount of 
such issue to be refunded ($2 million minus $2 million), plus (3) 
capital expenditures during the preceding 3 years financed other than 
out of the proceeds of outstanding issues to which section 103(b)(6)(A) 
and paragraph (b) of this section applied ($2 million), do not exceed $5 
million. If, however, the amount of the January 15, 1972, issue were 
$3\1/2\ million, the issue would not qualify as an exempt small issue 
under section 103(b)(6)(A) and paragraph (b)(2) of this section.
    Example (11). The facts are the same as in example (9), except that 
on June 15, 1971, Y purchases from an unrelated motor carrier business a 
warehouse terminal in the same city at a cost of $250,000 and tractor-
trailers and other automotive equipment based at the terminal at a cost 
of $1 million. This subsequent expenditure by Y has the effect of making 
the interest on the city C bonds includable in the gross income of the 
holders of such bonds as of June 15, 1971, because the face amount of 
the March 1, 1969, issue ($4 million) plus the subsequent capital 
expenditures within 3 years of the date of issue ($1,250,000) exceed $5 
million. (See section 103(b)(6)(D) and paragraph (b)(2)(i) of this 
section.)
    Example (12). The facts are the same as in example (9), except that 
in March, 1970, Y will move $3 million of additional used machinery and 
equipment into the factory from its factory in another city. The 
expenditures for such machinery and equipment were incurred by Y more 
than 3 years prior to the date of issue of the bonds. The transfer of 
such used equipment into city C does not constitute a section 
103(b)(6)(D) capital expenditure within the meaning of paragraph 
(b)(2)(ii) of this section since the expenditures with respect to such 
property were incurred more than 3 years prior to the date of issue of 
the bonds. Had the capital expenditures with respect to such property 
been incurred during the 6-year period beginning 3 years before the date 
of issue of the bonds and in the 3 years after such date, they would 
constitute section 103(b)(6)(D) capital expenditures.
    Example (13). The facts are the same as in example (9), except that 
in March 1970, corporation Y enters into an arrangement with respect to 
machinery and equipment to be used in the facility. The arrangement is 
labeled by the parties as a lease but is treated as a sale for Federal 
income tax purposes. The amount treated as the purchase price of the 
machinery and equipment is a section 103(b)(6)(D) capital expenditure.
    Example (14). On February 1, 1970, city D issues $5 million of its 
bonds to finance construction of an addition to the manufacturing plant 
of corporation Z. The bonds will be secured by the facility and lease 
payments to be made by Z which will be sufficient to pay the principal 
and interest on such bonds. Assume that the bonds qualify as an exempt 
small issue under section 103(b)(6)(A) pursuant to an election under 
section 103(b)(6)(D) and paragraph (b)(2) of this section. On February 
1, 1971, D plans to issue $1 million of its bonds to construct a 
pollution control facility to be leased to Z for use at its 
manufacturing plant. The rental payments from the lease will be 
sufficient to pay the principal and interest on the bonds. The bonds 
will be secured by such facility and the lease payments. Capital 
expenditures for the pollution control facility will be paid or incurred 
beginning before February 1, 1973. Although the pollution control 
facility is an exempt facility under section 103(b)(4)(F) and paragraph 
(g) of Sec. 1.103-8, amounts used for the pollution control facility 
shall be considered to be a section 103(b)(6)(D) capital expenditure and 
the interest on the February 1, 1970, issue will become taxable as of 
the date such capital expenditure began to be paid or incurred. See 
section 103(b)(6)(G) and paragraph (b)(2)(i) of this section.
    Example (15). On February 1, 1970, City E issues $500,000 of its 
bonds to acquire and develop an industrial park within the meaning of 
section 103(b)(5) and paragraph (b) of Sec. 1.103-9. The park consists 
of 100 acres and is divided into one 50 acre plantsite and 4 smaller 
sites. The aggregate acquisition cost of the undeveloped land is 
$150,000 or an average per acre cost of $1,500. Roads, sidewalks, 
sewers, utilities, sewage, and waste disposal facilities serving the 
entire industrial park cost $300,000. On September 1, 1970, E leases to 
corporation Y for 30 years the 50 acre plantsite (with an allocated cost 
of $75,000) and a railroad spur track from the railroad right of way to 
Y's plantsite for Y's exclusive use. The spur track was constructed 
using $50,000 of the proceeds of the industrial park bond issue. E also 
proposes to issue on September 1, 1970, $4,875,000 of its bonds to 
construct and equip a building on the leased plantsite to be leased to Y 
at an additional rental sufficient to pay the principal and interest on 
this issue of bonds. The September 1, 1970, issue will be an exempt 
small issue under section 103(b)(6)(A) pursuant to an election under 
section 103(b)(6)(D) and paragraph (b)(2) of this section since the sum 
of the amount of the second issue ($4,875,000) and the capital 
expenditures allocated to the plantsite ($75,000 for 50 acres of land 
plus $50,000 for the railroad spur tract, totaling $125,000) does not 
exceed $5 million. The sum of $300,000 which was spent in development of 
the industrial park provided facilities which will serve or benefit the 
users generally and

[[Page 404]]

hence under paragraph (b)(2)(iii) of this section is not considered to 
have provided facilities as to which Y will be the principal user.
    Example (16). On June 1, 1970, corporation Z simultaneously enters 
into separate arrangements with City F and City G under which each city 
will issue a $5 million exempt small issue of bonds the proceeds of 
which will be used by Z to construct separate facilities in each city. 
By June 1, 1971, the facilities have been completed in the respective 
cities. On January 1, 1972, Cities F and G, through a valid legal 
proceeding, merge into a new City FG. Since in this case F and G were 
separate cities on June 1, 1970 (the date of the bond issues), the 
factories are not considered to be located in the same incorporated 
municipality. Accordingly, each $5 million issue by City F and G will 
continue to qualify as an exempt small issue.
    Example (17). On June 1, 1973, City H issues an exempt small issue 
of $4.75 million to finance a facility of corporation S to be located in 
City H. On October 1, 1974, S and corporation T, previously unrelated to 
S, consummated a statutory merger which qualifies as a reorganization 
described in section 368(a)(1)(A) and thus as a transaction described in 
section 381(a). In the transaction, T transferred to S assets with a 
fair market value of $1.5 million in exchange for stock of S, $300,000 
of securities of S, and $100,000 cash. On March 23, 1971, T made 
$400,000 of capital expenditures for an addition to its factory located 
in City H. For purposes of testing the H issue of June 1, 1973, such 
expenditures would have been section 103(b)(6)(D) capital expenditures 
if T and S had been related persons. Under the provisions of paragraph 
(b)(2)(v)(a) of this section, the exchange of $1.5 million of stock, 
securities, and cash by S does not constitute a section 103(b)(6)(D) 
capital expenditure. Since, however, S and T are treated as related 
persons starting 3 years prior to the date of issue of the obligations, 
the $400,000 of expenditures by T constitute section 103(b)(6)(D) 
capital expenditures. Thus, the interest on the June 1, 1973, issue of 
obligations would become taxable (since the $5 million limit would be 
exceeded) on the date of the merger.
    Example (18). In 1965 City I issues $10 million of industrial 
development bonds to construct and equip a factory for corporation Z. In 
1975 the remaining principal amount of the bonds outstanding is $4.1 
million. If I issues $4.5 million of bonds to redeem the balance of the 
prior issue, and for other purposes, such issue cannot qualify as an 
exempt small issue under section 103(b)(6)(D) and paragraph (b)(2) of 
this section even though at the time of issue the interest on the 1965 
bonds was tax-exempt since the prior issue must be one which qualified 
under section 103(b)(6)(A) and this section. Further, the 1975 issue 
will be an issue of industrial development bonds notwithstanding the 
provisions of paragraph (d)(2) of Sec. 1.103-7 which provides that 
certain bonds issued to refund an issue of obligations issued on or 
before April 30, 1968 (or January 1, 1969, in certain cases) will not be 
so treated. Paragraph (d)(2) of Sec. 1.103-7 is not applicable because 
the 1975 issue makes funds available for a purpose other than the debt 
service obligation on the 1965 bonds.
    Example (19). In 1969 City J issues $4 million of industrial 
development bonds which qualify as an exempt small issue under section 
103(b)(6)(A) pursuant to an election under section 103(b)(6)(D) and 
paragraph (b)(2) of this section. In 1971, by reason of a $2 million 
addition to the factory built with the proceeds of the issue, the 1969 
exempt small issue loses its tax-exempt status. In 1972, the city issues 
a $5 million issue to redeem the prior 1969 issue. The redemption issue 
will not qualify as an exempt small issue since the prior 1969 issue did 
not continue to qualify under section 103(b)(6)(A) and this section.

[T.D. 7199, 37 FR 15494, Aug. 3, 1972; 37 FR 16177, Aug. 11, 1972; 37 FR 
17826, Sept. 1, 1972, as amended by T.D. 7511, 42 FR 54285, Oct. 5, 
1977; T.D. 7840, 47 FR 46084, Oct. 15, 1982; 51 FR 16299, May 2, 1986]



Sec. 1.103-11  Bonds held by substantial users.

    (a) In general. Section 103(c) (4), (5), or (6) (relating 
respectively to interest on bonds to finance certain exempt facilities, 
interest on bonds to finance industrial parks, and the exemption for 
certain small issues of industrial development bonds) does not apply, as 
provided in section 103(c)(7), with respect to any obligation for any 
period during which such obligation is held either by a person who is a 
substantial user of the facilities with respect to which the proceeds of 
such obligation were used or by a related person (within the meaning of 
section 103(c)(6)(C) and paragraph (e) of Sec. 1.103-10). Therefore, in 
such a case, interest paid on such an obligation is includable in the 
gross income of a substantial user (or related person) for any period 
during which such obligation is held by such user (or related person).
    (b) Substantial user. In general, a substantial user of a facility 
includes any nonexempt person who regularly uses a part of such facility 
in his trade or business. However, unless a facility, or

[[Page 405]]

a part thereof, is constructed, reconstructed, or acquired specifically 
for a nonexempt person or persons, such a nonexempt person shall be 
considered to be a substantial user of a facility only if (1) the gross 
revenue derived by such user with respect to such facility is more than 
5 percent of the total revenue derived by all users of such facility or 
(2) the amount of area of the facility occupied by such user is more 
than 5 percent of the entire usable area of the facility. Under certain 
facts and circumstances, where a nonexempt person has a contractual or 
preemptive right to the exclusive use of property or a portion of 
property, such person may be a substantial user of such property. A 
substantial user may also be a lessee or sublessee of all or any portion 
of the facility. A licensee or similar person may also be a substantial 
user where his use is regular and is not merely a casual, infrequent, or 
sporadic use of the facility. Absent special circumstances, individuals 
who are physically present on or in the facility as employees of a 
substantial user shall not be deemed to be substantial users.
    (c) Examples. The application of section 103(c)(7) and this section 
are illustrated by the following examples:

    Example (1). Pursuant to an arrangement with corporation X, County A 
issues $4 million of its bonds (an exempt small issue under section 
103(c)(6)(A) pursuant to an election under section 103(c)(6)(D) and 
paragraph (b)(2) of Sec. 1.103-10) and will use the proceeds to finance 
construction of a manufacturing facility which is to be leased to X for 
an annual rental of $500,000. X subleases space to a restaurant operator 
at an annual rental of $25,000 for the operation of a canteen and lunch 
counter for the convenience of X's employees. The canteen is required to 
be open at least 5 days each week (except holidays) from 8:30 a.m. to 5 
p.m., and the lunch counter must be in operation during the noon hour. 
The canteen regularly sells cigarettes, candy, and soft drinks, and uses 
advertising displays and dispensers with product names. The space 
physically occupied and the amount of revenue derived by the restaurant 
operator are more than 5 percent of the respective amounts with respect 
to the entire facility. Both X and the restaurant operator are 
substantial users. However, absent special circumstances none of X's 
employees, the employees of the restaurant operator, or the customers or 
salesmen who regularly visit the premises to do business either with X 
or the restaurant operator are substantial users. Similarly, the 
manufacturers, distributors, and dealers of products sold in the canteen 
ordinarily are not substantial users.
    Example (2). The facts are the same as in example (1) except that X 
rents food and beverage vending machines from a local dealer. The 
machines are regularly serviced by the local dealer under a contract 
with X. Title to and ownership of the machines are retained by the 
dealer. The local dealer is not deemed to be a substantial user if the 
revenue derived by such dealer from, and the space occupied by, such 
machines do not exceed 5 percent of the respective amounts with respect 
to the entire facility.
    Example (3). City B proposes to issue $2 million of bonds which 
qualify as an exempt small issue under section 103(c)(6)(A) pursuant to 
an election under section 103(c)(6)(D) and paragraph (b)(2) of Sec. 
1.103-10 in order to construct a medical building for certain physicians 
and dentists. The facility will contain 30 offices to be leased on equal 
terms and for the same rental rates to each physician or dentist for use 
in his trade or business. Each physician or dentist will be a 
substantial user of the facility since the facility is being constructed 
specifically for such physicians and dentists. The result would be the 
same in the case of an office building for general commercial use.
    Example (4). City C proposes to expand the airport it owns and 
operates with the proceeds of its bonds which qualify as bonds issued 
for an exempt facility under section 103(c)(4)(D) and paragraph (e) of 
Sec. 1.103-8 and which are secured by a pledge of airport revenues. The 
airport is serviced by several commercial airlines which have long-term 
agreements with C for the use of runways, terminal space, and hangar and 
storage facilities. Each of the airlines either occupies more than 5 
percent of the usable space of, or derives more than 5 percent of the 
revenue derived with respect to, the airport. C also leases counter and 
vehicle servicing and parking areas to car rental companies, space for 
restaurants, kiosks for the sale of newspapers and magazines, and space 
for the operations of a charter plane company. The latter operates its 
own planes, offers flying lessons and services, and stores private 
planes for local businesses and individuals. An airport limousine 
company has an exclusive franchise for passenger pickup at the terminal. 
Other taxi, transfer, freight, and express companies regularly deliver 
passengers and freight to the terminal but do not have space regularly 
assigned to them, nor do they have operating agreements with C. Various 
business concerns have advertising product displays in the terminal 
building. In addition to regular telephone service, coin-operated 
telephones, provided by the telephone company, are located throughout 
the terminal, at locations specified by C.

[[Page 406]]

None of the above exceed the 5-percent limitations of paragraph (b) of 
this section and the bond proceeds will not be specifically used for any 
of them. Only the commercial airlines, which violate the 5-percent 
limitations, are substantial users of the airport.
    Example (5). City D issues $25 million of its revenue bonds and will 
use $10 million of the proceeds to finance construction of a sports 
facility which qualifies as an exempt facility under section 
103(c)(4)(B) and paragraph (c) of Sec. 1.103-8, $8 million to acquire 
and develop land as the site for an industrial park within the meaning 
of section 103(c)(5) and Sec. 1.103-9, and $7 million to finance the 
construction of an office building to be used exclusively by the city, 
an exempt person. The revenues from the sports facility and the 
industrial park and all the facilities themselves will be the security 
for the bonds. The sports facility and the industrial park sites will be 
used in the trades of businesses of nonexempt persons. The bonds are 
industrial development bonds, but under the provisions of paragraph 
(a)(1) of Sec. 1.103-8 and paragraph (a) of Sec. 1.103-9, the interest 
on the $25 million issue will not be includable in gross income. 
However, the interest on bonds held shall be includable in the gross 
income of a substantial user of either the sports facility or the 
industrial park if such substantial user holds any of the obligations of 
the $25 million issue. The 5-percent limitations of paragraph (b) of 
this section are applied separately with respect to each facility.
    Example (6). Authority E issues $4 million of bonds which qualify as 
an exempt small issue under section 103(c)(6)(A) pursuant to an election 
under section 103(c)(6)(D) and paragraph (b)(2) of Sec. 1.103-10 in 
order to construct a bank building on the grounds of an airport. In 
addition, E issues $40 million to expand the airport. The bank will not 
derive revenue in excess of 5 percent of the revenue derived with 
respect to the airport nor will it occupy more than 5 percent of the 
usable area of such airport. The bank will be a substantial user of the 
bank building constructed with the proceeds of the $4 million issue 
since the facility was constructed specifically for the bank. However, 
the bank will not be a substantial user with respect to the airport 
because it does not exceed the 5-percent limitations of paragraph (b) of 
this section. Had E issued one issue of $44 million in order to expand 
the airport and construct a bank building, the bank would be a 
substantial user of the entire facility since the $44 million issue was 
being used to construct a facility a portion of which was specifically 
for the bank.

[T.D. 7199, 37 FR 15499, Aug. 3, 1972; 37 FR 16177, Aug. 11, 1972]



Sec. 1.103-16  Obligations of certain volunteer fire departments.

    (a) General rule. An obligation of a volunteer fire department 
issued after December 31, 1980, shall be treated as an obligation of a 
political subdivision of a State for purposes of section 103(a)(1) if--
    (1) The volunteer fire department is a qualified volunteer fire 
department within the meaning of paragraph (b) of this section, and
    (2) Substantially all of the proceeds of the issue of which the 
obligation is a part are to be used for the acquisition, construction, 
reconstruction, or improvement of a fire house or fire truck used or to 
be used by the qualified volunteer fire department.

An obligation of a volunteer fire department shall not be treated as an 
obligation of a political subdivision of a State for purposes of section 
103(a)(1) unless both conditions set forth in this paragraph (a) are 
satisfied. Thus, for example, if an obligation is issued by an ambulance 
and rescue squad that is a qualified volunteer fire department as 
required by paragraph (a)(1) of this section, but substantially all of 
the proceeds of the issue of which the obligation is a part are to be 
used for the furnishing of emergency medical services, rather than for 
the purposes specified in paragraph (a)(2) of this section, the 
obligation shall not be treated as an obligation of a political 
subdivision of a State for purposes of section 103(a)(1).

    (b) Definition of qualified volunteer fire department. For purposes 
of this section, the term ``qualified volunteer fire department'' means 
an organization--
    (1) That is organized and operated to provide firefighting services 
or emergency medical services in an area within the jurisdiction of a 
political subdivision, and
    (2) That is required to furnish firefighting services by written 
agreement with the political subdivision, and
    (3) That serves persons in an area within the jurisdiction of the 
political subdivision that is not provided with any other firefighting 
services.

The requirement of paragraph (b)(2) of this section that a qualified 
volunteer fire department be required to furnish firefighting services 
by written agreement with the political subdivision may be satisfied by 
an ordinance or statute of the political subdivision that

[[Page 407]]

establishes, regulates, or funds the volunteer fire department. A 
volunteer fire department does not fail to satisfy the requirement of 
pargraph (b)(3) of this section by furnishing or receiving firefighting 
services on an emergency basis, or by cooperative agreement with other 
fire departments, to or from areas outside of the area that the 
volunteer fire department is organized and operated to serve. The fact 
that tax revenues of a political subdivision served by a volunteer fire 
department contribute toward the support of the volunteer fire 
department in the form of salary, purchase of equipment, or other 
defrayment of expenses will not prevent the volunteer fire department 
from being a ``qualified volunteer fire department'' within the meaning 
of this paragraph (b). Moreover, an obligation of a volunteer fire 
department receiving such support may qualify as an obligation of a 
political subdivision within the meaning of section 103(a)(1) 
independently of section 103(i) and this section if the requirements of 
section 103(a)(1) are satisfied. See Sec. 1.103-1(b) for rules relating 
to qualification under section 103(a)(1).
    (c) ``Substantially all'' test. Substantially all of the proceeds of 
an issue are used for the purposes specified in paragraph (a)(2) of this 
section if 90 percent or more of the proceeds are so used. Thus, for 
example, if more than 10 percent of the proceeds of an obligation issued 
by a qualified volunteer fire department are used for the purchase of an 
ambulance or for rescue equipment not to be used in providing fire 
fighting services, interest on the obligation is not exempt from tax 
under section 103(i) and this section. In computing this percentage--
    (1) Costs are allocated between providing a firehouse or firetruck 
and other uses of the proceeds on a pro rata basis; and
    (2) The rules set forth in Sec. 1.103-8(a)(1)(i), relating to 
amounts allocable to exempt and nonexempt uses and amounts chargeable to 
capital account, apply.
    (d) Refunding issues. An obligation which is part of an issue issued 
by a qualified volunteer fire department after December 31, 1980, part 
or all of the proceeds of which issue are used directly or indirectly to 
pay principal, interest, call premium, or reasonable incidental costs of 
refunding a prior issue qualifies as an obligation of a political 
subdivision under section 103(i) and this section only if--
    (1) The prior issue was issued by a qualified volunteer fire 
department;
    (2) Substantially all of the proceeds of the prior issue were used 
for the purposes described in paragraph (a)(2) of this section;
    (3) The prior issue was issued after December 31, 1980; and
    (4) The refunding issue is issued not more than 180 days before the 
date on which the last obligation of the prior issue is discharged 
(within the meaning of Sec. 1.103-13)(b)(11)).
    (e) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example (1). The County M Volunteer Fire and Rescue Association 
provides firefighting, ambulance, and emergency medical services in 
County M. The board of county commissioners of County M contracts with 
the County M Volunteer Fire and Rescue Association for these services, 
and County M is not served by any other firefighting association. On 
August 1, 1981, the Association issues an obligation for funds to 
purchase a new fire truck, a new ambulance, and rescue equipment not to 
be used for fighting fires. Funds to be used for the purchase of the 
ambulance and rescue equipment constitute more than 10 percent of the 
proceeds of the obligation. Thus, substantially all of the proceeds of 
the obligations are not used for one of the purposes described in 
paragraph (a)(2) of this section. Although the County M Volunteer Fire 
and Rescue Association is a qualified volunteer fire department under 
paragraph (b) of this section because it provides firefighting and 
emergency medical services in an area within County M which is not 
provided with any other firefighting services and is required to provide 
these services by written agreement with County M, the August 1, 1981, 
obligation of County M Volunteer Fire and Rescue Association will not be 
treated as an obligation of a political subdivision of a State under 
section 103(i) and paragraph (a) of this section because substantially 
all of the proceeds of the obligation are not to be used for a purpose 
described in section 103(i)(l)(B) and paragraph (a)(2) of this section. 
Accordingly, interest on the August 1, 1981, obligation of County M 
Volunteer Fire and Rescue Association is not exempt from gross income 
under section 103(a)(1).

[[Page 408]]

    Example (2). County N Volunteer Fire Department provides 
firefighting services in County N by contract with the county, which is 
not served by any other firefighting association. On June 15, 1982, 
County N Volunteer Fire Department issues its obligation for funds to 
construct an addition to its firehouse to house a rescue squad, the 
rescue squad's vehicle, and rescue equipment not to be used in 
firefighting. Although the County N Volunteer Fire Department is a 
qualified volunteer fire department under paragraph (b) of this section, 
interest on its June 15, 1982, obligation will not be exempt from tax 
under section 103(i) and this section because the proceeds of this 
obligation will not be used for the purposes described in paragraph (a) 
of this section.
    Example (3). The County O Volunteer Fire and Rescue Association 
provides firefighting, ambulance, and emergency medical services in 
County O. The board of county commissioners of County O contracts with 
the County O Volunteer Fire and Rescue Association for these services, 
and County O is not served by any other firefighting association. On 
September 1, 1983, the Association issues its obligations for funds to 
construct a new building to house its firefighting, ambulance, and 
rescue functions. Although the ambulance and rescue equipment will 
occupy space in the projected facility, the cost allocable on a pro rata 
basis to providing housing for the ambulance and rescue equipment 
represents less than 10 percent of the proceeds of the obligations. 
Thus, substantially all of the proceeds of the obligations are used for 
one of the purposes described in paragraph (a)(2) of this section. The 
County O Volunteer Fire and Rescue Association is a qualified volunteer 
fire department under paragraph (b) of this section because it provides 
firefighting and emergency medical services in an area within County O 
which is not provided with any other firefighting services and is 
required to provide these services by written agreement with County O. 
The obligations of County O Volunteer Fire and Rescue Association will 
be treated as obligations of a political subdivision of a State under 
section 103(i) and paragraph (a) of this section because the obligations 
are those of a qualified volunteer fire department and because 
substantially all of the proceeds of the obligations are to be used for 
a purpose described in section 103(i)(1)(B) and paragraph (a)(2) of this 
section. Accordingly, interest on the September 1, 1983, issue of 
obligations of County O Volunteer Fire and Rescue Association is exempt 
from gross income under section 103(a)(1).

[T.D. 7901, 48 FR 32981, July 20, 1983]



Sec. 1.103(n)-1T  Limitation on aggregrate amount of private activity 
bonds (temporary).

    Q-1: What does section 103(n) provide?
    A-1: Interest on an issue of private activity bonds will not be tax 
exempt unless the aggregrate amount of bonds issued pursuant to that 
issue, when added to (i) the aggregate amount of private activity bonds 
previously issued by the issuing authority during the calendar year and 
(ii) the portion of that year's private activity bond limit that the 
issuing authority has elected to carry forward to a future year, does 
not exceed the issuing authority's private activity bond limit for that 
calendar year. See A-4 of Sec. 1.103(n)-4T with respect to private 
activity bonds issued under a carryforward election.
    Q-2: What is the effective date of section 103(n)?
    A-2: In general, section 103(n) applies to private activity bonds 
issued after December 31, 1983. Section 103(n) does not apply to any 
issue of obligations, however, if there was an inducement resolution (or 
other comparable preliminary approval) for the project before June 19, 
1984, and the issue for such project is issued before January 1, 1985. 
An issue of obligations will be considered to be issued for the project 
pursuant to the inducement resolution in existence before June 19, 1984, 
to the extent that the nature, character, and purpose of the facility 
has not changed in any material way, and to the extent that the capacity 
of the facility has not increased materially; in addition, the issue of 
obligations must be for the same or a related initial owner, manager, or 
operator. See Sec. 1.103-10(e) for the definition of related persons. 
See A-16 of Sec. 1.103(n)-3T with respect to certain projects 
preliminarily approved before October 19, 1983. The transitional rules 
provided by section 631(c) of the Tax Reform Act of 1984 do not apply to 
section 103(n). See Sec. 1.103-13(b)(6) for the rules relating to the 
date of issue of obligations.
    Q-3: If an issue of private activity bonds causes the issuer's 
private activity bond limit to be exceeded, what is the effect on that 
issue?

[[Page 409]]

    A-3: If an issue of private activity bonds causes the issuing 
authority's private activity bond limit to be exceeded, no portion of 
that issue will be treated as obligations described in section 103(a), 
and interest paid on the issue will be subject to Federal income 
taxation.
    Q-4: If an issue of private activity bonds causes the issuer's 
private activity bond limit to be exceeded, what is the effect on 
previous issues of private activity bonds that met the requirements of 
section 103(n) when issued?
    A-4: Private activity bonds issued as part of an issue that met the 
private activity bond limit when issued continue to meet the 
requirements of section 103(n) even though a subsequent issue causes the 
aggregate amount of private activity bonds issued by an issuing 
authority to exceed the authority's private activity bond limit for the 
calendar year.
    Example. The following example illustrates the provisions of A-3 and 
A-4 of this Sec. 1.103(n)-1T:

    Example. The State ceiling for State Z for 1986 is $200 million. 
City M, within the State, and State Z itself are authorized to issue 
private activity bonds. Under the allocation formula provided by the 
Governor of State Z, City M has a private activity bond limit of $50 
million; the balance of the State ceiling is allocated to State Z. On 
June 1, 1986, City M issues a $75 activity bonds. On September 1, 1986, 
State Z issues a $150 million issue of private activity bonds. Based on 
these facts, the obligations of City M do not meet the requirements of 
section 103(n) since the aggregate amount of private activity bonds 
issued by City M in 1986 exceeded its private activity bond limit for 
such year; thus, such obligations are not described in section 103(a). 
That the State Z issue caused the aggregate amount of private activity 
bonds issued in the State during 1986 to exceed the State ceiling does 
not cause such obligations to fail to meet the requirements of section 
103(n).

    Q-5: What is the aggregate amount of private activity bonds issued 
as part of an issue?
    A-5: The aggregate amount of private activity bonds issued as part 
of an issue is the face amount of the issue.

(Secs. 103(n) and 7805 of the Internal Revenue Code of 1954 (98 Stat. 
916, 26 U.S.C. 103(n); 68A Stat. 917, 26 U.S.C. 7805))

[T.D. 7981, 49 FR 39316, Oct. 5, 1984]



Sec. 1.103(n)-2T  Private activity bond defined (temporary).

    Q-1: What is the definition of the term ``private activity bond''?
    A-1: In general, for purposes of Sec. Sec. 1.103(n)-1T through 
1.103(n)-6T, the term ``private activity bond'' means any industrial 
development bond or student loan bond the interest on which is exempt 
from tax under section 103(a) (without application of section 103(n)). 
See Sec. 1.103-7(b) for the definition of the term ``industrial 
development bond.'' See A-17 of this Sec. 1.103(n)-2T for the 
definition of the term ``student loan bond.'' There are five exceptions 
to the general definition of the term ``private activity bond''; the 
exceptions include the exception for the Texas Veterans' Bond Program, 
the residential rental property exception, the exception for certain 
facilities described in section 103(b)(4) (C) or (D), and the refunding 
obligation exception. These exceptions are described in A-2 through A-16 
of this Sec. 1.103(n)-2T. In addition, the term ``private activity 
bond'' does not include any issue of obligations if there was an 
inducement resolution (or other comparable preliminary approval) for the 
project before June 19, 1984, and the issue for that project is issued 
before January 1, 1985. See A-2 of Sec. 1.103(n)-1T.
    Q-2: To which obligations does the exception for the Texas Veterans' 
Bond Program apply?
    A-2: The term ``private activity bond'' does not include general 
obligation bonds issued under the Texas Veterans' Bond Program if the 
proceeds of the issue, other than an amount that is not a major portion 
of the proceeds, are used to make loans of up to $20,000 for the 
purchase of land for purposes authorized by such program as in effect on 
June 19, 1984. The use of the proceeds may be established by the 
affidavit of the veteran receiving the loan. For purposes of this 
exception to the definition of the term ``private activity bond,'' the 
use of more than 25 percent of the proceeds of an issue of obligations 
will constitute the use of a major portion of such proceeds.
    Q-3: To which obligations does the residential rental property 
exception apply?

[[Page 410]]

    A-3: The term ``private activity bond'' does not include any 
obligation issued to provide projects for residential rental property 
(including property functionally related and subordinate to any such 
facility), as described in section 103(b)(4)(A) and Sec. 1.103-8(b). In 
addition, the term ``private activity bond'' does not include any 
housing program obligation under section 11(b) of the United States 
Housing Act of 1937.
    Q-4: To which obligations does the exception for certain facilities 
described in section 103(b)(4) (C) or (D) apply?
    A-4: Section 103(n)(7)(C) provides that the term ``private activity 
bond'' does not include any obligation issued as part of an issue to 
provide convention or trade show facilities, as described in section 
103(b)(4)(C) and Sec. 1.103-8(d) (including property functionally 
related and subordinate to any such facilities), if the property so 
described is owned by, or on behalf of, a governmental unit. In 
addition, the term ``private activity bond'' does not include any 
obligation issued as part of an issue to provide airports, docks, 
wharfs, mass commuting facilities, or storage or training facilities 
directly related to any of the foregoing facilities, as described in 
section 103(b)(4)(D) and Sec. 1.103-8(e) (including property 
functionally related and subordinate to any such facilities), if the 
property so described is owned by, or on behalf of, a governmental unit. 
See Sec. 1.103-8(a)(3), in general, for the definition of the term 
``functionally related and subordinate.'' For purposes of this exception 
to the definition of the term ``private activity bond,'' the term ``mass 
commuting facilities'' includes ``qualified mass commuting vehicles,'' 
as defined in section 103(b)(9), that are associated with a mass 
commuting facility described in Sec. 1.103-8(e)(2)(iv). Obligations 
issued as part of an issue to provide parking facilities, as described 
in section 103(b)(4)(D), are not excepted from the definition of the 
term ``private activity bond;'' however, parking facilities may be 
functionally related and subordinate to another facility described in 
section 103(b)(4) (C) or (D).
    Q-5: When is property described in section 103(b)(4) (C) or (D) 
owned by, or on behalf of, a governmental unit?
    A-5: In general, property described in section 103(b)(4) (C) or (D) 
will be considered to be owned by a governmental unit if a governmental 
unit is the owner of the property for Federal income tax purposes 
generally. See A-5 of Sec. 1.103(n)-3T for the definition of the term 
``governmental unit''. In general, property described in section 
103(b)(4) (C) or (D) will be considered to be owned on behalf of a 
governmental unit if a constituted authority empowered to issue 
obligations on behalf of a governmental unit is the owner of the 
property for Federal income tax purposes generally. Whether the property 
is owned by, or on behalf of, a governmental unit will be determined on 
the basis of the facts and circumstances of each particular case. The 
fact that the governmental unit's or constituted authority's obligation 
to pay principal and interest on an obligation is limited to revenues 
from fees collected from users of the property provided with the 
proceeds of such obligation will not, in itself, cause such property to 
be treated as not owned by, or on behalf of, the governmental unit. In 
order to qualify for the exception described in section 103(n)(7)(C), 
the property must be owned by, or on behalf of, the governmental unit 
throughout the term of the issue. See A-10 of this Sec. 1.103(n)-2T 
with respect to the consequences of a transfer of ownership.
    Q-6: Will property described in section 103(b)(4) (C) or (D) that is 
leased to a non-governmental entity be treated as owned by, or on behalf 
of, a governmental unit if the lessee is the owner of the property for 
Federal income tax purposes generally solely by reason of the length of 
the lease?
    A-6: If property, or any portion thereof, is leased to a non-
governmental entity and if, for Federal income tax purposes generally, 
the lessee is the owner of the property solely by reason of the length 
of the lease, then, for purposes of Sec. Sec. 1.103(n)-1T through 
1.103(n)-6T (but not for other Federal income tax purposes, such as 
whether payments under the lease constitute deductible rental payments), 
the governmental unit will be treated as the owner of the property if 
the lessee elects not to claim depreciation or an investment credit with 
respect to such

[[Page 411]]

property. See A-7 of this Sec. 1.103(n)-2T for the rules describing the 
method of making this election. For purposes of Sec. Sec. 1.103(n)-1T 
through 1.103(n)-6T, the term ``non-governmental entity'' means a person 
other than a governmental unit or a constituted authority empowered to 
issue obligations on behalf of a governmental unit. The fact that a non-
governmental entity lessee elects not to claim depreciation or an 
investment credit with respect to property does not, however, ensure 
that the property will be treated as owned by, or on behalf of a 
governmental unit for purposes of Sec. Sec. 1.103(n)-1T through 
1.103(n)-6T. Thus, for example, if the lessee is the owner of the 
property for Federal income tax purposes generally other than solely 
because of the length of the lease, the obligations issued as part of 
the issue are private activity bonds notwithstanding that the lessee 
elected not to claim depreciation or an investment credit with respect 
to the property.
    Similarly, even if a governmental unit is the owner of property for 
Federal income tax purposes generally, the property will not be treated 
as owned by, or on behalf of, a governmental unit for purposes of 
Sec. Sec. 1.103(n)-1T through 1.103(n)-6T if the lease under which such 
property is leased to a non-governmental entity provides for significant 
front end loading of rental accruals or payments. See A-12 of this Sec. 
1.103(n)-2T with respect to significant front end loading of rental 
accruals or payments.
    Q-7: What must a lessee do in order to elect not to take 
depreciation or an investment credit with respect to property described 
in section 103(b)(4) (C) or (D)?
    A-7: The lessee must make the election at the time the lease is 
executed. The election must include a description of the property with 
respect to which the election is being made; the name, address, and TIN 
of the issuing authority; the name, address, and TIN of the lessee; and 
the date and face amount of the issue the proceeds of which are to be 
used to provide the property. The election must be signed by the lessee, 
if a natural person, or by a duly authorized official of the lessee. The 
issuing authority must be provided with a copy of the election. The 
issuing authority and the lessee must retain copies of the election in 
their respective records for the entire term of the lease. In addition, 
the lease, and any publicly recorded document recorded in lieu of such 
lease, must state that neither the lessee nor any successor in interest 
under the lease may claim depreciation or an investment credit with 
respect to such property. This election may be made with respect to 
property whether or not such property otherwise would be eligible for 
depreciation or an investment tax credit. See section 7701(a)(41) for 
the definition of the term ``TIN''.
    Q-8: Is the election not to claim depreciation or an investment 
credit revocable?
    A-8: No, the election is irrevocable. In addition, the election is 
binding on all successors in interest under the lease regardless of 
whether the obligations remain outstanding. If a successor in interest 
claims depreciation or an investment credit with respect to property for 
which such an election has been made, such property will be considered 
transferred to a non-governmental entity. See A-10 of this Sec. 
1.103(n)-2T with respect to the consequences of such a transfer.
    Q-9: Where obligations are issued to provide all or any portion of a 
facility described in section 103(b)(4) (C) or (D), must all of the 
property described in section 103(b)(4) (C) or (D) that is part of such 
facility be owned by, or on behalf of, a governmental unit in order for 
such obligations to qualify for the exception to the definition of the 
term ``private activity bond'' provided in section 103(n)(7)(C)?
    A-9: Generally, yes. If obligations are issued to provide all or any 
portion of a facility described in section 103(b)(4) (C) or (D), the 
obligations comprising such issue will not qualify for the exception to 
the definition of the term ``private activity bond'' provided in section 
103(n)(7)(C) unless all of the property described in section 103(b)(4) 
(C) or (D) that is part of (or functionally related and subordinate to) 
the facility being financed is owned by, or on behalf of, a governmental 
unit throughout the term of the issue. For

[[Page 412]]

this purpose, the facility being financed will be construed to include 
the entire airport, dock, etc., under consideration and not merely the 
part of the facility being provided with the proceeds of the issue. For 
example, the term facility, when used in reference to an airport, will 
be considered to include all property that is part of, or included in, 
that airport under Sec. 1.103-8(e)(2)(ii)(a), including all property 
functionally related and subordinate thereto under Sec. 1.103--8 (a)(3) 
and (e)(2)(ii)(b ). Thus, if the proceeds of an issue are used to 
provide a hangar at an airport described in section 103(b)(4)(D), that 
airport is considered as being financed with such issue, and if any 
portion of that airport, including property functionally related and 
subordinate thereto, is treated as owned by a non-governmental entity, 
that issue does not qualify for the exception of the definition of the 
term ``private activity bond'' provided in section 103(n)(7)(C).
    There are three exceptions to this rule, however. First, if any 
property otherwise would be considered part of the facility financed and 
such property was not provided with proceeds of any obligation described 
in section 103(a), such property will not be considered part of the 
facility being financed.
    Second, if any property otherwise would be considered part of the 
facility being financed and such property was part of such facility on 
or before October 5, 1984, such property will not be considered part of 
the facility being financed. For this purpose, property will be 
considered part of the facility on or before October 5, 1984, if any 
person was under a binding contract to acquire or construct such 
property to be a part of such facility on October 5, 1984.
    Third, property will not be considered part of the facility being 
financed if such property (i) is land, a building, a structural 
component of a building, or other structure (other than tangible 
personal property (other than an air conditioning or heating unit)) and 
such property is not physically supported by, does not physically 
support, and is not physically connected to any property provided with 
the proceeds of obligations that qualify for the exception to the 
definition of the term ``private activity bond'' provided in section 
103(n)(7)(C), or (ii) is tangible personal property (other than an air 
conditioning or heating unit). For this purpose, contiguous parcels of 
land will not be considered to support, to be supported by, or to be 
physically connected to each other, and insignificant physical 
connections (such as a connection by a sidewalk) will be disregarded. 
For purposes of this A-9, the term ``tangible personal property'' shall 
have the meaning given to it under section 48(a)(1)(A) and Sec. 1.48-
1(c). Examples. The following examples illustrate the provisions of A-9 
of this Sec. 1.103(n)-2T:

    Example (1). On January 1, 1986, Governmental Unit M issues 
industrial development bonds to provide an airport, as described in 
section 103(b)(4)(D), which will consist of land, runways, a terminal 
and a functionally related and subordinate hotel. The hotel will be 
leased to N, a non-governmental entity. The lease does not call for 
significant front end loading of rental accruals or payments. For 
Federal income tax purposes generally, M will own the entire airport 
except that N will be the owner of the hotel solely by reason of the 
length of the lease. N properly elects not to claim depreciation of an 
investment credit with respect to the hotel. The industrial development 
bonds are not private activity bonds.
    Example (2). The facts are the same as in Example (1) except that N 
does not make the election and claims depreciation with respect to the 
hotel. The entire issue of industrial development bonds is treated as an 
issue of private activity bonds.
    Example (3). The facts are the same as in Example (2) except that 
the hotel is provided other than with the proceeds of an obligation 
described in section 103(a). The issue for the remainder of the airport 
qualifies for the exception to the definition of the term ``private 
activity bond'' provided in section 103(n)(7)(C).
    Example (4). The facts are the same as in Example (2) except that 
the hotel, including the hotel parking lot, the hotel grounds, and the 
parcel of land on which they rest, are provided with a separate issue of 
industrial development bonds. There are no significant connections 
between the hotel and the airport. The issue for the hotel is an issue 
of private activity bonds. The issue for the remainder of the airport 
qualifies for the exception to the definition of the term ``private 
activity bonds'' provided in section 103(n)(7)(C).

[[Page 413]]

    Example (5). The facts are the same as Example (4) except that the 
hotel is constructed upon land provided with the proceeds of the issue 
used to provide the remainder of the airport. Both issues are treated as 
issues of private activity bonds.
    Example (6). On June 30, 1983, construction began on the City NN 
airport, which consists of land, runways, a terminal, and hangars. 
Corporation XX (a non-governmental entity) owns for Federal income tax 
purposes generally several of the hangars, which it financed with 
obligations described in section 103(a) issued on June 30, 1983. On 
March 1, 1985, at a time when XX still owns the hangars, City NN issues 
an issue of obligations described in section 103(b)(4)(D) to enlarge the 
terminal at the City NN airport. City NN will own the addition to the 
terminal for Federal income tax purposes generally. The obligations 
comprising the March 1, 1985, issue will not be private activity bonds.

    Q-10: What are the consequences if a governmental unit ceases to be 
treated as owning property described in section 103(b)(4) (C) or (D) 
where the property was provided by obligations that were not private 
activity bonds on the date of issue due to the exception provided in 
section 103(n)(7)(C)?
    A-10: The obligations outstanding on the date such ownership ceases 
are private activity bonds and are treated as if they are the last 
private activity bonds issued by the issuer in the calendar year in 
which the transfer of ownership occurs. Thus, if the aggregate amount of 
bonds issued pursuant to such issue, when added to the aggregate amount 
of the other private activity bonds actually issued or treated as issued 
under this A-10 by the issuer during such year and the amount of any 
carryforward elections made during the year, exceeds the issuer's 
private activity bond limit for such year, the obligations are not 
described in section 103(a) as of the date on which transfer of 
ownership occurs; if such obligations do not comply with the 
requirements of section 103(n), the obligations will be treated as not 
described in section 103(a) as of the date such ownership ceases. 
However, if on the date of issue the issuer intended to transfer 
ownership of such property to a non-governmental entity during the term 
of the issue, then the obligations are treated as the last private 
activity bonds actually issued or treated as issued under this A-10 by 
the issuer during the year in which such obligations were actually 
issued; if such obligations do not comply with the requirements of 
section 103(n), the obligations will be treated as not described in 
section 103(a) as of the date of issue. The exception to the definition 
of the term ``private activity bond'' for facilities described in 
section 103(b)(4) (C) and (D) only applies if the property is owned by, 
or on behalf of, a governmental unit while all or any part of the issue 
or any refunding issue remains outstanding.
    If all or a portion of the property is sold to a non-governmental 
entity for its fair market value and all of the proceeds from the sale 
(except for a de minimis amount less than $5,000) are used within six 
months to redeem outstanding obligations, the obligations will not be 
treated as private entity bonds.
    Q-11: What are the consequences if private activity bonds are issued 
to provide additions to a facility that was provided with obligations 
that were not private activity bonds when issued by virtue of the 
exception provided in section 103(n)(7)(C) and such additions are not 
treated as owned by a governmental unit?
    A-11: In order to qualify for the exception to the definition of the 
term ``private activity bond'' for obligations described in section 
103(b)(4) (C) or (D), all of the property described in section 103(b)(4) 
(C) or (D) that is part of the facility provided with the proceeds 
generally must be owned by, or on behalf of, a governmental unit. See A-
9 of this Sec. 1.103 (n)-2T. However, if the proceeds of an issue of 
private activity bonds are used to make additions to a facility (other 
than additions that are not considered to be part of the facility under 
A-9 of this Sec. 1.103(n)-2T) that was provided with another issue of 
industrial development bonds that were not private activity bonds when 
issued by virtue of the exception provided in section 103(n)(7)(C), then 
the prior issue will not cease to qualify for that exception. 
Nevertheless, for purposes of determining the aggregate amount of 
private activity bonds issued during the year that the issue to provide 
the addition to the previously financed facility is issued, the portion 
of the prior issue

[[Page 414]]

outstanding on the date of issue of the issue to provide the addition 
will be treated as part of the issue to provide the addition.
    Example. The following example illustrates the provisions of A-11 of 
this Sec. 1.103 (n)-2T:

    Example. On March 1, 1986, City P issues a $100 million issue of 
industrial development bonds to provide an airport, as described in 
section 103(b)(4)(D). City P uses substantially all of the proceeds to 
acquire land and to construct runways and a terminal on that land. No 
other property is constructed on the land. City P is the owner of the 
land and the terminal for Federal income tax purposes generally. Thus, 
the obligations comprising the March 1, 1986, issue are not private 
activity bonds when issued. On September 1, 1988, City P leases a 
portion of the land adjacent to the terminal to Corporation V (a non-
governmental entity) under a true lease for Federal income tax purposes. 
City P's private activity bond limit for 1988 is $100 million, and as of 
September 30, 1988, City P has not issued any private activity bond 
during 1988. On September 30, 1988, City P issues a $20 million issue of 
industrial development bonds, the proceeds of which are to be used to 
construct a hotel that is functionally related and subordinate to the 
airport. The hotel is to be constructed on the land that P leased to 
Corporation V. The hotel will be owned by Corporation V for Federal 
income tax purposes generally. On September 30, 1988, the outstanding 
face amount of the March 1, 1986, issue is $100 million. Although the 
obligations comprising the March 1, 1986, issue will not become private 
activity bonds as a result of the subsequent issue, on September 30, 
1988, City P is treated as issuing a $120 million issue of private 
activity bonds. Since that amount exceeds City P's private activity bond 
limit, the $20 million issue of private activity bonds issued on 
September 30, 1988, does not meet the requirements of section 103(n). In 
addition, any subsequent issuance of private activity bonds by City P 
during 1988 will fail to meet the requirements of section 103(n). The 
March 1, 1986, issue continues to be described in section 103(a).

    Q-12: Section 103(n)(7)(C)(iv) provides that the exception for 
certain facilities described in section 103(b)(4) (C) or (D) shall not 
apply in any case where the facility is leased under a lease that has 
significant front end loading of rental accruals or payments. What does 
``significant front end loading of rental accruals or payments'' mean?
    A-12: Where a lease requires rental payments that are significantly 
higher in the early years of the lease than in later years, the lease 
calls for significant front end loading of rental accruals or payments. 
A lease that provides for flat rental payments during the entire lease 
term does not violate the prohibition against significant front end 
loading of rent. In addition, a lease may provide for adjustments in 
rent for inflation or deflation, provided that such adjustments are to 
be made on the basis of a generally recognized price index. In addition, 
a lease may provide that rental payments are to be determined, in whole 
or part, based on a percentage of income, production, etc., provided 
that the percentage rate is kept constant (or increases) over the term 
of the lease and that the threshold, if any, above which the percentage 
applies is kept constant (or decreases) over the term of the lease. 
Thus, for example, a lease that requires rental payments throughout the 
term of the lease of $100,000 per year plus 5 percent of the gross 
income from the facility in excess of $500,000 does not violate the 
prohibition against significant front end loading of rent.
    Examples. The following examples illustrate the provisions of A-4 
through A-12 of this Sec. 1.103(n)-2T:

    Example (1). On February 1, 1985, County Z issues obligations with a 
term of 30 years. Substantially all of the proceeds of the obligations 
are to be used to provide a trade show facility as described in section 
103(b)(4)(C). Z leases the entire facility to Corporation S. For Federal 
income tax purposes generally, S is treated as the owner of the facility 
solely by reason of the length of the lease. The lease provides that the 
lessee will elect not to claim depreciation or an investment credit with 
respect to the facility and that S will provide Z with a copy of the 
election. S makes the election, retains it in its records, and provides 
County Z with a copy. The lease provides that neither the lessee nor any 
successor in interest will claim a deduction for depreciation or an 
investment credit with respect to such facility. The obligations are not 
private activity bonds on the date of issue, provided that the lease 
does not call for significant front end loading of rental accruals or 
payments.
    Example (2). The facts are the same as in Example (1) except that on 
February 1, 1986, S assigns the lease to Corporation T. For its taxable 
year ending March 31, 1986, Corporation T claims depreciation with 
respect to the trade show facility. The obligations outstanding on the 
date Corporation T claims

[[Page 415]]

depreciation on its Federal income tax return are treated as the last 
private activity bonds actually issued or treated as issued by County Z 
during 1986, and such obligations must comply with the requirements of 
section 103(n). In addition, Corporation T is not entitled to claim 
depreciation or an investment credit with respect to the trade show 
facility during the balance of the term of the lease and will be subject 
to the applicable penalties for so claiming depreciation.
    Example (3). The facts are the same as in Example (1) except that 
the obligations are redeemed on January 31, 1998; on January 31, 1999, S 
assigns the lease to Corporation X; and on its Federal income tax return 
for calendar year 1999, Corporation X claims depreciation with respect 
to the facility. The obligations are not private activity bonds provided 
that the lease does not call for significant front end loading of rental 
accruals or payments. However, X is not entitled to claim depreciation 
or an investment credit with respect to the trade show facility during 
the balance of the term of the lease and will be subject to the 
applicable penalties for so claiming those items.

    Q-13: To which obligations does the refunding obligation exception 
apply?
    A-13: The term ``private activity bond'' does not include any 
refunding obligation to the extent specified in this A-13. The term 
``refunding obligation'' means an obligation that is part of an issue of 
obligations the proceeds of which are used to pay any principal or 
interest on any other issue of obligations described in section 103(a) 
(referred to as the prior issue). The term ``refunding obligation'' does 
not include any obligations issued more than 180 days before the prior 
issue is discharged (``advance refundings''). The exception for 
refunding obligations only applies to the extent that the aggregate 
amount of the refunding issue does not exceed the outstanding face 
amount of the prior issue, or portion thereof, being refunded. Thus, for 
example, in the case of an obligation part of the proceeds of which are 
to be used to refund a prior issue of private activity bonds and part of 
the proceeds of which are to be used to provide a pollution control 
facility under section 103(b)(4)(F), those proceeds to be used to refund 
all or any part of the principal amount of the prior issue are not the 
proceeds of a private activity bond; the balance of the proceeds are the 
proceeds of a private activity bond. The refunding obligation exception 
does not apply to obligations to the extent that amounts are used to pay 
the costs of issuing refunding obligations. If an issue of obligations 
consists of both obligations that qualify for the refunding obligation 
exception and private activity bonds that do not meet the requirements 
of section 103(n), the entire issue is treated as consisting of 
obligations not described in section 103(a).
    Q-14: Does the refunding obligation exception apply to obligations 
issued to refund a prior issue of student loan bonds?
    A-14: In the case of any student loan bond, the refunding obligation 
exception applies only if, in addition to the requirements stated in A-
13 of this Sec. 1.103(n)-2T, the maturity date of the funding 
obligation is not later than the later of (i) the maturity date of the 
obligation to be refunded, or (ii) the date 17 years after the date on 
which the refunded obligation was issued (or, in the case of a series of 
refundings, the date on which the original obligation was issued).
    Q-15: What is the ``maturity date'' of an obligation?
    A-15: For purposes of section 103(n), the ``maturity date'' of an 
obligation is the date on which interest ceases to accrue and the 
obligation may either be paid or redeemed without penalty. The date is 
determined without regard to optional redemption dates (including those 
at the option of holders). If the issuer is required by the obligations 
or the indenture to redeem portions of obligations or to make payments 
of principal with respect to obligations in specified amounts and at 
specified times, such mandatory redemptions or payments shall be treated 
as separate obligations.
    Q-16: Where private activity bonds are refunded with other 
obligations described in section 103(a), does the refunding obligation 
exception apply to the extent that the aggregate amount of the refunding 
obligations exceeds the outstanding principal amount of the prior issue 
due to the use of a portion of the proceeds of the refunding issue to 
fund a reasonably required reserve or replacement fund?
    A-16: Whether the prior issue was issued prior to January 1, 1984, 
or

[[Page 416]]

thereafter, the refunding obligation exception to the definition of the 
term ``private activity bond'' only applies to the extent that the 
aggregate amount of the refunding obligation does not exceed the 
outstanding principal amount of the prior issue. Thus, the additional 
obligations issued to provide for a reasonably required reserve or 
replacement fund are private activity bonds.
    Q-17: What is a ``student loan bond''?
    A-17: The term ``student loan bond'' means an obligation that is 
issued as part of an issue all or a major portion of the proceeds of 
which are to be used directly or indirectly to finance loans to 
individuals for educational expenses. For purposes of this A-17, the use 
of more than 25 percent of the proceeds of an issue of obligations to 
finance loans to individuals for educational expenses will constitute 
the use of a major portion of such proceeds in such manner.

(Secs. 103(n) and 7805 of the Internal Revenue Code of 1954 (98 Stat. 
916, 26 U.S.C.103(n); 68A Stat. 917, 26 U.S.C. 7805))

[T.D. 7981, 49 FR 39316, Oct. 5, 1984]



Sec. 1.103(n)-3T  Private activity bond limit (temporary).

    Q-1: What is the ``State ceiling''?
    A-1: In general, the State ceiling applicable to each State and the 
District of Columbia for any calendar year prior to 1987 shall be the 
greater of $200 million or an amount equal to $150 multiplied by the 
State's (or the District of Columbia's) population. In the case of any 
territory or possession of the United States, the State ceiling for any 
calendar year prior to 1987 shall be an amount equal to $150 multiplied 
by the population of such territory or possession. In the case of 
calendar years after 1986, the two preceding sentences shall be applied 
by substituting ``$100'' for ``$150.'' In the case of any State that had 
an excess bond amount for 1983, the State ceiling for calendar year 1984 
shall be the sum of the State ceiling determined under the general rule 
plus 50 percent of the excess bond amount for 1983. The excess bond 
amount for 1983 is the excess (if any) of (i) the aggregate amount of 
private activity bonds issued by issuing authorities in such State 
during the first 9 months of calendar year 1983 multiplied by \4/3\, 
over (ii) the State ceiling determined under the general rule for 1984. 
For purposes of determining the State ceiling amount applicable to any 
any State for calendar year 1984, an issuer may rely upon the State 
ceiling amount published by the Treasury Department for such calender 
year. However, an issuer may compute a different excess bond amount for 
1983 where the issuer or the State in which the issuer is located has 
made a more accurate determination of the amount of private activity 
bonds issued by issuing authorities in the issuer's State during 1983. 
See A-7 of this Sec. 1.103(n)-3T for rules regarding a State containing 
constitutional home rule cities.
    Q-2: What is the private activity bond limit for a State agency?
    A-2: Under section 103(n)(2) the private activity bond limit for any 
agency of the State authorized to issue private activity bonds for any 
calendar year shall be 50 percent of the State ceiling for such year 
unless the State provides for a different allocation. For this purpose, 
the State is considered an agency. See, however, A-17 of this Sec. 
1.103(n)-3T with respect to the penalty for failure to comply with the 
requirements of section 631(a)(3) of the Tax Reform Act of 1984.
    Q-3: How is private activity bond limit determined where a State has 
more than one agency?
    A-3: If any State has more than one agency (including the State) 
authorized to issue private activity bonds, all such agencies shall be 
treated as a single agency for purposes of determining the aggregate 
private activity bond limit available for all such agencies. Each of the 
State agencies is treated as having jurisdiction over the entire State. 
Therefore, under A-8 of this Sec. 1.103(n)-3T the aggregate private 
activity bond limit for all the State agencies is allocated to the State 
since it possesses the broadest sovereign powers of any of the State 
agencies. Each other State agency's private activity bond limit is zero 
until it is assigned part of the private activity bond limit of another 
governmental unit pursuant to these regulations.
    Q-4: What is a State agency?
    A-4: A State agency is an agency authorized by a State to issue 
private activity bonds on behalf of the State. In

[[Page 417]]

addition, a special purpose governmental unit that derives its sovereign 
powers from the State and may exercise its sovereign powers throughout 
the State is a State agency. See A-5 of this Sec. 1.103(n)-3T for the 
definition of the term ``special purpose governmental unit.'' The term 
``State agency'' does not include issuing authorities empowered by a 
State at the request of another governmental unit within the State to 
issue private activity bonds to provide facilities within the 
jurisdiction of such other governmental unit. For example, if County O 
requests the legislature of State P to create an issuing authority 
empowered to issue obligations to provide pollution control facilities 
in County O, the authority is not a State agency.
    Examples. The following examples illustrate the provisions of A-3 
and A-4 of this Sec. 1.103(n)-3T:

    Example (1). For 1987 State Q has a State ceiling of $200 million. 
Neither the Governor nor the legislature of State Q has provided a 
formula for allocating the State ceiling different from that provided by 
section 103(n) (2) and (3). State Q has authorized the following State 
agencies to issue private activity bonds on its behalf: Authority M, 
Authority N, and Authority O. The aggregate private activity bond limit 
available for State agencies of State Q is $100 million. As of January 
1, 1987, none of this aggregate private activity bond limit has been 
assigned to any of Authorities M, N, or O. On January 1, 1987, Authority 
M issues $25 million of private activity bonds. During 1987, the duly 
authorized official designated by State Q to allocate the aggregate 
private activity bond limit among the three authorities does not 
allocate any of the State's private activity bond limit to Authority M. 
The January 1, 1987, issue does not meet the requirements of section 
103(n) since Authority M has no private activity bond limit for 1987.
    Example (2). Under the laws of State U, only the State legislature 
can create constituted authorities empowered to issue private activity 
bonds on behalf of governmental units within State U. Authority R was 
created by the State U legislature at the request of County X. Authority 
R is a constituted authority empowered to issue private activity bonds 
on behalf of County X to provide facilities located in County X. 
Authority S was created by the legislature to issue private activity 
bonds to provide pollution control facilities throughout the State. 
Authority S is a State agency as defined in A-4 of this Sec. 1.103(n)-
3T. Authority R it is not a State agency.

    Q-5: What is a governmental unit?
    A-5: The term ``governmental unit'' has the meaning given such term 
by Sec. 1.103-1. For purposes of Sec. Sec. 1.103(n)-1T through 
1.103(n)-6T, a governmental unit is either a general purpose 
governmental unit or a special purpose governmental unit. The term 
``general purpose governmental unit'' means a State, territory, 
possession of the United States, the District of Columbia, or any 
general purpose political subdivision thereof. The term ``general 
purpose political subdivision'' denotes any division of government that 
possesses the right to exercise police powers, the power to tax, and the 
power of eminent domain and that is governed, at least in part, by 
popularly elected officials (e.g., county, city, town, township, parish, 
village). The term ``special purpose governmental unit'' means any 
governmental unit as defined in Sec. 1.103-1 other than a general 
purpose governmental unit. For example, a sewer authority with the power 
of eminent domain but without police powers is a special purpose 
governmental unit. A constituted authority empowered to issue private 
activity bonds on behalf of a governmental unit is not a governmental 
unit.
    Q-6: What is the private activity bond limit for a general purpose 
governmental unit other than a State, the District of Columbia, a 
territory, or a possession?
    A-6: The private activity bond limit for any such general purpose 
governmental unit for any calendar year is an amount equal to the 
general purpose governmental unit's proportionate share of 50 percent of 
the State ceiling amount for such calendar year. See A-10 of this Sec. 
1.103(n)-3T with respect to the rules for providing a different 
allocation. The proportionate share of a general purpose governmental 
unit is an amount that bears the same ratio to 50 percent of the State 
ceiling for such year as the population of the jurisdiction of such 
general purpose governmental unit bears to the population of the entire 
State, District of Columbia, territory, or possession in which its 
jurisdiction falls. See, however, A-17 of this Sec. 1.103(n)-3T with 
respect to the penalty for failure to comply with the requirements of 
section 631(a)(3) of the

[[Page 418]]

Tax Reform Act of 1984. See A-9 of this Sec. 1.103(n)-3T with respect 
to the private activity bond limit of issuing authorities other than 
general purpose governmental units.
    Q-7: What is the private activity bond limit for a general purpose 
governmental unit in a State with one or more constitutional homes rule 
cities?
    A-7: The private activity bond limit for a constitutional home rule 
city for any calendar year is an amount equal to the constitutional home 
rule city's proportionate share of 100 percent of the State ceiling 
amount for the calendar year. The proportionate share of a 
constitutional home rule city is an amount that bears the same ratio to 
the State ceiling for such year as the population of the jurisdiction of 
such constitutional home rule city bears to the population of the entire 
State. The private activity bond limit for issuers other than 
constitutional home rule cities is computed in the manner described in 
A-2 through A-6 of this Sec. 1.103(n)-3T, except that in computing the 
private activity bond limit for issuers other than such constitutional 
home rule cities, the State ceiling amount for any calendar year shall 
be reduced by the aggregate private activity bond limit for all 
constitutional home rule cities in the State. The term ``constitutional 
home rule city'' means, with respect to any calendar year, any political 
subdivision of a State that, under a State constitution that was adopted 
in 1970 and effective on July 1, 1971, had home rule powers on the first 
day of the calendar year. See, however, A-17 of this Sec. 1.103(n)-3T 
with respect to the penalty for failure to comply with the requirements 
of section 631(a)(3) of the Tax Reform Act of 1984.
    Q-8: How is the private activity bond limit of an issuing authority 
determined under section 103(n)(3) when there are overlapping 
jurisdictions?
    A-8: If an area is within the jurisdiction of two or more 
governmental units, that area will be treated as only within the 
jurisdiction of the governmental unit having jurisdiction over the 
smallest geographical area. However, the governmental unit with 
jurisdiction over the smallest geographical area may enter into a 
written agreement to allocate all or a designated portion of such 
overlapping area to the governmental unit having jurisdiction over the 
next smallest geographical area. Where two or more issuing authorities, 
whether governmental units or constituted authorities, have authority to 
issue private activity bonds and both issuing authorities have 
jurisdiction over the identical geographical area, that area will be 
treated as only within the jurisdiction of the one having the broadest 
sovereign powers. However, the issuing authority having the broadest 
sovereign powers may enter into a written agreement to allocate all or a 
designated portion of such area to the one with the narrower sovereign 
powers. All written agreements entered into pursuant to this A-8 must be 
retained by the assignee in its records for the term of all private 
activity bonds it issues in each calendar year to which such agreement 
applies. See A-9 of this Sec. 1.103(n)-3T with respect to the private 
activity bond limit of issuing authorities other than general purpose 
governmental units.
    Q-9: What is the private activity bond limit of an issuing authority 
(other than a State agency) that is not a general purpose governmental 
unit?
    A-9: A constituted authority empowered to issue private activity 
bonds on behalf of a governmental unit is treated as having jurisdiction 
over the same geographical area as the governmental unit on behalf of 
which it is empowered to issue private activity bonds. Since a 
governmental unit has broader sovereign powers than a constituted 
authority empowered to issue private activity bonds on its behalf, a 
constituted authority has a private activity bond limit under section 
103(n) (2) and (3) of zero. Similarly, a special purpose governmental 
unit is treated for purposes of section 103(n) as having jurisdiction 
over the same geographical area as that of the general purpose 
governmental unit or units from which the special purpose governmental 
unit derives its sovereign powers. Since a general purpose governmental 
unit has broader sovereign powers than a special purpose governmental 
unit, a special purpose governmental unit has a private activity bond 
limit under section 103(n) (2) and (3) of zero. An issuer

[[Page 419]]

of qualified scholarship funding bonds, as defined in section 103(e), is 
treated for purposes of section 103(n) as issuing on behalf of the State 
or politicial subdivision or subdivisions that requested its 
organization or its exercise of power to issue bonds. See A-13 and A-14 
of this Sec. 103(n)-3T with respect to assignments of private activity 
bond limit. For purposes of Sec. Sec. 1.103(n)-1T through 1.103(n)-6T, 
a special purpose governmental unit shall be considered to derive its 
authority from the smallest general purpose governmental unit that--
    (i) Enacts a specific law (e.g., a provision of a State 
constitution, charter, or statute) by or under which the special purpose 
governmental unit is created, or
    (ii) Otherwise empowers, approves, or requests the creation of the 
special purpose governmental unit, or
    (iii) Appoints members to the governing body of the special purpose 
governmental unit,

and within which general purpose governmental unit falls the entire area 
in which such special purpose governmental unit may exercise its 
sovereign powers. If no one general purpose governmental unit meets such 
criteria (e.g., a regional special purpose governmental unit that 
exercises its sovereign powers within three counties pursuant to a 
separate ordinance adopted by each such county), such special purpose 
governmental unit shall be considered to derive its sovereign powers 
from each of the general purpose governmental units comprising the 
combination of smallest general purpose governmental units within which 
falls the entire area in which such special purpose governmental unit 
may exercise its sovereign powers and each of which meets (i), (ii), or 
(iii) above.
    Q-10: Does the issue comply with the requirements of section 103 (n) 
under the following circumstances? Based on the most recent estimate of 
the resident population of State Y published by the Bureau of the Census 
before the beginning of 1988, the State ceiling for State Y is $200 
million. Based on the same estimate, the population of City Q is one-
fourth of the population of State Y. No part of the geographical area 
within the jurisidiction of City Q is within the jurisdiction of any 
other governmental unit with jurisdiction over a smaller geographical 
area. There are no consitutional home rule cities in State Y. Neither 
the Governor nor the legislature of State Y has provided a different 
formula for allocating the State ceiling than that provided by section 
103(n) (2) and (3); thus, City Q's private activity bond limit for 1988 
is $25 million (.25 x .50 x $200 million). As of March 1, 1988, City Q 
has issued $15 million of private activity bonds during calender year 
1988, none of which were issued pursuant to a carryforward election made 
in a prior year. On March 1, 1988, City Q will issue $5 million of 
private activity bonds to provide a pollution control facility as 
described in section 103(b)(4) (F). C, a duly authorized official of 
City Q responsible for issuing the bonds, provides a statement that will 
be included in the bond indenture or a related document providing that--
    (i) Under section 103(n) (2) and (3) of the Internal Revenue Code, 
City Q has a private activity bond limit of $25 million for calendar 
year 1988 (.25 x .50 x $200 million), none of which has been assigned to 
it by another governmental unit,
    (ii) State Y has not provided a different method of allocating the 
State ceiling,
    (iii) City Q has not assigned any portion of its private activity 
bond limit to a constituted authority empowered to issue private 
activity bonds on its behalf, or to any other governmental unit,
    (iv) City Q has not elected to carry forward any of its private 
activity bond limit for 1988 to another calendar year, nor has City Q in 
any prior year made a carryforward election for the pollution control 
facility,
    (v) The aggregate amount of private activity bonds issued by City Q 
during 1988 is $15 million, and
    (vi) The issuance of $5 million of private activity bonds on March 
1, 1988, will not violate the requirements of section 103 (n) and the 
regulations thereunder.
    In addition, C provides the certification described in section 103 
(n) (12) (A).

[[Page 420]]

    A-10: Based on these facts, the issue meets the requirements of 
section 103(n) and Sec. Sec. 1.103(n)-1T through 1.103(n)-6T. See Sec. 
1.103-13(b)(8) for the definition of the terms ``bond indenture'' 
and``related documents.''
    Q-11: May a State provide a different formula for allocating the 
state ceiling?
    A-11: A State, by law enacted at any time, may provide a different 
formula for allocating the State ceiling among the governmental units in 
the State (other than constitutional home rule cities) having authority 
to issue private activity bonds, subject to the limitation provided in 
A-12 of this Sec. 1.103(n)-3T. The governor of a State may proclaim a 
different formula for allocating the State ceiling among the 
governmental units in such State having authority to issue private 
activity bonds. The authority of the governor to proclaim a different 
formula shall not apply after the earlier of (i) the first day of the 
first calendar year beginning after the legislature of the State has met 
in regular session for more than 60 days after July 18, 1984, and (ii) 
the effective date of any State legislation dealing with the allocation 
of the State ceiling. If, on or before either date, the governor of any 
State exercises the authority to provide a different allocation, such 
allocation shall be effective until the date specified in (ii) of the 
immediately preceding sentence. Unless otherwise provided in a State 
constitutional amendment or by a law changing the home rule provisions 
adopted in the manner provided by the State constitution, the allocation 
of that portion of the State ceiling that is allocated to any 
constitutional home rule city may not be changed by the governor or 
State legislature unless such city agrees to such different allocation.
    Q-12: Where a State provides an allocation formula different from 
that provided in section 103 (n) (2) and (3), which allocation formula 
applies to obligations issued prior to the adoption of the different 
allocation formula?
    A-12: Where a State provides a different allocation formula, the 
determination as to whether a particular bond issue meets the 
requirements of section 103(n) will be based upon the allocation formula 
in effect at the time such bonds were issued. The amount that may be 
reallocated pursuant to the later allocation formula is limited to the 
State ceiling for such year reduced by the amount of private activity 
bonds issued under the prior allocation formula in effect for such year.
    Q-13: May an issuing authority assign a portion of its private 
activity bond limit to another issuing authority if the governor or 
legislature has not provided for an allocation formula different from 
that provided in section 103(n) (2) and (3)?
    A-13: Except as provided in this A-13 or in A-8, A-14, or A-15 of 
this Sec. 1.103(n)-3T, no issuing authority may assign, directly or 
indirectly, all or any portion of its private activity bond limit to any 
other issuing authority, and no such attempted assignment will be 
effective. However, a general purpose governmental unit may assign a 
portion of its private activity bond limit to (i) a constituted 
authority empowered to issue private activity bonds on behalf of the 
assigning governmental unit, and (ii) a special purpose governmental 
unit deriving sovereign powers from the governmental unit making the 
assignment. In addition, a State may assign a portion of its private 
activity bond limit to a constituted authority empowered to issue 
private activity bonds on behalf of any governmental unit within such 
State and to any governmental unit within such State. Finally, an 
issuing authority that is assigned all or a portion of the private 
activity bond limit of a governmental unit pursuant to the immediately 
preceding two sentences may assign such amount or any part thereof to 
the governmental unit from which it received the assignment. None of 
these permissible types of assignments shall be effective, however, 
unless made in writing by a duly authorized official of the governmental 
unit making the assignment and a record of the assignment is maintained 
by the assignee for the term of all private activity bonds it issues in 
each calendar year to which such assignment applies. None of these 
permissible types of assignments shall be effective if made 
retroactively; provided, however, that retroactive assignments may be 
made

[[Page 421]]

during 1984. In addition, except as provided in A-15 of this Sec. 
1.103(n)-3T, a purported assignment by a governmental unit of a portion 
of its private activity bond limit to an issuing authority will be 
ineffective to the extent that private activity bonds issued by such 
authority provide facilities not located within the jurisdiction of the 
governmental unit making the assignment, unless the sole beneficiary of 
the facility is the governmental unit attempting to make the assignment. 
Similarly, except as provided in A-15 of this Sec. 1.103(n)-3T, a 
governmental unit may not allocate a portion of its private activity 
bond limit to an issue of obligations to provide a facility not located 
within the jurisdiction of that governmental unit unless the sole 
beneficiary of the facility is the governmental unit attempting to 
allocate its private activity bond limit to the issue. If an issuing 
authority issues an issue of obligations a portion of the proceeds of 
which are to be used to provide a facility not within its jurisdiction 
other than one described in the immediately preceding sentence, that 
issue will not meet the requirements of section 103(n) unless an issuing 
authority within the jurisdiction of which the facility is to be located 
specifically allocates a portion of its private activity bond limit to 
such issue equal to the amount of proceeds to be used to provide such 
facility.
    Q-14: May an issuing authority assign a portion of its private 
activity bond limit to another issuing authority if the governor or 
legislature has provided for an allocation formula different from that 
provided in section 103(n) (2) and (3)?
    A-14: Yes, under certain conditions. In providing a different 
formula for allocating the State ceiling, a State may permit an issuing 
authority to assign all or a portion of its private activity bond limit 
to other issuing authorities within the State, provided that such 
assignment is made in writing and a record of that assignment is 
maintained by the assignee in its records for the term of all private 
activity bonds it issues in each calendar year to which such assignment 
applies and a record of that assignment is maintained during such period 
by the public official responsible for making allocations of the State 
ceiling to issuing authorities within the State. The preceding sentence 
will only apply where the different formula expressly permits such 
assignments. Notwithstanding this A-14, no assignments may be made to 
regional authorities without compliance with the provisions of A-15 of 
this Sec. 1.103(n)-3T.
    Q-15: May a general purpose governmental unit assign a portion of 
its private activity bond limit to a regional authority empowered to 
issue private activity bonds on behalf of two or more general purpose 
governmental units?
    A-15: Yes, under certain conditions. In order for an issue of 
private activity bonds issued by such a regional authority to meet the 
requirements of section 103(n), each of the governmental units on behalf 
of which the regional authority issues private activity bonds must 
assign to the regional authority a portion of its private activity bond 
limit based on the ratio of its population to the aggregate population 
of all such governmental units. The governmental unit within the 
jurisdiction of which the facility to be provided by the private 
activity bonds will be located, however, may elect to treat the regional 
authority as if it were a constituted authority empowered to issue such 
obligations solely on behalf of that governmental unit and, therefore, 
may assign a portion of its limit to the authority solely to provide the 
facility within its jurisdiction. Similarly, if a facility will solely 
benefit one governmental unit, that governmental unit may make the 
election described in the preceding sentence. In addition, any of the 
governmental units on behalf of which the regional authority issues 
private activity bonds, other than the governmental unit within the 
jurisdiction of which the facility will be located, may elect to be 
treated as if it had not empowered the authority to issue that issue of 
private activity bonds on its behalf. In providing a different formula 
for allocating the State ceiling, a State may permit a governmental unit 
to assign all or a portion of its private activity bond limit to a 
constituted authority empowered to issue private activity bonds on 
behalf of two or more governmental units, all

[[Page 422]]

of which are located within the State. The preceding sentence will only 
apply where the different formula expressly so provides. The principles 
of this A-15 shall not apply to any regional authority created with a 
principal purpose of avoiding the restrictions provided in A-13 or A-14 
of this Sec. 1.103(n)-3T. The principles of this A-15 shall also apply 
to a special purpose governmental unit providing facilities located 
within the jurisdiction of two or more general purpose governmental 
units from which it derives sovereign powers.
    Examples. The following examples illustrate the provisions of A-8 
through A-15 of this section:
    Example (1). Authority ZZ is empowered by City Y to issue 
obligations on its behalf to provide financing for pollution control 
facilities located within the jurisdiction of City Y and the 
geographical area within 10 miles of the limits of City Y. Authority ZZ 
has no sovereign powers. Although the authority of Authority ZZ to issue 
obligations enables it to provide facilities located outside of the 
jurisdiction of City Y, Authority ZZ is treated as having jurisdiction 
over the same geographical area as City Y. Since City Y has broader 
sovereign powers than Authority ZZ, under section 103(n)(3) Authority ZZ 
has a private activity bond limit of zero. On March 31, 1985, Authority 
ZZ issues $5 million of private activity bonds. City Y has not assigned 
any portion of its private activity bond limit to Authority ZZ. Thus, 
the March 31, 1985, issue of private activity bonds is treated as an 
issue of obligations not described in section 103(a), and the interest 
on such obligations is subject to Federal income taxation.
    Example (2). In 1972, State S, State T, and State V empowered 
Authority Z to issue industrial development bonds on behalf of the three 
States and to provide port facilities in a harbor serving residents of 
all three States. S, T, and V have populations of 1,000,000, 2,000,000, 
and 7,000,000, respectively. Authority Z will issue $100 million of 
private activity bonds on September 1, 1985, to finance construction of 
a dock to be located in State S. The obligations will not meet the 
requirements of section 103(n) unless S, T, and V assign a portion of 
their private activity bond limits to Authority Z pursuant to one of 
three methods. First, S, T, and V may assign $10 million, $20 million, 
and $70 million, respectively, of their private activity bond limits to 
Authority Z for this issue. Second, S, T, and V may assign $100 million, 
$0, and $0, respectively, of their private activity bond limits to 
Authority Z for this issue. Third, either T or V (but not S) may 
allocate $0 of its private activity bond limit to Authority Z for 
purposes of this issue, and the remaining two States may allocate the 
$100 million based upon their respective populations. For instance, if T 
were to allocate $0 for purposes of this issue, S and V must allocate 
$12.5 million and $87.5 million, respectively, of their private activity 
bond limits to Authority Z.

    Q-16: Must an issuing authority allocate any of its private activity 
bond limit to certain preliminarily approved projects?
    A-16: Yes. Section 631(a)(3) of the Tax Reform Act of 1984 provides 
that, with respect to certain projects preliminarily approved by an 
issuing authority before October 19, 1983, the issuing authority shall 
allocate its share of the private activity bond limit for the calendar 
year during which the obligations are to be issued first to those 
projects. For purposes of this A-16 and A-17 and A-18 of this Sec. 
1.103(n)-3T, a general purpose governmental unit will be treated as 
having preliminarily approved a project if the project was preliminarily 
approved by it, by a constituted authority empowered to issue private 
activity bonds on its behalf, or by a special purpose governmental unit 
treated as having jurisdiction over the same geographical area as the 
general purpose governmental unit. Thus, if a project was approved by a 
constituted authority, the governmental unit on behalf of which such 
issue is to be issued must assign a portion of its private activity bond 
limit to the authority pursuant to section 631(a)(3) of the Act. If a 
project was preliminarily approved by a constituted authority empowered 
to issue private activity bonds on behalf or more than one general 
purpose governmental unit or a special purpose governmental unit that 
derives its sovereign powers from more than one general purpose 
governmental unit, the project will be considered approved by each of 
such general purpose governmental units in proportion to their relative 
populations. The projects that receive priority under section 631(a)(3) 
of the Act and this A-16 are those with respect to which--
    (i) There was an inducement resolution (or other comparable 
preliminary approval) for a project before October 19, 1983, by an 
issuing authority,
    (ii) A substantial user of the project notified such issuing 
authority--

[[Page 423]]

    (A) By August 17, 1984, that it intended to claim its rights under 
section 631(a)(3) of the Tax Reform Act of 1984, and
    (B) By December 31, 1984, as to the calendar year in which it 
expects the obligations to provide the project to be issued, and
    (iii) Construction of such project began before October 19, 1983, or 
a substantial user was under a binding obligation on that date to incur 
significant expenditures with respect to the project.

For purposes of the preceding sentence, the term ``significant 
expenditures'' means expenditures that equal or exceed the lesser of $15 
million or 20 percent of the estimated cost of the facilities. An 
issuing authority may require, as part of the submission required by 
(ii)(B) of this A-16, that a substantial user specify the aggregate 
amount of private activity bonds necessary for the project. Section 
631(a)(3) does not apply to a project to the extent that the aggregate 
amount of obligations required for such project exceeds the amount, if 
any, provided for in the inducement resolution or resolutions in 
existence with respect to such project before October 19, 1983, or in 
the statement that may be required by the issuing authority as part of 
the submission required by (ii)(B) of this A-16. Similarly, section 
631(a)(3) does not apply to a project to the extent of any material 
change in its nature, character, purpose, or capacity. Section 631(a)(3) 
does not apply to a project if the owner, operator, or manager of such 
project is not the same (or a related person) as the owner, operator, or 
manager named in the latest inducement resolution with respect to such 
project in existence before October 19, 1983. Section 631(a)(3) of the 
Act does not apply to any project if the obligations to provide the 
project are not issued in the year specified in the submission required 
by (ii)(B) of this A-16. In addition, section 631(a)(3) of the Act does 
not apply to any project to the extent that the amount of obligations to 
be issued for such project exceeds the share of the State ceiling to 
which the issuing authority that authorized the project is entitled as 
determined under section 103(n) (2) and (3) without regard to any 
alternative formula for allocating the State ceiling. The requirements 
of section 631(a)(3) will not apply where a State statute specifically 
so provides.
    Q-17: What is the penalty for failure to comply with the 
requirements of section 631(a)(3) of the Act?
    A-17: If any issuing authority fails to comply with the requirements 
of section 631(a)(3) of the Act, its private activity bond limit for the 
calendar year following the year in which the failure occurs shall be 
reduced by the amount of private activity bonds with respect to which 
the failure occurs. This penalty applies whether the issuing authority's 
private activity bond limit is determined under the formula provided 
under section 103(n) (2) and (3) or a different formula provided under 
section 103(n)(6). The penalty is imposed on the issuing authority that 
failed to comply with the requirements of section 631(a)(3) or, if in 
the year in which the penalty is imposed the issuing authority does not 
have a sufficient private activity bond limit to absorb the entire 
penalty, on the general purpose governmental unit treated as having 
jurisdiction over the same geographical area as the issuing authority. 
For purposes of this A-17, the general purpose governmental unit's 
private activity bond limit includes the private activity bond limit of 
each issuing authority treated as having preliminarily approved the 
project under A-16 of this Sec. 1.103(n)-3T. Thus, for example, if a 
governmental unit failed to comply with the requirements of section 
631(a)(3) of the Act with respect to a $5 million issue to be issued in 
1985, and that governmental unit is assigned $15 million of the State 
ceiling for 1986 pursuant to a formula provided under section 103(n)(6), 
that governmental unit has a private activity bond limit of $10 million 
for 1986. Similarly, where a project that was preliminarily approved by 
an issuing authority that is not a governmental unit qualifies for $10 
million of priority under section 631(a)(3) of the Act is not allocated 
a total of $10 million by the governmental unit on behalf of which the 
issuing authority is empowered to issue private activity bonds, the 
issuing authority's private activity

[[Page 424]]

bond limit, if any, for the year following this failure is reduced by 
$10 million; if the issuing authority's private activity bond limit for 
the year following the failure is less than $10 million, the private 
activity bond limit of the governmental unit on behalf of which the 
private activity bonds would have been issued had the failure not 
occurred (including if necessary, on a proportionate basis, the private 
activity bond limit purported to have been assigned to each of the other 
constituted authorities empowered to issue private activity bonds on 
behalf of the governmental unit and each special purpose governmental 
unit deriving all or part of its sovereign powers from the governmental 
unit) is reduced by the difference between $10 million and the reduction 
made in the issuing authority's private activity bond limit with respect 
to such failure.
    Q-18: Will a penalty be assessed for failure to allocate private 
activity bond limit to all projects that meet the requirements section 
631(a)(3) if the amount of obligations required by all such projects 
preliminarily approved by (or treated as having been preliminarily 
approved by) an issuing authority exceeds the private activity bond 
limit of such issuing authority?
    A-18: No penalty will be assessed if priority is given to those 
eligible projects for which substantial expenditures were incurred 
before October 19, 1983. An issuer may define the term ``substantial 
expenditures'' in any reasonable manner based on the relevant facts and 
circumstances and its private activity bond limit.
    Examples. The following examples illustrate the provisions of A-16 
through A-18:

    Example (1). On October 1, 1983, County S approved an inducement 
resolution for the issuance of up to $30 million of industrial 
development bonds to provide a pollution control facility described in 
section 103(b)(4)(F) for Corporation R. On October 5, 1983, R contracted 
with Corporation Q to begin construction of the pollution control 
facility immediately, and construction began on October 10, 1983. Not 
later than August 17, 1984, Corporation R notified County S that it 
intended to seek priority under section 631(a)(3) of the Tax Reform Act 
of 1984. In addition, prior to December 31, 1984, Corporation R notified 
County S that it expected the County to issue $25 million of industrial 
development bonds for its project during calendar year 1985. Under 
section 103(n)(3), County S has a private activity bond limit of $50 
million for calendar year 1985, and neither the Governor nor the 
legislature of the State has provided a different allocation formula 
under section 103(n)(6). There are no other projects approved by County 
S that have rights under section 631(a)(3). On March 1, 1985, County S 
issues $25 million of industrial development bonds for the pollution 
control facility for Corporation R. If County S allocates less than $25 
million of its private activity bond limit to that project, its private 
activity bond limit for 1986 will be reduced by the difference between 
$25 million and the amount County S actually allocates to the project.
    Example (2). The facts are the same as in Example (1) except that 
during 1984 Corporation R fails to notify County S of the year in which 
it expects the obligations to be issued. Upon such failure the pollution 
control facility no longer qualifies for priority under section 
631(a)(3), and County S will not be penalized if it does not not 
allocate any of its private activity bond limit for 1985, or any future 
year, to that project.
    Example (3). The facts are the same as in Example (1) except that 
under section 103(n)(3) County S has a private activity bond limit of 
$10 million for 1985. County S will not be penalized if it allocates $10 
million of its private activity bond limit to the project.
    Example (4). The facts are the same as in Example (3) except that on 
December 31, 1984, the Governor of the State provides a different 
allocation from that provided under section 103(n) (2) and (3). (The 
State has not enacted a statute specifically providing that section 
631(a)(3) does not apply.) The different allocation provides that the 
entire State ceiling is allocated to the State and that the State will 
allocate the State ceiling to issuing authorities for specific projects 
on a first-come, first-served basis. Corporation R qualifies for the 
special rights granted by section 631(a)(3) of the Tax Reform Act to the 
extent of County S's private activity bond limit as determined under 
section 103(n)(3), i.e., $10 million. If the State fails to assign to 
County S $10 million of the State ceiling or if County S, after 
receiving such assignment, fails to allocate $10 million of private 
activity bond limit to the project, County S's private activity bond 
limit (if any) for 1986 will be reduced by the difference between $10 
million and the amount of private activity bond limit allocated to the 
project.

[[Page 425]]

    Example (5). The facts are the same as in Example (1) except that 
Corporation R notifies County S that it only requires $15 million for 
the pollution control facility, County S only issues $15 million of 
private activity bonds for the pollution control facility, and County S 
only allocates $15 million of its private activity bond limit to such 
obligations. County S will not be penalized for not allocating more than 
$15 million of its private activity bond limit to Corporation R even 
though the original inducement resolution provided for up to $25 
million.

(Secs. 103(n) and 7805 of the Internal Revenue Code of 1954 (98 Stat. 
916, 26 U.S.C.103(n); 68A Stat. 917, 26 U.S.C. 7805))

[T.D. 7981, 49 FR 39320, Oct. 5, 1984]



Sec. 1.103(n)-4T  Elective carryforward of unused private activity bond 
limit (temporary).

    Q-1: May an issuing authority carry forward any of its unused 
private activity bond limit for a calendar year?
    A-1: In any calendar year after 1983 in which an issuing authority's 
private activity bond limit exceeds the aggregate amount of private 
activity bonds issued during such calendar year by such issuing 
authority, such issuing authority may elect to treat all, or any 
portion, of such excess as a carryforward for any one or more projects 
described in A-5 of this Sec. 1.103(n)-4T (carryforward projects).
    Q-2: How is the election to carry forward an issuing authority's 
unused private activity bond limit made?
    A-2: (i) An issuing authority may make the election by means of a 
statement, signed by an authorized public official responsible for 
making allocations of such issuing authority's private activity bond 
limit, that the issuing authority elects to carry forward its unused 
private activity bond limit. The statement shall be filed with the 
Internal Revenue Service Center, Philadelphia, Pennsylvania 19255. 
Except with respect to elections to carry forward any unused private 
activity bond limit for calendar year 1984, the election must be filed 
prior to the end of the calendar year with respect to which the issuing 
authority has the unused private activity bond limit; elections with 
respect to unused private activity bond limit for calendar year 1984 
must be filed prior to February 26, 1985. The statement is to be titled 
``Carryforward election under section 103(n)''.
    (ii) The statement required by (i) of this A-2 shall contain the 
following information:
    (A) The name, address, and TIN of the issuing authority,
    (B) The issuing authority's private activity bond limit for the 
calendar year,
    (C) The aggregate amount of private activity bonds issued by the 
issuing authority during the calendar year for which the election is 
being made,
    (D) The unused private activity bond limit of the issuing authority, 
and
    (E) For each carryforward project--
    (1) A description of the project, including its address (by its 
street address or, if none, by a general description designed to 
indicate its specific location) and the general type of facility (e.g., 
an airport described in section 103(b)(4)(D)),
    (2) The name, address, and TIN of the initial owner, operator, or 
manager, and
    (3) The amount to be carried forward for the project.
    (iii) For purposes of (ii)(E) of this A-2, in the case of a 
carryforward project for which the initial owner, operator, or manager 
is to be selected pursuant to a competitive bidding process, the 
election may include up to 3 prospective addresses for the project and 
the name, address, and TIN of more than one prospective initial owner, 
operator, or manager, if prior to the end of the calendar year for which 
the election is made--
    (A) In the case of elections for calendar years other than 1984, the 
issuing authority has taken preliminary official action approving the 
undertaking of the carryforward project,
    (B) All persons included as prospective owners, operators, or 
managers have met all applicable conditions (if any) to submit proposals 
to provide the project, and
    (C) The issuing authority has expended (or has entered into binding 
contracts to expend) in connection with the planning and construction of 
the carryforward project the lesser of $500,000 or 2\1/2\ percent of the 
carryforward amount.

[[Page 426]]

    (iv) For purposes of (ii) of this A-2, in the case of a carryforward 
election for the purpose of issuing student loan bonds, the statement 
need not include the address of a facility or the name, address, and TIN 
of an initial owner, operator, or manager of a project but shall state 
that the carryforward election is for the purpose of issuing student 
loan bonds.
    Q-3: Is a carryforward election revocable?
    A-3: Any carryforward election, and any specification contained 
therein, shall be irrevocable after the last day of the calendar year in 
which the election is made. Thus, for example, obligations issued to 
finance a carryforward project with a different initial owner, operator, 
or manager from the owner, operator, or manager specified in the 
carryforward election shall not be issued purusant to such carryforward 
election. An insubstantial deviation from a specification contained in a 
carryforward election shall not prevent obligations from being issued 
pursuant to such carryforward election. In addition, where a 
carryforward election is made with respect to more than one carryforward 
project, a substantial deviation with respect to one carryforward 
project shall not prevent obligations from being issued pursuant to such 
carryforward election with respect to the other carryforward projects.
    Q-4: How is a carryforward used?
    A-4: Any private activity bonds issued during the three calendar 
years (six calendar years in the case of a project described in section 
103(b)(4)(F)) following the calendard year in which the carryforward 
election was first made with respect to a carryforward project shall not 
be taken into account in determining whether the issue meets the 
requirements of section 103(n). If, however, the amount of private 
activity bonds issued for the carryforward project exceeds the amount of 
the carryforward elected with respect to the project, then the portion 
of the issue that exceeds the carryforward shall be taken into account 
in determining whether the issue meets with the requirements of section 
103(n); if that portion of the issue does not meet the requirements of 
section 103(n) then the entire issue is treated as consisting of 
obligations not described in section 103(a). Carryforwards elected with 
respect to any project shall be used in the order of the calendar years 
in which they arose. Thus, for example, if an issuing authority makes 
carryforward elections in 1986 and 1988 for a carryforward project and 
issues private activity bonds for that project in 1989 and 1990, the 
obligations issued in 1989 will be applied to the 1986 carryforward 
election to the extent thereof.
    Q-5: For what projects may a carryforward election be made?
    A-5: A carryforward election may be made for any project described 
in section 103(b) (4) or (5), and for the purpose of issuing student 
loan bonds. Thus, for example, an issuing authority may elect to carry 
forward its unused private activity bond limit in order to provide a 
sports facility described in section 103(b)(4)(B). In addition, a 
governmental unit may elect to carry forward its unused private activity 
bond limit in order to issue qualified scholarship funding bonds. An 
issuing authority may not, however, elect to carry forward its unused 
private activity bond limit in order to issue an exempt small issue of 
industrial development bonds under section 103(b)(6).

(Secs. 103(n) and 7805 of the Internal Revenue Code of 1954 (98 Stat. 
916, 26 U.S.C.103(n); 68A Stat. 917, 26 U.S.C. 7805); sec. 644(b) of the 
Tax Reform Act of 1984 (98 Stat. 940); secs. 103(n) and 7805 of the 
Internal Revenue Code of 1954 (98 Stat. 915, 26 U.S.C. 103(n); 68A Stat. 
917, 26 U.S.C. 7805))

[T.D. 7981, 49 FR 39325, Oct. 5, 1984, as amended by T.D. 8001, 49 FR 
50389, Dec. 28, 1984]



Sec. 1.103(n)-5T  Certification of no consideration for allocation 
(temporary).

    Q-1: Who must certify that there was no consideration for an 
allocation?
    A-1: Section 103(n)(12)(A) provides that, with respect to any 
private activity bond allocated any portion of the State ceiling, the 
private activity bond will not be described under section 103(a) unless 
the public official, if any, responsible for such allocation 
(``responsible public official'') certifies under penalties of perjury 
that to the best of his knowledge the allocation of

[[Page 427]]

the State ceiling to that private activity bond was not made in 
consideration of any bribe, gift, gratuity, or direct or indirect 
contribution to any political campaign. With respect to any issue of 
private activity bonds, the responsible public official is the official 
or officer of the issuing authority that in fact is responsible for 
choosing which individual projects will be allocated a portion of the 
State ceiling. If a body of several individuals is responsible for such 
choices, any one member of such body qualifies as the responsible public 
official.
    Q-2: What is the penalty for willfully making an allocation in 
consideration of any bribe, gift, gratuity, or direct or indirect 
contribution to any political campaign?
    A-2: Section 103(n)(12)(B) provides that any person willfully making 
an allocation of any portion of the State ceiling in consideration of 
any bribe, gift, gratuity, or direct or indirect contribution to any 
political campaign will be subject to criminal penalty as though the 
allocation were a willful attempt to evade tax imposed by the Internal 
Revenue Code.

(Secs. 103(n) and 7805 of the Internal Revenue Code of 1954 (98 Stat. 
916, 26 U.S.C.103(n); 68A Stat. 917, 26 U.S.C. 7805))

[T.D. 7981, 49 FR 39326, Oct. 5, 1984]



Sec. 1.103(n)-6T  Determinations of population (temporary).

    Q-1: What is the proper method for determining population?
    A-1: All determinations of population must be made with respect to 
any calendar year on the basis of the most recent census estimate 
(whether final or provisional) of the resident population of the State 
or other governmental unit published by the Bureau of the Census in the 
``Current Population Reports'' series before the beginning of the 
calendar year.
    However, determinations of the population of a general purpose 
governmental unit (other than a State, territory, or possession) within 
a State, territory, or possession may not be based on estimates that do 
not contain estimates for all of the general purpose governmental units 
within such State, territory, or possession. Thus, a county may not 
determine its population on the basis of a census estimate that does not 
provide an estimate of the population of the other general purpose 
governmental units within the State (e.g., cities, towns). If no census 
estimate is available for all such general purpose governmental units, 
the most recent decennial census of population may be relied on.
    Example: The following example illustrates the provisions of A-1 of 
this Sec. 1.103(n)-6T:

    Example. County Q is located within State R. There are no 
constitutional home rule cities in State R. State R has not adopted a 
formula for allocating the State ceiling different from the formula 
provided in section 103(n) (2) and (3). The geographical area within the 
jurisdiction of County Q is not within the jurisdiction of any other 
governmental unit having jurisdiction over a smaller geographical area. 
As of December 31, 1984, the Bureau of the Census has published the 
following estimates of resident population: ``Current Population 
Reports; Series P-25: Population Estimates and Projections, Estimates of 
the Population of States: July 1, 1981-1983'' and ``Current Population 
Reports; Series P-26: Local Population Estimates: Population of State R, 
Counties, Incorporated Places, and Minor Civil Divisions: July 1, 1981-
1982.'' The most recent population estimate for State R available prior 
to 1985 provides population estimates as of July 1, 1983. The most 
recent population extimates for County Q available prior to 1985 is the 
estimate for July 1, 1982. Assuming that the State ceiling for State R 
for 1985 is in excess of $200 million (i.e., $150 multiplied by the 
estimated population of State R as of July 1, 1983, exceeds $200 
million), County Q may determine its private activity bond limit by 
using the following formula:

P = $150x.5xWxY/Z, where,

P = County Q's private activity bond limit,
W = the July 1, 1983, population estimate for State R,
Y = the July 1, 1982, population estimate for County Q, and
Z = the July 1, 1982, population estimate for State R.


If the State ceiling for State R is not in excess of $200 million, 
County Q may determine its private activity bond limit by using the 
following formula:

P = $200,000,000x.5xY/Z, where
P, Y, and Z have the same meaning as above.

(Secs. 103(n) and 7805 of the Internal Revenue Code of 1954 (98 Stat. 
916, 26 U.S.C.103(n); 68A Stat. 917, 26 U.S.C. 7805))

[T.D. 7981, 49 FR 39326, Oct. 5, 1984]

[[Page 428]]



Sec. 1.103(n)-7T  Election to allocate State ceiling to certain 
facilities for local furnishing of electricity (temporary).

    (a) Election--(1) In general. The issuing authorities of the State 
of New York (``New York'') may elect to use in 1984 up to one-half of 
the amount that would have been New York's State ceiling (as defined in 
section 103(n)(4) and A-1 of Sec. 1.103(n)-3T) for calendar years 1985, 
1986, and 1987 for the purpose of issuing obligations to provide 
facilities for the local furnishing of electric energy described in 
section 644(a) of the Tax Reform Act of 1984 (the ``Act''). For purposes 
of this paragraph, New York's State ceiling for calendar years 1985, 
1986, and 1987 is considered equal to the State ceiling for 1984 
(without taking into account any increase in the State ceiling for 1984 
as a result of an election under section 644(b) and this section).
    (2) Procedure. The election shall be made by filing the statement 
described in this paragraph (a)(2) with the Internal Revenue Service 
Center, Philadelphia, Pennsylvania, on or before December 31, 1984. The 
statement shall be titled ``Allocation election under section 644 of the 
Tax Reform Act of 1984,'' shall be signed by the Governor of New York or 
his authorized representative, and shall contain the following 
information:
    (i) The name, address, and TIN of the issuing authority (or 
authorities) that is expected to issue the obligations for the 
facilities described in section 644(a) of the Act pursuant to the 
election described in section 644(b) of the Act and this section, and
    (ii) The amount of the State ceiling for each of calendar years 
1985, 1986, and 1987 with respect to which the election is made.
    (b) Effect of election--(1) In 1984. The amount of the State ceiling 
for calendar years 1985, 1986, and 1987 with respect to which the 
election is made will be considered part of New York's State ceiling for 
calendar year 1984. For purposes of section 644(b) of the Act, such 
amount will be considered used in 1984 only to the extent that 
obligations are issued in 1984 to provide facilities for the local 
furnishing of electric energy described in section 644(a) of the Act, or 
to the extent that a proper election is made on or before December 31, 
1984 (and is not revoked or amended between the time it is made and the 
end of 1984) pursuant to section 103(n)(10) and Sec. 1.103(n)-4T to 
carry forward all or part of such amount to provide such facilities 
during the carryforward period applicable to calendar year 1984 State 
ceiling.
    (2) In 1985, 1986, and 1987. An election under section 644(b) of the 
Act and this section to use in calendar year 1984 an amount of New 
York's State ceiling for a subsequent calendar year reduces the State 
ceiling for such subsequent calendar year by the amount with respect to 
which the election is made, whether or not such amount is considered 
used in 1984 pursuant to this paragraph (b). Thus, no obligations may be 
issued pursuant to the election described in section 644(b) of the Act 
and this section to provide a facility other than the facilities for the 
furnishing of electric energy described in section 644(a) of the Act.
    (3) Other effects. An election or the failure to make an election 
under section 644(b) of the Act and this section shall not affect any 
otherwise applicable rule that permits an issuing authority, for any 
calendar year, to--
    (i) Allocate a portion of its private activity bond limit,
    (ii) Issue obligations within its private activity bond limit, or
    (iii) Elect under section 103(n)(10) and Sec. 1.103(n)-4T to carry 
forward any portion of its private activity bond limit,

in order to issue obligations to provide a facility described in section 
644(a) of the Act.
    (c) Revocation of election. An election made under section 644(b) of 
the Act and this section may not be revoked or amended. An insubstantial 
deviation from a specification contained in an election under section 
644(b) of the Act and this section shall not prevent obligations from 
being issued pursuant to such election.

(Sec. 644(b) of the Tax Reform Act of 1984 (98 Stat. 940); secs. 103(n) 
and 7805 of the Internal Revenue Code of 1954 (98 Stat. 915, 26 U.S.C. 
103(n); 68A Stat. 917, 26 U.S.C. 7805))

[T.D. 8001, 49 FR 50389, Dec. 28, 1984]

[[Page 429]]



Sec. 1.103A-2  Qualified mortgage bond.

    (a)-(j) [Reserved]
    (k) Information reporting requirement--(1) In general. An issue 
meets the requirements of this paragraph only if the issuer in good 
faith attempted to meet the information reporting requirements of this 
paragraph. Except as otherwise provided in paragraph (k)(5)(iv) of this 
section, the requirements of this paragraph apply to qualified veterans' 
mortgage bonds issued after July 18, 1984, and to qualified mortgage 
bonds issued after December 31, 1984. With respect to bonds issued after 
December 31, 1986, see the regulations under section 149(e).
    (2) Information required. (i) The issuer must, based on information 
and reasonable expectations determined as of the date of issue, submit 
on Form 8038 the information required therein; the issuer need not 
however, include the information required by Form 8038 that is relevant 
only to obligations described in section 103(l)(1) and the regulations 
thereunder. The information that must be submitted includes--
    (A) The name, address, and employer identification number of the 
issuer,
    (B) The date of issue,
    (C) The face amount of each obligation which is part of the issue,
    (D) The total purchase price of the issue,
    (E) The amount allocated to a reasonably required reserve or 
replacement fund,
    (F) The amount of lendable proceeds,
    (G) The stated interest rate of each maturity,
    (H) The term of each maturity,
    (I) In the case of an issue of qualified mortgage bonds, whether the 
issuer has elected under Sec. 6a.103A-2(i)(4)(v) to pay arbitrage to 
the United States,
    (J) In the case of an issue of qualified mortgage bonds, the 
issuer's market limitation as of the date of issue (as defined in Sec. 
6a.103A-2(g)), the amount of qualified mortgage bonds that the issuer 
has elected not to issue under section 25(c)(2) and the regulations 
thereunder, and the aggregate amount of qualified mortgage bonds issued 
to date by the issuer during the calendar year, and
    (K) In the case of an issue of qualified veterans' mortgage bonds, 
the issuer's State veterans limit (as defined in section 103A(o)(3)(B) 
and the regulations thereunder) and the aggregate amount of qualified 
veterans' mortgage bonds issued to date by the issuer during the 
calendar year and prior to the date of issue of the issue for which the 
Form 8038 is being submitted.
    (ii) With respect to issues issued after December 31, 1984, the 
issuer must submit a report containing information on the borrowers of 
the original proceeds of such issues. The report must be filed for each 
reporting period in which the original proceeds of any of such issues 
are used to provide mortgages. The issuer is not responsible for false 
information provided by a borrower if the issuer did not know or have 
reason to know that the information was false. The report must be filed 
on the form prescribed by the Internal Revenue Service. If no form is 
prescribed, or if the form prescribed is not readily available, the 
issuer may use its own form provided that such form is in the format set 
forth in paragraph (k)(3) of this section and contains the information 
required by this paragraph (k)(2)(ii). The report must be titled 
``Qualified Mortgage Bond Information Report'' or ``Qualified Veterans' 
Mortgage Bond Information Report'', and must include the name, address, 
and TIN of the issuer, the reporting period for which the information is 
provided, and the following tables containing information concerning the 
borrowers of the original proceeds of the issues subject to the 
requirements of this paragraph (k)(2)(ii) with respect to mortgages 
provided during the reporting period for which the report is filed:
    (A) A table titled ``Number of Mortgage Loans by Income and 
Acquisition Cost'' showing the number of mortgage loans (other than 
those issued in connection with qualified home improvement and 
rehabilitation loans) made during the reporting period according to the 
annualized gross income of the borrowers (categorized in the following 
intervals of income:

$0-$9,999
$10,000-$19,999
$20,000-$29,999
$30,000-$39,999
$40,000-$49,999
$50,000-$74,999

[[Page 430]]

$75,000 or more)


and according to the acquisition cost of each residence being financed 
(categorized in the following intervals of acquisition cost:

$0-$19,999
$20,000-$39,999
$40,000-$59,999
$60,000-$79,999
$80,000-$99,999
$100,000-$119,999
$120,000-$149,999
$150,000-$199,999
$200,000 or more)


For each interval of income and acquisition cost the table must also be 
categorized according to the number of borrowers that--
    (1) Did not have a present ownership interest in a principal 
residence at any time during the 3-year period ending on the date the 
mortgage is executed (i.e., satisfied the 3-year requirement) and 
purchased residences in targeted areas,
    (2) Satisfied the 3-year requirement and purchased residences not 
located in targeted areas,
    (3) Did have a present ownership interest in a principal residence 
at any time during the 3-year period ending on the date the mortgage is 
executed (i.e., did not satisfy the 3-year requirement) and purchased 
residences in targeted areas, and
    (4) Did not satisfy the 3-year requirement and purchased residences 
not located in targeted areas.

With respect to issues of qualified veterans' mortgage bonds, for each 
interval of income and acquisition cost the table need only be 
categorized according to the number of borrowers that satisfied the 3-
year requirement and the number of borrowers that failed to satisfy the 
3-year requirement.
    (B) A table titled ``Volume of Mortgage Loans by Income and 
Acquisition Cost'' showing the total principal amount of the mortgage 
loans (other than qualified home improvement and rehabilitation loans) 
provided during the reporting period according to annualized gross 
income (categorized in the same intervals of income as the preceding 
table) and according to the acquisition cost of the residences acquired 
(categorized in the same acquisition cost intervals as the preceding 
table). For each interval of income and acquisition cost the table must 
also be categorized according to the total principal amount of the 
mortgage loans of borrowers that--
    (1) Satisfied the 3-year requirement and purchased residences in 
targeted areas,
    (2) Satisfied the 3-year requirement and purchased residences not 
located in targeted areas,
    (3) Did not satisfy the 3-year requirement and purchased residences 
in targeted areas, and
    (4) Did not satisfy the 3-year requirement and purchased residences 
not located in targeted areas.

With respect to issues of qualified verterans' mortgage bonds, for each 
interval of income and acquisition cost the table need only be 
categorized according to the total principal amount of the mortgage 
loans of borrowers that satisified the 3-year requirement and the total 
principal amount of the mortgage loans of borrowers that did not satisfy 
the 3-year requirement.
    (C) For issues other than qualified veterans' mortgage bonds, a 
table titled ``Mortgage Subsidy Bonds for Qualified Home Improvement and 
Rehabilitation Loans'' showing the number of borrowers obtaining 
qualified home improvement loans and qualified rehabilitation loans and 
the total of the principal amounts of such loans; the information 
contained in the table must also be categorized according to whether the 
residences with respect to which the loans were provided are located in 
targeted areas.
    (3) Format. (i) With respect to the report required by paragraph 
(k)(2)(ii) of this section, if no form is prescribed by the Internal 
Revenue Service, or if the prescribed form is not readily available, the 
issuer must submit the report in the format specified in this paragraph 
(k)(3).
    (ii) With respect to issues of qualified mortgage bonds, the format 
of the report specified in this paragraph (k)(3) is the following:

               Qualified Mortgage Bond Information Report

Name of issuer:
Address of issuer:
TIN of issuer:
Reporting period:

[[Page 431]]



                             Number of Mortgage Loans by Income and Acquisition Cost
----------------------------------------------------------------------------------------------------------------
                                                                 Satisfied            Not Satisfied
  3-year requirement: Annualized gross monthly income of  ----------------------------------------------
                        borrowers                          Nontargeted  Targeted  Nontargeted  Targeted   Totals
                                                               area       area        area       area
----------------------------------------------------------------------------------------------------------------
$0 to $9,999.............................................
$10,000 to $19,999.......................................
$20,000 to $29,999.......................................
$30,000 to $39,999.......................................
$40,000 to $49,999.......................................
$50,000 to $74,999.......................................
$75,000 or more..........................................
                                                          ------------------------------------------------------
      Total..............................................
                     Acquisition Cost
$0 to $19,999............................................
$20,000 to $39,999.......................................
$40,000 to $59,999.......................................
$60,000 to $79,999.......................................
$80,000 to $99,999.......................................
$100,000 to $119,999.....................................
$120,000 to $149,999.....................................
$150,000 to $199,999.....................................
$200,000 or more.........................................
                                                          ------------------------------------------------------
      Total..............................................
----------------------------------------------------------------------------------------------------------------


                             Volume of Mortgage Loans by Income and Acquisition Cost
----------------------------------------------------------------------------------------------------------------
                                                                 Satisfied            Not Satisfied
  3-year requirement: Annualized gross monthly income of  ----------------------------------------------
                        borrowers                          Nontargeted  Targeted  Nontargeted  Targeted   Totals
                                                               area       area        area       area
----------------------------------------------------------------------------------------------------------------
$0 to $9,999.............................................
$10,000 to $19,999.......................................
$20,000 to $29,999.......................................
$30,000 to $39,999.......................................
$40,000 to $49,999.......................................
$50,000 to $74,999.......................................
$75,000 or more..........................................
                                                          ------------------------------------------------------
      Total..............................................
                     Acquisition Cost
$0 to $19,999............................................
$20,000 to $39,999.......................................
$40,000 to $59,999.......................................
$60,000 to $79,999.......................................
$80,000 to $99,999.......................................
$100,000 to $119,999.....................................
$120,000 to $149,999.....................................
$150,000 to $199,999.....................................
$200,000 or more.........................................
                                                          ------------------------------------------------------
      Total..............................................
----------------------------------------------------------------------------------------------------------------


Mortgage Subsidy Bonds for Qualified Home Improvement and Rehabilitation
                                  Loans
------------------------------------------------------------------------
                                          Nontargeted  Targeted
                                              area       area     Totals
------------------------------------------------------------------------
Number of qualified home improvement
 loans..................................
Volume of qualified home improvement
 loans..................................
Number of qualified rehabilitation loans
Volume of qualified rehabilitation loans
------------------------------------------------------------------------

    (iii) The format of the report specified in this paragraph (k)(3) 
for qualified veterans' mortgage bonds is the following:

          Qualified Veterans' Mortgage Bond Information Report

Name of issuer:
Address of issuer:
TIN of issuer:
Reporting period:

         Number of Mortgage Loans by Income and Acquisition Cost
------------------------------------------------------------------------
  3-year requirement: annualized gross                 Not
      monthly income of borrowers        Satisfied  satisfied    Totals
------------------------------------------------------------------------
$0 to $9,999...........................
$10,000 to $19,999.....................

[[Page 432]]

 
$20,000 to $29,999.....................
$30,000 to $39,999.....................
$40,000 to $49,999.....................
$50,000 to $74,999.....................
$75,000 or more........................
                                        --------------------------------
    Total..............................
            Acquistion Cost
$0 to $19,999..........................
$20,000 to $39,999.....................
$40,000 to $59,999.....................
$60,000 to $79,999.....................
$80,000 to $99,999.....................
$100,000 to $119,999...................
$120,000 to $149,999...................
$150,000 to $199,999...................
$200,000 or more.......................
    Total..............................
------------------------------------------------------------------------


         Number of Mortgage Loans by Income and Acquisition Cost
------------------------------------------------------------------------
  3-year requirement: annualized gross                 Not
      monthly income of borrowers        Satisfied  satisfied    Totals
------------------------------------------------------------------------
$0 to $9,999...........................
$10,000 to $19,999.....................
$20,000 to $29,999.....................
$30,000 to $39,999.....................
$40,000 to $49,999.....................
$50,000 to $74,999.....................
$75,000 or more........................
                                        --------------------------------
    Total..............................
            Acquistion Cost
$0 to $19,999..........................
$20,000 to $39,999.....................
$40,000 to $59,999.....................
$60,000 to $79,999.....................
$80,000 to $99,999.....................
$100,000 to $119,999...................
$120,000 to $149,999...................
$150,000 to $199,999...................
$200,000 or more.......................
                                        --------------------------------
    Total..............................
------------------------------------------------------------------------

    (4) Definitions and special rules. (i) For purposes of this 
paragraph the term ``annualized gross income'' means the borrower's 
gross monthly income muliplied by 12. Gross monthly income is the sum of 
monthly gross pay, any additional income from investments, pensions, 
Veterans Administration (VA) compensation, part-time employment, 
bonuses, dividends, interest, current overtime pay, net rental income, 
etc., and other income (such as alimony and child support, if the 
borrower has chosen to disclose such income). Information with respect 
to gross monthly income may be obtained from available loan documents, 
e.g., the sum of lines 23D and 23E on the Application for VA or FmHA 
Home Loan Guaranty or for HUD/FHA Insured Mortgage (VA Form 26-1802a, 
HUD 92900, Jan. 1982), or the total line from the Gross Monthly Income 
section of FHLMC Residential Loan Application form (FHLMC 65 Rev. 8/78). 
With respect to obligations issued prior to October 1, 1985, issuers may 
submit data based on annualized gross income or, instead, based on the 
adjusted income (as defined in Sec. 1.167(k)-3(b)(3)) of the 
mortgagor's family for the previous calendar year. If data is submitted 
based on adjusted income, the issuer must note this fact in the report.
    (ii) For purposes of this paragraph, the term ``reporting period'' 
means the following periods:
    (A) The period beginning January 1, 1985, and ending on September 
30, 1985,
    (B) The period beginning on October 1, 1985, and ending on June 30, 
1986, and
    (C) After June 30, 1986, each 1-year period beginning July 1 and 
ending June 30.
    (iii) See the regulations under section 103(l) for the definitions 
of the terms ``date of issue'', ``maturity'', and ``term of issue''.
    (iv) For purposes of this paragraph, verification of information 
concernig a borrower's gross monthly income with other available 
information concerning the borrower's income (e.g., Federal income tax 
returns) is not required. In determining whether a borrower acquiring a 
residence in a targeted area satisfies the 3-year requirement, the 
issuer may rely on a statement signed by the borrower.
    (5) Time for filing. (i) The report required by paragraph (k)(2)(i) 
of this section shall be filed not later than the 15th day of the second 
calendar month after the close of the calendar quarter in which the 
obligation is issued. The statement may be filed at any time before such 
date but must be complete based on facts and reasonable expectations as 
of the date of issue. The statement need not be amended to report 
information learned subsequent to the date of issue or to reflect 
changed circumstances with respect to the issuer.
    (ii) The report required by paragraph (k)(2)(ii) of this section 
(relating to use

[[Page 433]]

of proceeds) shall be filed not later than the 15th day of the second 
calendar month after the close of the reporting period, except that the 
report for the reporting period ending September 30, 1985, is due not 
later than February 15, 1986. The report may be filed at any time before 
such date but must be complete based on facts and reasonable 
expectations as of the date the report is filed. The report need not be 
amended to reflect information learned subsequent to the date the report 
is filed or to reflect changed circumstances with respect to any 
borrower.
    (iii) The Commissioner may grant an extension of time for the filing 
of a report required by paragraph (k)(2) (i) or (ii) of this section if 
there is reasonable cause for the failure to file such report in a 
timely fashion.
    (iv) An issue of qualified veterans' mortgage bonds issued after 
July 18, 1984, and prior to January 1, 1985, will be treated as 
satisfying the information reporting requirement of this paragraph if a 
Form 8038 with respect to the issue is properly filed not later than 
February 15, 1985; the report described in paragraph (k)(2)(ii) of this 
section need not be filed with respect to such issues.
    (6) Place for filing. The reports required by paragraph (k)(2) (i) 
and (ii) of this section are to be filed at the Internal Revenue Service 
Center, Philadelphia, Pennsylvania 19255.
    (l) Policy statement--(1) In general. (i) For obligations issued 
after December 31, 1984, an issue meets the requirements of this 
paragraph only if the applicable elected representative of the 
governmental unit which is the issuer (or on behalf of which the issuing 
authority is empowered to issue qualified mortgage bonds) has published 
(after a public hearing following reasonable public notice) the report 
described in paragraph (l)(3) of this section by the last day of the 
year preceding the year in which such issue is issued and a copy of such 
report has been submitted to the Commissioner on or before such last 
day. The Commissioner may grant an extension of time for publishing and 
filing the report if there is reasonable cause for the failure to 
publish or file such report in a timely fashion. The requirements of 
this paragraph will be treated as met if the issuer in good faith 
attempted to meet the policy statement requirements of this paragraph.
    (ii) With respect to reports required by paragraph (l)(1)(i) of this 
section to be published and submitted to the Commissioner not later than 
December 31, 1984, the Commissioner has determined that there is 
reasonable cause for the failure to publish or file such reports in a 
timely fashion; such a report will be considered published and filed in 
a timely fashion if, not later than March 11, 1985, the report is 
published (after a public hearing following reasonable public notice) 
and a copy is submitted to the Commissioner. In addition, any report 
submitted not later than December 31, 1984, with respect to which an 
issuer in good faith attempted to satisfy the requirements of section 
103A(j)(5) shall be treated as substantially satisfying the requirements 
of this paragraph. For example, with respect to a report submitted not 
later than December 31, 1984, an issuer shall not be treated as failing 
to satisfy the requirements of section 103A(j)(5) based on the fact that 
(A) the notice of public hearing failed to state the manner in which 
affected residents may obtain copies of the proposed report prior to the 
hearing, or (B) the proposed report was not available prior to or at the 
public hearing. With respect to reports required to be published and 
submitted to the Commissioner not later than December 31, 1986, the 
Commissioner has determined that there is a reasonable cause for the 
failure to publish and file such reports in a timely fashion; such 
reports will be considered published and filed in a timely fashion if, 
not later than December 31, 1987, the report is published (after having 
a public hearing following reasonable public notice) and a copy is 
submitted to the Commissioner.
    (2) Definitions and special rules. (i) In the case of an issuer that 
issues qualified mortgage bonds on behalf of one or more governmental 
units, a single report may be filed provided that such report is signed 
(A) by the applicable

[[Page 434]]

elected representative of each governmental unit on whose behalf 
obligations have been issued during any preceding calendar year or (B) 
by the Governor of the State in which the issuer is located.
    (ii) See notice 103(k)(2)(E) and the regulations thereunder for the 
definition of the term ``applicable elected representative''.
    (iii) In the case of qualified mortgage bonds issued by, or on 
behalf of, a governmental unit that did not reasonably expect during the 
preceding calendar year to issue (or have issued on its behalf by any 
other issuer) qualified mortgage bonds during the current calendar year, 
the requirements of this paragraph will be treated as met if the 
applicable governmental unit which is the issuer (or on behalf of which 
the issuing authority is empowered to issue qualified mortgage bonds) 
has published (after a public hearing following reasonable public 
notice) the report described in paragraph (l)(3) of this section prior 
to the issuance of any qualified mortgage bonds and a copy of such 
report has been submitted to the Commissioner prior to such issuance.
    (iv) For purposes of this paragraph a report will be considered to 
be ``published'' when the applicable elected representative of the 
governmental unit has made copies of the report available for 
distribution to the public. Reasonable public notice of the manner in 
which copies of the report may be obtained must be provided; such notice 
may be included as part of the public notice required by paragraph 
(l)(4) of this section.
    (3) Report. (i) A report is described in this paragraph (l)(3) if it 
contains the issuer's name, TIN, and the title ``Policy Report Under 
Section 103A'' stated on the cover page of the report and if it 
includes--
    (A) A statement of the policies of the issuer with respect to 
housing, development, and low-income housing assistance which such 
issuer is to follow in issuing qualified mortgage bonds and mortgage 
credit certificates, and
    (B) An assessment of the compliance of such issuer during the 1-year 
period preceding the date of the report with--
    (1) The statement of policy on qualified mortgage bonds and mortgage 
credit certificates that was set forth in the previous report, if any, 
of the issuer, and
    (2) The intent of Congress that State and local governments are 
expected to use their authority to issue qualified mortgage bonds and 
mortgage credit certificates to the greatest extent feasible (taking 
into account prevailing interest rates and conditions in the housing 
market) to assist lower income families to afford home ownership before 
assisting higher income families.
    (ii) For example, a report described in this paragraph (l)(3) may 
(but is not required to) contain--
    (A) A specific statement of the policies with respect to housing, 
development, and low-income housing assistance which the issuer is to 
follow in issuing qualified mortgage bonds and mortgage credit 
certificates, including, for example, a statement as to--
    (1) With respect to housing policies, (i) whether the proceeds will 
be used to provide financing for the acquisition of residences, to 
provide qualified home improvement loans, or to provide qualified 
rehabilitation loans; (ii) whether all or a portion of the proceeds will 
be targeted to new, existing, or any other particular class or type of 
housing; (iii) how the existence of a need or absence of a need for such 
targeting has been determined; (iv) the method by which the proceeds 
will be targeted; (v) any other pertinent information relating to the 
issuer's housing policies; and (vi) how the housing policies relate to 
the issuer's development and low-income housing assistance policies;
    (2) With respect to development policies, (i) whether all or a 
portion of the proceeds will be targeted to specific areas (including 
targeted areas as described in Sec. 6a.103A-2(b)(3)); (ii) a 
description of the areas to which the proceeds will be targeted; (iii) 
the reasons for selecting such areas; (iv) whether proceeds targeted to 
each area are to be used to finance redevelopment of existing housing or 
new construction; (v)

[[Page 435]]

any other pertinent information relating to the issuer's development 
policies; and (vi) how the development policies relate to the issuer's 
low-income housing assistance policies; and
    (3) With respect to low-income housing assistance policies, (i) 
whether all or a portion of the proceeds will be targeted to low-income 
(i.e., 80 percent of median income), moderate-income (i.e., 100 percent 
of median income), or any other class of borrowers; (ii) the method by 
which the proceeds will be targeted to such borrowers; and (iii) any 
other pertinent information relating to the issuer's low-income housing 
assistance policies;
    (B) An assessment of the compliance of the governmental unit or 
issuing authority during the twelve-month period ending with the date of 
the report with the statement of housing, development, and low-income 
housing assistance policies with respect to qualified mortgage bonds and 
mortgage credit certificates that were set forth in the report, if any, 
published in the preceding year with respect to such governmental unit, 
including, for example, a statement as to whether the governmental unit 
or issuing authority successfully implemented its policies and, if not, 
an analysis of the reasons for such failure; and
    (C) An assessment of the compliance of the governmental unit or 
issuing authority during the twelve-month period ending with the date of 
the report with the intent of Congress that State and local governments 
are expected to use their authority to issue qualified mortgage bonds 
and mortgage credit certificates to the greatest extent feasible (taking 
into account prevailing interest rates and conditions in the housing 
market) to assist lower income families to afford home ownership before 
assisting higher income families, including, for example, a description 
of (1) the method used by the governmental unit or issuing authority to 
distribute proceeds, (2) whether and how that method enabled the 
governmental unit or issuing authority to assist lower income families 
before higher income families, and (3) any income levels that have been 
defined and used by the governmental unit or issuing authority in 
connection with distribution of the proceeds (no specific definition of 
lower income and higher income is imposed on governmental units or 
issuing authorities).
    (iii) For purposes of the assessments of compliance required by 
paragraph (l)(3)(i)(B) of this section to be included in the report, the 
``date of the report'' means June 30. For purposes of the report 
required to be filed prior to January 1, 1986, an issuer need not 
perform these assessments of compliance with respect to any period prior 
to January 1, 1985.
    (iv) An issuer that fails to establish policies with respect to the 
criteria provided in paragraph (l)(3)(i) of this section will not be 
treated as failing to satisfy the requirements of this paragraph. Thus, 
for example, an issuer may state in its report that none of the proceeds 
of the issue will be targeted to specific areas. Similarly, an issuer 
that fails to successfully implement its policies will not be treated as 
failing to satisfy the requirements of this paragraph.
    (4) Public hearing. The public hearing required by paragraph (l)(1) 
of this section means a forum providing a reasonable opportunity for 
interested individuals to express their views, both orally and in 
writing, on the report that the applicable representative proposes to 
publish to satisfy the requirements of this paragraph (l). A public 
hearing held prior to January 1, 1985, will not fail to satisfy the 
requirements of this paragraph (l)(4) merely because the proposed policy 
statement was not available prior to the public hearing. In general, a 
governmental unit may select its own procedure for the hearing, provided 
that interested individuals have a reasonable opportunity to express 
their views. Thus, it may impose reasonable requirements on persons who 
wish to participate in the hearing, such as a requirement that persons 
desiring to speak at the hearing so request in writing at least 24 hours 
before the hearing or that they limit their oral remarks to 10 minutes. 
For purposes of this public hearing requirement, it is not necessary 
that the applicable elected representative who will publish the report 
be present at the hearing, that a report on the hearing be submitted to 
that official, or

[[Page 436]]

that State administrative procedural requirements for public hearings in 
general be observed. However, compliance with such State procedural 
requirements (except those at variance with a specific requirement set 
forth in this paragraph) will generally assure that the hearing 
satisfies the requirements of this paragraph. The hearing may be 
conducted by any individual appointed or employed to perform such 
function by the governmental unit, its agencies, or by the issuer. Thus, 
for example, for a report to be issued by an issuing authority that acts 
on behalf of a county, the hearing may be conducted by the issuing 
authority, the county, or an appointee or employee of either.
    (5) Reasonable public notice. (i) The reasonable public notice 
required by paragraph (l)(1) of this section means published notice 
which is reasonably designed to inform residents of the geographical 
area within the jurisdiction of the governmental unit that will publish 
the report. The notice must state the time and place for the hearing and 
contain the information required by paragraph (l)(5)(ii) of this 
section. Notice is presumed reasonable if published no fewer than 14 
days before the hearing. Notice is presumed reasonably designed to 
inform affected residents only if published in one or more newspapers of 
general circulation available to residents of that locality or if 
announced by radio or televison broadcast to those residents.
    (ii) The notice of hearing described in this paragraph (l)(5) must 
state--
    (A) The time and place for the hearing,
    (B) Any applicable limitations regarding participation in the 
hearing,
    (C) With respect to any notice of hearing published after December 
31, 1984, the manner in which affected residents may obtain copies of 
the proposed report prior to the hearing, and
    (D) With respect to any notice of hearing published after December 
31, 1984, that the hearing will involve the issuer's policies with 
respect to housing, development, and low-income housing assistance which 
the issuer is to follow in issuing qualified mortgage bonds and mortgage 
credit certificates.
    (6) Procedure for public hearings of multiple jurisdiction issuers. 
In the case of an issuer that issues qualified mortgage bonds on behalf 
of two or more governmental units (``multiple jurisdiction issuer''), 
each governmental unit on whose behalf the issuer reasonably expects to 
issue qualified mortgage bonds during the succeeding calendar year must 
hold a public hearing following reasonable public notice prior to the 
publication of the report required by this paragraph. A multiple 
jurisdiction issuer may hold a combined hearing as long as the combined 
hearing is a joint undertaking that provides all residents of the 
participating governmental units (i.e., each governmental unit on whose 
behalf qualified mortgage bonds were issued by the authority and each 
governmental unit on whose behalf the authority reasonably expects to 
issue qualified mortgage bonds during the succeeding calendar year) a 
reasonable opportunity to be heard. The location of any combined hearing 
is presumed to provide a reasonable opportunity for all affected 
residents to be heard if it is no farther than 100 miles from the seat 
of government of each participating governmental unit beyond whose 
geographic jurisdiction the hearing is conducted.
    (7) Place for filing. The report is to be filed with the Internal 
Revenue Service Center, Philadelphia, Pennsylvania 19255.
    (m) State certification requirements--(1) In general. An issue meets 
the requirements of this paragraph only if the issuer in good faith 
attempted to meet the State certification requirements of this 
paragraph. The requirements of this paragraph apply to obligations 
issued after December 31, 1984; see section 149(e) and the regulations 
thereunder with respect to obligations issued after December 31, 1986.
    (2) Certification. (i) An issue satisfied the requirements of 
section 103A(j)(4) and this paragraph (m)(2) only if the State official 
designated by law (or, if there is no State official, the Governor) 
certifies on or before the later of the date of issue or October 3, 
1985, following a request for such certification by the issuer, that, as 
of the date the certification is executed, the issue

[[Page 437]]

meets the requirements of section 103A(g) and the regulations thereunder 
(relating to volume limitation). In the case of any constitutional home 
rule city, the certification shall be made by the chief executive 
officer of the city. To the extent consistent with State and local law, 
the Governor (or the chief executive officer of any constitutional home 
rule city) may delegate the responsibility to execute the certification 
required by this paragraph.
    (ii) The certifying official need not perform an independent 
investigation in order to determine whether the issue meets the 
requirements of section 103A(g). In determining the aggregate amount of 
qualified mortgage bonds previously issued by an issuer during a 
calendar year, the certifying official may rely on copies of the reports 
submitted, to date, by the issuer pursuant to section 103A(j)(3) for 
other issues of qualified mortgage bonds issued during that year and 
copies of any elections previously made pursuant to section 25(c)(2) not 
to issue qualified mortgage bonds, together with an affidavit executed 
by an officer of the issuer responsible for issuing the bonds stating 
that the issuer has not, to date during the calendar year, issued any 
other qualified mortgage bonds, the amount, if any, of the issuer's 
market limitation that it has, to date during the calendar year, 
surrendered to other issuing authorities, and that it has not, to date 
during the calendar year, made any other elections not to issue 
qualified mortgage bonds. If, based on such information, the certifying 
official determines that, as of the date the certification is executed, 
the issue will not exceed the issuer's market limitation for the year, 
the official may certify that the issue meets the requirements of 
section 103A(g).
    (3) Special rule. If 15 days elapse after the issuer files a proper 
request for the certification described in paragraph (m)(2) of this 
section and the issuer has not received from the State official 
designated by law (or, if there is no State official, the Governor) 
certification that the issue meets the requirements of section 103A(g) 
and Sec. 6a.103A-2(g) or, in the alternative, a statement that the 
issue does not meet such requirements, the issuer may, instead, submit 
an affidavit executed by an officer of the issuer responsible for 
issuing the bonds stating that--
    (i) The issue meets the requirements of section 103(A)(g) and Sec. 
6a.103A-2(g),
    (ii) At least 15 days before the execution of the affidavit the 
issuer filed a proper request for the certification described in 
paragraph (m)(2) of this section, and
    (iii) The State official designated by law (or, if there is no State 
official, the Governor) has not provided the certification described in 
paragraph (m)(2) of this section.

In the case of obligations issued prior to October 4, 1985 the preceding 
sentence shall be applied by substituting ``30 days'' for ``15 days''. 
For purposes of this paragraph, a request for certification is proper if 
the request includes the reports and affidavits described in paragraph 
(m)(2)(ii) of this section.
    (4) Filing. The certification (or affidavit) required by this 
paragraph shall be filed with the Internal Revenue Service Center, 
Philadelphia, PA 19255. The certification (or affidavit) shall be 
submitted with the Form 8038 required to be filed by section 103A(j)(3) 
and paragraph (k) of this Sec. 1.103A-2. The Commissioner may grant an 
extension of time for filing the certification (or affidavit) if there 
is a reasonable cause for the failure to file such statement in a timely 
fashion.
    (5) Effect of certification. The fact that an issuer obtains the 
certification (or affidavit) described in this paragraph does not ensure 
that the requirements of paragraph (g) of Sec. 6a.103A-2 are met. 
Obligations that do not meet the requirements of paragraph (g) of Sec. 
6a.103A-2 are not described in section 103(a).

[T.D. 8049, 50 FR 35542, Sept. 3, 1985, as amended by T.D. 8129, 52 FR 
7410, Mar. 11, 1987]



Sec. 1.104-1  Compensation for injuries or sickness.

    (a) In general. Section 104(a) provides an exclusion from gross 
income with respect to certain amounts described in paragraphs (b), (c), 
(d) and (e) of this section, which are received for personal

[[Page 438]]

injuries or sickness, except to the extent that such amounts are 
attributable to (but not in excess of) deductions allowed under section 
213 (relating to medical, etc., expenses) for any prior taxable year. 
See section 213 and the regulations thereunder.
    (b) Amounts received under workmen's compensation acts. Section 
104(a)(1) excludes from gross income amounts which are received by an 
employee under a workmen's compensation act (such as the Longshoremen's 
and Harbor Workers' Compensation Act, 33 U.S.C., c. 18), or under a 
statute in the nature of a workmen's compensation act which provides 
compensation to employees for personal injuries or sickness incurred in 
the course of employment. Section 104(a)(1) also applies to compensation 
which is paid under a workmen's compensation act to the survivor or 
survivors of a deceased employee. However, section 104(a)(1) does not 
apply to a retirement pension or annuity to the extent that it is 
determined by reference to the employee's age or length of service, or 
the employee's prior contributions, even though the employee's 
retirement is occasioned by an occupational injury or sickness. Section 
104(a)(1) also does not apply to amounts which are received as 
compensation for a nonoccupational injury or sickness nor to amounts 
received as compensation for an occupational injury or sickness to the 
extent that they are in excess of the amount provided in the applicable 
workmen's compensation act or acts. See, however, Sec. Sec. 1.105-1 
through 1.105-5 for rules relating to exclusion of such amounts from 
gross income.
    (c) Damages received on account of personal injuries or sickness. 
Section 104(a)(2) excludes from gross income the amount of any damages 
received (whether by suit or agreement) on account of personal injuries 
or sickness. The term ``damages received (whether by suit or 
agreement)'' means an amount received (other than workmen's 
compensation) through prosecution of a legal suit or action based upon 
tort or tort type rights, or through a settlement agreement entered into 
in lieu of such prosecution.
    (d) Accident or health insurance. Section 104(a)(3) excludes from 
gross income amounts received through accident or health insurance for 
personal injuries or sickness (other than amounts received by an 
employee, to the extent that such amounts (1) are attributable to 
contributions of the employer which were not includible in the gross 
income of the employee, or (2) are paid by the employer). Similar 
treatment is also accorded to amounts received under accident or health 
plans and amounts received from sickness or disability funds. See 
section 105(e) and Sec. 1.105-5. If, therefore, an individual purchases 
a policy accident or health insurance out of his own funds, amounts 
received thereunder for personal injuries or sickness are excludable 
from his gross income under section 104(a)(3). See, however, section 213 
and the regulations thereunder as to the inclusion in gross income of 
amounts attributable to deductions allowed under section 213 for any 
prior taxable year. Section 104(a)(3) also applies to amounts received 
by an employee for personal injuries or sickness from a fund which is 
maintained exclusively by employee contributions. Conversely, if an 
employer is either the sole contributor to such a fund, or is the sole 
purchaser of a policy of accident or health insurance for his employees 
(on either a group or individual basis), the exclusion provided under 
section 104(a)(3) does not apply to any amounts received by his 
employees through such fund or insurance. If the employer and his 
employees contribute to a fund or purchase insurance which pays accident 
or health benefits to employees, section 104(a)(3) does not apply to 
amounts received thereunder by employees to the extent that such amounts 
are attributable to the employer's contributions. See Sec. 1.105-1 for 
rules relating to the determination of the amount attributable to 
employer contributions. Although amounts paid by or on behalf of an 
employer to an employee for personal injuries or sickness are not 
excludable from the employee's gross income under section 104(a)(3), 
they may be excludable therefrom under section 105. See Sec. Sec. 
1.105-1 through 1.105-5, inclusive. For treatment of accident or health 
benefits paid to or on behalf of a self- employed

[[Page 439]]

individual by a trust described in section 401(a) which is exempt under 
section 501(a) or under a plan described in section 403(a), see 
paragraph (g) of Sec. 1.72-15.
    (e) Amounts received as pensions, etc., for certain personal 
injuries or sickness. (1) Section 104(a)(4) excludes from gross income 
amounts which are received as a pension, annuity, or similar allowance 
for personal injuries or sickness resulting from active service in the 
armed forces of any country, or in the Coast and Geodetic Survey, or the 
Public Health Service. For purposes of this section, that part of the 
retired pay of a member of an armed force, computed under formula No. 1 
or 2 of 10 U.S.C. 1401, or under 10 U.S.C. 1402(d), on the basis of 
years of service, which exceeds the retired pay that he would receive if 
it were computed on the basis of percentage of disability is not 
considered as a pension, annuity, or similar allowance for personal 
injury or sickness, resulting from active service in the armed forces of 
any country, or in the Coast and Geodetic Survey, or the Public Health 
Service (see 10 U.S.C. 1403 (formerly 37 U.S.C. 272(h), section 402(h) 
of the Career Compensation Act of 1949)). See paragraph (a)(3)(i)(a) of 
Sec. 1.105-4 for the treatment of retired pay in excess of the part 
computed on the basis of percentage of disability as amounts received 
through a wage continuation plan. For the rules relating to certain 
reduced uniformed services retirement pay, see paragraph (c)(2) of Sec. 
1.122-1. For rules relating to a waiver by a member or former member of 
the uniformed services of a portion of disability retired pay in favor 
of a pension or compensation receivable under the laws administered by 
the Veterans Administration (38 U.S.C. 3105), see Sec. 1.122-1(c)(3). 
For rules relating to a reduction of the disability retired pay of a 
member or former member of the uniformed services under the Dual 
Compensation Act of 1964 (5 U.S.C. 5531) by reason of Federal 
employment, see Sec. 1.122-1(c)(4).
    (2) Section 104(a)(4) excludes from gross income amounts which are 
received by a participant in the Foreign Service Retirement and 
Disability System in a taxable year of such participant ending after 
September 8, 1960, as a disability annuity payable under the provisions 
of section 831 of the Foreign Service Act of 1946, as amended (22 U.S.C. 
1081; 60 Stat. 1021). However, if any amount is received by a survivor 
of a disabled or incapacitated participant, such amount is not excluded 
from gross income by reason of the provisions of section 104(a)(4).

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6722, 29 FR 
5070, Apr. 14, 1964; T.D. 7043, 35 FR 8477, June 2, 1970]



Sec. 1.105-1  Amounts attributable to employer contributions.

    (a) In general. Under section 105(a), amounts received by an 
employee through accident or health insurance for personal injuries or 
sickness must be included in his gross income to the extent that such 
amounts (1) are attributable to contributions of the employer which were 
not includible in the gross income of the employee, or (2) are paid by 
the employer, unless such amounts are excluded therefrom under section 
105(b), (c), or (d). For purposes of this section, the term ``amounts 
received by an employee through an accident or health plan'' refers to 
any amounts received through accident or health insurance, and also to 
any amounts which, under section 105(e), are treated as being so 
received. See Sec. 1.105-5. In determining the extent to which amounts 
received for personal injuries or sickness by an employee through an 
accident or health plan are subject to the provisions of section 105(a), 
rather than section 104(a)(3), the provisions of paragraphs (b), (c), 
(d), and (e) of this section shall apply. A self-employed individual is 
not an employee for purposes of section 105 and Sec. Sec. 1.105-1 
through 1.105-5. See paragraph (g) of Sec. 1.72-15. Thus, such an 
individual will not be treated as an employee with respect to benefits 
described in section 105 received from a plan in which he participates 
as an employee within the meaning of section 401(c)(1) at the time he, 
his spouse, or any of his dependents becomes entitled to receive such 
benefits.
    (b) Noncontributory plans. All amounts received by employees through 
an accident or health plan which is financed solely by their employer, 
either by payment of premiums

[[Page 440]]

on an accident or health insurance policy (whether on a group or 
individual basis), by contributions to a fund which pays accident or 
health benefits, or by direct payment of the benefits under the plan, 
are subject to the provisions of section 105(a), except to the extent 
that they are excludable under section 105(b), (c), or (d). This rule 
may be illustrated by the following examples:

    Example (1). Employer A maintains a plan for his employees which 
provides that he will continue to pay regular wages to employees who are 
absent from work due to sickness or personal injuries. Employees make no 
contributions to the plan and all benefits are paid by the employer. 
Amounts received by employees under the plan are subject to section 
105(a), and must be included in gross income unless excluded therefrom 
under section 105(b), (c), or (d).
    Example (2). Pursuant to a State nonoccupational disability benefits 
law, employer B maintains an accident and health plan for his employees. 
Although under the State law B is authorized to withhold from his 
employees' wages a specified amount for employee contributions to the 
State fund, in actual practice B does not so withhold and makes all 
contributions out of his own funds. All amounts received by B's 
employees from the State fund are subject to section 105(a), and must be 
included in gross income unless excluded therefrom under section 105 
(b), (c), or (d).

    (c) Contributory plans. (1) In the case of amounts received by an 
employee through an accident or health plan which is financed partially 
by his employer and partially by contributions of the employee, section 
105(a) applies to the extent that such amounts are attributable to 
contributions of the employer which were not includible in the 
employee's gross income. The portion of such amounts which is 
attributable to such contributions of the employer shall be determined 
in accordance with paragraph (d) of this section in the case of an 
insured plan, or paragraph (e) of this section in the case of a 
noninsured plan. As used in this section, the phrase ``contributions of 
the employer'' means employer contributions which were not includible in 
the gross income of the employee. See section 106 for the exclusion from 
an employee's gross income of employer contributions to accident or 
health plans.
    (2) A separate determination of the portion of the amounts received 
under the accident or health plan which is attributable to the 
contributions of the employer shall be made with respect to each class 
of employees in any case where the plan provides that some classes of 
covered employees contribute but others do not, or that the employer 
will make different contributions for different classes of employees, or 
that different classes of employees will make different contributions, 
and where in any such case both the contributions of the employer on 
account of each such class of employees and the contributions of such 
class of employees can be ascertained. For example, if employees 
contribute during the first year of employment but not thereafter, there 
will have to be a separate determination for first year employees, 
provided that the amount of the contributions of the employer on account 
of first-year employees and the contributions of such first-year 
employees can be ascertained for the required periods to apply the rules 
of paragraph (d) or (e) of this section. If in such a case the 
contributions of the employer to the plan on account of first-year 
employees are not distinguishable from his other contributions to the 
plan, then the determination shall be made for all employees under the 
plan, and such determination shall be used by all employees under the 
plan.
    (3) Except as provided in paragraph (c)(2) of Sec. 1.72-15, if the 
plan provides accident or health benefits as well as other benefits for 
the employees, and if the respective contributions made by the employer 
and the employees to provide the accident or health benefits cannot be 
ascertained, the determination of the portion of the accident or health 
benefits received under such plan which is attributable to the 
contributions of the employer shall be made in accordance with the rules 
of paragraph (d) or (e) of this section on the basis of the 
contributions of the employer and of the employees to the entire plan.
    (4) A determination of the portion attributable to the contributions 
of the employer, once made in accordance with the rules of this section, 
shall as

[[Page 441]]

to such portion be used for all purposes. For example, if an employee 
receives amounts under a wage continuation plan during the month of 
January and terminates his services during February, the portion of such 
amounts which is attributable to the contributions of the employer may 
be determined in order to provide the employee with such information at 
the time he is provided his Form W-2. The determination made for such 
purpose will also be used by the employee to report his income for his 
taxable year in which such amounts are received, without regard to the 
experience under the plan for the rest of the year.
    (d) Insured plans--(1) Individual policies. If an amount is received 
from an insurance company by an employee under an individual policy of 
accident or health insurance purchased by contributions of the employer 
and the employee, the portion of the amount received which is 
attributable to the employer's contributions shall be an amount which 
bears the same ratio to the amount received as the portion of the 
premiums paid by the employer for the current policy year bears to the 
total premiums paid by the employer and the employee for that year. This 
rule may be illustrated by the following example:

    Example. Employer A maintains a plan whereby he pays two-thirds of 
the annual premium cost on individual policies of accident and health 
insurance for his employees. The remainder of each employee's premium is 
paid by a payroll deduction from the wages of the employee. The annual 
premium for employee X is $24, of which $16 is paid by the employer. 
Thus, 16/24 or two-thirds of all amounts received by X under such 
insurance policy are attributable to the contributions of the employer 
and are subject to section 105(a), and the remaining one-third of such 
amounts is excludable from X's gross income under section 104(a)(3).

    (2) Group policies. If the accident or health coverage is provided 
under or is a part of a group insurance policy purchased by 
contributions of the employer and of the employees, and the net premiums 
for such coverage for a period of at least three policy years are known 
at the beginning of the calendar year, the portion of any amount 
received by an employee which is attributable to the contributions of 
the employer for such coverage shall be an amount which bears the same 
ratio to the amount received as the portion of the net premiums 
contributed by the employer for the last three policy years which are 
known at the beginning of the calendar year, bears to the total of the 
net premiums contributed by the employer and all employees for such 
policy years. If the net premiums for such coverage for a period of at 
least three policy years are not known at the beginning of the calendar 
year but are known for at least one policy year, such determination 
shall be made by using the net premiums for such coverage which are 
known at the beginning of the calendar year. If the net premiums for 
such coverage are not known at the beginning of the calendar year for 
even one policy year, such determination shall be made by using either 
(i) a reasonable estimate of the net premiums for the first policy year, 
or (ii) if the net premiums for a policy year are ascertained during the 
calendar year, by using such net premiums. These rules may be 
illustrated by the following example:

    Example. An employer maintains a plan under which a portion of the 
cost of a group policy of accident and health insurance for his 
employees is paid through payroll deductions from wages of the 
employees. The remainder of the cost is borne by the employer. The 
policy year begins on November 1 and ends on October 31. The net premium 
for the policy year ended October 31, 1954, is not known on January 1, 
1955, because certain retroactive premium adjustments, such as dividends 
and credits, are not determinable until after January 1. Therefore, for 
purposes of this computation the last three policy years are the policy 
years ended October 31, 1951, 1952, and 1953. The net premium for the 
policy year ended October 31, 1953, was $8,000, of which the employer 
contributed $3,000; the net premium for the policy year ended October 
31, 1952, was $9,000, of which the employer contributed $3,500; and the 
net premium for the policy year ended October 31, 1951, was $7,000, of 
which the employer contributed $1,500. The portion of any amount 
received under the policy by an employee at any time during 1955 which 
is attributable to the contributions of the employer is to be determined 
by using the ratio of $8,000 ($3,000 plus $3,500 plus $1,500) to $24,000 
($8,000 plus $9,000 plus $7,000. Thus, $8,000 / $24,000 or one-third, of 
the amounts received by an employee at any time during

[[Page 442]]

1955 is attributable to contributions of the employer.

    (e) Noninsured plans. If the accident or health benefits are a part 
of a noninsured plan to which the employer and the employees contribute, 
and such plan has been in effect for at least three years before the 
beginning of the calendar year, the portion of the amount received which 
is attributable to the employer's contributions shall be an amount which 
bears the same ratio to the amount received as the contributions of the 
employer for the period of three calendar years next preceding the year 
of receipt bear to the total contributions of the employer and all the 
employees for such period. If, at the beginning of the calendar year of 
receipt, such plan has not been in effect for three years but has been 
in effect for at least one year, such determination shall be based upon 
the contributions made during the 1-year or 2-year period during which 
the plan has been in effect. If such plan has not been in effect for one 
full year at the beginning of the calendar year of receipt, such 
determination may be based upon the portion of the year of receipt 
preceding the time when the determination is made, or such determination 
may be made periodically (such as monthly or quarterly) and used 
throughout the succeeding period. For example, if an employee terminates 
his services on April 15, 1955, and 1955 is the first year the plan has 
been in effect, such determination may be based upon the contributions 
of the employer and the employees during the period beginning with 
January 1 and ending with April 15, or during the month of March, or 
during the quarter consisting of January, February, and March.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6722, 29 FR 
5071, Apr. 14, 1964]



Sec. 1.105-2  Amounts expended for medical care.

    Section 105(b) provides an exclusion from gross income with respect 
to the amounts referred to in section 105(a) (see Sec. 1.105-1) which 
are paid, directly or indirectly, to the taxpayer to reimburse him for 
expenses incurred for the medical care (as defined in section 213(e)) of 
the taxpayer, his spouse, and his dependents (as defined in section 
152). However, the exclusion does not apply to amounts which are 
attributable to (and not in excess of) deductions allowed under section 
213 (relating to medical, etc., expenses) for any prior taxable year. 
See section 213 and the regulations thereunder. Section 105(b) applies 
only to amounts which are paid specifically to reimburse the taxpayer 
for expenses incurred by him for the prescribed medical care. Thus, 
section 105(b) does not apply to amounts which the taxpayer would be 
entitled to receive irrespective of whether or not he incurs expenses 
for medical care. For example, if under a wage continuation plan the 
taxpayer is entitled to regular wages during a period of absence from 
work due to sickness or injury, amounts received under such plan are not 
excludable from his gross income under section 105(b) even though the 
taxpayer may have incurred medical expenses during the period of 
illness. Such amounts may, however, be excludable from his gross income 
under section 105(d). See Sec. 1.105-4. If the amounts are paid to the 
taxpayer solely to reimburse him for expenses which he incurred for the 
prescribed medical care, section 105(b) is applicable even though such 
amounts are paid without proof of the amount of the actual expenses 
incurred by the taxpayer, but section 105(b) is not applicable to the 
extent that such amounts exceed the amount of the actual expenses for 
such medical care. If the taxpayer incurs an obligation for medical 
care, payment to the obligee in discharge of such obligation shall 
constitute indirect payment to the taxpayer as reimbursement for medical 
care. Similarly, payment to or on behalf of the taxpayer's spouse or 
dependents shall constitute indirect payment to the taxpayer.



Sec. 1.105-3  Payments unrelated to absence from work.

    Section 105(c) provides an exclusion from gross income with respect 
to the amounts referred to in section 105(a) to the extent that such 
amounts (a) constitute payments for the permanent

[[Page 443]]

loss or permanent loss of use of a member or function of the body, or 
the permanent disfigurement, of the taxpayer, his spouse, or a dependent 
(as defined in section 152), and (b) are computed with reference to the 
nature of the injury without regard to the period the employee is absent 
from work. Loss of use or disfigurement shall be considered permanent 
when it may reasonably be expected to continue for the life of the 
individual. For purposes of section 105(c), loss or loss of use of a 
member or function of the body includes the loss or loss of use of an 
appendage of the body, the loss of an eye, the loss of substantially all 
of the vision of an eye, and the loss of substantially all of the 
hearing in one or both ears. The term ``disfigurement'' shall be given a 
reasonable interpretation in the light of all the particular facts and 
circumstances. Section 105(c) does not apply if the amount of the 
benefits is determined by reference to the period the employee is absent 
from work. For example, if an employee is absent from work as a result 
of the loss of an arm, and under the accident and health plan 
established by his employer, he is to receive $125 a week so long as he 
is absent from work for a period not in excess of 52 weeks, section 
105(c) is not applicable to such payments. See, however, section 105(d) 
and Sec. 1.105-4. However, for purposes of section 105(c), it is 
immaterial whether an amount is paid in a lump sum or in installments. 
Section 105(c) does not apply to amounts which are treated as workmen's 
compensation under paragraph (b) of Sec. 1.104-1, or to amounts paid by 
reason of the death of the employee (see section 101).



Sec. 1.105-4  Wage continuation plans.

    (a) In general. (1) Subject to the limitations provided in this 
section, section 105(d) provides an exclusion from gross income with 
respect to amounts referred to in section 105(a) which are paid to an 
employee through a wage continuation plan and which constitute wages or 
payments in lieu of wages for a period during which the employee is 
absent from work on account of personal injuries or sickness.
    (2)(i) Section 105(d) is applicable only if the wages or payments in 
lieu of wages are paid pursuant to a wage continuation plan. (See Sec. 
1.105-6 for special rules for employees retired before January 27, 
1975). The term ``wage continuation plan'' means an accident or health 
plan, as defined in Sec. 1.105-5, under which wages, or payments in 
lieu of wages, are paid to an employee for a period during which he is 
absent from work on account of a personal injury or sickness. Such term 
includes plans under which payments are continued as long as the 
employee is absent from work on account of personal injury or sickness. 
It includes plans under which there is a limitation on the period for 
which benefits will be paid, such as 13 or 26 weeks, and also plans 
under which benefits are continued until the employee is either able to 
return to work or reaches mandatory retirement age. Such term also 
includes a plan under which wages or payments in lieu of wages are paid 
to an employee who is absent from work on account of personal injury or 
sickness, even though the plan also provides that wages or payments in 
lieu of wages may be paid to an employee who is absent from work for 
reasons other than a personal injury or sickness.
    (ii) Section 105(d) is applicable if, and only if, the employee is 
absent from work and such absence is due to a personal injury or 
sickness. Thus, if an employer has a plan for continuing the wages of 
employees when they are absent from work, regardless of the cause of the 
absence from work, section 105(d) is applicable to any payments made 
under this plan to an employee whose absence from work is in fact due to 
a personal injury or sickness. On the other hand, although the terms of 
a plan provide that benefits are to be continued only as long as the 
employee is absent from work on account of a personal injury or 
sickness, section 105(d) does not apply to payments made to an employee 
for a period of absence from work where such absence is not in fact due 
to a personal injury or sickness.
    (3)(i)(A) Section 105(d) applies only to amounts attributable to 
periods during which the employee would be at work were it not for a 
personal injury or sickness. Thus, an employee is not absent from work 
if he is not expected to

[[Page 444]]

work because, for example, he has reached mandatory retirement age. If a 
plan provides that an employee, who is absent from work on account of a 
personal injury or sickness, will receive a disability pension or 
annuity as long as he is disabled, section 105(d) is applicable to any 
payments that he receives under this plan before reaching mandatory 
retirement age, as defined in paragraph (a)(3)(i)(B) of this section. 
Thus, section 105(d) would not apply to the payments that an employee 
receives after reaching mandatory retirement age. The disability retired 
pay received by a member on the retired list pursuant to section 402 of 
the Career Compensation Act of 1949 (63 Stat. 802) or chapter 61 of 
title 10, United States Code (10 U.S.C. 1201 et seq.) which is in excess 
of the amounts excludable under section 104(a)(4) and paragraph (e) of 
Sec. 1.104-1 shall be excluded from gross income subject to the 
limitations of section 105(d) and this section, if such pay is received 
before the member reaches mandatory retirement age. See Sec. 1.72-15 
for additional rules relating to the tax treatment of disability 
pensions. For the rules relating to certain reduced uniformed services 
retirement pay, see paragraph (c)(2) of Sec. 1.122-1. For rules 
relating to a waiver by a member or former member of the uniformed 
services of a portion of disability retired pay in favor of a pension or 
compensation receivable under the laws administered by the Veterans 
Administration (38 U.S.C. 3105), see Sec. 1.122-1(c)(3).
    (B) The term ``mandatory retirement age'' as used in paragraph 
(a)(3)(i)(A) of this section means the age set by an employer for the 
mandatory retirement of employees in the class to which the taxpayer 
last belonged, unless such age has been set at an age higher than that 
at which it has been the practice of the employer to terminate, due to 
age, the services of such employees, or for purposes of tax avoidance. 
Where no age is set for mandatory retirement, such term means age 65, 
or, if higher, the age at which it has been the practice of the employer 
to terminate, due to age, the services of the class of employees to 
which the taxpayer last belonged.
    (ii) Similarly, an employee who incurs a personal injury or sickness 
during his paid vacation is not allowed to exclude under section 105(d) 
any of the vacation pay which he receives, since he is not absent from 
work on account of the personal injury or sickness. Likewise, a teacher 
who becomes sick during the summer or other vacation period when he is 
not expected to teach, is not entitled to any exclusion under section 
105(d) for the summer or vacation period. However, if an employee who 
would otherwise be at work during a particular period is absent from 
work and his absence is in fact due to a personal injury or sickness, a 
payment which he receives for such period under a wage continuation plan 
is subject to section 105(d).
    (4) A period of absence from work shall commence the moment the 
employee first becomes absent from work and shall end the moment the 
employee first returns to work. However, the exclusion provided under 
section 105(d) is applicable only to payments attributable to a period 
of absence from work which is due to a personal injury or sickness, and 
to payments attributable to a period when the employee would have been 
at work but for such personal injury or sickness.
    (5) For the purpose of section 105(d), whether an employee is absent 
from work depends upon all the circumstances. For example, an employee, 
who is a farm hand and who lives upon the premises of his employer, is 
absent from work when he is unable to work even though he remains on the 
premises of his employer. A member of the Armed Forces, who on a 
particular day has no assigned duties but to stand ready for duty, is 
absent from work if he is unable to answer any duty call that may be 
made upon him. An employee is not absent from work when he performs any 
services for his employer at his usual place or places of employment, 
whether or not the services are the usual services performed by the 
employee. Furthermore, the employee is not absent from work when he 
performs substantial services for his employer, even though they are 
performed at a place other than his usual place of employment. Thus, if 
an employee returns to his usual place or places of employment and 
performs any services for his employer, he has

[[Page 445]]

returned to work, but if he merely holds occasional short conferences 
concerning his work with other employees or clients while hospitalized 
or at home recuperating, such conferences do not constitute a return to 
work.
    (b) Determination of amount attributable to period of absence. The 
amount which is paid to an employee as wages or payments in lieu of 
wages for a period of absence from work due to a personal injury or 
sickness shall be determined by reference to the plan under which the 
amount is paid, and to the contract, statute, or regulation which 
provides the terms of the employment. However, unless the plan, 
contract, statute, or regulation provides otherwise, it will be presumed 
that no wages or plan benefits are attributable to days (or portions of 
days) which are not normal working days for the particular employee. 
Also, section 105(d) does not apply to amounts earned prior to or 
subsequent to the period of absence from work, even though received 
during such period. These rules may be illustrated by the following 
examples:

    Example (1). Employee A, who receives regular wages of $70 per week, 
normally works five days (Monday through Friday) during each week. A is 
absent from work on a Friday and the succeeding Monday (two working 
days) on account of a personal injury, but receives his regular wages 
with respect to such period of absence under his employer's accident and 
health plan. Unless the plan of A's employer, or the contract, statute, 
or regulation under which A is employed, provides otherwise, it will be 
presumed that A is not paid with respect to nonworking days (Saturday 
and Sunday). Therefore, the amount received by A with respect to his 
period of absence from work due to injury is $28, which is two days 
regular wages. If the plan, or the employment contract, statute, or 
regulation had provided that wages were paid on a 7-day per week basis 
and that A must be available for call to work on Saturday and Sunday, 
A's daily wage would have been $10, and the amount attributable to the 
period of absence would have been $40 ($10 per day for four days).
    Example (2). Employee B is a salesman who is paid on a commission 
basis. The employer purchases for B an accident and health insurance 
policy which provides that B shall receive $50 per week during any 
period (after a 7-day waiting period) that he is unable to work due to 
personal injuries or sickness. B incurs a personal injury and is 
incapacitated for two weeks. He receives $50 under the insurance policy 
with respect to the second week of absence. In addition, during the 2-
week period of absence he receives a check for $40 from his employer as 
his commission on a sale which he made before becoming incapacitated. 
Section 105(d) applies to the $50 received through the insurance policy, 
but does not apply to the $40 commission which B earned prior to the 
period of absence from work.

    (c) Limitation in the case of absence from work due to sickness for 
periods commencing prior to January 1, 1964. (1) In the case of a period 
of absence from work on account of sickness commencing prior to January 
1, 1964, the exclusion provided by section 105(d) does not apply to 
amounts attributable to the first seven calendar days of each such 
period, unless the employee is hospitalized on account of sickness for 
at least one day during the period of absence from work. This 7-day rule 
applies to each period of absence from work because of sickness, 
regardless of the frequency of such absences or the closeness in time to 
any prior period of absence from work because of sickness. For example, 
employee A becomes absent from work because of sickness on Friday, 
October 4, 1963, and returns to work on the morning of Monday, October 
14, 1963. He suffers a relapse and again becomes absent from work on the 
afternoon of Monday, October 14, 1963. A's return to work on the morning 
of Monday, October 14, 1963, terminates the first period of absence from 
work because of sickness, and a new period of absence from work because 
of sickness begins on the afternoon of Monday, October 14, 1963. The 7-
day limitation does not apply if the absence from work is due to 
personal injury. These rules may be illustrated by the following 
examples:

    Example (1). Employee C normally works five days (Monday through 
Friday) during each week. On Saturday, October 5, 1963 (a nonworking 
day), C becomes sick and as a result, he does not return to work until 
Thursday, October 17, 1963. The period of absence from work due to 
sickness commences on Monday, October 7, 1963, and terminates when C 
returns to work on Thursday, October 17, 1963. If C is not hospitalized 
during such period of absence from work, section 105(d) does not apply 
to amounts which C receives under his employer's wage continuation plan 
attributable to the 7-day period commencing Monday, October 7, 1963, and 
ending Sunday, October 13, 1963, inclusive.

[[Page 446]]

    Example (2). Employee D incurs a personal injury which causes him to 
be absent from work two days. His regular wages are continued during 
this period in accordance with the wage continuation plan of his 
employer. Since D's absence from work was due to a personal injury, 
rather than a sickness, the 7-day waiting period does not apply, and, 
subject to the other requirements of section 105(d), D is entitled to an 
exclusion with respect to the amounts received under the employer's plan 
attributable to the 2-day period of absence.

    (2) For the purpose of starting the 7-day waiting period, if the 
period of absence due to sickness commences after the start of a working 
day, the amount received with respect to the portion of such day that 
the employee is absent from work shall be considered the amount 
attributable to the first calendar day of the period of absence from 
work due to sickness. This rule may be illustrated by the following 
example:

    Example. Employee E normally works from 9 a.m. until 5:30 p.m. on 
five days (Monday through Friday) during each week. From noon on Friday, 
September 6, 1963, until noon on Monday, September 16, 1963, E is absent 
from work on account of sickness but is not hospitalized at any time 
during this period. Section 105(d) does not apply to amounts received by 
E under his employer's wage continuation plan which are attributable to 
the calendar period beginning September 6, 1963, and ending September 
12, 1963, inclusive. However, if the other requirements of section 
105(d) are met, E may exclude from gross income amounts attributable to 
the period beginning September 13, 1963, and ending at noon on September 
16, 1963, inclusive.

    (3) If the absence from work is due to sickness, the amount 
attributable to the first seven calendar days of such absence includes 
all amounts paid for such seven calendar days, regardless of the number 
of work days included in such seven calendar days. For example, if one 
of such seven calendar days an employee would have worked two 8-hour 
shifts, the amount he is paid for the two shifts is considered to be an 
amount attributable to only one calendar day.
    (4) An employee is considered to be hospitalized for one day only if 
he is admitted to and confined in a hospital as a bed patient for at 
least one hospital day. Entry into a hospital as an in-and-out patient 
does not constitute hospitalization for purposes of section 105(d). The 
same applies to mere entry into the outpatient ward or the emergency 
ward of a hospital.
    (d) Exclusion not applicable to the extent that amounts exceed a 
weekly rate of $100 for periods of absence commencing prior to January 
1, 1964--(1) In general. Amounts received under a wage continuation 
plan, attributable to periods of absence commencing before January 1, 
1964, which are not excludable from gross income as being attributable 
to contributions of the employee (see Sec. 1.105-1) must be included in 
gross income under section 105(d) to the extent that the weekly rate of 
such amounts exceeds $100. Thus, an employee, who receives $50 under his 
employer's wage continuation plan on account of his being absent from 
work for two days due to a personal injury, cannot exclude the entire 
$50 under section 105(d) if the weekly rate of such benefits exceeds 
$100. If an employee receives payments under a wage continuation plan 
for less than a full pay period, the excludability of such payments 
shall be determined under subparagraph (2) of this paragraph. In all 
other cases, the weekly rate and excludability of such payments under a 
wage continuation plan shall be determined under subparagraph (3) of 
this paragraph. If, with respect to any pay period or portion thereof, 
the employee receives amounts under two or more wage continuation plans 
(whether such plans are maintained by or for the same employer or by 
different employers), the weekly rate and excludability of amounts 
received under each plan shall be determined under subparagraph (3) of 
this paragraph and the weekly rate for purposes of section 105(d) shall 
be the sum of all such weekly rates. This rule may be illustrated by the 
following examples:

    Example (1). An employee whose weekly salary is $120 is covered by 
two wage continuation plans maintained by his employer. Plan A is a 
contributory insured plan to which the employee contributes 60 percent 
of the premiums and which provides a weekly payment of $30. Plan B is a 
salary continuation plan completely financed by the employer. Since 60 
percent of the cost of plan A is contributed by the employee, 60 percent 
of the weekly payment of $30 ($18) is excluded from gross income under 
section 104(a)(3). The remainder of each weekly payment ($12)

[[Page 447]]

is the weekly rate of plan A. Since the employer pays the entire cost of 
plan B, the weekly rate of this plan is the total amount paid per week. 
In the case of an employee whose weekly wages of $120 are continued 
under plan B, the weekly rate for the employee for purposes of section 
105(d) is $132 ($120 from plan B, plus $12 from plan A).
    Example (2). Assume in Example (1) that plan A provides a waiting 
period of four calendar days while plan B is effective immediately. For 
the first four days of absence the weekly rate for purposes of section 
105(d) is $120, and for periods after the first four days the weekly 
rate for purposes of section 105(d) is $132.

    (2) Daily exclusion. If an employee receives payments under a wage 
continuation plan for less than a full pay period, the extent to which 
such benefits are excludable under section 105(d) shall be determined by 
computing the daily rate of the benefits which can be excluded under 
section 105(d). Such daily rate is determined by dividing the weekly 
rate at which wage continuation payments are excludable ($100) by the 
number of work days in a normal work week. This rule may be illustrated 
by the following example:

    Example. Employee E is covered by a wage continuation plan 
maintained by his employer providing that E's regular salary of $220 
semimonthly will be continued in case he is absent from work on account 
of a personal injury or sickness. E is absent from work on account of a 
personal injury for three days and under the plan he received $66 as 
wage continuation payments. The extent to which the $66 is excludable 
under section 105(d) shall be determined by dividing $100 by 5, the 
number of work days in a normal work week for E, resulting in a daily 
exclusion of $20 and a total exclusion of $60.

    (3) Determination of weekly rate at which amounts are paid under a 
wage continuation plan. (i) For purposes of this subparagraph the pay 
period of a particular wage continuation plan shall be determined by 
reference to such plan. If, in the usual operation of the plan, benefits 
are paid for the same periods as regular wages, then the pay period of 
such benefits shall be the period for which a payment of wages is 
ordinarily made to the employee by the employer. If plan benefits are 
ordinarily paid for different periods than regular wages then the pay 
period of such benefits shall be the period for which payment of such 
benefits is ordinarily made.
    (ii) The weekly rate shall be determined in accordance with the 
following rules:
    (a) Weekly pay period. If benefits are paid on the basis of a weekly 
pay period, the weekly rate at which such benefits are paid shall be the 
weekly amount of such benefits.
    (b) Biweekly pay period. If benefits are paid on the basis of a 
biweekly pay period, the weekly rate at which such benefits are paid 
shall be one-half of the biweekly rate.
    (c) Semimonthly pay period. If benefits are paid on the basis of a 
semimonthly pay period, the weekly rate at which such benefits are paid 
shall be the semimonthly rate multiplied by 24 and divided by 52.
    (d) Monthly pay period. If benefits are paid on the basis of a 
monthly pay period, the weekly rate at which such benefits are paid 
shall be the monthly rate multiplied by 12 and divided by 52.
    (e) Other pay periods. If benefits are paid on the basis of a period 
other than a period described in (a) through (d), of this subdivision 
the weekly rate at which such benefits are paid shall be determined by 
ascertaining the annual rate at which such benefits are paid and 
dividing such annual rate by 52.
    (f) Examples. The operation of the rules of this subdivision may be 
illustrated by the following examples:

    Example (1). A's employer maintains a noncontributory plan which 
provides for the continuation of regular salary during periods of 
absence from work due to personal injury or sickness. A, an office 
employee, receives regular salary of $520 per month, and he is paid on 
the basis of a monthly pay period. Since benefits under the salary 
continuation plan are paid for the same periods as regular salary, the 
pay period of the plan is monthly. For purposes of section 105(d), the 
weekly rate at which benefits are paid to A under the plan is $120, 
determined as follows:

$520 (monthly rate)x12.................  $6,240 (annual rate).
$6,240/52..............................  $120 (weekly rate).
 

    Example (2). B, a factory employee of the same employer, is paid 
regular wages on the basis of a 10-day pay period. B's regular wages are 
$200 per pay period. If B is absent from work for 15 days, the weekly 
rate of the amount he receives under his employer's plan will be 
determined as follows:

365x$200/10............................  $7,300 (annual rate).
$7,300/52..............................  $140.38 (weekly rate).
 


[[Page 448]]

    (iii) If the weekly rate for purposes of section 105(d) (as 
determined in subdivision (ii) of this subparagraph) does not exceed 
$100, the amount received which is not attributable to the 7-day waiting 
period described in paragraph (c) of this section is fully excludable 
from gross income. If the weekly rate for purposes of section 105(d) (as 
determined in subdivision (ii) of this subparagraph) exceeds $100, the 
amount received which is not attributable to the 7-day waiting period 
provided in paragraph (c) of this section is only partially excludable. 
The excludable portion of such amount shall bear the same ratio to such 
amount as $100 bears to the weekly rate for purposes of section 105(d). 
This rule may be illustrated by the following example:

    Example. The weekly rate of benefits in the case of employee A in 
example (1) of subdivision (ii) of this subparagraph was $120. If A does 
not receive amounts under any other plan, this is the weekly rate for 
purposes of section 105(d). Assume that A is absent from work on account 
of a personal injury for one full month and receives full pay of $520 
for such period of absence. Since there is no waiting period 
requirement, the exclusion is $433.33 computed as follows:

$100/$120x$520 or $433.33.

    (e) Limitation in the case of absence from work on account of 
personal injury or sickness for periods commencing after December 31, 
1963. (1) In the case of periods of absence from work on account of 
sickness or personal injury commencing after December 31, 1963, the 
exclusion provided by section 105(d) does not apply to amounts 
attributable to the first 30 calendar days of each such period, if such 
amounts are at a rate which exceeds 75 percent of the employee's 
``regular weekly rate of wages'', as determined under subparagraph (5) 
of this paragraph. If the amounts are at a rate of 75 percent or less of 
the employee's ``regular weekly rate of wages'', the exclusion provided 
by section 105(d) does not apply to amounts attributable to the first 7 
calendar days of each such period, unless the employee is hospitalized 
on account of personal injury or sickness for at least one day during 
the period of absence from work. The 7- or 30-day waiting period 
(whichever is applicable) applies to each period of absence from work 
because of personal injury or sickness, regardless of the frequency of 
such absences or the closeness in time to any prior period of absence 
from work because of personal injury or sickness. The waiting period is 
to be counted by beginning with the first work day for which the 
employee was absent. These rules may be illustrated by the following 
examples:

    Example (1). Employee A is absent from work because of sickness on 
Tuesday, January 7, 1964, and returns to work on the morning of 
Thursday, February 13, 1964. He suffers a relapse and again becomes 
absent from work on the afternoon of Thursday, February 13, 1964. A's 
return to work on the morning of Thursday, February 13, 1964, terminates 
the first period of absence from work because of sickness, and a new 
period of absence from work because of sickness begins on the afternoon 
of Thursday, February 13, 1964.
    Example (2). Employee B normally works five days (Monday through 
Friday) during each week. On Saturday, January 11, 1964 (a nonworking 
day), B becomes sick or injured and as a result he does not return to 
work until Monday, February 17, 1964. The period of absence from work 
commences on Monday, January 13, 1964, and terminates when B returns to 
work on Monday, February 17, 1964. Assuming B receives amounts under his 
employer's wage continuation plan at a rate exceeding 75 percent of his 
``regular weekly rate of wages'' (as determined under subparagraph (5) 
of this paragraph), the exclusion provided by section 105(d) does not 
apply to amounts B receives under his employer's wage continuation plan 
which are attributable to the 30-day period commencing Monday, January 
13, 1964, and ending Tuesday, February 11, 1964, inclusive. If B 
receives amounts under his employer's wage continuation plan at a rate 
which is 75 percent or less of his ``regular weekly rate of wages'' and 
he is not hospitalized during the period of absence from work, the 
exclusion provided by section 105(d) does not apply to amounts B 
receives which are attributable to the 7-day period commencing Monday, 
January 13, 1964, and ending Sunday, January 19, 1964, inclusive.
    Example (3). Employee C is sick or incurs a personal injury which 
causes him to be absent from work for two weeks. He receives amounts 
under his employer's wage continuation plan at a rate which is 75 
percent or less of his ``regular weekly rate of wages'' (as determined 
under subparagraph (5) of this paragraph) and is hospitalized from the 
eighth through the eleventh day of his absence. Since C was hospitalized 
on account of personal injury or sickness for at least one day during 
the period of absence, the 7-day

[[Page 449]]

waiting period does not apply, and, subject to the other requirements of 
section 105(d), C is entitled to an exclusion with respect to the 
amounts received under his employer's plan attributable to the two- week 
period of absence. If C were receiving amounts under his employer's wage 
continuation plan at a rate exceeding 75 percent of his ``regular weekly 
rate of wages'', he would not be entitled to an exclusion under section 
105(d).

    (2) For the purpose of starting the 7- or 30-day waiting period, 
whichever is applicable, if the period of absence commences after the 
start of a working day, the amount received with respect to the portion 
of such day that the employee is absent from work shall be considered an 
amount attributable to the first calendar day of the period of absence 
from work. This rule may be illustrated by the following example:

    Example. Employee D normally works from 9 a.m. until 5:30 p.m. on 
five days (Monday through Friday) during each week. From noon on 
Wednesday, January 8, 1964, until noon on Monday, February 17, 1964, D 
is absent from work on account of personal injury or sickness but is not 
hospitalized at any time during this period. D receives amounts under 
his employer's wage continuation plan at a rate not exceeding 75 percent 
of his ``regular weekly rate of wages'' (as determined under 
subparagraph (5) of this paragraph). Section 105(d) does not apply to 
amounts received by D under his employer's wage continuation plan which 
are attributable to the calendar period beginning January 8, 1964, and 
continuing through January 14, 1964, inclusive. However, if the other 
requirements of section 105(d) are met, D may exclude from gross income 
amounts attributable to the remainder of the period of absence, ending 
at noon on Monday, February 17, 1964.

    (3) If the exclusion is subject to a 7- or 30-calendar-day waiting 
period, any amount attributable to such 7- or 30- calendar-day waiting 
period includes all amounts paid therefor, regardless of the number of 
work days included in such 7 or 30 calendar days. For example, if on one 
of the days included in the waiting period, an employee would have 
worked two 8-hour shifts, the amount he is paid for the two shifts is 
considered to be attributable to only one calendar day.
    (4) An employee is considered to be hospitalized for one day only if 
he is admitted to and confined in a hospital as a bed patient for at 
least one hospital day. Entry into a hospital as an in-and-out-patient 
does not constitute hospitalization for purposes of section 105(d). The 
same applies to mere entry into the out-patient ward or the emergency 
ward of a hospital.
    (5)(i) In general, the ``regular weekly rate of wages'', for 
purposes of section 105(d), shall be the average weekly wages paid for 
the last four weekly periods falling within a full pay period or full 
pay periods immediately preceding the commencement of the period of 
absence. If the employee was absent from work for three or more normal 
working days during any such pay period, and the amount of wages paid 
for such pay period was less than the amount of wages paid for the 
immediately preceding pay period during which the employee was not 
absent from work for three or more normal working days, then the amount 
of wages paid for the weekly period or weekly periods falling wholly or 
partly within the pay period during which each such absence occurred 
shall not be used in the determination of ``regular weekly rate of 
wages''. In such a case, there shall be substituted the amount of wages 
paid for the last weekly period or weekly periods falling within the pay 
period or pay periods immediately preceding the pay period or pay 
periods in which such absence or absences occurred during which the 
employee was not absent from work for three or more normal working days.
    (a) In order to compute wages paid for the last four weekly periods 
falling within a full pay period or full pay periods immediately 
preceding the commencement of the period of absence, or any substituted 
weekly periods therefor, it will be necessary to convert the wages paid 
for any pay period other than a weekly pay period into a weekly rate or 
weekly rates of payment of such wages in accordance with the rules 
stated in subdivision (iv) of this subparagraph. Such weekly rate or 
weekly rates of wage payments are then used in determining the wages for 
the last four weekly periods falling within a full pay period or full 
pay periods immediately preceding the commencement of the period of 
absence, or any substituted weekly periods therefor.

[[Page 450]]

    (b) If the employee does not have four weekly periods falling within 
a full pay period or full pay periods preceding his absence during which 
he was not absent from work for three or more normal working days, then 
the greatest number of available weekly periods shall be used, 
consistent with the rules set forth in this subdivision (i), in 
determining the ``regular weekly rate of wages.''
    (c) If the employee has been employed for a full pay period or more 
preceding his absence, and has worked for the number of days in a normal 
work week, but was absent from work for three or more normal working 
days during each of the pay periods preceding his absence, then the 
``regular weekly rate of wages'' shall be determined by multiplying the 
employee's actual wages paid for the total number of normal working days 
in the pay period immediately preceding the employee's absence by the 
number of days that the employee is expected to work in a normal work 
week, and by dividing the product by the number of normal work days in 
such pay period for which wages were paid.
    (d) If the employee has not been employed for a full pay period 
preceding his absence, and has worked for the number of days in a normal 
work week, the ``regular weekly rate of wages'' shall be determined by 
multiplying the employee's actual wages paid for the total number of 
normal working days preceding the employee's absence by the number of 
days that the employee is expected to work in a normal work week, and by 
dividing the product by the number of normal work days for which wages 
were paid.
    (e) If the employee has not worked the number of days in a normal 
work week, then there is no ``regular weekly rate of wages,'' and the 
employee will not be permitted an exclusion under section 105(d) for 
amounts attributable to the first 30 calendar days in the period of 
absence.
    (f) Wages paid by a former employer shall not be used in the 
determination of ``regular weekly rate of wages'' as described in this 
subparagraph.
    (ii) In the case of a wage continuation plan of an employer under 
which the benefits are computed as a specified percentage of average 
wages, the formula for computing the employee's average wages included 
in the plan may be used (in lieu of the formula provided in subdivision 
(i) of this subparagraph) for determining the ``regular weekly rate of 
wages'' for purposes of section 105(d), if under the plan--
    (a) The definition of wages does not include any items which are not 
considered ``wages'' as defined in subdivision (iii) of this 
subparagraph,
    (b) The period for computing average wages is not less than twenty-
eight successive calendar days, does not end earlier than five months 
preceding the date on which the period of absence commences, and is one 
in which the employee was at work at least 35 percent of the normal 
working time, and
    (c) The period and formula for computing average wages are applied 
uniformly with respect to all employees eligible to receive benefits 
under the plan. A plan will not fail to meet the conditions of this 
subdivision merely because different portions of the employee's wages 
are averaged over different periods for purposes of computing his 
average wages, so long as each such period meets the requirements in (b) 
and (c) of this subdivision.
    (iii) For the purpose of determining ``regular weekly rate of 
wages'' under subdivision (i) or (ii) of this subparagraph, whichever is 
applicable, an employee's wages shall comprise basic salary, fees, 
commissions, tips, gratuities, overtime, and any other type of taxable 
compensation which is normally paid for services. However, wages shall 
not include any type of compensation which is not normally paid, such as 
bonuses and incentive payments. An employee's compensation, for the 
purpose of determining his ``regular weekly rate of wages'', will not 
include any compensation which is not currently includible in gross 
income. For example, an employee's wages for the purpose of this 
subdivision shall not include deferred compensation paid by the employer 
which is not includible in gross income until received by the employee, 
such as employer contributions to a qualified annuity under section 
403(a), or employer contributions to an accident or health plan excluded 
under section 106.

[[Page 451]]

    (iv) The following rules shall be used to convert wages for pay 
periods other than weekly pay periods into weekly rates of wage payments 
to be used in determining ``regular weekly rate of wages'' as described 
in subdivision (i) of this subparagraph.
    (a) If wages are paid biweekly, the weekly rate of wage payments 
shall be one-half of the biweekly wages paid.
    (b) If the employee is paid semi-monthly, the weekly rate of wage 
payments shall be the semimonthly wages paid multiplied by 24 and 
divided by 52.
    (c) If wages are paid monthly, the weekly rate of wage payments 
shall be the monthly wages paid multiplied by 12 and divided by 52.
    (d) If wages are paid on the basis of a pay period other than a 
period described in (a) through (c) of this subdivision, the weekly rate 
of wage payments shall be determined by ascertaining the annual rate of 
wage payments and dividing by 52.
    (e) For the purpose of this subparagraph, if separate portions of an 
employee's wages are paid on the basis of different pay periods, the 
weekly rate or weekly rates of wage payments of each portion of wages 
paid with respect to each pay period shall first be determined under the 
rules set forth in (a) through (d) of this subdivision and the average 
weekly rate of each portion of wages, determined in accordance with the 
rules set forth in subdivision (i) of this subparagraph, shall be 
aggregated to determine the employee's ``regular weekly rate of wages'' 
for purposes of section 105(d).
    (v) The provisions of subdivisions (i), (iii) and (iv) of this 
subparagraph may be illustrated by the following examples:

    Example (1). Employee A is a salesman who is paid a basic salary of 
$60 per week and, in addition, is paid commissions on a weekly basis. A 
became ill and did not report for work beginning Monday, February 17, 
1964. For the four-week period preceding the commencement of the period 
of absence, A was paid the following:

------------------------------------------------------------------------
                                                                 Total
             Week of--                  Basic    Commissions    weekly
                                       salary                    wages
------------------------------------------------------------------------
Jan. 20, 1964......................         $60          $10         $70
Jan. 27, 1964......................          60           50         110
Feb. 3, 1964.......................          60           30          90
Feb. 10, 1964......................          60           40         100
                                    ------------------------------------
  Total 4-week wages...............  ..........  ...........         370
------------------------------------------------------------------------


A's wages, under the rules set forth in subdivision (iii) of this 
subparagraph, consist of basic salary plus commissions. Since the amount 
of A's average weekly wages paid for the last four weekly periods 
falling within the four pay periods immediately preceding the 
commencement of his period of absence from work is $92.50 ($370/4), such 
amount is considered as the ``regular weekly rate of wages'' (as 
computed under subdivision (i) of this subparagraph) for purposes of 
section 105(d).
    Example (2). Assume, in example (1), that A normally works five days 
during each week (Monday through Friday) and that he was also absent 
from work for any reason from Monday, February 3, 1964, through 
Wednesday, February 5, 1964. Since A was absent from work for three 
normal working days during the pay period of February 3, 1964, and was 
paid a lesser amount of wages for such pay period than in the 
immediately preceding pay period during which he was not absent from 
work (week of January 27), the weekly pay period beginning January 27, 
1964 is substituted for the weekly pay period beginning February 3, 1964 
in the determination of ``regular weekly rate of wages'' (as computed 
under subdivision (i) of this subparagraph) for purposes of section 
105(d). The ``regular weekly rate of wages'' is calculated to be $97.50, 
as follows:

------------------------------------------------------------------------
                      Week of                                Total wages
------------------------------------------------------------------------
February 10........................................    $100
January 27 (substitute for week of Feb. 3).........     110
January 27.........................................     110
January 20.........................................      70
                                                    --------
      390/4 = $97.50....................................................
------------------------------------------------------------------------

    Example (3). Employee B is a salesman who is paid a basic salary of 
$75 and, in addition, is paid commissions for semi-monthly periods 
ending on the 15th day and the last day of each month. He was absent 
from work on account of a personal injury beginning Monday, February 17, 
1964. He was paid the following amounts:

------------------------------------------------------------------------
                                                                   Total
                 Pay period                  Salary  Commissions   wages
------------------------------------------------------------------------
Feb. 1-15, 1964............................     $75        $60      $135
Jan. 16-31, 1964...........................      75         50       125
------------------------------------------------------------------------


The four weekly periods falling within full pay periods preceding the 
commencement of

[[Page 452]]

the period of absence are the weeks beginning February 9, February 2, 
January 26, and January 19. B's wages are converted to weekly rates of 
wage payments per pay period in accordance with the rule set forth in 
subdivision (iv)(b) of this subparagraph as follows:

From February 1, 1964--February 15, 1964, inclusive:
[GRAPHIC] [TIFF OMITTED] TC14NO91.170

From January 16-31, inclusive:
[GRAPHIC] [TIFF OMITTED] TC14NO91.171


$125x24 = $3000.00 (annual rate)
 
 
             $3000.00
----------------------------------
                                   =$57.69 (weekly rate)
               52E
 

The weekly rates are then used in determining the wages for four weekly 
periods falling within the pay periods immediately preceding the 
commencement of B's absence. B's ``regular weekly rate of wages'' (as 
computed under subdivision (i) of this subparagraph) is calculated to be 
$60.17, as follows:

Feb. 9-15, inclusive.............................    $62.31
February 2-8, inclusive..........................     62.31
January 26-February 1, inclusive (\6/7\x$57.69+\1/    58.35
 7\x$62.31)......................................
January 19-25, inclusive.........................     57.69
                                                  ----------
                            240.66/4 = $60.17
 

    Example (4). Employee C is paid semi-monthly on the 5th and 20th of 
each month and he began working for his present employer at the 
beginning of the semi-monthly pay period commencing Tuesday, January 21, 
1964. C received total wages of $200 for the pay period of January 21, 
1964 through February 5, 1964, inclusive. He was not absent during that 
pay period. C became sick and was absent from work beginning February 7, 
1964. Since employee C does not have four weekly periods falling within 
a full pay period or full pay periods preceding his absence, the average 
wages for the last two weekly periods falling within such full pay 
period will be C's ``regular weekly rate of wages'' (as computed under 
subdivision (i) of this subparagraph) for purposes of section 105(d), 
determined to be $92.31, as follows:

$200x24 = $4800 (annual rate)
$4800/52 = $92.31 (weekly rate)

    Example (5). Employee D, an office worker, is paid weekly and is 
expected to work five days during each week. He has been employed by his 
present employer for three weeks, but has been absent from work for 
three normal work days in each of the weeks preceding his illness. He 
became ill and was absent from work on Monday, February 17, 1964. During 
the weekly pay period immediately preceding his absence (week of 
February 10) D was paid $48 salary. He was paid for two working days 
during such weekly pay period. D's ``regular weekly rate of wages'' (as 
computed under subdivision (i) of this subparagraph), is calculated to 
be $120.00, determined as follows:
[GRAPHIC] [TIFF OMITTED] TC14NO91.172

    Example (6). Employee E is an hourly worker who is paid a salary of 
$1.25 per hour. E is paid basic salary on a biweekly basis for the 
periods beginning every other Thursday and ending every other Wednesday. 
E is also paid monthly for his overtime work and is compensated for such 
work at one and one-half times the hourly rate. E worked 16 hours of 
overtime for his employer during the month of January. E was injured and 
could not report for work on Friday, February 21, 1964. E returned to 
work on Monday, March 16, 1964. E was paid as follows for the pay 
periods indicated:

----------------------------------------------------------------------------------------------------------------
                                               Hours                      Salary per hour
           Pay period            ----------------------------------------------------------------  Total salary
                                      Regular        Overtime         Regular        Overtime
----------------------------------------------------------------------------------------------------------------
Month of January 1964...........  ..............              16  ..............          $1.875             $30
Jan. 23-Feb. 5, 1964, inclusive.              80  ..............           $1.25  ..............             100
Feb. 6-19, 1964, inclusive......              80  ..............            1.25  ..............             100
----------------------------------------------------------------------------------------------------------------


[[Page 453]]


Under the rule set forth in subdivision (iv)(e) of this subparagraph, 
the weekly rates of payment of salary and overtime must be determined 
separately. Since basic salary is paid biweekly, the weekly rate of 
payment is determined to be one-half of $100.00, or $50.00. The full pay 
period immediately preceding the commencement of E's absence for 
overtime compensation ended on January 31, 1964. E's overtime earnings 
are converted to a weekly rate for such period, as follows:
$30.00 (overtime pay)x12 = $360.00
(annual rate)
$360.00/52 = $6.93 (weekly rate)
The average wages for the last four weekly periods falling within pay 
periods immediately preceding the commencement of E's absence with 
respect to basic salary (weeks of February 13, 6, January 30, and 23) is 
$50.00. The average wages for the last four weekly periods falling 
within the pay period immediately preceding the commencement of E's 
absence with respect to overtime compensation (weeks of January 25, 18, 
11, and 4) is $6.93. Accordingly, E's ``regular weekly rate of wages'' 
(as computed under subdivision (i) of this subparagraph) for the purpose 
of section 105(d) is $56.93.

    (6)(i) Amounts paid under a wage continuation plan must be converted 
to a weekly rate in order to determine the percentage of benefits paid 
in relation to the employee's ``regular weekly rate of wages'', since 
such percentage is used in determining the waiting period, if any, after 
which an exclusion is allowable under section 105(d). In order to 
calculate the weekly rate at which benefits are being paid, reference is 
made to the particular wage continuation plan. If, in the usual 
operation of the plan, benefits are paid for the same periods as regular 
wages, then the pay period of such benefits shall be the period for 
which a payment of wages is ordinarily made to the employee by the 
employer. If plan benefits are ordinarily paid for different periods 
than regular wages, then the pay period of such benefits shall be the 
period for which payment of such benefits is ordinarily made.
    (ii) The weekly rate at which the benefits are paid under a wage 
continuation plan shall be determined in accordance with the following 
rules:
    (a) If benefits are paid on the basis of a weekly pay period, the 
weekly rate at which such benefits are paid shall be the weekly amount 
of such benefits.
    (b) If benefits are paid on the basis of a biweekly pay period, the 
weekly rate at which such benefits are paid shall be one-half of the 
biweekly rate.
    (c) If benefits are paid on the basis of a semimonthly pay period, 
the weekly rate at which such benefits are paid shall be the semimonthly 
rate multiplied by 24 and divided by 52.
    (d) If benefits are paid on the basis of a monthly pay period, the 
weekly rate at which such benefits are paid shall be the monthly rate 
multiplied by 12 and divided by 52.
    (e) If benefits are paid on the basis of a period other than a 
period described in (a) through (d) of this subdivision the weekly rate 
at which such benefits are paid shall be determined by ascertaining the 
annual rate at which such benefits are paid and dividing such annual 
rate by 52.
    (iii) The principles of subdivisions (i) and (ii) of this 
subparagraph may be illustrated by the following example:

    Example. A's employer maintains a noncontributory plan which 
provides for a monthly benefit of $400 during periods of absence from 
work due to personal injury or sickness. A, a salesman, receives regular 
salary of $520 per calendar month plus commissions, depending upon the 
amount of sales made by A during the month. During the month of January 
1964, A was paid commissions of $180. A received a total benefit of $200 
for an absence of two weeks because of illness occurring in February 
1964. He was not hospitalized. Since benefits under the salary 
continuation plan are paid for the same period as regular wages, the pay 
period of the plan is monthly. A's ``regular weekly rate of wages'', 
determined in accordance with the rules set forth in subparagraph (5)(i) 
of this paragraph is $161.54. ($700x12)/52.

For purposes of determining the percentage of benefits paid in relation 
to A's ``regular weekly rate of wages'', the weekly rate of the benefits 
are calculated to be $92.31, as follows:

$400 (monthly rate)x12 = $4,800 (annual rate)
$4,800/52 = $92.31 (weekly rate)
Since $92.31 does not exceed 75 percent of A's ``regular weekly rate of 
wages'', A is entitled to an exclusion under section 105(d) for the 
second week of absence, subject to the other limitations provided in 
this section.

    (iv) For the purpose of determining whether or not the rate of 
benefits paid under a wage continuation plan for a period of absence 
exceeds 75 percent of the employee's ``regular weekly rate of

[[Page 454]]

wages'' (as determined under subparagraph (5) of this paragraph), it is 
necessary to ascertain the average percentage of benefits paid in 
relation to the employee's ``regular weekly rate of wages'' for the 
first 30 calendar days in the period of absence. Such percentage is 
derived from a fraction, the numerator of which is the sum of benefits 
paid (attributable to employer contributions) for the period of absence 
occurring within the first 30 calendar days, and the denominator of 
which is the collective sum of the employee's ``regular weekly rate of 
wages'' during such period. This rule may be illustrated by the 
following examples:

    Example (1). Employee A is paid a semi-monthly basic salary of $150 
plus commissions. He normally works five days during each week (Monday 
through Friday). During the month of January 1964, A received wages of 
$150 plus commissions of $66.67 for each of the semimonthly pay periods. 
A became ill on Monday, February 3, 1964, and as a result was absent 
from work until Monday, February 17, 1964, but was not hospitalized. 
Under the noncontributory wage continuation plan of A's employer, A 
received no benefits for the first three working days' absence (Monday 
through Wednesday) and was paid benefits at the rate of $100 a week 
thereafter. A's ``regular weekly rate of wages,'' determined under the 
rules set forth in subparagraph (5) of this paragraph, is $100. A is 
considered to have received average benefits at a rate of 70 percent of 
his ``regular weekly rate of wages'', computed as follows:

------------------------------------------------------------------------
                       (1)                            (2)         (3)
------------------------------------------------------------------------
                                                                Regular
                                                   Benefits     weekly
                 Week of absence                     paid       rate of
                                                                 wages
------------------------------------------------------------------------
1-Feb. 3........................................         $40        $100
2-Feb. 10.......................................         100         100
                                                 -----------------------
  Total.........................................         140         200
------------------------------------------------------------------------


Average percentage of benefits paid--140/200 = 70%. Accordingly, A may 
exclude amounts attributable to the second week of absence, subject to 
the other limitations of section 105(d).
    Example (2). Assume, in example (1), that A did not return to work 
until Thursday, February 20, 1964. A is considered to have received 
average benefits at the rate of 76.92 percent of his ``regular weekly 
rate of wages'', computed as follows:

------------------------------------------------------------------------
                       (1)                            (2)         (3)
------------------------------------------------------------------------
                                                                Regular
                                                   Benefits     weekly
                 Week of absence                     paid       rate of
                                                                 wages
------------------------------------------------------------------------
1-Feb. 3........................................         $40        $100
2-Feb. 10.......................................         100         100
2\3/5\--Feb. 17.................................      \1\ 60      \1\ 60
                                                 -----------------------
  Total.........................................         200         260
------------------------------------------------------------------------
\1\ Three-fifths of 100.


Average percentage of benefits paid--200/260 = 76.92%. Accordingly, A 
would not be permitted any exclusion under section 105(d).

    (v) If with respect to any pay period or portion thereof the 
employee receives amounts under two or more wage continuation plans 
(whether such plans are maintained by or for the same employers or by 
different employers), the weekly rate for purposes of section 105(d) 
shall be the sum of the weekly rates received under all plans. This rule 
may be illustrated by the following example:

    Example. An employee who is absent because of personal injuries or 
sickness receives $100 biweekly under wage continuation plan A 
maintained by his employer. He contributes one-half of the premiums for 
maintenance of the plan. Under wage continuation plan B maintained by 
his employer the employee receives $400 monthly. Plan B is 
noncontributory. The weekly rate at which benefits are paid for the 
purpose of section 105(d) is computed as follows:

                                      $100
Plan A--                        ----------     = $50.00  (weekly rate)
                                         2        25.00  (less amount
                                                          attributable
                                                          to employee
                                                          con-
                                                          tributions (\1/
                                                          2\))
                               ...........   ----------
                               ...........        25.00  (weekly rate of
                                                          Plan A)
                                   $400x12  ...........
Plan B--                        ----------      = 92.31  (weekly rate of
                                                          Plan B)
                                        52      $117.31  (combined
                                                          weekly rate at
                                                          which benefits
                                                          are paid)
------------------------------------------------------------------------
------------------------------------------------------------------------


The $25 attributable to contributions made by the employee under Plan A 
would be subject to section 104(a)(3).

    (f) Amount of exclusion for periods of absence commencing after 
December 31, 1963--(1) In general. Amounts received

[[Page 455]]

under a wage continuation plan attributable to periods of absence 
commencing after December 31, 1963, and which are not excludable from 
gross income as being attributable to contributions of the employee (see 
Sec. 1.105-1) are excludable from gross income of the employee to the 
extent that such amounts do not exceed--
    (i) A weekly rate of $75, during the first 30 calendar days in the 
period of absence; and
    (ii) A weekly rate of $100, after the first 30 calendar days in the 
period of absence.

For example, an employee who normally works five days during each week 
is absent from work for two days, is hospitalized during his absence, 
and receives $75 under his employer's wage continuation plan, which 
amount is at a rate of 75 percent of his ``regular weekly rate of 
wages''. The employee cannot exclude the entire $75 under section 
105(d), if the weekly rate of such benefits exceeds $75.
    (2) Daily exclusion. An employee receiving payments under a wage 
continuation plan must, in order to determine the amount of the 
exclusion under section 105(d), compute the daily rate of the benefits. 
Such daily rate is determined, for amounts attributable to the first 30 
calendar days in the period of absence, by dividing the weekly rate at 
which benefits are paid (as determined under paragraph (e)(6)(ii) of 
this section), or the maximum weekly rate at which wage continuation 
payments are excludable ($75), whichever is lower, by the number of work 
days in a normal work week. In the case of amounts attributable to days 
in a period of absence after the first 30 calendar days, the daily rate 
for such period is determined by dividing the weekly rate at which 
benefits are paid (as determined under paragraph (e)(6)(ii) of this 
section), or the maximum weekly rate at which wage continuation payments 
are excludable ($100), whichever is lower, by the number of work days in 
a normal work week. The daily rate or daily rates of exclusion are then 
multiplied by the number of normal work days in the period of absence 
for which an exclusion is allowable in order to determine the total 
allowable exclusion. These rules may be illustrated by the following 
examples:

    Example (1). Employee A is a salesman receiving salary and 
commissions on a weekly basis. His employer maintains a noncontributory 
wage continuation plan which provides for the continuation of A's basic 
salary of $80 per week during periods of absence. A was absent from work 
on account of sickness from Monday, February 3, 1964, through Sunday, 
March 15, 1964, but was not hospitalized. His normal work week is from 
Monday through Friday. The weekly amount of benefits paid to A ($80) 
does not exceed 75 percent of his ``regular weekly rate of wages'' as 
defined in paragraph (e)(5) of this section. Under section 105(d), the 
daily rate of exclusion for amounts attributable to the first 30 
calendar days in the period of absence, excluding the first 7 days 
thereof (Monday, February 10, 1964, through Tuesday, March 3, 1964, 
inclusive) is limited to $15 ($75, maximum weekly rate of exclusion 
divided by 5 (number of normal work days in week)). The daily rate of 
exclusion for amounts attributable to the period of absence in excess of 
30 calendar days (Wednesday, March 4, 1964, through Sunday, March 15, 
1964, inclusive) is limited to $16 ($80, weekly rate of benefits divided 
by 5). Thus, the total exclusion permitted to employee A by section 
105(d) is $383.00 ($15 x 17 work days ($255) + $16 x 8 work days 
($128)).
    Example (2). Assume the facts in example (1) except that A is paid 
benefits at the rate of $500 a month during periods of absence. The 
weekly rate of the benefits computed under the rules stated in paragraph 
(e)(6)(ii) of this section is $115.38, which amount does not exceed 75 
percent of his ``regular weekly rate of wages'' as defined in paragraph 
(e)(5) of this section. Under section 105(d), the daily rate of 
exclusion for amounts attributable to the first 30 calendar days in the 
period of absence, excluding the first 7 days thereof (Monday, February 
10, 1964, through Tuesday, March 3, 1964, inclusive) is limited to $15 
($75, maximum weekly rate of exclusion divided by 5). The daily rate of 
exclusion for amounts attributable to the period of absence in excess of 
30 calendar days (Wednesday, March 4, 1964, through Sunday, March 15, 
1964, inclusive) is limited to $20 ($100, maximum weekly rate of 
exclusion divided by 5). Thus, the total exclusion permitted to employee 
A by section 105(d) is $415.00 ($15 x 17 work days ($255) + $20 x 8 work 
days ($160)).
    Example (3). Employee B, an office worker works five days during 
each week (Monday through Friday) and receives a salary of $85 per week. 
His employer maintains a noncontributory wage continuation plan which 
provides for no benefits during the first three days of absence, the 
continuation of full salary for one week thereafter and benefits at

[[Page 456]]

the rate of $65 per week thereafter. B was absent from work on account 
of sickness from Monday, March 16, 1964, through Tuesday, March 31, 
1964, and was hospitalized from Wednesday, March 18, through Tuesday, 
March 24. B received total benefits of $137 for the period of absence, 
which does not exceed 75 percent of his ``regular weekly rate of wages'' 
as determined under paragraph (e)(5) of this section. B is permitted an 
exclusion under section 105(d) of $127 calculated as follows:

----------------------------------------------------------------------------------------------------------------
                                                  Maximum weekly                      Days of
        Period of absence         Weekly rate of      rate of      Daily rate of    absence in        Maximum
                                     benefits        exclusion       exclusion        period         exclusion
----------------------------------------------------------------------------------------------------------------
Mar. 16-18......................               0             $75               0               3               0
Mar. 19-25......................             $85              75             $15               5             $75
Mar. 26-31......................              65              75              13               4              52
                                 -------------------------------------------------------------------------------
  Total exclusion...............  ..............  ..............  ..............  ..............            $127
----------------------------------------------------------------------------------------------------------------

    (g) Definitions. The term ``personal injury'' as used in this 
section, means an externally caused sudden hurt or damage to the body 
brought about by an identifiable event. The term ``sickness'' as used in 
this section, means mental illnesses and all bodily infirmities and 
disorders other than ``personal injuries''. Diseases, whether resulting 
from the occupation or otherwise, are not considered personal injuries, 
but they are treated as a sickness.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6770, 29 FR 
15366, Nov. 17, 1964; T.D. 7352, 40 FR 16666, Apr. 14, 1975]



Sec. 1.105-5  Accident and health plans.

    (a) In general. Sections 104(a)(3) and 105 (b), (c), and (d) exclude 
from gross income certain amounts received through accident or health 
insurance. Section 105(e) provides that for purposes of sections 104 and 
105 amounts received through an accident or health plan for employees, 
and amounts received from a sickness and disability fund for employees 
maintained under the law of a State, a Territory, or the District of 
Columbia, shall be treated as amounts received through accident or 
health insurance. In general, an accident or health plan is an 
arrangement for the payment of amounts to employees in the event of 
personal injuries or sickness. A plan may cover one or more employees, 
and there may be different plans for different employees or classes of 
employees. An accident or health plan may be either insured or 
noninsured, and it is not necessary that the plan be in writing or that 
the employee's rights to benefits under the plan be enforceable. 
However, if the employee's rights are not enforceable, an amount will be 
deemed to be received under a plan only if, on the date the employee 
became sick or injured, the employee was covered by a plan (or a 
program, policy, or custom having the effect of a plan) providing for 
the payment of amounts to the employee in the event of personal injuries 
or sickness, and notice or knowledge of such plan was reasonably 
available to the employee. It is immaterial who makes payment of the 
benefits provided by the plan. For example, payment may be made by the 
employer, a welfare fund, a State sickness or disability benefits fund, 
an association of employers or employees, or by an insurance company.
    (b) Self-employed individuals. Under section 105(g), a self-employed 
individual is not treated as an employee for purposes of section 105. 
Therefore, for example, benefits paid under an accident or health plan 
as referred to in section 105(e) to or on behalf of an individual who is 
self-employed in the business with respect to which the plan is 
established will not be treated as received through accident and health 
insurance for purposes of sections 104(a)(3) and 105.

[T.D. 6722, 29 FR 5071, Apr. 14, 1964]



Sec. 1.105-6  Special rules for employees retired before January 27, 
1975.

    (a) Application of section 105(d) to amounts received as retirement 
annuities. An employee who retired from work before January 27, 1975, 
receiving payments under his employer-established plan (to which Sec. 
1.72-15(a) applies) which payments were not treated as

[[Page 457]]

amounts received under a wage continuation plan for purposes of section 
105(d), may, as of the date the employee retired, treat such plan as 
such a wage continuation plan to the extent such payments are received 
prior to mandatory retirement age (as described in Sec. 1.105-
4(a)(3)(i)(B)), if--
    (1) His employer had in operation at the time of his retirement a 
program providing accident and health benefits under a wage continuation 
plan to which section 105(d) would apply;
    (2) The employer certifies, under procedures approved in advance 
under paragraph (c) of this section, that the employee would have been 
eligible for wage continuation benefits, under the terms and conditions 
of his employer's plan, because of personal injuries or sickness;
    (3) At the time of the employee's retirement there was no 
substantive difference between the benefits being actually received and 
the benefits he would have received had he retired under his employer's 
wage continuation plan; and
    (4) The employee agrees to the adjustments and conditions required 
by the Commissioner with respect to amounts excluded under section 72 
(b) or (d) in taxable years ending before January 27, 1975.
    (b) Filing requirements. (1) The certification required in paragraph 
(a)(2) and the agreement required in paragraph (a)(4) of this section 
shall be filed on or before April 15, 1977, with the return, or timely 
amended return or claim, made for the taxable year in which the employee 
reached retirement age as described in Sec. 1.79-2(b)(3), or, for the 
first taxable year for which the taxpayer files an income tax return 
claiming an exclusion under section 105(d), as provided in paragraph (a) 
of this section.
    (2) The Commissioner may prescribe a form and instructions with 
respect to the agreement provided for in paragraph (a)(4) of this 
section.
    (c) Employer certification--(1) Advance approval of procedures. Any 
reasonable and consistently applied procedures, approved in advance by 
the Internal Revenue Service, which require the employee to provide the 
employer or the insurer with medical documentation sufficient to show 
that an illness or disability existed as of the date of the employee's 
retirement, which would have entitled him to retire on account of 
personal injuries or sickness alone, are sufficient for purposes of this 
paragraph.
    (2) Place of submission. Request for advance approval of procedures 
for certification shall be submitted to the district director.
    (d) Cross reference. For special rules pertaining to taxpayers 
retired on disability before January 27, 1975, see Sec. 1.72-15(i).

[T.D. 7352, 40 FR 16666, Apr. 14, 1975]



Sec. 1.105-11  Self-insured medical reimbursement plan.

    (a) In general. Under section 105(a), amounts received by an 
employee through a self-insured medical reimbursement plan which are 
attributable to contributions of the employer, or are paid by the 
employer, are included in the employee's gross income unless such 
amounts are excludable under section 105(b). For amounts reimbursed to a 
highly compensated individual to be fully excludable from such 
individual's gross income under section 105(b), the plan must satisfy 
the requirements of section 105(h) and this section. Section 105(h) is 
not satisfied if the plan discriminates in favor of highly compensated 
individuals as to eligibility to participate or benefits. All or a 
portion of the reimbursements or payments on behalf of such individuals 
under a discriminatory plan are not excludable from gross income under 
section 105(b). However, benefits paid to participants who are not 
highly compensated individuals may be excluded from gross income if the 
requirements of section 105(b) are satisfied, even if the plan is 
discriminatory.
    (b) Self-insured medical reimbursement plan--(1) General rule--(i) 
Definition. A self-insured medical reimbursement plan is a separate 
written plan for the benefit of employees which provides for 
reimbursement of employee medical expenses referred to in section 
105(b). A plan or arrangement is self-insured unless reimbursement is 
provided under an individual or group policy of accident or health 
insurance issued by a licensed insurance company or under an arrangement 
in the nature of a prepaid

[[Page 458]]

health care plan that is regulated under federal or state law in a 
manner similar to the regulation of insurance companies. Thus, for 
example, a plan of a health maintenance organization, established under 
the Health Maintenance Organization Act of 1973, would qualify as a 
prepaid health care plan. In addition, this section applies to a self-
insured medical reimbursement plan, determined in accordance with the 
rules of this section, maintained by an employee organization described 
in section 501(c)(9).
    (ii) Shifting of risk. A plan underwritten by a policy of insurance 
or a prepaid health care plan that does not involve the shifting of risk 
to an unrelated third party is considered self-insured for purposes of 
this section. Accordingly, a cost-plus policy or a policy which in 
effect merely provides administrative or bookkeeping services is 
considered self-insured for purposes of this section. However, a plan is 
not considered self-insured merely because one factor the insurer uses 
in determining the premium is the employer's prior claims experience.
    (iii) Captive insurance company. A plan underwritten by a policy of 
insurance issued by a captive insurance company is not considered self-
insured for purposes of this section if for the plan year the premiums 
paid by companies unrelated to the captive insurance company equal or 
exceed 50 percent of the total premiums received and the policy of 
insurance is similar to policies sold to such unrelated companies.
    (2) Other rules. The rules of this section apply to a self-insured 
portion of an employer's medical plan or arrangement even if the plan is 
in part underwritten by insurance. For example, if an employer's medical 
plan reimburses employees for benefits not covered under the insured 
portion of an overall plan, or for deductible amounts under the insured 
portions, such reimbursement is subject to the rules of this section. 
However, a plan which reimburses employees for premiums paid under an 
insured plan is not subject to this section. In addition, medical 
expense reimbursements not described in the plan are not paid pursuant 
to a plan for the benefit of employees, and therefore are not excludable 
from gross income under section 105(b). Such reimbursements will not 
affect the determination of whether or not a plan is discriminatory.
    (c) Prohibited discrimination--(1) In general. A self-insured 
medical reimbursement plan does not satisfy the requirements of section 
105(h) and this paragraph for a plan year unless the plan satisfies 
subparagraphs (2) and (3) of this paragraph. However, a plan does not 
fail to satisfy the requirements of this paragraph merely because 
benefits under the plan are offset by benefits paid under a self-insured 
or insured plan of the employer or another employer, or by benefits paid 
under Medicare or other Federal or State law or similar foreign law. A 
self-insured plan may take into account the benefits provided under 
another plan only to the extent that the type of benefit subject to 
reimbursement is the same under both plans. For example, an amount 
reimbursed to an employee for a hospital expense under a medical plan 
maintained by the employer of the employee's spouse may be offset 
against the self-insured benefit where the self-insured plan covering 
the employee provides the same type of hospital benefit.
    (2) Eligibility to participate--(i) Percentage test. A plan 
satisfies the requirements of this subparagraph if it benefits--
    (A) Seventy percent or more of all employees, or
    (B) Eighty percent or more of all the employees who are eligible to 
benefit under the plan if 70 percent or more of all employees are 
eligible to benefit under the plan.
    (ii) Classification test. A plan satisfies the requirements of this 
subparagraph if it benefits such employees as qualify under a 
classification of employees set up by the employer which is found by the 
Internal Revenue Service not to be discriminatory in favor of highly 
compensated individuals. In general, this determination will be made 
based upon the facts and circumstances of each case, applying the same 
standards as are applied under section 410(b)(1)(B) (relating to 
qualified pension, profit-

[[Page 459]]

sharing and stock bonus plans), without regard to the special rules in 
section 401(a)(5) concerning eligibility to participate.
    (iii) Exclusion of certain employees. Under section 105(h)(3), for 
purposes of this subparagraph (2), there may be excluded from 
consideration:
    (A) Employees who have not completed 3 years of service prior to the 
beginning of the plan year. For purposes of this section years of 
service may be determined by any method that is reasonable and 
consistent. A determination made in the same manner as (and not 
requiring service in excess of how) a year of service is determined 
under section 410(a)(3) shall be deemed to be reasonable. For purposes 
of the 3-year rule, all of an employee's years of service with the 
employer prior to a separation from service are not taken into account. 
For purposes of the 3-year rule, an employee's years of service prior to 
age 25, as a part-time or seasonal employee, as a member of a collective 
bargaining unit, or as a nonresident alien, as each is described in this 
subdivision, are not excluded by reason of being so described from 
counting towards satisfaction of the rule. In addition, if the employer 
is a predecessor employer (determined in a manner consistent with 
section 414(a)), service for such predecessor is treated as service for 
the employer.
    (B) Employees who have not attained age 25 prior to the beginning of 
the plan year.
    (C) Part-time employees whose customary weekly employment is less 
than 35 hours, if other employees in similar work with the same employer 
(or, if no employees of the employer are in similar work, in similar 
work in the same industry and location) have substantially more hours, 
and seasonal employees whose customary annual employment is less than 9 
months, if other employees in similar work with the same employer (or, 
if no employees of the employer are in similar work, in similar work in 
the same industry and location) have substantially more months. 
Notwithstanding the preceding sentence, any employee whose customary 
weekly employment is less than 25 hours or any employee whose customary 
annual employment is less than 7 months may be considered as a part-time 
or seasonal employee.
    (D) Employees who are included in a unit of employees covered by an 
agreement between employee representatives and one or more employers 
which the Commissioner finds to be a collective bargaining agreement, if 
accident and health benefits were the subject of good faith bargaining 
between such employee representatives and such employer or employers. 
For purposes of determining whether such bargaining occurred, it is not 
material that such employees are not covered by another medical plan or 
that the plan was not considered in such bargaining.
    (E) Employees who are nonresident aliens and who receive no earned 
income (within the meaning of section 911(b) and the regulations 
thereunder) from the employer which constitutes income from sources 
within the United States (within the meaning of section 861(a)(3) and 
the regulations thereunder).
    (3) Nondiscriminatory benefits--(i) In general. In general, benefits 
subject to reimbursement under a plan must not discriminate in favor of 
highly compensated individuals. Plan benefits will not satisfy the 
requirements of this subparagraph unless all the benefits provided for 
participants who are highly compensated individuals are provided for all 
other participants. In addition, all the benefits available for the 
dependents of employees who are highly compensated individuals must also 
be available on the same basis for the dependents of all other employees 
who are participants. A plan that provides optional benefits to 
participants will be treated as providing a single benefit with respect 
to the benefits covered by the option provided that (A) all eligible 
participants may elect any of the benefits covered by the option and (B) 
there are either no required employee contributions or the required 
employee contributions are the same amount. This test is applied to the 
benefits subject to reimbursement under the plan rather than the actual 
benefit payments or claims under the plan. The presence or absence of 
such discrimination will be determined by considering

[[Page 460]]

the type of benefit subject to reimbursement provided highly compensated 
individuals, as well as the amount of the benefit subject to 
reimbursement. A plan may establish a maximum limit for the amount of 
reimbursement which may be paid a participant for any single benefit, or 
combination of benefits. However, any maximum limit attributable to 
employer contributions must be uniform for all participants and for all 
dependents of employees who are participants and may not be modified by 
reason of a participant's age or years of service. In addition, if a 
plan covers employees who are highly compensated individuals, and the 
type or the amount of benefits subject to reimbursement under the plan 
are in proportion to employee compensation, the plan discriminates as to 
benefits.
    (ii) Discriminatory operation. Not only must a plan not discriminate 
on its face in providing benefits in favor of highly compensated 
individuals, the plan also must not discriminate in favor of such 
employees in actual operation. The determination of whether plan 
benefits discriminate in operation in favor of highly compensated 
individuals is made on the basis of the facts and circumstances of each 
case. A plan is not considered discriminatory merely because highly 
compensated individuals participating in the plan utilize a broad range 
of plan benefits to a greater extent than do other employees 
participating in the plan. In addition, if a plan (or a particular 
benefit provided by a plan) is terminated, the termination would cause 
the plan benefits to be discriminatory if the duration of the plan (or 
benefit) has the effect of discriminating in favor of highly compensated 
individuals. Accordingly, the prohibited discrimination may occur where 
the duration of a particular benefit coincides with the period during 
which a highly compensated individual utilizes the benefit.
    (iii) Retired employees. To the extent that an employer provides 
benefits under a self-insured medical reimbursement plan to a retired 
employee that would otherwise be excludible from gross income under 
section 105(b), determined without regard to section 105(h), such 
benefits shall not be considered a discriminatory benefit under this 
paragraph (c). The preceding sentence shall not apply to a retired 
employee who was a highly compensated individual unless the type, and 
the dollar limitations, of benefits provided retired employees who were 
highly compensated individuals are the same for all other retired 
participants. If this subdivision applies to a retired participant, that 
individual is not considered an employee for purposes of determining the 
highest paid 25 percent of all employees under paragraph (d) of this 
section solely by reason of receiving such plan benefits.
    (4) Multiple plans, etc.--(i) General rule. An employer may 
designate two or more plans as constituting a single plan that is 
intended to satisfy the requirements of section 105(h)(2) and paragraph 
(c) of this section, in which case all plans so designated shall be 
considered as a single plan in determining whether the requirements of 
such section are satisfied by each of the separate plans. A 
determination that the combination of plans so designated does not 
satisfy such requirements does not preclude a determination that one or 
more of such plans, considered separately, satisfies such requirements. 
A single plan document may be utilized by an employer for two or more 
separate plans provided that the employer designates the plans that are 
to be considered separately and the applicable provisions of each 
separate plan.
    (ii) Other rules. If the designated combined plan discriminates as 
to eligibility to participate or benefits, the amount of excess 
reimbursement will be determined under the rules of section 105(h)(7) 
and paragraph (e) of this section by taking into account all 
reimbursements made under the combined plan.
    (iii) H.M.O. participants. For purposes of section 105(h)(2)(A) and 
paragraph (c)(2) of this section, a self-insured plan will be deemed to 
benefit an employee who has enrolled in a health maintenance 
organization (HMO) that is offered on an optional basis by the employer 
in lieu of coverage under the self-insured plan if, with respect to

[[Page 461]]

that employee, the employer's contributions to the HMO plan equal or 
exceed those that would be made to the self-insured plan, and if the HMO 
plan is designated in accordance with subdivision (i) with the self-
insured plan as a single plan. For purposes of section 105(h) and this 
section, except as provided in the preceding sentence, employees covered 
by, and benefits under, the HMO plan are not treated as part of the 
self-insured plan.
    (d) Highly compensated individuals defined. For purposes of section 
105(h) and this section, the term ``highly compensated individual'' 
means an individual who is--
    (1) One of the 5 highest paid officers,
    (2) A shareholder who owns (with the application of section 318) 
more than 10 percent in value of the stock of the employer, or
    (3) Among the highest paid 25 percent of all employees (including 
the 5 highest paid officers, but not including employees excludable 
under paragraph (c)(2)(iii) of this section who are not participants in 
any self-insured medical reimbursement plan of the employer, whether or 
not designated as a single plan under paragraph (c)(4) of this section, 
or in a health maintenance organization plan).

The status of an employee as an officer or stockholder is determined 
with respect to a particular benefit on the basis of the employee's 
officer status or stock ownership at the time during the plan year at 
which the benefit is provided. In calculating the highest paid 25 
percent of all employees, the number of employees included will be 
rounded to the next highest number. For example, if there are 5 
employees, the top two are in the highest paid 25 percent. The level of 
an employee's compensation is determined on the basis of the employee's 
compensation for the plan year. For purposes of the preceding sentence, 
fiscal year plans may determine employee compensation on the basis of 
the calendar year ending within the plan year.
    (e) Excess reimbursement of highly compensated individual--(1) In 
general. For purposes of section 105(h) and this section, a 
reimbursement paid to a highly compensated individual is an excess 
reimbursement if it is paid pursuant to a plan that fails to satisfy the 
requirements of paragraph (c)(2) or (c)(3) for the plan year. The amount 
reimbursed to a highly compensated individual which constitutes an 
excess reimbursement is not excludable from such individual's gross 
income under section 105(b).
    (2) Discriminatory benefit. In the case of a benefit available to 
highly compensated individuals but not to all other participants (or 
which otherwise discriminates in favor of highly compensated individuals 
as opposed to other participants), the amount of excess reimbursement 
equals the total amount reimbursed to the highly compensated individual 
with respect to the benefit.
    (3) Discriminatory coverage. In the case of benefits (other than 
discriminatory benefits described in subparagraph (2)) paid to a highly 
compensated individual under a plan which fails to satisfy the 
requirements of paragraph (c)(2) relating to nondiscrimination in 
eligibility to participate, the amount of excess reimbursement is 
determined by multiplying the total amount reimbursed to the individual 
by a fraction. The numerator of the fraction is the total amount 
reimbursed during that plan year to all highly compensated individuals. 
The denominator of the fraction is the total amount reimbursed during 
that plan year to all participants. In computing the fraction and the 
total amount reimbursed to the individual, discriminatory benefits 
described in subparagraph (2) are not taken into account. Accordingly, 
any amount which is included in income by reason of the benefit's not 
being available to all other participants will not be taken into 
account.
    (4) Examples. The provisions of this paragraph are illustrated by 
the following examples:

    Example (1). Corporation M maintains a self-insured medical 
reimbursement plan which covers all employees. The plan provides the 
following maximum limits on the amount of benefits subject to 
reimbursement: $5,000 for officers and $1,000 for all other 
participants. During a plan year Employee A, one of the 5 highest paid 
officers, received reimbursements in the amount of $4,000. Because the 
amount of benefits provided for highly compensated individuals is not 
provided for all other participants, the

[[Page 462]]

plan benefits are discriminatory. Accordingly, Employee A received an 
excess reimbursement of $3,000 ($4,000-$1,000) which constitutes a 
benefit available to highly compensated individuals, but not to all 
other participants.
    Example (2). Corporation N maintains a self-insured medical 
reimbursement plan which covers all employees. The plan provides a broad 
range of medical benefits subject to reimbursement for all participants. 
However, only the 5 highest paid officers are entitled to dental 
benefits. During the plan year Employee B, one of the 5 highest paid 
officers, received dental payments under the plan in the amount of $300. 
Because dental benefits are provided for highly compensated individuals, 
and not for all other participants, the plan discriminates as to 
benefits. Accordingly, Employee B received an excess reimbursement in 
the amount of $300.
    Example (3). Corporation O maintains a self-insured medical 
reimbursement plan which discriminates as to eligibility by covering 
only the highest paid 40% of all employees. Benefits subject to 
reimbursement under the plan are the same for all participants. During a 
plan year Employee C, a highly compensated individual, received benefits 
in the amount of $1,000. The amount of excess reimbursement paid 
Employee C during the plan year will be calculated by multiplying the 
$1,000 by a fraction determined under subparagraph (3).
    Example (4). Corporation P maintains a self-insured medical 
reimbursement plan for its employees. Benefits subject to reimbursement 
under the plan are the same for all plan participants. However, the plan 
fails the eligibility tests of section 105(h)(3)(A) and thereby 
discriminates as to eligibility. During the 1980 plan year Employee D, a 
highly compensated individual, was hospitalized for surgery and incurred 
medical expenses of $4,500 which were reimbursed to D under the plan. 
During that plan year the Corporation P medical plan paid $50,000 in 
benefits under the plan, $30,000 of which constituted benefits paid to 
highly compensated individuals. The amount of excess reimbursement not 
excludable by D under section 105(b) is $2,700:
[GRAPHIC] [TIFF OMITTED] TC14NO91.173

    Example (5). Corporation Q maintains a self-insured medical 
reimbursement plan for its employees. The plan provides a broad range of 
medical benefits subject to reimbursement for participants. However, 
only the five highest paid officers are entitled to dental benefits. In 
addition, the plan fails the eligibility test of section 105(h)(3)(A) 
and thereby discriminates as to eligibility. During the calendar 1981 
plan year, Employee E, a highly compensated individual, received dental 
benefits under the plan in the amount of $300, and no other employee 
received dental benefits. In addition, Employee E was hospitalized for 
surgery and incurred medical expenses, reimbursement for which was 
available to all participants, of $4,500 which were reimbursed to E 
under the plan. Because dental benefits are only provided for highly 
compensated individuals, Employee E received an excess reimbursement 
under paragraph (e)(2) above in the amount of $300. For the 1981 plan 
year, the Corporation Q medical plan paid $50,300 in total benefits 
under the plan, $30,300 of which constituted benefits paid to highly 
compensated individuals. In computing the fraction under paragraph 
(e)(3), discriminatory benefits described in paragraph (e)(2) are not 
taken into account. Therefore, the amount of excess reimbursement not 
excludable to Employee E with respect to the $4,500 of medical expenses 
incurred is $2,700:
[GRAPHIC] [TIFF OMITTED] TC14NO91.174


and the total amount of excess reimbursements includable in E's income 
for 1981 is $3,000.
    Example (6). (i) Corporation R maintains a calendar year self-
insured medical reimbursement plan which covers all employees. The type 
of benefits subject to reimbursement under the plan include all medical 
care expenses as defined in section 213(e). The amount of reimbursement 
available to any employee for any calendar year is limited to 5 percent 
of the compensation paid to each employee during the calendar year. The 
amount of compensation and reimbursement paid to Employees A-F for the 
calendar year is as follows:

------------------------------------------------------------------------
                                                           Reimbursable
                Employee                   Compensation     amount paid
------------------------------------------------------------------------
A.......................................        $100,000          $5,000
B.......................................          25,000           1,250
C.......................................          15,000             750
D.......................................          10,000             500
E.......................................          10,000             500
F.......................................           8,000             400
                                         -----------------
                                          ..............           8,400
------------------------------------------------------------------------

    (ii) Because the amount of benefits subject to reimbursement under 
the plan is in proportion to employee compensation the plan 
discriminates as to benefits. In addition, Employees A and B are highly 
compensated individuals. The amount of excess reimbursement paid 
Employees A and B during the plan year will be determined under 
paragraph (e)(2). Because benefits in excess of $400 (Employee F's 
maximum benefit) are provided for highly compensated individuals and not 
for all other participants, Employees

[[Page 463]]

A and B received, respectively, an excess reimbursement of $4,600 and 
$850.

    (f) Certain controlled groups. For purposes of applying the 
provisions of section 105(h) and this section, all employees who are 
treated as employed by a single employer under section 414 (b) and (c), 
and the regulations thereunder (relating to special rules for qualified 
pension, profit-sharing and stock bonus plans), shall be treated as 
employed by a single employer.
    (g) Exception for medical diagnostic procedures--(1) In general. For 
purposes of applying section 105(h) and this section, reimbursements 
paid under a plan for medical diagnostic procedures for an employee, but 
not a dependent, are not considered to be a part of a plan described in 
this section. The medical diagnostic procedures include routine medical 
examinations, blood tests, and X-rays. Such procedures do not include 
expenses incurred for the treatment, cure or testing of a known illness 
or disability, or treatment or testing for a physical injury, complaint 
or specific symptom of a bodily malfunction. For example, a routine 
dental examination with X-rays is a medical diagnostic procedure, but X-
rays and treatment for a specific complaint are not. In addition, such 
procedures do not include any activity undertaken for exercise, fitness, 
nutrition, recreation, or the general improvement of health unless they 
are for medical care as defined in section 213(e). The diagnostic 
procedures must be performed at a facility which provides no services 
(directly or indirectly) other than medical, and ancillary, services. 
For purposes of the preceding sentence, physical proximity between a 
medical facility and nonmedical facilities will not for that reason 
alone cause the medical facility not to qualify. For example, an 
employee's annual physical examination conducted at the employee's 
personal physician's office is not considered a part of the medical 
reimbursement plan and therefore is not subject to the nondiscrimination 
requirements. Accordingly, the amount reimbursed may be excludable from 
the employee's income if the requirements of section 105(b) are 
satisfied.
    (2) Transportation, etc. expenses. Transportation expenses primarily 
for an allowable diagnostic procedure are included within the exception 
described in this paragraph, but only to the extent they are ordinary 
and necessary. Transportation undertaken merely for the general 
improvement of health, or in connection with a vacation, is not within 
the scope of this exception, nor are any incidental expenses for food or 
lodging; therefore, amounts reimbursed for such expenses may be excess 
reimbursements under paragraph (e).
    (h) Time of inclusion. Excess reimbursments (determined under 
paragraph (e)) paid to a highly compensated individual for a plan year 
will be considered as received in the taxable year of the individual in 
which (or with which) the plan year ends. The particular plan year to 
which reimbursements relate shall be determined under the plan 
provisions. In the absence of plan provisions reimbursements shall be 
attributed to the plan year in which payment is made. For example, under 
a calendar year plan an excess reimbursement paid to A in 1981 on 
account of an expense incurred and subject to reimbursement for the 1980 
plan year under the terms of the plan will be considered as received in 
1980 by A.
    (i) Self-insured contributory plan. A medical plan subject to this 
section may provide for employer and employee contributions. See Sec. 
1.105-1(c). The tax treatment of reimbursements attributable to employee 
contributions is determined under section 104(a)(3). The tax treatment 
of reimbursements attributable to employer contributions is determined 
under section 105. The amount of reimbursements which are attributable 
to contributions of the employer shall be determined in accordance with 
Sec. 1.105-1(e).
    (j) Effective date. Section 105(h) and this section are effective 
for taxable years beginning after December 31, 1979 and for amounts 
reimbursed after December 31, 1979. In determining plan discrimination 
and the taxability of excess reimbursements made for a plan year 
beginning in 1979 and ending in 1980, a plan's eligibility and benefit 
requirements as well as actual reimbursements made in the plan year 
during 1979, will not be taken into account. In addition, this section 
does

[[Page 464]]

not apply to expenses which are incurred in 1979 and paid in 1980.
    (k) Special rules--(1) Relation to cafeteria plans. If a self-
insured medical reimbursement plan is included in a cafeteria plan as 
described in section 125, the rules of this section will determine the 
status of a benefit as a taxable or nontaxable benefit, and the rules of 
section 125 will determine whether an employee is taxed as though he 
elected all available taxable benefits (including taxable benefits under 
a discriminatory medical reimbursement plan). This rule is illustrated 
by the following example:

    Example. Corporation M maintains a cafeteria plan described in 
section 125. Under the plan an officer of the corporation may elect to 
receive medical benefits provided by a self-insured medical 
reimbursement plan which is subject to the rules of this section. 
However, the self-insured medical reimbursement plan fails the 
nondiscrimination rules under paragraph (c) of this section. 
Accordingly, the amount of excess reimbursement is taxable to the 
officer participating in the medical reimbursement plan pursuant to 
section 105(h) and this section. Therefore, the self-insured medical 
reimbursement plan will be considered a taxable benefit under section 
125 and the regulations thereunder.

    (2) Benefit subject to reimbursement. For purposes of this section, 
a benefit subject to reimbursement is a benefit described in the plan 
under which a claim for reimbursement or for a payment directly to the 
health service provider may be filed by a plan participant. It does not 
refer to actual claims or benefit reimbursements paid under a plan.

[T.D. 7754, 46 FR 3505, Jan. 15, 1981]



Sec. 1.106-1  Contributions by employer to accident and health plans.

    The gross income of an employee does not include contributions which 
his employer makes to an accident or health plan for compensation 
(through insurance or otherwise) to the employee for personal injuries 
or sickness incurred by him, his spouse, or his dependents, as defined 
in section 152. The employer may contribute to an accident or health 
plan either by paying the premium (or a portion of the premium) on a 
policy of accident or health insurance covering one or more of his 
employees, or by contributing to a separate trust or fund (including a 
fund referred to in section 105(e)) which provides accident or health 
benefits directly or through insurance to one or more of his employees. 
However, if such insurance policy, trust, or fund provides other 
benefits in addition to accident or health benefits, section 106 applies 
only to the portion of the employer's contribution which is allocable to 
accident or health benefits. See paragraph (d) of Sec. 1.104-1 and 
Sec. Sec. 1.105-1 through 1.105-5, inclusive, for regulations relating 
to exclusion from an employee's gross income of amounts received through 
accident or health insurance and through accident or health plans.



Sec. 1.107-1  Rental value of parsonages.

    (a) In the case of a minister of the gospel, gross income does not 
include (1) the rental value of a home, including utilities, furnished 
to him as a part of his compensation, or (2) the rental allowance paid 
to him as part of his compensation to the extent such allowance is used 
by him to rent or otherwise provide a home. In order to qualify for the 
exclusion, the home or rental allowance must be provided as remuneration 
for services which are ordinarily the duties of a minister of the 
gospel. In general, the rules provided in Sec. 1.1402(c)-5 will be 
applicable to such determination. Examples of specific services the 
performance of which will be considered duties of a minister for 
purposes of section 107 include the performance of sacerdotal functions, 
the conduct of religious worship, the administration and maintenance of 
religious organizations and their integral agencies, and the performance 
of teaching and administrative duties at theological seminaries. Also, 
the service performed by a qualified minister as an employee of the 
United States (other than as a chaplain in the Armed Forces, whose 
service is considered to be that of a commissioned officer in his 
capacity as such, and not as a minister in the exercise of his 
ministry), or a State, Territory, or possession of the United States, or 
a political subdivision of any of the foregoing, or the District of 
Columbia, is in the exercise of

[[Page 465]]

his ministry provided the service performed includes such services as 
are ordinarily the duties of a minister.
    (b) For purposes of section 107, the term ``home'' means a dwelling 
place (including furnishings) and the appurtenances thereto, such as a 
garage. The term ``rental allowance'' means an amount paid to a minister 
to rent or otherwise provide a home if such amount is designated as 
rental allowance pursuant to official action taken prior to January 1, 
1958, by the employing church or other qualified organization, or if 
such amount is designated as rental allowance pursuant to official 
action taken in advance of such payment by the employing church or other 
qualified organization when paid after December 31, 1957. The 
designation of an amount as rental allowance may be evidenced in an 
employment contract, in minutes of or in a resolution by a church or 
other qualified organization or in its budget, or in any other 
appropriate instrument evidencing such official action. The designation 
referred to in this paragraph is a sufficient designation if it permits 
a payment or a part thereof to be identified as a payment of rental 
allowance as distinguished from salary or other remuneration.
    (c) A rental allowance must be included in the minister's gross 
income in the taxable year in which it is received, to the extent that 
such allowance is not used by him during such taxable year to rent or 
otherwise provide a home. Circumstances under which a rental allowance 
will be deemed to have been used to rent or provide a home will include 
cases in which the allowance is expended (1) for rent of a home, (2) for 
purchase of a home, and (3) for expenses directly related to providing a 
home. Expenses for food and servants are not considered for this purpose 
to be directly related to providing a home. Where the minister rents, 
purchases, or owns a farm or other business property in addition to a 
home, the portion of the rental allowance expended in connection with 
the farm or business property shall not be excluded from his gross 
income.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6691, 28 FR 
12817, Dec. 3, 1963]



Sec. 1.108-1  Stock-for-debt exception not to apply in de minimis cases.

    (a) Overview. Section 108(e)(8) provides that the common law stock-
for-debt exception does not apply if stock issued for indebtedness is 
nominal or token or if a proportionality test is not met. Paragraph (b) 
of this section provides rules for the nominal or token determination 
under section 108(e)(8)(A). Paragraph (c) of this section provides rules 
for the proportionality test under section 108(e)(8)(B). Paragraph (d) 
of this section provides certain general rules and definitions. 
Paragraph (e) of this section provides an effective date.
    (b) Issuance of nominal or token stock. Under section 108(e)(8)(A), 
the common law stock-for-debt exception does not apply to indebtedness 
discharged for stock that is nominal or token. All relevant facts and 
circumstances must be considered in making this determination. If common 
and preferred stock are issued for indebtedness, the determination is 
made separately with respect to the common stock and the preferred 
stock. The determination of whether common stock issued for unsecured 
indebtedness is nominal or token is made on an aggregate basis with 
respect to all common stock issued for unsecured indebtedness in the 
title 11 case or insolvency workout. Preferred stock issued for 
unsecured indebtedness is also tested on an aggregate basis with respect 
to all preferred stock issued for unsecured indebtedness in the title 11 
case or insolvency workout.
    (c) Issuance of a disproportionately small amount of stock for 
unsecured indebtedness--(1) Common stock issued for unsecured 
indebtedness--(i) In general. The common law stock-for-debt exception 
does not apply to an unsecured indebtedness discharged for common stock 
in a title 11 case or insolvency workout if the individual common stock 
ratio does not equal at least one-half of the group common stock ratio.
    (ii) Individual common stock ratio defined. The individual common 
stock ratio is the ratio of the value of the common stock issued for an 
unsecured indebtedness to the amount of the unsecured indebtedness 
allocated to that common stock. The amount of unsecured indebtedness 
allocated to the

[[Page 466]]

common stock is the amount of the indebtedness for which the common 
stock is issued (as defined in paragraph (d)(5) of this section), 
reduced by the amount of other consideration, if any, transferred in 
exchange for the indebtedness, including--
    (A) The amount of any money;
    (B) The issue price (determined under section 1273 or 1274) of any 
new indebtedness;
    (C) With respect to any preferred stock, the amount of indebtedness 
allocated to the preferred stock under paragraph (c)(2)(ii) of this 
section; and
    (D) The value of any other property, including any disqualified 
stock.
    (iii) Group common stock ratio defined. The group common stock ratio 
is the ratio of the aggregate value of all common stock issued for 
unsecured indebtedness in the title 11 case or insolvency workout to the 
aggregate amount of unsecured indebtedness allocated to that common 
stock. The amount of unsecured indebtedness allocated to the common 
stock is the aggregate amount of all unsecured indebtedness exchanged 
for stock or cancelled in the title 11 case or insolvency workout, 
reduced by the amount of other consideration, if any, issued for that 
indebtedness, including--
    (A) The amount of any money;
    (B) The issue price (determined under section 1273 or 1274) of any 
new indebtedness;
    (C) With respect to any preferred stock, the amount of indebtedness 
allocated to the preferred stock under paragraph (c)(2)(iii) of this 
section; and
    (D) The value of any other property, including any disqualified 
stock.
    (iv) Example. The following example illustrates these provisions.

    Example. (A) X Corporation has three outstanding debts, Debt 1, Debt 
2, and Debt 3. Debts 1 and 2 are unsecured and each has an adjusted 
issue price of $100,000. Debt 3 is also unsecured, and it has an 
adjusted issue price of $90,000 and accrued but unpaid interest of 
$10,000. In a title 11 case, Debt 1 is exchanged for $50,000 cash and 
$20,000 of common stock, Debt 2 is exchanged for $10,000 cash, and Debt 
3 is exchanged for $5,000 common stock. The individual common stock 
ratio for Debt 1 is 40 percent, which is determined by comparing the 
value of the common stock issued for the indebtedness ($20,000) to the 
amount of unsecured indebtedness allocated to that stock ($100,000 
adjusted issue price less $50,000 cash received). The individual common 
stock ratio for Debt 2 is 0 percent because no stock is received in 
exchange for the indebtedness. The individual common stock ratio for 
Debt 3 is 5 percent, which is determined by comparing the value of the 
common stock issued for the indebtedness ($5,000) to the amount of 
unsecured indebtedness allocated to that stock ($100,000 = $90,000 
adjusted issue price and $10,000 of accrued but unpaid interest).
    (B) The group common stock ratio is 10.4 percent, which is 
determined by comparing the value of all of the common stock issued for 
unsecured indebtedness in the title 11 case ($25,000) to the amount of 
unsecured indebtedness allocated to the stock ($290,000 aggregate 
adjusted issue price of all indebtedness exchanged for stock or 
cancelled in the title 11 case plus $10,000 accrued but unpaid interest 
less $60,000 cash received). Accordingly, section 108(e)(8)(B) is 
satisfied only with respect to the common stock issued for Debt 1. The 
stock-for-debt exception does not apply to Debt 2 or Debt 3.

    (2) Preferred stock issued for unsecured indebtedness--(i) In 
general. The common law stock-for-debt exception does not apply to an 
unsecured indebtedness discharged for preferred stock in a title 11 case 
or insolvency workout if the individual preferred stock ratio does not 
equal at least one-half of the group preferred stock ratio.
    (ii) Individual preferred stock ratio defined. The individual 
preferred stock ratio is the ratio of the value of the preferred stock 
issued for an unsecured indebtedness to the amount of the unsecured 
indebtedness allocated to the preferred stock. The amount of the 
unsecured indebtedness allocated to preferred stock is equal to the 
lesser of the lowest redemption price (if any) or lowest liquidation 
preference (if any) of the preferred stock (determined at issuance). 
However, the allocable indebtedness may not be less than the fair market 
value of the preferred stock or greater than the amount of the unsecured 
indebtedness.
    (iii) Group preferred stock ratio defined. The group preferred stock 
ratio is the ratio of the aggregate value of all preferred stock issued 
for unsecured indebtedness in the title 11 case or insolvency workout to 
the aggregate amount of unsecured indebtedness allocated to the 
preferred stock under paragraph (c)(2)(ii) of this section.
    (d) Definitions and special rules. For purposes of this section:

[[Page 467]]

    (1) Common stock. Common stock is all stock other than disqualified 
stock and preferred stock.
    (2) Disqualified stock. Disqualified stock is disqualified stock as 
defined in section 108(e)(10)(B)(ii).
    (3) Liquidation preference. A liquidation preference exists if the 
stock's right to share in liquidation proceeds is limited and preferred.
    (4) Preferred stock. Preferred stock is any stock (other than 
disqualified stock) that has a limited or fixed redemption price or 
liquidation preference and does not upon issuance have a right to 
participate in corporate growth to a meaningful extent. Preferred stock 
that is convertible into common stock is not treated as preferred stock 
if the conversion right represents, in substance, a meaningful right to 
participate in corporate growth. Solely for purposes of this paragraph 
(d)(4), a right to participate in corporate growth is not established by 
the fact that the redemption price or liquidation preference exceeds the 
fair market value of the preferred stock.
    (5) Amount of indebtedness. Generally, the amount of indebtedness is 
the adjusted issue price of the indebtedness. Appropriate adjustments 
are made for accrued but unpaid stated interest. (See the example in 
paragraph (c)(1)(iv) of this section.)
    (6) Undersecured indebtedness--(i) General rule. If an indebtedness 
is secured by property with a value less than its adjusted issue price, 
the indebtedness is considered to be two separate debts: a secured 
indebtedness with an adjusted issue price equal to the value of the 
property, and an unsecured indebtedness with an adjusted issue price 
equal to the remainder. Absent strong evidence to the contrary, the 
value of the property securing the indebtedness is presumed to be equal 
to the issue price of any new secured indebtedness received for the 
indebtedness plus the value of any other consideration (except stock or 
new unsecured indebtedness) received for the indebtedness. A valuation 
of that property by a court in a title 11 case is a factor in 
determining value, but is not controlling.
    (ii) Example. The following example illustrates these provisions:

    Example Corporation X owes an indebtedness with an adjusted issue 
price of $100,000. The indebtedness is secured by certain property owned 
by Corporation X. Corporation X exchanges the indebtedness for $10,000 
of stock and new secured indebtedness with an issue price of $70,000. 
Under paragraph (d)(6)(i) of this section, the indebtedness is 
bifurcated into a secured indebtedness of $70,000 (the issue price of 
the new secured indebtedness received in exchange therefor) and an 
unsecured indebtedness of $30,000 (the remainder of the adjusted issue 
price of the indebtedness).

    (e) Effective date. This section is effective with respect to any 
issuance of stock for indebtedness on or before December 31, 1994, or 
any issuance of stock for indebtedness in a title 11 or similar case (as 
defined in section 368(a)(3)(A) of the Internal Revenue Code) that was 
filed on or before December 31, 1993--
    (1) Pursuant to a plan confirmed by the court in a title 11 case 
after May 17, 1994; or
    (2) If there is no title 11 case, pursuant to an insolvency workout 
in which all issuances of stock for indebtedness occur after May 17, 
1994.

[59 FR 12831, Mar. 18, 1994]



Sec. 1.108-2  Acquisition of indebtedness by a person related to the 
debtor.

    (a) General rules. The acquisition of outstanding indebtedness by a 
person related to the debtor from a person who is not related to the 
debtor results in the realization by the debtor of income from discharge 
of indebtedness (to the extent required by section 61(a)(12) and section 
108) in an amount determined under paragraph (f) of this section. Income 
realized pursuant to the preceding sentence is excludible from gross 
income to the extent provided in section 108(a). The rules of this 
paragraph apply if indebtedness is acquired directly by a person related 
to the debtor in a direct acquisition (as defined in paragraph (b) of 
this section) or if a holder of indebtedness becomes related to the 
debtor in an indirect acquisition (as defined in paragraph (c) of this 
section).
    (b) Direct acquisition. An acquisition of outstanding indebtedness 
is a direct acquisition under this section if a person related to the 
debtor (or a person who becomes related to the debtor on

[[Page 468]]

the date the indebtedness is acquired) acquires the indebtedness from a 
person who is not related to the debtor. Notwithstanding the foregoing, 
the Commissioner may provide by Revenue Procedure or other published 
guidance that certain acquisitions of indebtedness described in the 
preceding sentence are not direct acquisitions for purposes of this 
section.
    (c) Indirect acquisition--(1) In general. An indirect acquisition is 
a transaction in which a holder of outstanding indebtedness becomes 
related to the debtor, if the holder acquired the indebtedness in 
anticipation of becoming related to the debtor.
    (2) Proof of anticipation of relationship. In determining whether 
indebtedness was acquired by a holder in anticipation of becoming 
related to the debtor, all relevant facts and circumstances will be 
considered. Such facts and circumstances include, but are not limited 
to, the intent of the parties at the time of the acquisition, the nature 
of any contacts between the parties (or their respective affiliates) 
before the acquisition, the period of time for which the holder held the 
indebtedness, and the significance of the indebtedness in proportion to 
the total assets of the holder group (as defined in paragraph (c)(5) of 
this section). For example, if a holder acquired the indebtedness in the 
ordinary course of its portfolio investment activities and the holder's 
acquisition of the indebtedness preceded any discussions concerning the 
acquisition of the holder by the debtor (or by a person related to the 
debtor) or the acquisition of the debtor by the holder (or by a person 
related to the holder), as the case may be, these facts, taken together, 
would ordinarily establish that the holder did not acquire the 
indebtedness in anticipation of becoming related to the debtor. The 
absence of discussions between the debtor and the holder (or their 
respective affiliates), however, does not by itself establish that the 
holder did not acquire the indebtedness in anticipation of becoming 
related to the debtor (if, for example, the facts and circumstances show 
that the holder was considering a potential acquisition of or by the 
debtor, or the relationship is created within a relatively short period 
of time of the acquisition, or the indebtedness constitutes a 
disproportionate portion of the holder group's assets).
    (3) Indebtedness acquired within 6 months of becoming related. 
Notwithstanding any other provision of this paragraph (c), a holder of 
indebtedness is treated as having acquired the indebtedness in 
anticipation of becoming related to the debtor if the holder acquired 
the indebtedness less than 6 months before the date the holder becomes 
related to the debtor.
    (4) Disclosure of potential indirect acquisition--(i) In general. If 
a holder of outstanding indebtedness becomes related to the debtor under 
the circumstances described in paragraph (c)(4)(ii) or (iii) of this 
section, the debtor is required to attach the statement described in 
paragraph (c)(4)(iv) of this section to its tax return (or to a 
qualified amended return within the meaning of Sec. 1.6664-2(c)(3)) for 
the taxable year in which the debtor becomes related to the holder, 
unless the debtor reports its income on the basis that the holder 
acquired the indebtedness in anticipation of becoming related to the 
debtor. Disclosure under this paragraph (c)(4) is in addition to, and is 
not in substitution for, any disclosure required to be made under 
section 6662, 6664 or 6694.
    (ii) Indebtedness represents more than 25 percent of holder group's 
assets--(A) In general. Disclosure under this paragraph (c)(4) is 
required if, on the date the holder becomes related to the debtor, 
indebtedness of the debtor represents more than 25 percent of the fair 
market value of the total gross assets of the holder group (as defined 
in paragraph (c)(5) of this section).
    (B) Determination of total gross assets. In determining the total 
gross assets of the holder group, total gross assets do not include any 
cash, cash item, marketable stock or security, short-term indebtedness, 
option, futures contract, notional principal contract, or similar item 
(other than indebtedness of the debtor), nor do total gross assets 
include any asset in which the holder has substantially reduced its risk 
of loss. In addition, total gross assets do not

[[Page 469]]

include any ownership interest in or indebtedness of a member of the 
holder group.
    (iii) Indebtedness acquired within 6 to 24 months of becoming 
related. Disclosure under this paragraph (c)(4) is required if the 
holder acquired the indebtedness 6 months or more before the date the 
holder becomes related to the debtor, but less than 24 months before 
that date.
    (iv) Contents of statement. A statement under this paragraph (c)(4) 
must include the following--
    (A) A caption identifying the statement as disclosure under Sec. 
1.108-2(c);
    (B) An identification of the indebtedness with respect to which 
disclosure is made;
    (C) The amount of such indebtedness and the amount of income from 
discharge of indebtedness is section 108(e)(4) were to apply;
    (D) Whether paragraph (c)(4)(ii) or (iii) of this section applies to 
the transaction; and
    (E) A statement describing the facts and circumstances supporting 
the debtor's position that the holder did not acquire the indebtedness 
in anticipation of becoming related to the debtor.
    (v) Failure to disclose. In addition to any other penalties that may 
apply, if a debtor fails to provide a statement required by this 
paragraph (c)(4), the holder is presumed to have acquired the 
indebtedness in anticipation of becoming related to the debtor unless 
the facts and circumstances clearly established that the holder did not 
acquire the indebtedness in anticipation of becoming related to the 
debtor.
    (5) Holder group. For purposes of this paragraph (c), the holder 
group consists of the holder of the indebtedness and all persons who are 
both--
    (i) Related to the holder before the holder becomes related to the 
debtor; and
    (ii) Related to the debtor after the holder becomes related to the 
debtor.
    (6) Holding period--(i) Suspensions. The running of the holding 
periods set forth in paragraphs (c)(3) and (c)(4)(iii) of this section 
is suspended during any period in which the holder or any person related 
to the holder is protected (directly or indirectly) against risk of loss 
by an option, a short sale, or any other device or transaction.
    (ii) Tacking. For purposes of paragraphs (c)(3) and (c)(4)(iii) of 
this section, the period for which a holder held the debtor's 
indebtedness includes--
    (A) The period for which the indebtedness was held by a corporation 
to whose attributes the holder succeeded pursuant to section 381; and
    (B) The period (ending on the date on which the holder becomes 
related to the debtor) for which the indebtedness was held continuously 
by members of the holder group (as defined in paragraph (c)(5) of this 
section).
    (d) Definitions--(1) Acquisition date. For purposes of this section, 
the acquisition date is the date on which a direct acquisition of 
indebtedness or an indirect acquisition of indebtedness occurs.
    (2) Relationship. For purposes of this section, persons are 
considered related if they are related within the meaning of sections 
267(b) or 707(b)(1). However--
    (i) Sections 267(b) and 707(b)(1) are applied as if section 
267(c)(4) provided that the family of an individual consists of the 
individual's spouse, the individual's children, grandchildren, and 
parents, and any spouse of the individual's children or grandchildren; 
and
    (ii) Two entities that are treated as a single employer under 
subsection (b) or (c) of section 414 are treated as having a 
relationship to each other that is described in section 267(b).
    (e) Exceptions--(1) Indebtedness retired within one year. This 
section does not apply to a direct or indirect acquisition of 
indebtedness with a stated maturity date on or before the date that is 
one year after the acquisition date, if the indebtedness is, in fact, 
retired on or before its stated maturity date.
    (2) Acquisitions by securities dealers. (i) This section does not 
apply to a direct acquisition or an indirect acquisition of indebtedness 
by a dealer that acquires and disposes of such indebtedness in the 
ordinary course of its business of dealing in securities if--
    (A) The dealer accounts for the indebtedness as a security held 
primarily for sale to customers in the ordinary course of business;

[[Page 470]]

    (B) The dealer disposes of the indebtedness (or it matures while 
held by the dealer) within a period consistent with the holding of the 
indebtedness for sale to customers in the ordinary course of business, 
taking into account the terms of the indebtedness and the conditions and 
practices prevailing in the markets for similar indebtedness during the 
period in which it is held; and
    (C) The dealer does not sell or otherwise transfer the indebtedness 
to a person related to the debtor (other than in a sale to a dealer that 
in turn meets the requirements of this paragraph (e)(2)).
    (ii) A dealer will continue to satisfy the conditions of this 
paragraph (e)(2) with respect to indebtedness that is exchanged for 
successor indebtedness in a transaction in which unrelated holders also 
exchange indebtedness of the same issue, provided that the conditions of 
this paragraph (e)(2) are met with respect to the successor 
indebtedness.
    (iii) For purposes of this paragraph (e)(2), if the period 
consistent with the holding of indebtedness for sale to customers in the 
ordinary course of business is 30 days or less, the dealer is considered 
to dispose of indebtedness within that period if the aggregate principal 
amount of indebtedness of that issue sold by the dealer to customers in 
the ordinary course of business (or that mature and are paid while held 
by the dealer) in the calendar month following the month in which the 
indebtedness is acquired equals or exceeds the aggregate principal 
amount of indebtedness of that issue held in the dealer's inventory at 
the close of the month in which the indebtedness is acquired. If the 
period consistent with the holding of indebtedness for sale to customers 
in the ordinary course of business is greater than 30 days, the dealer 
is considered to dispose of the indebtedness within that period if the 
aggregate principal amount of indebtedness of that issue sold by the 
dealer to customers in the ordinary course of business (or that mature 
and are paid while held by the dealer) within that period equals or 
exceeds the aggregate principal amount of indebtedness of that issue 
held in inventory at the close of the day on which the indebtedness was 
acquired.
    (f) Amount of discharge of indebtedness income realized--(1) Holder 
acquired the indebtedness by purchase on or less than six months before 
the acquisition date. Except as otherwise provided in this paragraph 
(f), the amount of discharge of indebtedness income realized under 
paragraph (a) of this section is measured by reference to the adjusted 
basis of the related holder (or of the holder that becomes related to 
the debtor) in the indebtedness on the acquisition date if the holder 
acquired the indebtedness by purchase on or less than six months before 
the acquisition date. For purposes of this paragraph (f), indebtedness 
is acquired ``by purchase'' if the indebtedness in the hands of the 
holder is not substituted basis property within the meaning of section 
7701(a)(42). However, indebtedness is also considered acquired by 
purchase within six months before the acquisition date if the holder 
acquired the indebtedness as transferred basis property (within the 
meaning of section 7701(a)(43)) from a person who acquired the 
indebtedness by purchase on or less than six months before the 
acquisition date.
    (2) Holder did not acquire the indebtedness by purchase on or less 
than six months before the acquisition date. Except as otherwise 
provided in this paragraph (f), the amount of discharge of indebtedness 
income realized under paragraph (a) of this section is measured by 
reference to the fair market value of the indebtedness on the 
acquisition date if the holder (or the transferor to the holder in a 
transferred basis transaction) did not acquire the indebtedness by 
purchase on or less than six months before the acquisition date.
    (3) Acquisitions of indebtedness in nonrecognition transactions. 
[Reserved]
    (4) Avoidance transactions. The amount of discharge of indebtedness 
income realized by the debtor under paragraph (a) of this section is 
measured by reference to the fair market value of the indebtedness on 
the acquisition date if the indebtedness is acquired in a direct or an 
indirect acquisition in which a principal purpose for the acquisition is 
the avoidance of federal income tax.

[[Page 471]]

    (g) Correlative adjustments--(1) Deemed issuance. For income tax 
purposes, if a debtor realizes income from discharge of its indebtedness 
in a direct or an indirect acquisition under this section (whether or 
not the income is excludible under section 108(a)), the debtor's 
indebtedness is treated as new indebtedness issued by the debtor to the 
related holder on the acquisition date (the deemed issuance). The new 
indebtedness is deemed issued with an issue price equal to the amount 
used under paragraph (f) of this section to compute the amount realized 
by the debtor under paragraph (a) of this section (i.e., either the 
holder's adjusted basis or the fair market value of the indebtedness, as 
the case may be). Under section 1273(a)(1), the excess of the stated 
redemption price at maturity (as defined in section 1273(a)(2)) of the 
indebtedness over its issue price is original issue discount (OID) 
which, to the extent provided in sections 163 and 1272, is deductible by 
the debtor and includible in the gross income of the related holder. 
Notwithstanding the foregoing, the Commissioner may provide by Revenue 
Procedure or other published guidance that the indebtedness is not 
treated as newly issued indebtedness for purposes of designated 
provisions of the income tax laws.
    (2) Treatment of related holder. The related holder does not 
recognize any gain or loss on the deemed issuance described in paragraph 
(g)(1) of this section. The related holder's adjusted basis in the 
indebtedness remains the same as it was immediately before the deemed 
issuance. The deemed issuance is treated as a purchase of the 
indebtedness by the related holder for purposes of section 1272(a)(7) 
(pertaining to reduction of original issue discount where a subsequent 
holder pays acquisition premium) and section 1276 (pertaining to 
acquisitions of debt at a market discount).
    (3) Loss deferral on disposition of indebtedness acquired in certain 
exchanges. (i) Any loss otherwise allowable to a related holder on the 
disposition at any time of indebtedness acquired in a direct or indirect 
acquisition (whether or not any discharge of indebtedness income was 
realized under paragraph (a) of this section) is deferred until the date 
the debtor retires the indebtedness if--
    (A) The related holder acquired the debtor's indebtedness in 
exchange for its own indebtedness; and
    (B) The issue price of the related holder's indebtedness was not 
determined by reference to its fair market value (e.g., the issue price 
was determined under section 1273(b)(4) or 1274(a) or any other 
provision of applicable law).
    (ii) Any comparable tax benefit that would otherwise be available to 
the holder, debtor, or any person related to either, in any other 
transaction that directly or indirectly results in the disposition of 
the indebtedness is also deferred until the date the debtor retires the 
indebtedness.
    (4) Examples. The following examples illustrate the application of 
this paragraph (g). In each example, all taxpayers are calendar-year 
taxpayers, no taxpayer is insolvent or under the jurisdiction of a court 
in a title 11 case and no indebtedness is qualified farm indebtedness 
described in section 108(g).

    Example 1. (i) P, a domestic corporation, owns 70 percent of the 
single class of stock of S, a domestic corporation. S has outstanding 
indebtedness that has an issue price of $10,000,000 and provides for 
monthly interest payments of $80,000 payable at the end of each month 
and a payment at maturity of $10,000,000. The indebtedness has a stated 
maturity date of December 31, 1994. On January 1, 1992, P purchases S's 
indebtedness from I, an individual not related to S within the meaning 
of paragraph (d)(2) of this section, for cash in the amount of 
$9,000,000. S repays the indebtedness in full at maturity.
    (ii) Under section 61(a)(12), section 108(e)(4), and paragraphs (a) 
and (f) of this section, S realizes $1,000,000 of income from discharge 
of indebtedness on January 1, 1992.
    (iii) Under paragraph (g)(1) of this section, the indebtedness is 
treated as issued to P on January 1, 1992, with an issue price of 
$9,000,000. Under section 1273(a), the $1,000,000 excess of the stated 
redemption price at maturity of the indebtedness ($10,000,000) over its 
issue price ($9,000,000) is original issue discount, which is includible 
in gross income by P and deductible by S over the remaining term of the 
indebtedness under sections 163(e) and 1272(a).
    (iv) Accordingly, S deducts and P includes in income original issue 
discount, in addition to stated interest, as follows: in 1992, 
$289,144.88; in 1993, $331,286.06; and in 1994, $379,569.06.

[[Page 472]]

    Example 2. The facts are the same as in Example 1, except that on 
January 1, 1992, P sells S's indebtedness to J, who is not related to S 
within the meaning of paragraph (d)(2) of this section, for $9,400,000 
in cash. J holds S's indebtedness to maturity. On January 1, 1993, P's 
adjusted basis in S's indebtedness is $9,289,144.88. Accordingly, P 
realizes gain in the amount of $110,855.12 upon the disposition. S and J 
continue to deduct and include the original issue discount on the 
indebtedness in accordance with Example 1. The amount of original issue 
discount includible by J is reduced by the $110,855.12 acquisition 
premium as provided in section 1272(a)(7).
    Example 3. The facts are the same as in Example 1, except that on 
February 1, 1992 (one month after P purchased S's indebtedness), S 
retires the indebtedness for an amount of cash equal to the fair market 
value of the indebtedness. Assume that the fair market value of the 
indebtedness is $9,022,621.41, which in this case equals the issue price 
of indebtedness determined under paragraph (g)(1) of this section 
($9,000,000) plus the accrued original issue discount through February 1 
($22,621.41). Section 1.61-12(c)(3) provides that if indebtedness is 
repurchased for a price that is exceeded by the issue price of the 
indebtedness plus the amount of discount already deducted, the excess is 
income from discharge of indebtedness. Therefore, S does not realize 
income from discharge of indebtedness. The result would be the same if P 
had contributed the indebtedness to the capital of S. Under section 
108(e)(6), S would be treated as having satisfied the indebtedness with 
an amount of money equal to P's adjusted basis and, under section 
1272(d)(2), P's adjusted basis is equal to $9,022,621.41.
    Example 4. (i) P, a domestic corporation, owns 70 percent of the 
single class of stock of S, a domestic corporation. On January 1, 1986, 
P issued indebtedness that has an issue price of $5,000,000 and provides 
for no stated interest payments and a payment at maturity of 
$10,000,000. The indebtedness has a stated maturity date of December 31, 
1995. On January 1, 1992, S purchases P's indebtedness from K, a 
partnership not related to P within the meaning of paragraph (d)(2) of 
this section, for cash in the amount of $6,000,000. The sum of the 
debt's issue price and previously deducted original issue discount is 
$7,578,582.83. P repays the indebtedness in full at maturity.
    (ii) Under section 61(a)(12), section 108(e)(4), and paragraphs (a) 
and (f) of this section, P realizes $1,578,582.83 in income from 
discharge of indebtedness ($7,578,582.83 minus $6,000,000) on January 1, 
1992.
    (iii) Under paragraph (g)(1) of this section, the indebtedness is 
treated as issued to S on January 1, 1992, with an issue price of 
$6,000,000. Under section 1273(a), the $4,000,000 excess of the stated 
redemption price at maturity of the indebtedness ($10,000,000) over its 
issue price ($6,000,000) is orignial issue discount, which is includible 
in gross income by S and deductible by P over the remaining term of the 
indebtedness under sections 163(e) and 1272(a).
    (iv) Accordingly, P deducts and S includes in income original issue 
discount as follows: in 1992, $817,316.20; in 1993, $928,650.49; in 
1994, $1,055,150.67; and in 1995, $1,198,882.64.

    (h) Effective date. This section applies to any transaction 
described in paragraph (a) and in either paragraph (b) or (c) of this 
section with an acquisition date on or after March 21, 1991. Although 
this section does not apply to direct or indirect acquisitions occurring 
before March 21, 1991, section 108(e)(4) is effective for any 
transaction after December 31, 1980, subject to the rules of section 7 
of the Bankruptcy Tax Act of 1980 (Pub. L. 96-589, 94 Stat. 3389, 3411). 
Taxpayers may use any reasonable method of determining the amount of 
discharge of indebtedness income realized and the treatment of 
correlative adjustments under section 108(e)(4) for acquisitions of 
indebtedness before March 21, 1991, if such method is applied 
consistently by both the debtor and related holder.

[T.D. 8460, 57 FR 61808, Dec. 29, 1992]



Sec. 1.108-3  Intercompany losses and deductions.

    (a) General rule. This section applies to certain losses and 
deductions from the sale, exchange, or other transfer of property 
between corporations that are members of a consolidated group or a 
controlled group (an intercompany transaction). See section 267(f) 
(controlled groups) and Sec. 1.1502-13 (consolidated groups) for 
applicable definitions. For purposes of determining the attributes to 
which section 108(b) applies, a loss or deduction not yet taken into 
account under section 267(f) or Sec. 1.1502-13 (an intercompany loss or 
deduction) is treated as basis described in section 108(b) that the 
transferor retains in property. To the extent a loss not yet taken into 
account is reduced under this section, it cannot subsequently be taken 
into account under section 267(f) or Sec. 1.1502-13. For example, if S 
and B are corporations filing a consolidated return, and S sells land 
with a $100 basis to B for $90 and the $10 loss is deferred under 
section 267(f) and

[[Page 473]]

Sec. 1.1502-13, the deferred loss is treated for purposes of section 
108(b) as $10 of basis that S has in land (even though S has no 
remaining interest in the land sold to B) and is subject to reduction 
under section 108(b)(2)(E). Similar principles apply, with appropriate 
adjustments, if S and B are members of a controlled group and S's loss 
is deferred only under section 267(f).
    (b) Effective date. This section applies with respect to discharges 
of indebtedness occurring on or after September 11, 1995.

[T.D. 8597, 60 FR 36680, July 18, 1995]



Sec. 1.108-4  Election to reduce basis of depreciable property under 
section 108(b)(5) of the Internal Revenue Code .

    (a) Description. An election under section 108(b)(5) is available 
whenever a taxpayer excludes discharge of indebtedness income (COD 
income) from gross income under sections 108(a)(1)(A), (B), or (C) 
(concerning title 11 cases, insolvency, and qualified farm indebtedness, 
respectively). See sections 108(d)(2) and (3) for the definitions of 
title 11 case and insolvent. See section 108(g)(2) for the definition of 
qualified farm indebtedness.
    (b) Time and manner. To make an election under section 108(b)(5), a 
taxpayer must enter the appropriate information on Form 982, Reduction 
of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 
Basis Adjustment), and attach the form to the timely filed (including 
extensions) Federal income tax return for the taxable year in which the 
taxpayer has COD income that is excluded from gross income under section 
108(a). An election under this section may be revoked only with the 
consent of the Commissioner.
    (c) Effective date. This section applies to elections concerning 
discharges of indebtedness occurring on or after October 22, 1998.

[T.D. 8787, 63 FR 56562, Oct. 22, 1998]



Sec. 1.108-5  Time and manner for making election under the Omnibus 
Budget Reconciliation Act of 1993.

    (a) Description. Section 108(c)(3)(C), as added by section 13150 of 
the Omnibus Budget Reconciliation Act of 1993 (Pub. L. 103-66, 107 Stat. 
446), allows certain noncorporate taxpayers to elect to treat certain 
indebtedness described in section 108(c)(3) that is discharged after 
December 31, 1992, as qualified real property business indebtedness. 
This discharged indebtedness is excluded from gross income to the extent 
allowed by section 108.
    (b) Time and manner for making election. The election described in 
this section must be made on the timely-filed (including extensions) 
Federal income tax return for the taxable year in which the taxpayer has 
discharge of indebtedness income that is excludible from gross income 
under section 108(a). The election is to be made on a completed Form 
982, in accordance with that Form and its instructions.
    (c) Revocability of election. The election described in this section 
is revocable with the consent of the Commissioner.
    (d) Effective date. The rules set forth in this section are 
effective December 27, 1993.

[T.D. 8688, 61 FR 65322, Dec. 12, 1996. Redesignated by T.D. 8787, 63 FR 
56563, Oct. 22, 1998]



Sec. 1.108-6  Limitations on the exclusion of income from the discharge 
of qualified real property business indebtedness.

    (a) Indebtedness in excess of value. With respect to any qualified 
real property business indebtedness that is discharged, the amount 
excluded from gross income under section 108(a)(1)(D) (concerning 
discharges of qualified real property business indebtedness) shall not 
exceed the excess, if any, of the outstanding principal amount of that 
indebtedness immediately before the discharge over the net fair market 
value of the qualifying real property, as defined in Sec. 1.1017-
1(c)(1), immediately before the discharge. For purposes of this section, 
net fair market value means the fair market value of the qualifying real 
property (notwithstanding section 7701(g)), reduced by the outstanding 
principal amount of any qualified real property business indebtedness 
(other than the discharged indebtedness) that is secured by such 
property immediately before and after the discharge. Also, for purposes 
of section 108(c)(2)(A) and this section, outstanding principal amount 
means the

[[Page 474]]

principal amount of indebtedness together with all additional amounts 
owed that, immediately before the discharge, are equivalent to 
principal, in that interest on such amounts would accrue and compound in 
the future, except that outstanding principal amount shall not include 
amounts that are subject to section 108(e)(2) and shall be adjusted to 
account for unamortized premium and discount consistent with section 
108(e)(3).
    (b) Overall limitation. The amount excluded from gross income under 
section 108(a)(1)(D) shall not exceed the aggregate adjusted bases of 
all depreciable real property held by the taxpayer immediately before 
the discharge (other than depreciable real property acquired in 
contemplation of the discharge) reduced by the sum of any--
    (1) Depreciation claimed for the taxable year the taxpayer excluded 
discharge of indebtedness from gross income under section 108(a)(1)(D); 
and
    (2) Reductions to the adjusted bases of depreciable real property 
required under section 108(b) or section 108(g) for the same taxable 
year.
    (c) Effective date. This section applies to discharges of qualified 
real property business indebtedness occurring on or after October 22, 
1998.

[T.D. 8787, 63 FR 56563, Oct. 22, 1998]



Sec. 1.108-7  Reduction of attributes.

    (a) In general. (1) If a taxpayer excludes discharge of indebtedness 
income (COD income) from gross income under section 108(a)(1)(A), (B), 
or (C), then the amount excluded shall be applied to reduce the 
following tax attributes of the taxpayer in the following order:
    (i) Net operating losses.
    (ii) General business credits.
    (iii) Minimum tax credits.
    (iv) Capital loss carryovers.
    (v) Basis of property.
    (vi) Passive activity loss and credit carryovers.
    (vii) Foreign tax credit carryovers.
    (2) The taxpayer may elect under section 108(b)(5), however, to 
apply any portion of the excluded COD income to reduce first the basis 
of depreciable property. To the extent the excluded COD income is not so 
applied, the taxpayer must then reduce any remaining tax attributes in 
the order specified in section 108(b)(2). If the excluded COD income 
exceeds the sum of the taxpayer's tax attributes, the excess is 
permanently excluded from the taxpayer's gross income. For rules 
relating to basis reductions required by sections 108(b)(2)(E) and 
108(b)(5), see sections 1017 and 1.1017-1. For rules relating to the 
time and manner for making an election under section 108(b)(5), see 
Sec. 1.108-4.
    (b) Carryovers and carrybacks. The tax attributes subject to 
reduction under section 108(b)(2) and paragraph (a)(1) of this section 
that are carryovers to the taxable year of the discharge, or that may be 
carried back to taxable years preceding the year of the discharge, are 
taken into account by the taxpayer for the taxable year of the discharge 
or the preceding years, as the case may be, before such attributes are 
reduced pursuant to section 108(b)(2) and paragraph (a)(1) of this 
section.
    (c) Transactions to which section 381 applies. If a taxpayer 
realizes COD income that is excluded from gross income under section 
108(a) either during or after a taxable year in which the taxpayer is 
the distributor or transferor of assets in a transaction described in 
section 381(a), any tax attributes to which the acquiring corporation 
succeeds, including the basis of property acquired by the acquiring 
corporation in the transaction, must reflect the reductions required by 
section 108(b). For this purpose, all attributes listed in section 
108(b)(2) immediately prior to the transaction described in section 
381(a), but after the determination of tax for the year of the 
distribution or transfer of assets, including basis of property, will be 
available for reduction under section 108(b)(2). However, the basis of 
stock or securities of the acquiring corporation, if any, received by 
the taxpayer in exchange for the transferred assets shall not be 
available for reduction under section 108(b)(2).
    (d) Examples. The following examples illustrate the application of 
this section:

    Example 1. (i) Facts. In Year 4, X, a corporation in a title 11 
case, is entitled under section 108(a)(1)(A) to exclude from gross 
income $100,000 of COD income. For Year 4, X

[[Page 475]]

has gross income in the amount of $50,000. In each of Years 1 and 2, X 
had no taxable income or loss. In Year 3, X had a net operating loss of 
$100,000, the use of which when carried over to Year 4 is not subject to 
any restrictions other than those of section 172.
    (ii) Analysis. Pursuant to paragraph (b) of this section, X takes 
into account the net operating loss carryover from Year 3 in computing 
its taxable income for Year 4 before any portion of the COD income 
excluded under section 108(a)(1)(A) is applied to reduce tax attributes. 
Thus, the amount of the net operating loss carryover that is reduced 
under section 108(b)(2) and paragraph (a) of this section is $50,000.
    Example 2. (i) Facts. The facts are the same as in Example 1, except 
that in Year 4 X sustains a net operating loss in the amount of 
$100,000. In addition, in each of Years 2 and 3, X reported taxable 
income in the amount of $25,000.
    (ii) Analysis. Pursuant to paragraph (b) of this section and section 
172, the net operating loss sustained in Year 4 is carried back to Years 
2 and 3 before any portion of the COD income excluded under section 
108(a)(1)(A) is applied to reduce tax attributes. Thus, the amount of 
the net operating loss that is reduced under section 108(b)(2) and 
paragraph (a) of this section is $50,000.
    Example 3. (i) Facts. In Year 2, X, a corporation in a title 11 
case, has outstanding debts of $200,000 and a depreciable asset that has 
an adjusted basis of $75,000 and a fair market value of $100,000. X has 
no other assets or liabilities. X has a net operating loss of $80,000 
that is carried over to Year 2 but has no general business credit, 
minimum tax credit, or capital loss carryovers. Under a plan of 
reorganization, X transfers its asset to Corporation Y in exchange for Y 
stock with a value of $100,000. X distributes the Y stock to its 
creditors in exchange for release of their claims against X. X's 
shareholders receive nothing in the transaction. The transaction 
qualifies as a reorganization under section 368(a)(1)(G) that satisfies 
the requirements of section 354(b)(1)(A) and (B). For Year 2, X has 
gross income of $10,000 (without regard to any income from the discharge 
of indebtedness) and is allowed a depreciation deduction of $10,000 in 
respect of the asset. In addition, it generates no general business 
credits.
    (ii) Analysis. On the distribution of Y stock to X's creditors, 
under section 108(a)(1)(A), X is entitled to exclude from gross income 
the debt discharge amount of $100,000. (Under section 108(e)(8), X is 
treated as satisfying $100,000 of the debt owed the creditors for 
$100,000, the fair market value of the Y stock transferred to those 
creditors.) In Year 2, X has no taxable income or loss because its gross 
income is exactly offset by the depreciation deduction. As a result of 
the depreciation deduction, X's basis in the asset is reduced by $10,000 
to $65,000. Pursuant to paragraph (c) of this section, the amount of X's 
net operating loss to which Y succeeds pursuant to section 381 and the 
basis of X's property transferred to Y must take into account the 
reductions required by section 108(b). Pursuant to paragraph (a) of this 
section, X's net operating loss carryover in the amount of $80,000 is 
reduced by $80,000 of the COD income excluded under section 108(a)(1). 
In addition, X's basis in the asset is reduced by $20,000, the extent to 
which the COD income excluded under section 108(a)(1) did not reduce the 
net operating loss. Accordingly, as a result of the reorganization, 
there is no net operating loss to which Y succeeds under section 381. 
Pursuant to section 361, X recognizes no gain or loss on the transfer of 
its property to Y. Pursuant to section 362(b), Y's basis in the asset 
acquired from X is $45,000.
    Example 4. (i) Facts. The facts are the same as in Example 3, except 
that X elects under section 108(b)(5) to reduce first the basis of its 
depreciable asset.
    (ii) Analysis. As in Example 3, on the distribution of Y stock to 
X's creditors, under section 108(a)(1)(A), X is entitled to exclude from 
gross income the debt discharge amount of $100,000. In addition, in Year 
2, X has no taxable income or loss because its gross income is exactly 
offset by the depreciation deduction. As a result of the depreciation 
deduction, X's basis in the asset is reduced by $10,000 to $65,000. 
Pursuant to paragraph (c) of this section, the amount of X's net 
operating loss to which Y succeeds pursuant to section 381 and the basis 
of X's property transferred to Y must take into account the reductions 
required by section 108(b). As a result of the election under section 
108(b)(5), X's basis in the asset is reduced by $65,000 to $0. In 
addition, X's net operating loss is reduced by $35,000, the extent to 
which the amount excluded from income under section 108(a)(1)(A) does 
not reduce X's asset basis. Accordingly, as a result of the 
reorganization, Y succeeds to X's net operating loss in the amount of 
$45,000 under section 381. Pursuant to section 361, X recognizes no gain 
or loss on the transfer of its property to Y. Pursuant to section 
362(b), Y's basis in the asset acquired from X is $0.

    (e) Effective date. This section applies to discharges of 
indebtedness occurring on or after May 10, 2004.

[T.D. 9080, 68 FR 42592, July 18, 2003; 68 FR 56556, Oct. 1, 2003. 
Redesignated and amended by T.D. 9127, 69 FR 26039, May 11, 2004]

[[Page 476]]



Sec. 1.108(c)-1T  [Reserved]



Sec. 1.109-1  Exclusion from gross income of lessor of real property of 
value of improvements erected by lessee.

    (a) Income derived by a lessor of real property upon the 
termination, through forfeiture or otherwise, of the lease of such 
property and attributable to buildings erected or other improvements 
made by the lessee upon the leased property is excluded from gross 
income. However, where the facts disclose that such buildings or 
improvements represent in whole or in part a liquidation in kind of 
lease rentals, the exclusion from gross income shall not apply to the 
extent that such buildings or improvements represent such liquidation. 
The exclusion applies only with respect to the income realized by the 
lessor upon the termination of the lease and has no application to 
income, if any, in the form of rent, which may be derived by a lessor 
during the period of the lease and attributable to buildings erected or 
other improvements made by the lessee. It has no application to income 
which may be realized by the lessor upon the termination of the lease 
but not attributable to the value of such buildings or improvements. 
Neither does it apply to income derived by the lessor subsequent to the 
termination of the lease incident to the ownership of such buildings or 
improvements.
    (b) The provisions of this section may be illustrated by the 
following example:

    Example. The A Corporation leased in 1945 for a period of 50 years 
unimproved real property to the B Corporation under a lease providing 
that the B Corporation erect on the leased premises an office building 
costing $500,000, in addition to paying the A Corporation a lease rental 
of $10,000 per annum beginning on the date of completion of the 
improvements, the sum of $100,000 being placed in escrow for the payment 
of the rental. The building was completed on January 1, 1950. The lease 
provided that all improvements made by the lessee on the leased property 
would become the absolute property of the A Corporation on the 
termination of the lease by forfeiture or otherwise and that the lessor 
would become entitled on such termination to the remainder of the sum, 
if any, remaining in the escrow fund. The B Corporation forfeited its 
lease on January 1, 1955, when the improvements had a value of $100,000. 
Under the provisions of section 109, the $100,000 is excluded from gross 
income. The amount of $50,000 representing the remainder in the escrow 
fund is forfeited to the A Corporation and is included in the gross 
income of that taxpayer. As to the basis of the property in the hands of 
the A Corporation, see Sec. 1.1019-1.



Sec. 1.110-1  Qualified lessee construction allowances.

    (a) Overview. Amounts provided to a lessee by a lessor for property 
to be constructed and used by the lessee pursuant to a lease are not 
includible in the lessee's gross income if the amount is a qualified 
lessee construction allowance under paragraph (b) of this section.
    (b) Qualified lessee construction allowance--(1) In general. A 
qualified lessee construction allowance means any amount received in 
cash (or treated as a rent reduction) by a lessee from a lessor--
    (i) Under a short-term lease of retail space;
    (ii) For the purpose of constructing or improving qualified long-
term real property for use in the lessee's trade or business at that 
retail space; and
    (iii) To the extent the amount is expended by the lessee in the 
taxable year received on the construction or improvement of qualified 
long-term real property for use in the lessee's trade or business at 
that retail space.
    (2) Definitions--(i) Qualified long-term real property is 
nonresidential real property under section 168(e)(2)(B) that is part of, 
or otherwise present at, the retail space referred to in paragraph 
(b)(1)(i) of this section and which reverts to the lessor at the 
termination of the lease. Thus, qualified long-term real property does 
not include property qualifying as section 1245 property under section 
1245(a)(3).
    (ii) Short-term lease is a lease (or other agreement for occupancy 
or use) of retail space for 15 years or less (as determined pursuant to 
section 168(i)(3)).
    (iii) Retail space is nonresidential real property under section 
168(e)(2)(B) that is leased, occupied, or otherwise used by the lessee 
in its trade or business of selling tangible personal property or 
services to the general public. The term retail space includes not only 
the

[[Page 477]]

space where the retail sales are made, but also space where activities 
supporting the retail activity are performed (such as an administrative 
office, a storage area, and employee lounge). Examples of services 
typically sold to the general public include services provided by hair 
stylists, tailors, shoe repairmen, doctors, lawyers, accountants, 
insurance agents, stock brokers, securities dealers (including dealers 
who sell securities out of inventory), financial advisors and bankers. 
For purposes of this paragraph (b)(2)(iii), a taxpayer is selling to the 
general public if the products or services for sale are made available 
to the general public, even if the product or service is targeted to 
certain customers or clients.
    (3) Purpose requirement. An amount will meet the requirement in 
paragraph (b)(1)(ii) of this section only to the extent that the lease 
agreement for the retail space expressly provides that the construction 
allowance is for the purpose of constructing or improving qualified 
long-term real property for use in the lessee's trade or business at the 
retail space. An ancillary agreement between the lessor and the lessee 
providing for a construction allowance, executed contemporaneously with 
the lease or during the term of the lease, is considered a provision of 
the lease agreement for purposes of the preceding sentence, provided the 
agreement is executed before payment of the construction allowance.
    (4) Expenditure requirement--(i) In general. Expenditures referred 
to in paragraph (b)(1)(iii) of this section may be treated as being made 
first from the lessee's construction allowance. Tracing of the 
construction allowance to the actual lessee expenditures for the 
construction or improvement of qualified long-term real property is not 
required. However, the lessee should maintain accurate records of the 
amount of the qualified lessee construction allowance received and the 
expenditures made for qualified long-term real property.
    (ii) Time when expenditures deemed made. For purposes of paragraph 
(b)(1)(iii) of this section, an amount is deemed to have been expended 
by a lessee in the taxable year in which the construction allowance was 
received by the lessee if--
    (A) The amount is expended by the lessee within 8\1/2\ months after 
the close of the taxable year in which the amount was received; or
    (B) The amount is a reimbursement from the lessor for amounts 
expended by the lessee in a prior year and for which the lessee has not 
claimed any depreciation deductions.
    (5) Consistent treatment by lessor. Qualified long-term real 
property constructed or improved with any amount excluded from a 
lessee's gross income by reason of paragraph (a) of this section must be 
treated as nonresidential real property owned by the lessor (for 
purposes of depreciation under 168(e)(2)(B) and determining gain or loss 
under section 168(i)(8)(B)). For purposes of the preceding sentence, the 
lessor must treat the construction allowance as fully expended in the 
manner required by paragraph (b)(1)(iii) of this section unless the 
lessor is notified by the lessee in writing to the contrary. General tax 
principles apply for purposes of determining when the lessor may begin 
depreciation of its nonresidential real property. The lessee's exclusion 
from gross income under paragraph (a) of this section, however, is not 
dependent upon the lessor's treatment of the property as nonresidential 
real property.
    (c) Information required to be furnished--(1) In general. The lessor 
and the lessee described in paragraph (b) of this section who are paying 
and receiving a qualified lessee construction allowance, respectively, 
must furnish the information described in paragraph (c)(3) of this 
section in the time and manner prescribed in paragraph (c)(2) of this 
section.
    (2) Time and manner for furnishing information. The requirement to 
furnish information under paragraph (c)(1) of this section is met by 
attaching a statement with the information described in paragraph (c)(3) 
of this section to the lessor's or the lessee's, as applicable, timely 
filed (including extensions) Federal income tax return for the taxable 
year in which the construction allowance was paid by the lessor or 
received by the lessee (either in cash

[[Page 478]]

or treated as a rent reduction), as applicable. A lessor or a lessee may 
report the required information for several qualified lessee 
construction allowances on a combined statement. However, a lessor's or 
a lessee's failure to provide information with respect to each lease 
will be treated as a separate failure to provide information for 
purposes of paragraph (c)(4) of this section.
    (3) Information required--(i) Lessor. The statement provided by the 
lessor must contain the lessor's name (and, in the case of a 
consolidated group, the parent's name), employer identification number, 
taxable year and the following information for each lease:
    (A) The lessee's name (in the case of a consolidated group, the 
parent's name).
    (B) The address of the lessee.
    (C) The employer identification number of the lessee.
    (D) The location of the retail space (including mall or strip center 
name, if applicable, and store name).
    (E) The amount of the construction allowance.
    (F) The amount of the construction allowance treated by the lessor 
as nonresidential real property owned by the lessor.
    (ii) Lessee. The statement provided by the lessee must contain the 
lessee's name (and, in the case of a consolidated group, the parent's 
name), employer identification number, taxable year and the following 
information for each lease:
    (A) The lessor's name (in the case of a consolidated group, the 
parent's name).
    (B) The address of the lessor.
    (C) The employer identification number of the lessor.
    (D) The location of the retail space (including mall or strip center 
name, if applicable, and store name).
    (E) The amount of the construction allowance.
    (F) The amount of the construction allowance that is a qualified 
lessee construction allowance under paragraph (b) of this section.
    (4) Failure to furnish information. A lessor or a lessee that fails 
to furnish the information required in this paragraph (c) may be subject 
to a penalty under section 6721.
    (d) Effective date. This section is applicable to leases entered 
into on or after October 5, 2000.

[T.D. 8901, 65 FR 53586, Sept. 5, 2000]



Sec. 1.111-1  Recovery of certain items previously deducted or credited.

    (a) General. Section 111 provides that income attributable to the 
recovery during any taxable year of bad debts, prior taxes, and 
delinquency amounts shall be excluded from gross income to the extent of 
the ``recovery exclusion'' with respect to such items. The rule of 
exclusion so prescribed by statute applies equally with respect to all 
other losses, expenditures and accruals made the basis of deductions 
from gross income for prior taxable years, including war losses referred 
to in section 127 of the Internal Revenue Code of 1939, but not 
including deductions with respect to depreciation, depletion, 
amortization, or amortizable bond premiums. The term ``recovery 
exclusion'' as used in this section means an amount equal to the portion 
of the bad debts, prior taxes, and delinquency amounts (the items 
specifically referred to in section 111), and of all other items subject 
to the rule of exclusion which, when deducted or credited for a prior 
taxable year, did not result in a reduction of any tax of the taxpayer 
under subtitle A (other than the accumulated earnings tax imposed by 
section 531 or the personal holding company tax imposed by section 541) 
of the Internal Revenue Code of 1954 or corresponding provisions of 
prior income tax laws (other than the World War II excess profits tax 
imposed under subchapter E, chapter 2 of the Internal Revenue Code of 
1939).
    (1) Section 111 items. The term ``section 111 items'' as used in 
this section means bad debts, prior taxes, delinquency amounts, and all 
other items subject to the rule of exclusion, for which a deduction or 
credit was allowed for a prior taxable year. If a bad debt was 
previously charged against a reserve by a taxpayer on the reserve method 
of treating bad debts, it was not deducted, and it is therefore not 
considered a section 111 item. Bad debts, prior taxes, and delinquency 
amounts are defined in section 111(b)

[[Page 479]]

(1), (2), and (3), respectively. An example of a delinquency amount is 
interest on delinquent taxes. An example of the other items not 
expressly referred to in section 111 but nevertheless subject to the 
rule of exclusion is a loss sustained upon the sale of stock and later 
recovered, in whole or in part, through an action against the party from 
whom such stock had been purchased.
    (2) Definition of ``recovery''. Recoveries result from the receipt 
of amounts in respect of the previously deducted or credited section 111 
items, such as from the collection or sale of a bad debt, refund or 
credit of taxes paid, or cancellation of taxes accrued. Care should be 
taken in the case of bad debts which were treated as only partially 
worthless in prior years to distinguish between the item described in 
section 111, that is, the part of such debt which was deducted, and the 
part not previously deducted, which is not a section 111 item and is 
considered the first part collected. The collection of the part not 
deducted is not considered a ``recovery''. Furthermore, the term 
``recovery'' does not include the gain resulting from the receipt of an 
amount on account of a section 111 item which, together with previous 
such receipts, exceeds the deduction or credit previously allowed for 
such item. For instance, a $100 corporate bond purchased for $40 and 
later deducted as worthless is subsequently collected to the extent of 
$50. The $10 gain (excess of $50 collection over $40 cost) is not a 
recovery of a section 111 item. Such gain is in no case excluded from 
gross income under section 111, regardless of whether the $40 recovery 
is or is not excluded.
    (3) Treatment of debt deducted in more than one year by reason of 
partial worthlessness. In the case of a bad debt deducted in part for 
two or more prior years, each such deduction of a part of the debt is 
considered a separate section 111 item. A recovery with respect to such 
debt is considered first a recovery of those items (or portions 
thereof), resulting from such debt, for which there are recovery 
exclusions. If there are recovery exclusions for two or more items 
resulting from the same bad debt, such items are considered recovered in 
the order of the taxable years for which they were deducted, beginning 
with the latest. The recovery exclusion for any such item is determined 
by considering the recovery exclusion with respect to the prior year for 
which such item was deducted as being first used to offset all other 
applicable recoveries in the year in which the bad debt is recovered.
    (4) Special provisions as to worthless bonds, etc., which are 
treated as capital losses. Certain bad debts arising from the 
worthlessness of securities and certain nonbusiness bad debts are 
treated as losses from the sale or exchange of capital assets. See 
sections 165(g) and 166(d). The amounts of the deductions allowed for 
any year under section 1211 on account of such losses for such year are 
considered to be section 111 items. Any part of such losses which, under 
section 1211, is a deduction for a subsequent year through the capital 
loss carryover (any later receipt of an amount with respect to such 
deducted loss is a recovery) is considered a section 111 item for the 
year in which such loss was sustained.
    (b) Computation of recovery exclusion--(1) Amount of recovery 
exclusion allowable for year of recovery. For the year of any recovery, 
the section 111 items which were deducted or credited for one prior year 
are considered as a group and the recovery thereon is considered 
separately from recoveries of any items which were deducted or credited 
for other years. This recovery is excluded from gross income to the 
extent of the recovery exclusion with respect to this group of items as 
(i) determined for the original year for which such items were deducted 
or credited (see subparagraph (2) of this paragraph) and (ii) reduced by 
the excludable recoveries in intervening years on account of all section 
111 items for such original year. A taxpayer claiming a recovery 
exclusion shall submit, at the time the exclusion is claimed, the 
computation of the recovery exclusion claimed for the original year for 
which the items were deducted or credited, and computations showing the 
amount recovered in intervening years on account of the section 111 
items deducted or credited for the original year.

[[Page 480]]

    (2) Determination of recovery exclusion for original year for which 
items were deducted or credited. (i) The recovery exclusion for the 
taxable year for which section 111 items were deducted or credited (that 
is, the ``original taxable year'') is the portion of the aggregate 
amount of such deductions and credits which could be disallowed without 
causing an increase in any tax of the taxpayer imposed under subtitle A 
(other than the accumulated earnings tax imposed by section 531 or the 
personal holding company tax imposed by section 541) of the Internal 
Revenue Code of 1954 or corresponding provisions of prior income tax 
laws (other than the World War II excess profits tax imposed under 
subchapter E, chapter 2 of the Internal Revenue Code of 1939). For the 
purpose of such recovery exclusion, consideration must be given to the 
effect of net operating loss carryovers and carrybacks or capital loss 
carryovers.
    (ii) This rule shall be applied by determining the recovery 
exclusion as the aggregate amount of the section 111 items for the 
original year for which such items were deducted or credited reduced by 
whichever of the following amounts is the greater:
    (a) The difference between (1) the taxable income for such original 
year and (2) the taxable income computed without regard to the section 
111 items for such original year.
    (b) In the case of a taxpayer subject to any income tax in lieu of 
normal tax or surtax or both (except the alternative tax on capital 
gains imposed by section 1201, which is disregarded), the difference 
between (1) the income subject to such tax for such original year and 
(2) the income subject to such tax computed without regard to the 
section 111 items for such original year.

(Neither the amount determined under (1) nor the amount under (2) of (a) 
or (b) of this subdivision shall in any case be considered less than 
zero.) For this determination of the recovery exclusion, the aggregate 
of the section 111 items must be further decreased by the portion 
thereof which caused a reduction in tax in preceding or succeeding 
taxable years through any net operating loss carryovers or carrybacks or 
capital loss carryovers affected by such items. This decrease is the 
aggregate of the largest amount determined for each of such preceding 
and succeeding years under (a) and (b) of this subdivision, the 
computation of each carryover or carryback to the preceding or 
succeeding year being made under (1) of (a) and (b) of this subdivision 
with regard to the section 111 items for the original year and such 
computation being made under (2) of (a) and (b) of this subdivision 
without regard to such items. For the purpose of the preceding sentence, 
the computations under both (1) and (2) of (a) and (b) of this 
subdivision shall be made without regard to any section 111 items for 
such preceding or succeeding year and the carryovers and carrybacks to 
such year shall be determined without regard to any section 111 items 
for years subsequent to the original year.
    (iii) The determination of the recovery exclusion for original 
taxable years subject to the provisions of the Internal Revenue Code of 
1939 shall be made under 26 CFR (1939) 39.22(b)(12)-1(b)(2) (Regulations 
118).
    (3) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. A single individual with no dependents has for his 1954 
taxable year the following income and deductions:

------------------------------------------------------------------------
                                                       With     Without
                                                    deduction  deduction
                                                        of         of
                                                     section    section
                                                    111 items  111 items
------------------------------------------------------------------------
Gross income......................................   $25,000     $25,000
                                                   =====================
Less deductions:
  Depreciation....................................    20,000      20,000
  Business bad debts and taxes....................     6,300
  Personal exemption..............................       600         600
                                                   ---------------------
                                                      26,900      20,600
                                                   =====================
Taxable income or (loss)..........................    (1,900)      4,400
Adjustment under section 172(d)(3)................       600
                                                   ---------------------
    Net operating loss............................    (1,300)  .........
------------------------------------------------------------------------


The full amount of the net operating loss of $1,300 is carried back and 
allowed as a deduction for 1952. The aggregate of the section 111 items 
for 1954 is $6,300 (bad debts and taxes). The recovery exclusion on 
account of section 111 items for 1954 is $600, determined by reducing 
the $6,300 aggregate of the section 111 items by $5,700, i.e., the sum 
of (1) the difference between the amount of the taxable

[[Page 481]]

income for 1954 computed without regard to the section 111 items 
($4,400) and the amount of the taxable income for 1954 (not less than 
zero) computed by taking such items into account, and (2) the amount of 
the net operating loss ($1,300) which caused the reduction in tax for 
1952 by reason of the carryback provisions. If in 1956 the taxpayer 
recovers $400 of the bad debts, all of the recovery is excluded from the 
income by reason of the recovery exclusion of $600 determined for the 
original year 1954. If in 1957 the taxpayer recovers an additional $300 
of the bad debts, only $200 is excluded from gross income. That is, the 
recovery exclusion of $600 determined for the original year 1954 is 
reduced by the $400 recovered in 1956, leaving a balance of $200 which 
is used in 1957. The balance of the amount recovered in 1957, $100 ($300 
less $200), is included in gross income for 1957.

    (c) Provisions as to taxes imposed by section 531 (relating to the 
accumulated earnings tax) and section 541 (relating to the tax on 
personal holding companies). A recovery exclusion allowed for purposes 
of subtitle A (other than section 531 or section 541) of the Internal 
Revenue Code of 1954 shall also be allowed for the purpose of 
determining the accumulated earnings tax under section 531 or the 
personal holding company tax under section 541 regardless of whether or 
not the section 111 items on which such recovery exclusion is based 
resulted in a reduction of the tax under section 531 or section 541 of 
the Internal Revenue Code of 1954 (or corresponding provisions of prior 
income tax laws) for the prior taxable year. Furthermore, if there is 
recovery of a section 111 item which was not allowable as a deduction or 
credit for the prior taxable year for purposes of Subtitle A (not 
including section 531 or section 541) or corresponding provisions of 
prior income tax laws (other than Subchapter E, Chapter 2 of the 
Internal Revenue Code of 1939, relating to World War II excess profits 
tax), but was allowable for such prior taxable year in determining the 
tax under section 531 or section 541 (or corresponding provisions of 
prior income tax laws) then for the purpose of determining the tax under 
section 531 or section 541 a recovery exclusion shall be allowable with 
respect to such recovery if the section 111 item did not result in a 
reduction of the tax under section 531 or section 541 (or corresponding 
provisions of prior income tax laws).



Sec. 1.112-1  Combat zone compensation of members of the Armed Forces.

    (a) Combat zone compensation exclusion--(1) Amount excluded. In 
addition to the exemptions and credits otherwise applicable, section 112 
excludes from gross income the following compensation of members of the 
Armed Forces:
    (i) Enlisted personnel. Compensation received for active service as 
a member below the grade of commissioned officer in the Armed Forces of 
the United States for any month during any part of which the member 
served in a combat zone or was hospitalized at any place as a result of 
wounds, disease, or injury incurred while serving in the combat zone.
    (ii) Commissioned officers. Compensation not exceeding the monthly 
dollar limit received for active service as a commissioned officer in 
the Armed Forces of the United States for any month during any part of 
which the officer served in a combat zone or was hospitalized at any 
place as a result of wounds, disease, or injury incurred while serving 
in the combat zone. The monthly dollar limit is the monthly amount 
excludable from the officer's income under section 112(b) as amended. 
Beginning in 1966, the monthly dollar limit for periods of active 
service after 1965 became $500. As of September 10, 1993, the monthly 
dollar limit continues to be $500.
    (2) Time limits on exclusion during hospitalization. Compensation 
received for service for any month of hospitalization that begins more 
than 2 years after the date specified by the President in an Executive 
Order as the date of the termination of combatant activities in the 
combat zone cannot be excluded under section 112. Furthermore, 
compensation received while hospitalized after January 1978 for wounds, 
disease, or injury incurred in the Vietnam combat zone designated by 
Executive Order 11216 cannot be excluded under section 112.
    (3) Special terms. A commissioned warrant officer is not a 
commissioned officer under section 112(b) and is entitled to the 
exclusion allowed to enlisted personnel under section 112(a). 
Compensation, for the purpose of section

[[Page 482]]

112, does not include pensions and retirement pay. Armed Forces of the 
United States is defined (and members of the Armed Forces are described) 
in section 7701(a)(15).
    (4) Military compensation only. Only compensation paid by the Armed 
Forces of the United States to members of the Armed Forces can be 
excluded under section 112, except for compensation paid by an agency or 
instrumentality of the United States or by an international organization 
to a member of the Armed Forces whose military active duty status 
continues during the member's assignment to the agency or 
instrumentality or organization on official detail. Compensation paid by 
other employers (whether private enterprises or governmental entities) 
to members of the Armed Forces cannot be excluded under section 112 even 
if the payment is made to supplement the member's military compensation 
or is labeled by the employer as compensation for active service in the 
Armed Forces of the United States. Compensation paid to civilian 
employees of the federal government, including civilian employees of the 
Armed Forces, cannot be excluded under section 112, except as provided 
in section 112(d)(2) (which extends the exclusion to compensation of 
civilian employees of the federal government in missing status due to 
the Vietnam conflict).
    (b) Service in combat zone--(1) Active service. The exclusion under 
section 112 applies only if active service is performed in a combat 
zone. A member of the Armed Forces is in active service if the member is 
actually serving in the Armed Forces of the United States. Periods 
during which a member of the Armed Forces is absent from duty on account 
of sickness, wounds, leave, internment by the enemy, or other lawful 
cause are periods of active service. A member of the Armed Forces in 
active service in a combat zone who becomes a prisoner of war or missing 
in action in the combat zone is deemed, for the purpose of section 112, 
to continue in active service in the combat zone for the period for 
which the member is treated as a prisoner of war or as missing in action 
for military pay purposes.
    (2) Combat zone status. Except as provided in paragraphs (e) and (f) 
of this section, service is performed in a combat zone only if it is 
performed in an area which the President of the United States has 
designated by Executive Order, for the purpose of section 112, as an 
area in which Armed Forces of the United States are or have been engaged 
in combat, and only if it is performed on or after the date designated 
by the President by Executive Order as the date of the commencing of 
combatant activities in that zone and on or before the date designated 
by the President by Executive Order as the date of the termination of 
combatant activities in that zone.
    (3) Partial month service. If a member of the Armed Forces serves in 
a combat zone for any part of a month, the member is entitled to the 
exclusion for that month to the same extent as if the member has served 
in that zone for the entire month. If a member of the Armed Forces is 
hospitalized for a part of a month as a result of wounds, disease, or 
injury incurred while serving in that zone, the member is entitled to 
the exclusion for the entire month.
    (4) Payment time and place. The time and place of payment are 
irrelevant in considering whether compensation is excludable under 
section 112; rather, the time and place of the entitlement to 
compensation determine whether the compensation is excludable under 
section 112. Thus, compensation can be excluded under section 112 
whether or not it is received outside a combat zone, or while the 
recipient is hospitalized, or in a year different from that in which the 
service was rendered for which the compensation is paid, provided that 
the member's entitlement to the compensation fully accrued in a month 
during which the member served in the combat zone or was hospitalized as 
a result of wounds, disease, or injury incurred while serving in the 
combat zone. For this purpose, entitlement to compensation fully accrues 
upon the completion of all actions required of the member to receive the 
compensation. Compensation received by a member of the Armed Forces for 
services rendered while in active service can be excluded under section 
112

[[Page 483]]

even though payment is received subsequent to discharge or release from 
active service. Compensation credited to a deceased member's account for 
a period subsequent to the established date of the member's death and 
received by the member's estate can be excluded from the gross income of 
the estate under section 112 to the same extent that it would have been 
excluded from the gross income of the member had the member lived and 
received the compensation.
    (5) Examples of combat zone compensation. The rules of this section 
are illustrated by the following examples:

    Example 1. On January 5, outside of a combat zone, an enlisted 
member received basic pay for active duty services performed from the 
preceding December 1 through December 31. On December 4 (and no other 
date), the member performed services within a combat zone. The member 
may exclude from income the entire payment received on January 5, 
although the member served in the combat zone only one day during 
December, received the payment outside of the combat zone, and received 
the payment in a year other than the year in which the combat zone 
services were performed.
    Example 2. From March through December, an enlisted member became 
entitled to 25 days of annual leave while serving in a combat zone. The 
member used all 25 days of leave in the following year. The member may 
exclude from income the compensation received for those 25 days, even if 
the member performs no services in the combat zone in the year the 
compensation is received.
    Example 3. From March through December, a commissioned officer 
became entitled to 25 days of annual leave while serving in a combat 
zone. During that period the officer also received basic pay of $1,000 
per month from which the officer excluded from income $500 per month 
(exhausting the monthly dollar limit under section 112 for that period). 
The officer used all 25 days of leave in the following year. The officer 
may not exclude from income any compensation received in the following 
year related to those 25 days of leave, since the officer had already 
excluded from income the maximum amount of combat zone compensation for 
the period in which the leave was earned.
    Example 4. In November, while serving in a combat zone, an enlisted 
member competing for a cash award submitted an employee suggestion. 
After November, the member neither served in a combat zone nor was 
hospitalized for wounds incurred in the combat zone. In June of the 
following year, the member's suggestion was selected as the winner of 
the competition and the award was paid. The award can be excluded from 
income as combat zone compensation although granted and received outside 
of the combat zone, since the member completed the necessary action to 
win the award (submission of the suggestion) in a month during which the 
member served in the combat zone.
    Example 5. In July, while serving in a combat zone, an enlisted 
member voluntarily reenlisted. After July, the member neither served in 
a combat zone nor was hospitalized for wounds incurred in the combat 
zone. In February of the following year, the member received a bonus as 
a result of the July reenlistment. The reenlistment bonus can be 
excluded from income as combat zone compensation although received 
outside of the combat zone, since the member completed the necessary 
action for entitlement to the reenlistment bonus in a month during which 
the member served in the combat zone.
    Example 6. In July, while serving outside a combat zone, an enlisted 
member voluntarily reenlisted. In February of the following year, the 
member, while performing services in a combat zone, received a bonus as 
a result of the July reenlistment. The reenlistment bonus cannot be 
excluded from income as combat zone compensation although received while 
serving in the combat zone, since the member completed the necessary 
action for entitlement to the reenlistment bonus in a month during which 
the member had neither served in the combat zone nor was hospitalized 
for wounds incurred while serving in a combat zone.

    (c) Hospitalization--(1) Presumption of combat zone injury. If an 
individual is hospitalized for wound, disease, or injury while serving 
in a combat zone, the wound, disease, or injury will be presumed to have 
been incurred while serving in a combat zone, unless the contrary 
clearly appears. In certain cases, however, a wound, disease, or injury 
may have been incurred while serving in a combat zone even though the 
individual was not hospitalized for it while so serving. In exceptional 
cases, a wound, disease, or injury will not have been incurred while 
serving in a combat zone even though the individual was hospitalized for 
it while so serving.
    (2) Length of hospitalization. An individual is hospitalized only 
until the date the individual is discharged from the hospital.
    (3) Examples of combat zone injury. The rules of this paragraph (c) 
are illustrated by the following examples:


[[Page 484]]


    Example 1. An individual is hospitalized for a disease in the combat 
zone where the individual has been serving for three weeks. The 
incubation period of the disease is two to four weeks. The disease is 
incurred while serving in the combat zone.
    Example 2. The facts are the same as in Example 1 except that the 
incubation period of the disease is one year. The disease is not 
incurred while serving in the combat zone.
    Example 3. A member of the Air Force, stationed outside the combat 
zone, is shot while participating in aerial combat over the combat zone, 
but is not hospitalized until returning to the home base. The injury is 
incurred while serving in a combat zone.
    Example 4. An individual is hospitalized for a disease three weeks 
after having departed from a combat zone. The incubation period of the 
disease is two to four weeks. The disease is incurred while serving in a 
combat zone.

    (d) Married members. The exclusion under section 112 applies without 
regard to the marital status of the recipient of the compensation. If 
both spouses meet the requirements of the statute, then each spouse is 
entitled to the benefit of an exclusion. In the case of a husband and 
wife domiciled in a State recognized for Federal income tax purposes as 
a community property State, any exclusion from gross income under 
section 112 operates before apportionment of the gross income of the 
spouses under community property law. For example, a husband and wife 
are domiciled in a community property State and the member spouse is 
entitled, as a commissioned officer, to the benefit of the exclusion 
under section 112(b) of $500 for each month. The member receives $7,899 
as compensation for active service for 3 months in a combat zone. Of 
that amount, $1,500 is excluded from gross income under section 112(b) 
and $6,399 is taken into account in determining the gross income of both 
spouses.
    (e) Service in area outside combat zone--(1) Combat zone treatment. 
For purposes of section 112, a member of the Armed Forces who performs 
military service in an area outside the area designated by Executive 
Order as a combat zone is deemed to serve in that combat zone while the 
member's service is in direct support of military operations in that 
zone and qualifies the member for the special pay for duty subject to 
hostile fire or imminent danger authorized under section 310 of title 37 
of the United States Code, as amended (37 U.S.C. 310) (hostile fire/
imminent danger pay).
    (2) Examples of combat zone treatment. The examples in this 
paragraph (e)(2) are based on the following circumstances: Certain 
areas, airspace, and adjacent waters are designated as a combat zone for 
purposes of section 112 as of May 1. Some members of the Armed Forces 
are stationed in the combat zone; others are stationed in two foreign 
countries outside the combat zone, named Nearby Country and Destination 
Country.

    Example 1. B is a member of an Armed Forces ground unit stationed in 
the combat zone. On May 31, B's unit crosses into Nearby Country. B 
performs military service in Nearby Country in direct support of the 
military operations in the combat zone from June 1 through June 8 that 
qualifies B for hostile fire/imminent danger pay. B does not return to 
the combat zone during June. B is deemed to serve in the combat zone 
from June 1 through June 8. Accordingly, B is entitled to the exclusion 
under section 112 for June. Of course, B is also entitled to the 
exclusion for any month (May, in this example) in which B actually 
served in the combat zone.
    Example 2. B is a member of an Armed Forces ground unit stationed in 
the combat zone. On May 31, B's unit crosses into Nearby Country. On 
June 1, B is wounded while performing military service in Nearby Country 
in direct support of the military operations in the combat zone that 
qualifies B for hostile fire/imminent danger pay. On June 2, B is 
transferred for treatment to a hospital in the United States. B is 
hospitalized from June through October for those wounds. B is deemed to 
have incurred the wounds while serving in the combat zone on June 1. 
Accordingly, B is entitled to the exclusion under section 112 for June 
through October. Of course, B is also entitled to the exclusion for any 
month (May, in this example) in which B actually served in the combat 
zone.
    Example 3. B is stationed in Nearby Country for the entire month of 
June as a member of a ground crew servicing combat aircraft operating in 
the combat zone. B's service in Nearby Country during June does not 
qualify B for hostile fire/imminent danger pay. Accordingly, B is not 
deemed to serve in the combat zone during June and is not entitled to 
the exclusion under section 112 for that month.
    Example 4. B is assigned to an air unit stationed in Nearby Country 
for the entire month of June. In June, members of air

[[Page 485]]

units of the Armed Forces stationed in Nearby Country fly combat and 
supply missions into and over Destination Country in direct support of 
military operations in the combat zone. B flies combat missions over 
Destination Country from Nearby Country from June 1 through June 8. B's 
service qualifies B for hostile fire/imminent danger pay. Accordingly, B 
is deemed to serve in the combat zone during June and is entitled to the 
exclusion under section 112. The result would be the same if B were to 
fly supply missions into Destination Country from Nearby Country in 
direct support of operations in the combat zone qualifying B for hostile 
fire/imminent danger pay.
    Example 5. Assigned to an air unit stationed in Nearby Country, B 
was killed in June when B's plane crashed on returning to the airbase in 
Nearby Country. B was performing military service in direct support of 
the military operations in the combat zone at the time of B's death. B's 
service also qualified B for hostile fire/imminent danger pay. B is 
deemed to have died while serving in the combat zone or to have died as 
a result of wounds, disease, or injury incurred while serving in the 
combat zone for purposes of section 692(a) and section 692(b) (providing 
relief from certain income taxes for members of the Armed Forces dying 
in a combat zone or as a result of wounds, disease, or injury incurred 
while serving in a combat zone) and section 2201 (providing relief from 
certain estate taxes for members of the Armed Forces dying in a combat 
zone or by reason of combat-zone-incurred wounds). The result would be 
the same if B's mission had been a supply mission instead of a combat 
mission.
    Example 6. In June, B was killed as a result of an off-duty 
automobile accident while leaving the airbase in Nearby Country shortly 
after returning from a mission over Destination Country. At the time of 
B's death, B was not performing military duty qualifying B for hostile 
fire/imminent danger pay. B is not deemed to have died while serving in 
the combat zone or to have died as the result of wounds, disease, or 
injury incurred while serving in the combat zone. Accordingly, B does 
not qualify for the benefits of section 692(a), section 692(b), or 
section 2201.
    Example 7. B performs military service in Nearby Country from June 1 
through June 8 in direct support of the military operations in the 
combat zone. Nearby Country is designated as an area in which members of 
the Armed Forces qualify for hostile fire/imminent danger pay due to 
imminent danger, even though members in Nearby Country are not subject 
to hostile fire. B is deemed to serve in the combat zone from June 1 
through June 8. Accordingly, B is entitled to the exclusion under 
section 112 for June.

    (f) Nonqualifying presence in combat zone--(1) Inapplicability of 
exclusion. The following members of the Armed Forces are not deemed to 
serve in a combat zone within the meaning of section 112(a)(1) or 
section 112(b)(1) or to be hospitalized as a result of wounds, disease, 
or injury incurred while serving in a combat zone within the meaning of 
section 112(a)(2) or section 112(b)(2)--
    (i) Members present in a combat zone while on leave from a duty 
station located outside a combat zone;
    (ii) Members who pass over or through a combat zone during the 
course of a trip between two points both of which lie outside a combat 
zone; or
    (iii) Members present in a combat zone solely for their own personal 
convenience.
    (2) Exceptions for temporary duty or special pay. Paragraph (f)(1) 
of this section does not apply to members of the Armed Forces who--
    (i) Are assigned on official temporary duty to a combat zone 
(including official temporary duty to the airspace of a combat zone); or
    (ii) Qualify for hostile fire/imminent danger pay.
    (3) Examples of nonqualifying presence and its exceptions. The 
examples in this paragraph (f)(3) are based on the following 
circumstances: Certain areas, airspace, and adjacent waters are 
designated as a combat zone for purposes of section 112 as of May 1. 
Some members of the Armed Forces are stationed in the combat zone; 
others are stationed in two foreign countries outside the combat zone, 
named Nearby Country and Destination Country.

    Example 1. B is a member of the Armed Forces assigned to a unit 
stationed in Nearby Country. On June 1, B voluntarily visits a city 
within the combat zone while on leave. B is not deemed to serve in a 
combat zone since B is present in a combat zone while on leave from a 
duty station located outside a combat zone.
    Example 2. B is a member of the Armed Forces assigned to a unit 
stationed in Nearby Country. During June, B takes authorized leave and 
elects to spend the leave period by visiting a city in the combat zone. 
While on leave in the combat zone, B is subject to hostile fire 
qualifying B for hostile fire/imminent danger pay. Although B is present 
in the combat zone while on leave from a duty

[[Page 486]]

station outside the combat zone, B qualifies for the exclusion under 
section 112 because B qualifies for hostile fire/imminent danger pay 
while in the combat zone.
    Example 3. B is a member of the Armed Forces assigned to a ground 
unit stationed in the combat zone. During June, B takes authorized leave 
and elects to spend the leave period in the combat zone. B is not on 
leave from a duty station located outside a combat zone, nor is B 
present in a combat zone solely for B's own personal convenience. 
Accordingly, B's combat zone tax benefits continue while B is on leave 
in the combat zone.
    Example 4. B is assigned as a navigator to an air unit stationed in 
Nearby Country. On June 4, during the course of a flight between B's 
home base in Nearby Country and another base in Destination Country, the 
aircraft on which B serves as a navigator flies over the combat zone. B 
is not on official temporary duty to the airspace of the combat zone and 
does not qualify for hostile fire/imminent danger pay as a result of the 
flight. Accordingly, B is not deemed to serve in a combat zone since B 
passes over the combat zone during the course of a trip between two 
points both of which lie outside the combat zone without either being on 
official temporary duty to the combat zone or qualifying for hostile 
fire/imminent danger pay.
    Example 5. B is a member of the Armed Forces assigned to a unit 
stationed in Nearby Country. B enters the combat zone on a 3-day pass. B 
is not on official temporary duty and does not qualify for hostile fire/
imminent danger pay while present in the combat zone. Accordingly, B is 
not deemed to serve in a combat zone since B is present in the combat 
zone solely for B's own personal convenience.
    Example 6. B, stationed in Nearby Country, is a military courier 
assigned on official temporary duty to deliver military pouches in the 
combat zone and in Destination Country. On June 1, B arrives in the 
combat zone from Nearby Country, and on June 2, B departs for 
Destination Country. Although B passes through the combat zone during 
the course of a trip between two points outside the combat zone, B is 
nevertheless deemed to serve in a combat zone while in the combat zone 
because B is assigned to the combat zone on official temporary duty.
    Example 7. B is a member of an Armed Forces ground unit stationed in 
Nearby Country. On June 1, B took authorized leave and elected to spend 
the leave period by visiting a city in the combat zone. On June 2, while 
on leave in the combat zone, B was wounded by hostile fire qualifying B 
for hostile fire/imminent danger pay. On June 3, B was transferred for 
treatment to a hospital in the United States. B is hospitalized from 
June through October for those wounds. Although B was present in the 
combat zone while on leave from a duty station outside the combat zone, 
B is deemed to have incurred the wounds while serving in the combat zone 
on June 2, because B qualified for hostile fire/imminent danger pay 
while in the combat zone. Accordingly, B is entitled to the exclusion 
under section 112 for June through October.
    Example 8. The facts are the same as in Example 7 except that B dies 
on September 1 as a result of the wounds incurred in the combat zone. B 
is deemed to have died as a result of wounds, disease, or injury 
incurred while serving in the combat zone for purposes of section 692(a) 
and section 692(b) (providing relief from certain income taxes for 
members of the Armed Forces dying in a combat zone or as a result of 
wounds, disease, or injury incurred while serving in a combat zone) and 
section 2201 (providing relief from certain estate taxes for members of 
the Armed Forces dying in a combat zone or by reason of combat-zone-
incurred wounds).

[T.D. 8489, 58 FR 47640, Sept. 10, 1993]



Sec. 1.113-1  Mustering-out payments for members of the Armed Forces.

    For the purposes of the exclusion from gross income under section 
113 of mustering-out payments with respect to service in the Armed 
Forces, mustering-out payments are payments made to any recipients 
pursuant to the provisions of 38 U.S.C. 2105 (formerly section 5 of the 
Mustering-out Payment Act of 1944 and section 505 of the Veterans' 
Readjustment Assistance Act of 1952).



Sec. 1.117-1  Exclusion of amounts received as a scholarship or 
fellowship grant.

    (a) In general. Any amount received by an individual as a 
scholarship at an educational institution or as a fellowship grant, 
including the value of contributed services and accommodations, shall be 
excluded from the gross income of the recipient, subject to the 
limitations set forth in section 117(b) and Sec. 1.117-2. The exclusion 
from gross income of an amount which is a scholarship or fellowship 
grant is controlled solely by section 117. Accordingly, to the extent 
that a scholarship or a fellowship grant exceeds the limitations of 
section 117(b) and Sec. 1.117-2, it is includible in the gross income 
of the recipient notwithstanding the provisions of section 102 relating 
to exclusion from gross income of gifts, or section 74(b) relating to 
exclusion from gross

[[Page 487]]

income of certain prizes and awards. For definitions, see Sec. 1.117-3.
    (b) Exclusion of amounts received to cover expenses. (1) Subject to 
the limitations provided in subparagraph (2) of this paragraph, any 
amount received by an individual to cover expenses for travel (including 
meals and lodging while traveling and an allowance for travel of the 
individual's family), research, clerical help, or equipment is 
excludable from gross income provided that such expenses are incident to 
a scholarship or fellowship grant which is excludable from gross income 
under section 117(a)(1). If, however, only a portion of a scholarship or 
fellowship grant is excludable from gross income under section 117(a)(1) 
because of the part-time employment limitation contained in section 
117(b)(1) or because of the expiration of the 36-month period described 
in section 117(b)(2)(B), only the amount received to cover expenses 
incident to such excludable portion is excludable from gross income. The 
requirement that these expenses be incident to the scholarship or the 
fellowship grant means that the expenses of travel, research, clerical 
help, or equipment must be incurred by the individual in order to 
effectuate the purpose for which the scholarship or the fellowship grant 
was awarded.
    (2)(i) In the case of a scholarship or fellowship grant which is 
awarded after July 28, 1956, the exclusion provided under subparagraph 
(1) of this paragraph is not applicable unless the amount received by 
the individual is specifically designated to cover expenses for travel, 
research, clerical help, or equipment.
    (ii) In the case of a scholarship or fellowship grant awarded before 
July 29, 1956, the exclusion provided under subparagraph (1) of this 
paragraph is not applicable unless the recipient establishes, by 
competent evidence, that the amount was received to cover expenses for 
travel, research, clerical help, or equipment, but such amount need not 
be specifically designated. The fact that the recipient actually 
incurred expenses for travel, research, clerical help, or equipment is 
not sufficient to establish that the amount was received to cover such 
expenses.
    (iii) The exclusion provided under subparagraph (1) of this 
paragraph is applicable only to the extent that the amount received for 
travel, research, clerical help, or equipment is actually expended for 
such expenses by the recipient during the term of the scholarship or 
fellowship grant and within a reasonable time before and after such 
term.
    (3) The portion of any amount received to cover the expenses 
described in subparagraph (1) of this paragraph which is not actually 
expended for such expenses within the exclusion period described in 
subparagraph (2) of this paragraph shall, if not returned to the grantor 
within this period, be included in the gross income of the recipient for 
the taxable year in which such exclusion period expires.



Sec. 1.117-2  Limitations.

    (a) Individuals who are candidates for degrees--(1) In general. 
Under the limitations provided by section 117(b)(1) in the case of an 
individual who is a candidate for a degree at an educational 
institution, the exclusion from gross income shall not apply (except as 
otherwise provided in subparagraph (2) of this paragraph) to that 
portion of any amount received as payment for teaching, research, or 
other services in the nature of parttime employment required as a 
condition to receiving the scholarship or fellowship grant. Payments for 
such part-time employment shall be included in the gross income of the 
recipient in an amount determined by reference to the rate of 
compensation ordinarily paid for similar services performed by an 
individual who is not the recipient of a scholarship or a fellowship 
grant. A typical example of employment under this subparagraph is the 
case of an individual who is required, as a condition to receiving the 
scholarship or the fellowship grant, to perform part-time teaching 
services. A requirement that the individual shall furnish periodic 
reports to the grantor of the scholarship or the fellowship grant for 
the purpose of keeping the grantor informed as to the general progress 
of the individual shall not be deemed to constitute the performance of 
services in the nature of part-time employment.

[[Page 488]]

    (2) Exception. If teaching, research, or other services are required 
of all candidates (whether or not recipients of scholarships or 
fellowship grants) for a particular degree as a condition to receiving 
the degree, such teaching, research, or other services on the part of 
the recipient of a scholarship or fellowship grant who is a candidate 
for such degree shall not be regarded as part-time employment within the 
meaning of this paragraph. Thus, if all candidates for a particular 
education degree are required, as part of their regular course of study 
or curriculum, to perform part-time practice teaching services, such 
services are not to be regarded as part-time employment within the 
meaning of this paragraph.
    (b) Individuals who are not candidates for degrees--(1) Conditions 
for exclusion. In the case of an individual who is not a candidate for a 
degree at an educational institution, the exclusion from gross income of 
an amount received as a scholarship or a fellowship grant shall apply 
(to the extent provided in subparagraph (2) of this paragraph) only if 
the grantor of the scholarship or fellowship grant is--
    (i) An organization described in section 501(c)(3) which is exempt 
from tax under section 501(a),
    (ii) The United States or an instrumentality or agency thereof, or a 
State, a territory, or a possession of the United States, or any 
political subdivision thereof, or the District of Columbia, or
    (iii) For taxable years beginning after December 31, 1961, a foreign 
government, an international organization, or a binational or 
multinational educational and cultural foundation or commission created 
or continued pursuant to section 103 of the Mutual Educational and 
Cultural Exchange Act of 1961 (22 U.S.C. 2453).
    (2) Extent of exclusion. (i) In the case of an individual who is not 
a candidate for a degree, the amount received as a scholarship or a 
fellowship grant which is excludable from gross income under section 
117(a)(1) shall not exceed an amount equal to $300 times the number of 
months for which the recipient received amounts under the scholarship or 
fellowship grant during the taxable year. In determining the number of 
months during the period for which the recipient received amounts under 
a scholarship or fellowship grant, computation shall be made on the 
basis of whole calendar months. A whole calendar month means a period of 
time terminating with the day of the succeeding month numerically 
corresponding to the day of the month of its beginning, less one, except 
that if there be no corresponding day of the succeeding month the period 
terminates with the last day of the succeeding month. For purposes of 
this computation a fractional part of a calendar month consisting of a 
period of time including 15 days or more shall be considered to be a 
whole calendar month and a fractional part of a calendar month 
consisting of a period of time including 14 days or less shall be 
disregarded. For example, if an individual receives a fellowship grant 
on September 13 which is to expire on June 12 of the following year, the 
grant shall be considered to have extended for a period of 9 months. If 
in the preceding example the grant expired on June 27, instead of June 
12, the grant shall be considered to have extended for a period of 10 
months.
    (ii) No exclusion shall be allowed under section 117(a)(1) to an 
individual who is not a candidate for a degree after the recipient has, 
as an individual who is not a candidate for a degree, been entitled to 
an exclusion under that section for a period of 36 months. This 
limitation applies if the individual has received any amount which was 
either excluded or excludable from his gross income under section 
117(a)(1) for any prior 36 months, whether or not consecutive. For 
example, if the individual received a fellowship grant of $7,200 for 3 
years (which he elected to receive in 36 monthly installments of $200), 
his exclusion period would be exhausted even though he did not in any of 
the 36 months make use of the maximum exclusion. Accordingly, such 
individual would be entitled to no further exclusion from gross income 
with respect to any additional grants which he may receive as an 
individual who is not a candidate for a degree.
    (iii) If an individual who is not a candidate for a degree receives 
amounts

[[Page 489]]

from more than one scholarship or fellowship grant during the taxable 
year, the total amounts received in the taxable year shall be aggregated 
for the purpose of computing the amount which may be excludable from 
gross income for such taxable year. If amounts are received from more 
than one scholarship or fellowship grant during the same month or months 
within the taxable year, such month or months shall be counted only once 
for the purpose of determining the number of months for which the 
individual received such amounts under the scholarships or fellowship 
grants during the taxable year. For example, if an individual receives a 
fellowship grant from one source for the months of January to June of 
the taxable year and also receives a fellowship grant from another 
source for the months of March through December of the same taxable 
year, he shall be considered to have received amounts for 12 months of 
the taxable year. See example (4) in subparagraph (3) of this paragraph 
for further illustration.
    (3) Examples. The application of this paragraph may be further 
illustrated by the following examples, it being assumed that in each 
example the grantor is a grantor who is described in section 
117(b)(2)(A) and subparagraph (1) of this paragraph:

    Example (1). B, an individual who files his return on the calendar 
year basis, is awarded a post-doctorate fellowship grant in March 1955. 
The grant is to commence on September 1, 1955, and is to end on May 31, 
1956, so that it will extend over a period of 9 months. The amount of 
the fellowship grant is $4,500 and B receives this amount in monthly 
installments of $500 on the first day of each month commencing September 
1, 1955. During the taxable year 1955, B receives a total of $2,000 with 
respect to the 4-month period September through December, inclusive. He 
may exclude $1,200 from gross income in the taxable year 1955 ($300x4) 
and must include the remaining $800 in gross income for that year. For 
the year 1956, he will exclude $1,500 ($300x5) from gross income with 
respect to the $2,500 which he receives in that year and must include in 
gross income $1,000.
    Example (2). Assume the same facts as in example (1) except that B 
receives the full amount of the grant ($4,500) on September 1, 1955. 
Since the amount received in the taxable year 1955 is for the full term 
of the fellowship grant (9 months), B may exclude $2,700 ($300x9) from 
gross income for the taxable year 1955. The remaining $1,800 must be 
included in gross income for that year.
    Example (3). C, an individual who files his return on the calendar 
year basis, is awarded a post-doctorate fellowship grant in March 1955. 
The amount of the grant is $4,500 for a period commencing on September 
1, 1955, and ending 24 months thereafter. C receives the full amount of 
the grant on September 1, 1955. C may exclude from gross income for the 
taxable year 1955, the full amount of the grant ($4,500) since this 
amount does not exceed an amount equal to $300 times the number of 
months (24) for which he received the amount of the grant during that 
taxable year.
    Example (4). (i) F, an individual who files his return on the 
calendar year basis, is awarded a post-doctorate fellowship grant (Grant 
A) for two years commencing June 1, 1955, in the amount of $4,800. He 
elects to receive his grant in monthly installments of $200 commencing 
June 1, 1955. On March 1, 1956, F is awarded another post-doctorate 
fellowship grant (Grant B) for two years commencing September 1, 1956, 
in the amount of $7,200. He elects to receive this grant in monthly 
installments of $300 commencing September 1, 1956.
    (ii) For the calendar year 1955, F receives $1,400 from Grant A 
which he is entitled to exclude from gross income since it does not 
exceed an amount equal to $300 times the number of months (7) for which 
he received amounts under the grant in the taxable year.
    (iii) For the calendar year 1956, F receives $3,600 as the aggregate 
of amounts received under fellowship grants ($2,400 from Grant A and 
$1,200 from Grant B). F will be entitled to exclude the entire amount of 
$3,600 from gross income for the calendar year 1956 since such amount 
does not exceed an amount equal to $300 times the number of months (12) 
for which he received amounts under the grants in the taxable year.
    (iv) For the calendar year 1957, F receives $4,600 as the aggregate 
of amounts received under fellowship grants ($1,000 from Grant A and 
$3,600 from Grant B). F will be entitled to exclude $3,600 ($300x12) 
from gross income for the calendar year 1957 and he will have to include 
$1,000 in gross income.
    (v) For the calendar year 1958, F receives $2,400 from Grant B. F is 
entitled to exclude $1,500 ($300x5) from gross income for the calendar 
year 1958 and he will have to include $900 in gross income. While F 
receives amounts under fellowship Grant B for 8 months during the 
calendar year 1958, he is limited to an amount equal to $300 times 5 
(months) because of the fact that he has already been entitled to 
exclude (and has in fact excluded) amounts received as a fellowship 
grant for a period of 31 months. Accordingly, he can only exclude 
amounts received under the fellowship grant for 5 months during the 
calendar year 1958, because of the 36-

[[Page 490]]

month limitation period. The fact that he was entitled to exclude only 
$1,400 ($200 a month for 7 months) instead of the maximum amount of 
$2,100 ($300x7) in 1955, is immaterial and the limitation period of 36 
months is applicable.
    (vi) The following chart illustrates the computation of the number 
of months for which F received amounts under the fellowship grants 
during the respective taxable years and the computation of the total 
amounts received under the fellowship grants during each taxable year:

------------------------------------------------------------------------
                                                       Number
        Period for which received and source             of      Amounts
                                                       months   received
------------------------------------------------------------------------
1955:
  June 1 to December 31.............................         7
    Grant A.........................................  ........    $1,400
    Grant B.........................................  ........      None
                                                     -------------------
      Aggregate.....................................         7     1,400
1956:
  January 1 to August 31............................         8
    Grant A.........................................  ........     1,600
    Grant B.........................................  ........      None
  September 1 to December 31........................         4
    Grant A.........................................  ........       800
    Grant B.........................................  ........     1,200
                                                     -------------------
      Aggregate.....................................        12     3,600
1957:
  January 1 to May 31...............................         5
    Grant A.........................................  ........     1,000
    Grant B.........................................  ........     1,500
  June 1 to December 31.............................         7
    Grant A.........................................  ........      None
    Grant B.........................................  ........     2,100
                                                     -------------------
      Aggregate.....................................        12     4,600
1958:
  January 1 to August 31............................         8
    Grant A.........................................  ........      None
    Grant B.........................................  ........     2,400
                                                     -------------------
      Aggregate.....................................  ........     2,400
------------------------------------------------------------------------


[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6782, 29 FR 
18355, Dec. 24, 1964]



Sec. 1.117-3  Definitions.

    (a) Scholarship. A scholarship generally means an amount paid or 
allowed to, or for the benefit of, a student, whether an undergraduate 
or a graduate, to aid such individual in pursuing his studies. The term 
includes the value of contributed services and accommodations (see 
paragraph (d) of this section) and the amount of tuition, matriculation, 
and other fees which are furnished or remitted to a student to aid him 
in pursuing his studies. The term also includes any amount received in 
the nature of a family allowance as a part of a scholarship. However, 
the term does not include any amount provided by an individual to aid a 
relative, friend, or other individual in pursuing his studies where the 
grantor is motivated by family or philanthropic considerations. If an 
educational institution maintains or participates in a plan whereby the 
tuition of a child of a faculty member of such institution is remitted 
by any other participating educational institution attended by such 
child, the amount of the tuition so remitted shall be considered to be 
an amount received as a scholarship.
    (b) Educational organization. For definition of ``educational 
organization'' paragraphs (a) and (b) of section 117 adopt the 
definition of that term which is prescribed in section 151(e)(4). 
Accordingly, for purposes of section 117 the term ``educational 
organization'' means only an educational organization which normally 
maintains a regular faculty and curriculum and normally has a regularly 
organized body of students in attendance at the place where its 
educational activities are carried on. See section 151(e)(4) and 
regulations thereunder.
    (c) Fellowship grant. A fellowship grant generally means an amount 
paid or allowed to, or for the benefit of, an individual to aid him in 
the pursuit of study or research. The term includes the value of 
contributed services and accommodations (see paragraph (d) of this 
section) and the amount of tuition, matriculation, and other fees which 
are furnished or remitted to an individual to aid him in the pursuit of 
study or research. The term also includes any amount received in the 
nature of a family allowance as a part of a fellowship grant. However, 
the term does not include any amount provided by an individual to aid a 
relative, friend, or other individual in the pursuit of study or 
research where the grantor is motivated by family or philanthropic 
considerations.
    (d) Contributed services and accommodations. The term ``contributed 
services and accommodations'' means such services and accommodations as 
room, board, laundry service, and similar services or accommodations 
which are received by an individual as a part of a scholarship or 
fellowship grant.

[[Page 491]]

    (e) Candidate for a degree. The term ``candidate for a degree'' 
means an individual, whether an undergraduate or a graduate, who is 
pursuing studies or conducting research to meet the requirements for an 
academic or professional degree conferred by colleges or universities. 
It is not essential that such study or research be pursued or conducted 
at an educational institution which confers such degrees if the purpose 
thereof is to meet the requirements for a degree of a college or 
university which does confer such degrees. A student who receives a 
scholarship for study at a secondary school or other educational 
institution is considered to be a ``candidate for a degree.''

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as 
amended by T.D. 8032, 50 FR 27232, July 2, 1985]



Sec. 1.117-4  Items not considered as scholarships or fellowship grants.

    The following payments or allowances shall not be considered to be 
amounts received as a scholarship or a fellowship grant for the purpose 
of section 117:
    (a) Educational and training allowances to veterans. Educational and 
training allowances to a veteran pursuant to section 400 of the 
Servicemen's Readjustment Act of 1944 (58 Stat. 287) or pursuant to 38 
U.S.C. 1631 (formerly section 231 of the Veterans' Readjustment 
Assistance Act of 1952).
    (b) Allowances to members of the Armed Forces of the United States. 
Tuition and subsistence allowances to members of the Armed Forces of the 
United States who are students at an educational institution operated by 
the United States or approved by the United States for their education 
and training, such as the United States Naval Academy and the United 
States Military Academy.
    (c) Amounts paid as compensation for services or primarily for the 
benefit of the grantor. (1) Except as provided in paragraph (a) of 
Sec. Sec. 1.117-2 and 1.117-5, any amount paid or allowed to, or on 
behalf of, an individual to enable him to pursue studies or research, if 
such amount represents either compensation for past, present, or future 
employment services or represents payment for services which are subject 
to the direction or supervision of the grantor.
    (2) Any amount paid or allowed to, or on behalf of, an individual to 
enable him to pursue studies or research primarily for the benefit of 
the grantor.

However, amounts paid or allowed to, or on behalf of, an individual to 
enable him to pursue studies or research are considered to be amounts 
received as a scholarship or fellowship grant for the purpose of section 
117 if the primary purpose of the studies or research is to further the 
education and training of the recipient in his individual capacity and 
the amount provided by the grantor for such purpose does not represent 
compensation or payment for the services described in subparagraph (1) 
of this paragraph. Neither the fact that the recipient is required to 
furnish reports of his progress to the grantor, nor the fact that the 
results of his studies or research may be of some incidental benefits to 
the grantor shall, of itself, be considered to destroy the essential 
character of such amount as a scholarship or fellowship grant.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as 
amended by T.D. 8032, 50 FR 27232, July 2, 1985]



Sec. 1.117-5  Federal grants requiring future service as a Federal 
employee.

    (a) In general. Under section 117(c), amounts received by an 
individual under a Federal program as a scholarship or grant for 
qualified tuition and expenses at an institution of higher education are 
excluded from the gross income of the recipient even though the 
recipient is required to perform future service as a Federal employee. 
See paragraph (c) of this section for the definitions of the terms 
``qualified tuition and expenses'' and ``institution of higher 
education.''
    (b) Exception for uniformed services scholarship programs. The 
requirements of this section do not apply to amounts received before 
1985 by a member of a uniformed service who entered training before 1981 
under the Armed Forces Health Professions Scholarship Program, National 
Public Health Service Corps Scholarship Training Program, or other 
substantially similar Federal programs requiring the recipient to work 
for a uniformed Federal service after completion of studies. These 
awards are governed by section 4 of

[[Page 492]]

Pub. L. 93-483 as amended by Pub. L. 95-171, Pub. L. 95-600 and Pub. L. 
96-167. See section 101(3) of title 37, United States Code for the 
definition of the term ``uniformed service.''
    (c) Definitions--(1) Qualified tuition and related expenses. For 
purposes of section 117(c) and this section, qualified tuition and 
related expenses are those amounts which under the terms of the Federal 
program are required to be used and in fact are used for payment of:
    (i) Tuition and fees that are required for the recipient's 
enrollment or attendance at an institution of higher education; and
    (ii) Those amounts used for payment of fees, books, supplies and 
equipment required for courses of instruction at such an institution.

Incidental expenses are not considered related expenses and thus are not 
excludable from gross income under section 117(c). Incidental expenses 
include room and board at an institution of higher education, expenses 
for travel (including expenses for meals and lodging incurred during 
travel and allowances for travel of the recipient's family), research, 
clerical help, equipment and other expenses which are not required for 
enrollment at the institution or in a course of instruction at such 
institution.
    (2) Institution of higher education. To qualify as an institution of 
higher education under this section, the institution must be a public or 
other nonprofit institution in any state which--
    (i) Admits as regular students only individuals who have a 
certificate of graduation from a high school or the recognized 
equivalent of such a certificate;
    (ii) Is legally authorized within the state to provide a program of 
education beyond high school; and
    (iii) Provides an education program for which it awards a bachelor's 
or higher degree or which is acceptable for full credit towards such a 
degree, or which trains and prepares students for gainful employment in 
a recognized health profession. For purposes of this section, recognized 
health professions are those health professions which are supervised or 
monitored by appropriate state or Federal agencies or governing 
professional associations and which require members to be currently 
licensed or certified in order to practice.
    (3) Service as a Federal employee--(i) In general. Except as 
otherwise provided in paragraph (c)(3)(ii) of this section, service as a 
Federal employee refers to employment of the recipient by the Federal 
government to work directly for the Federal government. Thus, Federal 
grants or scholarships which do not require the recipient to work 
directly for the Federal government are not governed by the rules of 
this section.
    (ii) Service in a health manpower shortage area. For purposes of 
this section an obligation under a grant for the recipient to serve in a 
health related field in a health manpower shortage area as designated by 
the Secretary of Health and Human Services according to the criteria of 
the Public Health Services Act (42 U.S.C. 254(e)) and the regulations 
promulgated thereunder (42 CFR 5.1-5.4) will be considered an obligation 
to serve as a Federal employee.
    (d) Records required for exclusion from gross income. To exclude 
amounts received under Federal programs requiring future services as a 
Federal employee, the recipient must maintain records that establish 
that the amounts received under such programs were used for qualified 
tuition and related expenses as defined in paragraph (c)(1) of this 
section. Qualifying uses may be established by providing to the Service, 
upon request, copies of relevant bills, receipts, cancelled checks or 
other convenient documentation or records which clearly reflect the use 
of the money received under the grant. The recipient must also submit, 
upon request, documentation establishing receipt of the grant and 
setting out the terms and requirements of the particular grant.
    (e) Applicability of rules of Sec. Sec. 117(a) and 117(b). Except 
where a different rule has been expressly provided in this section, 
amounts received under Federal grants requiring future service as a 
Federal employee, and which meet the requirements for exclusion from 
gross income under this section, are subject to the rules, limitations 
and definitions specified in Sec. Sec. 117 (a) and (b) of the Code and 
Sec. Sec. 1.117-1 through 1.117-4.

[[Page 493]]

    (f) Effective date. Except as provided in paragraph (b) of this 
section, this section will apply to amounts received after December 31, 
1980 under Federal programs which meet the requirements of this section.

[T.D. 8032, 50 FR 27232, July 2, 1985]



Sec. 1.118-1  Contributions to the capital of a corporation.

    In the case of a corporation, section 118 provides an exclusion from 
gross income with respect to any contribution of money or property to 
the capital of the taxpayer. Thus, if a corporation requires additional 
funds for conducting its business and obtains such funds through 
voluntary pro rata payments by its shareholders, the amounts so received 
being credited to its surplus account or to a special account, such 
amounts do not constitute income, although there is no increase in the 
outstanding shares of stock of the corporation. In such a case the 
payments are in the nature of assessments upon, and represent an 
additional price paid for, the shares of stock held by the individual 
shareholders, and will be treated as an addition to and as a part of the 
operating capital of the company. Section 118 also applies to 
contributions to capital made by persons other than shareholders. For 
example, the exclusion applies to the value of land or other property 
contributed to a corporation by a governmental unit or by a civic group 
for the purpose of inducing the corporation to locate its business in a 
particular community, or for the purpose of enabling the corporation to 
expand its operating facilities. However, the exclusion does not apply 
to any money or property transferred to the corporation in consideration 
for goods or services rendered, or to subsidies paid for the purpose of 
inducing the taxpayer to limit production. See section 362 for the basis 
of property acquired by a corporation through a contribution to its 
capital by its stockholders or by nonstockholders.



Sec. 1.118-2  Contribution in aid of construction.

    (a) Special rule for water and sewerage disposal utilities--(1) In 
general. For purposes of section 118, the term contribution to the 
capital of the taxpayer includes any amount of money or other property 
received from any person (whether or not a shareholder) by a regulated 
public utility that provides water or sewerage disposal services if--
    (i) The amount is a contribution in aid of construction under 
paragraph (b) of this section;
    (ii) In the case of a contribution of property other than water or 
sewerage disposal facilities, the amount satisfies the expenditure rule 
under paragraph (c) of this section; and
    (iii) The amount (or any property acquired or constructed with the 
amount) is not included in the taxpayer's rate base for ratemaking 
purposes.
    (2) Definitions--(i) Regulated public utility has the meaning given 
such term by section 7701(a)(33), except that such term does not include 
any utility which is not required to provide water or sewerage disposal 
services to members of the general public in its service area.
    (ii) Water or sewerage disposal facility is defined as tangible 
property described in section 1231(b) that is used predominately (80% or 
more) in the trade or business of furnishing water or sewerage disposal 
services.
    (b) Contribution in aid of construction--(1) In general. For 
purposes of section 118(c) and this section, the term contribution in 
aid of construction means any amount of money or other property 
contributed to a regulated public utility that provides water or 
sewerage disposal services to the extent that the purpose of the 
contribution is to provide for the expansion, improvement, or 
replacement of the utility's water or sewerage disposal facilities.
    (2) Advances. A contribution in aid of construction may include an 
amount of money or other property contributed to a regulated public 
utility for a water or sewerage disposal facility subject to a 
contingent obligation to repay the amount, in whole or in part, to the 
contributor (commonly referred to as an advance). For example, an amount 
received by a utility from a developer to construct a water facility 
pursuant to an agreement under which the utility will pay the developer 
a percentage of the receipts from the facility over a fixed period may 
constitute a contribution in aid of construction. Whether an

[[Page 494]]

advance is a contribution or a loan is determined under general 
principles of federal tax law based on all the facts and circumstances. 
For the treatment of any amount of a contribution in aid of construction 
that is repaid by the utility to the contributor, see paragraphs 
(c)(2)(ii) and (d)(2) of this section.
    (3) Customer connection fee--(i) In general. Except as provided in 
paragraph (b)(3)(ii) of this section, a customer connection fee is not a 
contribution in aid of construction under this paragraph (b) and 
generally is includible in income. The term customer connection fee 
includes any amount of money or other property transferred to the 
utility representing the cost of installing a connection or service line 
(including the cost of meters and piping) from the utility's main water 
or sewer lines to the line owned by the customer or potential customer. 
A customer connection fee also includes any amount paid as a service 
charge for starting or stopping service.
    (ii) Exceptions--(A) Multiple customers. Money or other property 
contributed for a connection or service line from the utility's main 
line to the customer's or the potential customer's line is not a 
customer connection fee if the connection or service line serves, or is 
designed to serve, more than one customer. For example, a contribution 
for a split service line that is designed to serve two customers is not 
a customer connection fee. On the other hand, if a water or sewerage 
disposal utility treats an apartment or office building as one utility 
customer, then the cost of installing a connection or service line from 
the utility's main water or sewer lines serving that single customer is 
a customer connection fee.
    (B) Fire protection services. Money or other property contributed 
for public and private fire protection services is not a customer 
connection fee.
    (4) Reimbursement for a facility previously placed in service--(i) 
In general. If a water or sewerage disposal facility is placed in 
service by the utility before an amount is contributed to the utility, 
the contribution is not a contribution in aid of construction under this 
paragraph (b) with respect to the cost of the facility unless, no later 
than 8\1/2\ months after the close of the taxable year in which the 
facility was placed in service, there is an agreement, binding under 
local law, that the utility is to receive the amount as reimbursement 
for the cost of acquiring or constructing the facility. An order or 
tariff, binding under local law, that is issued or approved by the 
applicable public utility commission requiring current or prospective 
utility customers to reimburse the utility for the cost of acquiring or 
constructing the facility, is a binding agreement for purposes of the 
preceding sentence. If an agreement exists, the basis of the facility 
must be reduced by the amount of the expected contributions. Appropriate 
adjustments must be made if actual contributions differ from expected 
contributions.
    (ii) Example. The application of paragraph (b)(4)(i) of this section 
is illustrated by the following example:

    Example. M, a calendar year regulated public utility that provides 
water services, spent $1,000,000 for the construction of a water 
facility that can serve 200 customers. M placed the facility in service 
in 2000. In June 2001, the public utility commission that regulates M 
approves a tariff requiring new customers to reimburse M for the cost of 
constructing the facility by paying a service availability charge of 
$5,000 per lot. Pursuant to the tariff, M expects to receive 
reimbursements for the cost of the facility of $100,000 per year for the 
years 2001 through 2010. The reimbursements are contributions in aid of 
construction under paragraph (b) of this section because no later than 
8\1/2\ months after the close of the taxable year in which the facility 
was placed in service there was a tariff, binding under local law, 
approved by the public utility commission requiring new customers to 
reimburse the utility for the cost of constructing the facility. The 
basis of the $1,000,000 facility is zero because the expected 
contributions equal the cost of the facility.

    (5) Classification by ratemaking authority. The fact that the 
applicable ratemaking authority classifies any money or other property 
received by a utility as a contribution in aid of construction is not 
conclusive as to its treatment under this paragraph (b).
    (c) Expenditure rule--(1) In general. An amount satisfies the 
expenditure rule of section 118(c)(2) if the amount is expended for the 
acquisition or construction of property described in section

[[Page 495]]

118(c)(2)(A), the amount is paid or incurred before the end of the 
second taxable year after the taxable year in which the amount was 
received as required by section 118(c)(2)(B), and accurate records are 
kept of contributions and expenditures as provided in section 
118(c)(2)(C).
    (2) Excess amount--(i) Includible in the utility's income. An amount 
received by a utility as a contribution in aid of construction that is 
not expended for the acquisition or construction of water or sewerage 
disposal facilities as required by paragraph (c)(1) of this section (the 
excess amount) is not a contribution to the capital of the taxpayer 
under paragraph (a) of this section. Except as provided in paragraph 
(c)(2)(ii) of this section, such excess amount is includible in the 
utility's income in the taxable year in which the amount was received.
    (ii) Repayment of excess amount. If the excess amount described in 
paragraph (c)(2)(i) of this section is repaid, in whole or in part, 
either--
    (A) Before the end of the time period described in paragraph (c)(1) 
of this section, the repayment amount is not includible in the utility's 
income; or
    (B) After the end of the time period described in paragraph (c)(1) 
of this section, the repayment amount may be deducted by the utility in 
the taxable year in which it is paid or incurred to the extent such 
amount was included in income.
    (3) Example. The application of this paragraph (c) is illustrated by 
the following example:

    Example. M, a calendar year regulated public utility that provides 
water services, received a $1,000,000 contribution in aid of 
construction in 2000 for the purpose of constructing a water facility. 
To the extent that the $1,000,000 exceeded the actual cost of the 
facility, the contribution was subject to being returned. In 2001, M 
built the facility at a cost of $700,000 and returned $200,000 to the 
contributor. As of the end of 2002, M had not returned the remaining 
$100,000. Assuming accurate records are kept, the requirement under 
section 118(c)(2) is satisfied for $700,000 of the contribution. Because 
$200,000 of the contribution was returned within the time period during 
which qualifying expenditures could be made, this amount is not 
includible in M's income. However, the remaining $100,000 is includible 
in M's income for its 2000 taxable year (the taxable year in which the 
amount was received) because the amount was neither spent nor repaid 
during the prescribed time period. To the extent M repays the remaining 
$100,000 after year 2002, M would be entitled to a deduction in the year 
such repayment is paid or incurred.

    (d) Adjusted basis--(1) Exclusion from basis. Except for a repayment 
described in paragraph (d)(2) of this section, to the extent that a 
water or sewerage disposal facility is acquired or constructed with an 
amount received as a contribution to the capital of the taxpayer under 
paragraph (a) of this section, the basis of the facility is reduced by 
the amount of the contribution. To the extent the water or sewerage 
disposal facility is acquired as a contribution to the capital of the 
taxpayer under paragraph (a) of this section, the basis of the 
contributed facility is zero.
    (2) Repayment of contribution. If a contribution to the capital of 
the taxpayer under paragraph (a) of this section is repaid to the 
contributor, either in whole or in part, then the repayment amount is a 
capital expenditure in the taxable year in which it is paid or incurred, 
resulting in an increase in the property's adjusted basis in such year. 
Capital expenditures allocated to depreciable property under paragraph 
(d)(3) of this section may be depreciated over the remaining recovery 
period for that property.
    (3) Allocation of contributions. An amount treated as a capital 
expenditure under this paragraph (d) is to be allocated proportionately 
to the adjusted basis of each property acquired or constructed with the 
contribution based on the relative cost of such property.
    (4) Example. The application of this paragraph (d) is illustrated by 
the following example:

    Example. A, a calendar year regulated public utility that provides 
water services, received a $1,000,000 contribution in aid of 
construction in 2000 as an advance from B, a developer, for the purpose 
of constructing a water facility. To the extent that the $1,000,000 
exceeds the actual cost of the facility, the contribution is subject to 
being returned. Under the terms of the advance, A agrees to pay to B a 
percentage of the receipts from the facility over a fixed period, but 
limited to the cost of the facility. In 2001, A builds the facility at a 
cost of $700,000 and returns $300,000 to B. In 2002, A pays

[[Page 496]]

$20,000 to B out of the receipts from the facility. Assuming accurate 
records are kept, the $700,000 advance is a contribution to the capital 
of A under paragraph (a) of this section and is excludable from A's 
income. The basis of the $700,000 facility constructed with this 
contribution to capital is zero. The $300,000 excess amount is not a 
contribution to the capital of A under paragraph (a) of this section 
because it does not meet the expenditure rule described in paragraph 
(c)(1) of this section. However, this excess amount is not includible in 
A's income pursuant to paragraph (c)(2)(ii) of this section since the 
amount is repaid to B within the required time period. The repayment of 
the $300,000 excess amount to B in 2001 is not treated as a capital 
expenditure by A. The $20,000 payment to B in 2002 is treated as a 
capital expenditure by A in 2002 resulting in an increase in the 
adjusted basis of the water facility from zero to $20,000.

    (e) Statute of limitations--(1) Extension of statute of limitations. 
Under section 118(d)(1), the statutory period for assessment of any 
deficiency attributable to a contribution to capital under paragraph (a) 
of this section does not expire before the expiration of 3 years after 
the date the taxpayer notifies the Secretary in the time and manner 
prescribed in paragraph (e)(2) of this section.
    (2) Time and manner of notification. Notification is made by 
attaching a statement to the taxpayer's federal income tax return for 
the taxable year in which any of the reportable items in paragraphs 
(e)(2)(i) through (iii) of this section occur. The statement must 
contain the taxpayer's name, address, employer identification number, 
taxable year, and the following information with respect to 
contributions of property other than water or sewerage disposal 
facilities that are subject to the expenditure rule described in 
paragraph (c) of this section--
    (i) The amount of contributions in aid of construction expended 
during the taxable year for property described in section 118(c)(2)(A) 
(qualified property) as required under paragraph (c)(1) of this section, 
identified by taxable year in which the contributions were received;
    (ii) The amount of contributions in aid of construction that the 
taxpayer does not intend to expend for qualified property as required 
under paragraph (c)(1) of this section, identified by taxable year in 
which the contributions were received; and
    (iii) The amount of contributions in aid of construction that the 
taxpayer failed to expend for qualified property as required under 
paragraph (c)(1) of this section, identified by taxable year in which 
the contributions were received.
    (f) Effective date. This section is applicable for any money or 
other property received by a regulated public utility that provides 
water or sewerage disposal services on or after January 11, 2001.

[T.D. 8936, 66 FR 2254, Jan. 11, 2001]



Sec. 1.119-1  Meals and lodging furnished for the convenience of the 
employer.

    (a) Meals--(1) In general. The value of meals furnished to an 
employee by his employer shall be excluded from the employee's gross 
income if two tests are met: (i) The meals are furnished on the business 
premises of the employer, and (ii) the meals are furnished for the 
convenience of the employer. The question of whether meals are furnished 
for the convenience of the employer is one of fact to be determined by 
analysis of all the facts and circumstances in each case. If the tests 
described in subdivisions (i) and (ii) of this subparagraph are met, the 
exclusion shall apply irrespective of whether under an employment 
contract or a statute fixing the terms of employment such meals are 
furnished as compensation.
    (2) Meals furnished without a charge. (i) Meals furnished by an 
employer without charge to the employee will be regarded as furnished 
for the convenience of the employer if such meals are furnished for a 
substantial noncompensatory business reason of the employer. If an 
employer furnishes meals as a means of providing additional compensation 
to his employee (and not for a substantial noncompensatory business 
reason of the employer), the meals so furnished will not be regarded as 
furnished for the convenience of the employer. Conversely, if the 
employer furnishes meals to his employee for a substantial 
noncompensatory business reason, the meals so furnished will be regarded 
as furnished for the convenience of the employer, even though

[[Page 497]]

such meals are also furnished for a compensatory reason. In determining 
the reason of an employer for furnishing meals, the mere declaration 
that meals are furnished for a noncompensatory business reason is not 
sufficient to prove that meals are furnished for the convenience of the 
employer, but such determination will be based upon an examination of 
all the surrounding facts and circumstances. In subdivision (ii) of this 
subparagraph, there are set forth some of the substantial 
noncompensatory business reasons which occur frequently and which 
justify the conclusion that meals furnished for such a reason are 
furnished for the convenience of the employer. In subdivision (iii) of 
this subparagraph, there are set forth some of the business reasons 
which are considered to be compensatory and which, in the absence of a 
substantial noncompensatory business reason, justify the conclusion that 
meals furnished for such a reason are not furnished for the convenience 
of the employer. Generally, meals furnished before or after the working 
hours of the employee will not be regarded as furnished for the 
convenience of the employer, but see subdivision (ii) (d) and (f) of 
this subparagraph for some exceptions to this general rule. Meals 
furnished on nonworking days do not qualify for the exclusion under 
section 119. If the employee is required to occupy living quarters on 
the business premises of his employer as a condition of his employment 
(as defined in paragraph (b) of this section), the exclusion applies to 
the value of any meal furnished without charge to the employee on such 
premises.
    (ii)(a) Meals will be regarded as furnished for a substantial 
noncompensatory business reason of the employer when the meals are 
furnished to the employee during his working hours to have the employee 
available for emergency call during his meal period. In order to 
demonstrate that meals are furnished to the employee to have the 
employee available for emergency call during the meal period, it must be 
shown that emergencies have actually occurred, or can reasonably be 
expected to occur, in the employer's business which have resulted, or 
will result, in the employer calling on the employee to perform his job 
during his meal period.
    (b) Meals will be regarded as furnished for a substantial 
noncompensatory business reason of the employer when the meals are 
furnished to the employee during his working hours because the 
employer's business is such that the employee must be restricted to a 
short meal period, such as 30 or 45 minutes, and because the employee 
could not be expected to eat elsewhere in such a short meal period. For 
example, meals may qualify under this subdivision when the employer is 
engaged in a business in which the peak work load occurs during the 
normal lunch hours. However, meals cannot qualify under this subdivision 
(b) when the reason for restricting the time of the meal period is so 
that the employee can be let off earlier in the day.
    (c) Meals will be regarded as furnished for a substantial 
noncompensatory business reason of the employer when the meals are 
furnished to the employee during his working hours because the employee 
could not otherwise secure proper meals within a reasonable meal period. 
For example, meals may qualify under this subdivision (c) when there are 
insufficient eating facilities in the vicinity of the employer's 
premises.
    (d) A meal furnished to a restaurant employee or other food service 
employee for each meal period in which the employee works will be 
regarded as furnished for a substantial noncompensatory business reason 
of the employer, irrespective of whether the meal is furnished during, 
immediately before, or immediately after the working hours of the 
employee.
    (e) If the employer furnishes meals to employees at a place of 
business and the reason for furnishing the meals to each of 
substantially all of the employees who are furnished the meals is a 
substantial noncompensatory business reason of the employer, the meals 
furnished to each other employee will also be regarded as furnished for 
a substantial noncompensatory business reason of the employer.
    (f) If an employer would have furnished a meal to an employee during 
his working hours for a substantial

[[Page 498]]

noncompensatory business reason, a meal furnished to such an employee 
immediately after his working hours because his duties prevented him 
from obtaining a meal during his working hours will be regarded as 
furnished for a substantial noncompensatory business reason.
    (iii) Meals will be regarded as furnished for a compensatory 
business reason of the employer when the meals are furnished to the 
employee to promote the morale or goodwill of the employee, or to 
attract prospective employees.
    (3) Meals furnished with a charge. (i) If an employer provides meals 
which an employee may or may not purchase, the meals will not be 
regarded as furnished for the convenience of the employer. Thus, meals 
for which a charge is made by the employer will not be regarded as 
furnished for the convenience of the employer if the employee has a 
choice of accepting the meals and paying for them or of not paying for 
them and providing his meals in another manner.
    (ii) If an employer furnishes an employee meals for which the 
employee is charged an unvarying amount (for example, by subtraction 
from his stated compensation) irrespective of whether he accepts the 
meals, the amount of such flat charge made by the employer for such 
meals is not, as such, part of the compensation includible in the gross 
income of the employee; whether the value of the meals so furnished is 
excludable under section 119 is determined by applying the rules of 
subparagraph (2) of this paragraph. If meals furnished for an unvarying 
amount are not furnished for the convenience of the employer in 
accordance with the rules of subparagraph (2) of this paragraph, the 
employee shall include in gross income the value of the meals regardless 
of whether the value exceeds or is less than the amount charged for such 
meals. In the absence of evidence to the contrary, the value of the 
meals may be deemed to be equal to the amount charged for them.
    (b) Lodging. The value of lodging furnished to an employee by the 
employer shall be excluded from the employee's gross income if three 
tests are met:
    (1) The lodging is furnished on the business premises of the 
employer,
    (2) The lodging is furnished for the convenience of the employer, 
and
    (3) The employee is required to accept such lodging as a condition 
of his employment.

The requirement of subparagraph (3) of this paragraph that the employee 
is required to accept such lodging as a condition of his employment 
means that he be required to accept the lodging in order to enable him 
properly to perform the duties of his employment. Lodging will be 
regarded as furnished to enable the employee properly to perform the 
duties of his employment when, for example, the lodging is furnished 
because the employee is required to be available for duty at all times 
or because the employee could not perform the services required of him 
unless he is furnished such lodging. If the tests described in 
subparagraphs (1), (2), and (3) of this paragraph are met, the exclusion 
shall apply irrespective of whether a charge is made, or whether, under 
an employment contract or statute fixing the terms of employment, such 
lodging is furnished as compensation. If the employer furnishes the 
employee lodging for which the employee is charged an unvarying amount 
irrespective of whether he accepts the lodging, the amount of the charge 
made by the employer for such lodging is not, as such, part of the 
compensation includible in the gross income of the employee; whether the 
value of the lodging is excludable from gross income under section 119 
is determined by applying the other rules of this paragraph. If the 
tests described in subparagraph (1), (2), and (3) of this paragraph are 
not met, the employee shall include in gross income the value of the 
lodging regardless of whether it exceeds or is less than the amount 
charged. In the absence of evidence to the contrary, the value of the 
lodging may be deemed to be equal to the amount charged.
    (c) Business premises of the employer--(1) In general. For purposes 
of this section, the term ``business premises of the employer'' 
generally means the place of employment of the employee.

[[Page 499]]

For example, meals and lodging furnished in the employer's home to a 
domestic servant would constitute meals and lodging furnished on the 
business premises of the employer. Similarly, meals furnished to 
cowhands while herding their employer's cattle on leased land would be 
regarded as furnished on the business premises of the employer.
    (2) Certain camps. For taxable years beginning after December 31, 
1981, in the case of an individual who is furnished lodging by or on 
behalf of his employer in a camp (as defined in paragraph (d) of this 
section) in a foreign country (as defined in Sec. 1.911-2(h)), the camp 
shall be considered to be part of the business premises of the employer.
    (d) Camp defined--(1) In general. For the purposes of paragraph 
(c)(2) of this section, a camp is lodging that is all of the following:
    (i) Provided by or on behalf of the employer for the convenience of 
the employer because the place at which the employee renders services is 
in a remote area where satisfactory housing is not available to the 
employee on the open market within a reasonable commuting distance of 
that place;
    (ii) Located, as near as practicable, in the vicinity of the place 
at which the employee renders services; and
    (iii) Furnished in a common area or enclave which is not available 
to the general public for lodging or accommodations and which normally 
accommodates ten or more employees.
    (2) Satisfactory housing. For purposes of paragraph (d)(1)(i) of 
this section, facts and circumstances that may be relevant in 
determining whether housing available to the employee is satisfactory 
include, but are not limited to, the size and condition of living space 
and the availability and quality of utilities such as water, sewers or 
other waste disposal facilities, electricity, or heat. The general 
environment in which housing is located (e.g., climate, prevalence of 
insects, etc.) does not of itself make housing unsatisfactory. The 
general environment is relevant, however, if housing is inadequate to 
protect the occupants from environmental conditions. The individual 
employee's income level is not relevant in determining whether housing 
is satisfactory; it may, however, be relevant in determining whether 
satisfactory housing is available to the employee (see paragraph 
(d)(3)(i)(B) of this section).
    (3) Availability of satisfactory housing--(i) Facts and 
circumstances. For purposes of paragraph (d)(1)(i) of this section, 
facts and circumstances to be considered in determining whether 
satisfactory housing is available to the employee on the open market 
include but are not limited to:
    (A) The number of housing units available on the open market in 
relation to the number of housing units required for the employer's 
employees;
    (B) The cost of housing available on the open market;
    (C) The quality of housing available on the open market; and
    (D) The presence of warfare or civil insurrection within the area 
where housing would be available which would subject U.S. citizens to 
unusual risk of personal harm or property loss.
    (ii) Presumptions. Satisfactory housing will generally be considered 
to be unavailable to the employee on the open market if either of the 
following conditions is satisfied:
    (A) The foreign government requires the employer to provide housing 
for its employees other than housing available on the open market; or
    (B) An unrelated person awarding work to the employer requires that 
the employer's employees occupy housing specified by such unrelated 
person.

The condition of either paragraph (d)(3)(ii) (A) or (B) of this section 
is not satisfied if the requirement described therein and imposed either 
by a foreign government or unrelated person applies primarily to U.S. 
employers and not to a significant number of third country employers or 
applies primarily to employers of U.S. employees and not to a 
significant number of employers of third country employees.
    (4) Reasonable commuting distance. For purposes of paragraph 
(d)(1)(i) of this section, in determining whether a commuting distance 
is reasonable, the accessibility of the place at which the employee 
renders services due to geographic factors, the quality of the roads, 
the customarily available transportation, and the usual travel time (at

[[Page 500]]

the time of day such travel would be required) to the place at which the 
employee renders services shall be taken into account.
    (5) Common area or enclave. A cluster of housing units does not 
satisfy paragraph (d)(1)(iii) of this section if it is adjacent to or 
surrounded by substantially similar housing available to the general 
public. Two or more common areas or enclaves that house employees who 
work on the same project (for example, a highway project) are considered 
to be one common area or enclave in determining whether they normally 
accommodate ten or more employees.
    (e) Rules. The exclusion provided by section 119 applies only to 
meals and lodging furnished in kind by or on behalf of an employer to 
his employee. If the employee has an option to receive additional 
compensation in lieu of meals or lodging in kind, the value of such 
meals and lodging is not excludable from gross income under section 119. 
However, the mere fact that an employee, at his option, may decline to 
accept meals tendered in kind will not of itself require inclusion of 
the value thereof in gross income. Cash allowances for meals or lodging 
received by an employee are includible in gross income to the extent 
that such allowances constitute compensation.
    (f) Examples. The provisions of section 119 may be illustrated by 
the following examples:

    Example (1). A waitress who works from 7 a.m. to 4 p.m. is furnished 
without charge two meals a work day. The employer encourages the 
waitress to have her breakfast on his business premises before starting 
work, but does not require her to have breakfast there. She is required, 
however, to have her lunch on such premises. Since the waitress is a 
food service employee and works during the normal breakfast and lunch 
periods, the waitress is permitted to exclude from her gross income both 
the value of the breakfast and the value of the lunch.
    Example (2). The waitress in example (1) is allowed to have meals on 
the employer's premises without charge on her days off. The waitress is 
not permitted to exclude the value of such meals from her gross income.
    Example (3). A bank teller who works from 9 a.m. to 5 p.m. is 
furnished his lunch without charge in a cafeteria which the bank 
maintains on its premises. The bank furnishes the teller such meals in 
order to limit his lunch period to 30 minutes since the bank's peak work 
load occurs during the normal lunch period. If the teller had to obtain 
his lunch elsewhere, it would take him considerably longer than 30 
minutes for lunch, and the bank strictly enforces the 30-minute time 
limit. The bank teller may exclude from his gross income the value of 
such meals obtained in the bank cafeteria.
    Example (4). Assume the same facts as in example (3), except that 
the bank charges the bank teller an unvarying rate per meal regardless 
of whether he eats in the cafeteria. The bank teller is not required to 
include in gross income such flat amount charged as part of his 
compensation, and he is entitled to exclude from his gross income the 
value of the meals he receives for such flat charge.
    Example (5). A Civil Service employee of a State is employed at an 
institution and is required by his employer to be available for duty at 
all times. The employer furnishes the employee with meals and lodging at 
the institution without charge. Under the applicable State statute, his 
meals and lodging are regarded as part of the employee's compensation. 
The employee would nevertheless be entitled to exclude the value of such 
meals and lodging from his gross income.
    Example (6). An employee of an institution is given the choice of 
residing at the institution free of charge, or of residing elsewhere and 
receiving a cash allowance in addition to his regular salary. If he 
elects to reside at the institution, the value to the employee of the 
lodging furnished by the employer will be includible in the employee's 
gross income because his residence at the institution is not required in 
order for him to perform properly the duties of his employment.
    Example (7). A construction worker is employed at a construction 
project at a remote job site in Alaska. Due to the inaccessibility of 
facilities for the employees who are working at the job site to obtain 
food and lodging and the prevailing weather conditions, the employer is 
required to furnish meals and lodging to the employee at the camp site 
in order to carry on the construction project. The employee is required 
to pay $40 a week for the meals and lodging. The weekly charge of $40 is 
not, as such, part of the compensation includible in the gross income of 
the employee, and under paragraphs (a) and (b) of this section the value 
of the meals and lodging is excludable from his gross income.
    Example (8). A manufacturing company provides a cafeteria on its 
premises at which its employees can purchase their lunch. There is no 
other eating facility located near the company's premises, but the 
employee can furnish his own meal by bringing his lunch. The amount of 
compensation which any employee is required to include in gross income 
is not reduced by the amount charged for the meals, and the meals are 
not

[[Page 501]]

considered to be furnished for the convenience of the employer.
    Example (9). A hospital maintains a cafeteria on its premises where 
all of its 230 employees may obtain a meal during their working hours. 
No charge is made for these meals. The hospital furnishes such meals in 
order to have each of 210 of the employees available for any emergencies 
that may occur, and it is shown that each such employee is at times 
called upon to perform services during his meal period. Although the 
hospital does not require such employees to remain on the premises 
during meal periods, they rarely leave the hospital during their meal 
period. Since the hospital furnishes meals to each of substantially all 
of its employees in order to have each of them available for emergency 
call during his meal period, all of the hospital employees who obtain 
their meals in the hospital cafeteria may exclude from their gross 
income the value of such meals.

[T.D. 6745, 29 FR 9380, July 9, 1964, as amended by T.D. 8006, 50 FR 
2964, Jan. 23, 1985]



Sec. 1.120-1  Statutory subsistence allowance received by police.

    (a) Section 120 excludes from the gross income of an individual 
employed as a police official by a State, Territory, or possession of 
the United States, by any of their political subdivisions, or by the 
District of Columbia, any amount received as a statutory subsistence 
allowance to the extent that such allowance does not exceed $5 per day. 
For purposes of this section, the term ``statutory subsistence 
allowance'' means an amount which is designated as a subsistence 
allowance under the laws of a State, a Territory, or a possession of the 
United States, any political subdivision of any of the foregoing, or the 
District of Columbia and which is paid to an individual who is employed 
as a police official of such governmental unit. A subsistence allowance 
paid to a police official by any of the foregoing governmental units 
which is not so provided by statute may not be excluded from gross 
income under the provisions of section 120. The term ``police official'' 
includes an employee of any of the foregoing governmental units who has 
police duties, such as a sheriff, a detective, a policeman, or a State 
police trooper, however designated.
    (b) The exclusion provided by section 120 is to be computed on a 
daily basis, that is, for each day for which the statutory allowance is 
paid. If the statute providing the allowance does not specify the daily 
amount of such allowance, the allowance shall be converted to a daily 
basis for the purpose of applying the limitation provided herein. For 
example, if a State statute provides for a weekly subsistence allowance, 
the daily amount is to be determined by dividing the weekly amount by 
the number of days for which the allowance is paid. Thus, if a State 
trooper receives a weekly statutory subsistence allowance of $40 would 
be $8, that is, $40 divided by 5 for 5 days of the week, the daily 
amount would be $8, that is, $40 divided by 5. However, for purposes of 
this section, only $5 per day may be excluded, or $25 on a weekly basis.
    (c) Expenses in respect of which the allowance under section 120 is 
paid may not be deducted under any provision of the income tax laws 
except to the extent that (1) such expenses exceed the amount of the 
exclusion, and (2) the excess is otherwise allowable as a deduction. For 
example, if a State statute provides a subsistence allowance of $3 per 
day and the taxpayer, a state trooper, incurs expenditures of $4.50 for 
meals while away from home overnight on official police duties only $3 
would be excludable under this section. Expenses relating to such 
exclusion ($3) may not be deducted under any provision of the income tax 
laws. However, the remaining $1.50 may be an allowable deduction under 
section 162 as traveling expenses while away from home in the 
performance of official duties. See Sec. 1.162-2.
    (d) In the case of taxable years ending after September 30, 1958, 
section 120 and this section do not apply to amounts received as a 
statutory subsistence allowance for any day after September 30, 1958.



Sec. 1.120-3  Notice of application for recognition of status of 
qualified group legal services plan.

    (a) In general. In order for a plan to be a qualified group legal 
services plan for purposes of the exclusion from gross income provided 
by section 120(a), the plan must give notice to the Internal Revenue 
Service that it is applying for recognition of its status as a qualified 
plan. Paragraph (b) of this

[[Page 502]]

section describes how the notice is to be filed for the plan. Paragraph 
(c) of this section describes the action that the Internal Revenue 
Service will take in response to the notice submitted for the plan. 
Paragraph (d) of this section describes the period of plan 
qualification.
    (b) Filing of notice--(1) In general. A notice of application for 
recognition of the status of a qualified group legal services plan must 
be filed with the key district director of internal revenue as described 
in Sec. 601.201(n). The notice must be filed on Form 1024, Application 
for Recognition of Exemption Under section 501(a) or for Determination 
Under section 120, with the accompanying Schedule L, and must contain 
the information required by the form and any accompanying instructions. 
The form may be filed by either the employer adopting the plan or the 
person administering the plan. No Form 1024 and Schedule L may be filed 
for a plan before an employer adopts the plan, or proposes to adopt the 
plan contingent only upon the recognition of the plan as a qualified 
plan.
    (2) Plans to which more than one employer contributes. In general, 
for purposes of section 120 the adoption of a plan by an employer 
constitutes the adoption of a separate plan to which that employer alone 
contributes, notwithstanding that, in form, the employer purports to 
adopt a plan with respect to which the employer is one of two or more 
contributing employers. Accordingly, a separate Schedule L must be filed 
pursuant to the instructions accompanying Form 1024 for each employer 
adopting a plan.
    (3) Certain collectively bargained plans. Notwithstanding 
subparagraph (2) of this paragraph, if a plan to which more than one 
employer contributes is a plan to which this subparagraph (3) applies, 
the plan is treated as a single plan for purposes of section 120. 
Accordingly, only one Form 1024 and Schedule L is required to be filed 
for the plan, regardless of the number of employers originally adopting 
the plan. In addition, once a Form 1024 and Schedule L is filed, no 
additional filing is required with respect to an employer who thereafter 
adopts the plan. In general, this subparagraph (3) applies to any plan 
that is maintained pursuant to a collective bargaining agreement between 
employee representatives and more than one employer who is required by 
the plan instrument or other agreement to contribute to the plan with 
respect to employees (or their spouses or dependents) participating in 
the plan. This subparagraph does not apply, however, if all employers 
required to contribute to the plan are corporations which are members of 
a controlled group of corporations within the meaning of section 
1563(a), determined without regard to section 1563(e)(3)(C). If all 
employers required to contribute to the plan are corporations which are 
members of such a controlled group, the filing requirements described in 
subparagraph (2) of this paragraph apply, notwithstanding that the plan 
is maintained pursuant to a collective bargaining agreement.
    (c) Internal Revenue Service action on notice of application for 
recognition. The Internal Revenue Service will issue to the person 
submitting Form 1024 and Schedule L a ruling or determination letter 
stating that the plan is or is not a qualified group legal services 
plan. For general procedural rules, see Sec. 601.201 (a) through (n), 
as that section relates to rulings and determination letters.
    (d) Period of plan qualification--(1) In general. In the case of a 
favorable determination, the plan will be considered a qualified group 
legal services plan. If a Form 1024 and Schedule L required to be filed 
by or on behalf of an employer is filed before--
    (i) The end of the first plan year (as determined under the plan),
    (ii) The end of the plan year within which the employer adopts the 
plan, or
    (iii) July 29, 1980,

the period of plan qualification with respect to the employer will begin 
on the date the plan is adopted by the employer (or, if later, January 
1, 1977). If the form and schedule are not filed before the latest of 
the dates described in subdivisions (i), (ii) and (iii), the period of 
plan qualification with respect to the employer will begin on the date 
of filing. In any case in which either the Form 1024 or Schedule L filed 
by or on behalf of an employer is incomplete, the date of filing is the 
date on which

[[Page 503]]

the incomplete form or schedule is filed, if the necessary additional 
information is provided at the request of the Commissioner within the 
additional time period allowed by the Commissioner. If the additional 
information is not provided within the additional time period, allowed, 
the date of filing is the date on which the additional information is 
filed. If no separate Form 1024 and Schedule L are required to be filed 
by or on behalf of an employer (see paragraph (b)(3) of this section), 
the period of plan qualification with respect to the employer will begin 
on the date the plan is adopted by the employer (or, if later, January 
1, 1977). In any case in which a plan is materially modified to conform 
to the requirements of section 120, either before or after a Form 1024 
and Schedule L are filed, the period of plan qualification will not 
include any period before the effective date of the modification.
    (2) Plans in existence on June 4, 1976. (i) Notwithstanding 
paragraph (d)(1) of this section, a written group legal services plan 
providing for employer contributions which was in existence on June 4, 
1976, will be considered a qualified group legal services plan for the 
period January 1, 1977, through April 2, 1977. However, if the plan is 
maintained pursuant to one or more agreements which were in effect on 
October 4, 1976, and which the Secretary of Labor finds to be collective 
bargaining agreements, the period of deemed qualification will extend 
beyond April 2, 1977, and end on the date on which the last of the 
collective bargaining agreements relating to the plan terminates. 
Extensions of a bargaining agreement which are agreed to after October 
4, 1976, are to be disregarded. The period of deemed qualification for a 
plan maintained pursuant to a collective bargaining agreement will not, 
however, extend beyond December 31, 1981.
    (ii) A written group legal services plan will be considered to have 
been in existence on June 4, 1976, if on or before that date the plan 
was reduced to writing and adopted by one or more employers. No amounts 
need have been contributed under the plan as of June 4, 1976.
    (iii) Notwithstanding that a plan is a qualified plan for the period 
of deemed qualification described in this paragraph (d)(2), the rules of 
paragraphs (c) and (d)(1) of this section still apply with respect to a 
Form 1024 and Schedule L filed for the plan. For example, if a Form 1024 
and Schedule L filed by or on behalf of an employer are filed before the 
latest of the 3 dates described in paragraph (d)(1) of this section, in 
the case of a favorable determination the plan will be a qualified plan 
from the date the plan is adopted by the employer (or, if later, January 
1, 1977), and any period of deemed qualification and the period of 
qualification based upon the favorable determination will overlap. 
However, in the case of a plan to which this paragraph (d)(2) applies, 
if a Form 1024 and Schedule L required to be filed by or on behalf of an 
employer is not filed before the latest of the 3 dates described in 
paragraph (d)(1) of this section, the following rules shall apply. In 
general, if Form 1024 and Schedule L are filed before the end of the 
plan year following the plan year with or within which the plan's period 
of deemed qualification expires, in the event of a favorable 
determination the plan will be a qualified plan with respect to the 
employer beginning on the earlier of the day following the date on which 
the period of deemed qualification expires or the date on which the Form 
1024 and Schedule L are filed. The period of plan qualification with 
respect to an employer cannot, however, include any period before the 
employer adopts the plan. If the Form 1024 and Schedule L are not filed 
before the end of the plan year following the plan year with or within 
which the plan's period of deemed qualification expires, in the case of 
a favorable determination the plan will be a qualified plan with respect 
to an employer from the later of the date of filing or adoption of the 
plan by the employer. The rules described in paragraph (d)(1) of this 
section relating to incomplete filings and plan modifications apply with 
respect to a filing described in this paragraph (d)(2).
    (e) Effective date. This section is effective for notices of 
application for recognition of the status of a qualified

[[Page 504]]

group legal services plan filed after May 29, 1980.

(Secs. 120(c)(4) and 7805 of the Internal Revenue Code of 1954, 90 Stat. 
1926, 68A Stat. 917; (26 U.S.C. 120(c)(4), 7805))

[T.D. 7696, 45 FR 28320, Apr. 29, 1980]



Sec. 1.121-1  Exclusion of gain from sale or exchange of a principal 
residence.

    (a) In general. Section 121 provides that, under certain 
circumstances, gross income does not include gain realized on the sale 
or exchange of property that was owned and used by a taxpayer as the 
taxpayer's principal residence. Subject to the other provisions of 
section 121, a taxpayer may exclude gain only if, during the 5-year 
period ending on the date of the sale or exchange, the taxpayer owned 
and used the property as the taxpayer's principal residence for periods 
aggregating 2 years or more.
    (b) Residence--(1) In general. Whether property is used by the 
taxpayer as the taxpayer's residence depends upon all the facts and 
circumstances. A property used by the taxpayer as the taxpayer's 
residence may include a houseboat, a house trailer, or the house or 
apartment that the taxpayer is entitled to occupy as a tenant-
stockholder in a cooperative housing corporation (as those terms are 
defined in section 216(b)(1) and (2)). Property used by the taxpayer as 
the taxpayer's residence does not include personal property that is not 
a fixture under local law.
    (2) Principal residence. In the case of a taxpayer using more than 
one property as a residence, whether property is used by the taxpayer as 
the taxpayer's principal residence depends upon all the facts and 
circumstances. If a taxpayer alternates between 2 properties, using each 
as a residence for successive periods of time, the property that the 
taxpayer uses a majority of the time during the year ordinarily will be 
considered the taxpayer's principal residence. In addition to the 
taxpayer's use of the property, relevant factors in determining a 
taxpayer's principal residence, include, but are not limited to--
    (i) The taxpayer's place of employment;
    (ii) The principal place of abode of the taxpayer's family members;
    (iii) The address listed on the taxpayer's federal and state tax 
returns, driver's license, automobile registration, and voter 
registration card;
    (iv) The taxpayer's mailing address for bills and correspondence;
    (v) The location of the taxpayer's banks; and
    (vi) The location of religious organizations and recreational clubs 
with which the taxpayer is affiliated.
    (3) Vacant land--(i) In general. The sale or exchange of vacant land 
is not a sale or exchange of the taxpayer's principal residence unless--
    (A) The vacant land is adjacent to land containing the dwelling unit 
of the taxpayer's principal residence;
    (B) The taxpayer owned and used the vacant land as part of the 
taxpayer's principal residence;
    (C) The taxpayer sells or exchanges the dwelling unit in a sale or 
exchange that meets the requirements of section 121 within 2 years 
before or 2 years after the date of the sale or exchange of the vacant 
land; and
    (D) The requirements of section 121 have otherwise been met with 
respect to the vacant land.
    (ii) Limitations--(A) Maximum limitation amount. For purposes of 
section 121(b)(1) and (2) (relating to the maximum limitation amount of 
the section 121 exclusion), the sale or exchange of the dwelling unit 
and the vacant land are treated as one sale or exchange. Therefore, only 
one maximum limitation amount of $250,000 ($500,000 for certain joint 
returns) applies to the combined sales or exchanges of vacant land and 
the dwelling unit. In applying the maximum limitation amount to sales or 
exchanges that occur in different taxable years, gain from the sale or 
exchange of the dwelling unit, up to the maximum limitation amount under 
section 121(b)(1) or (2), is excluded first and each spouse is treated 
as excluding one-half of the gain from a sale or exchange to which 
section 121(b)(2)(A) and Sec. 1.121-2(a)(3)(i) (relating to the 
limitation for certain joint returns) apply.
    (B) Sale or exchange of more than one principal residence in 2-year 
period. If a dwelling unit and vacant land are sold or exchanged in 
separate transactions

[[Page 505]]

that qualify for the section 121 exclusion under this paragraph (b)(3), 
each of the transactions is disregarded in applying section 121(b)(3) 
(restricting the application of section 121 to only 1 sale or exchange 
every 2 years) to the other transactions but is taken into account as a 
sale or exchange of a principal residence on the date of the transaction 
in applying section 121(b)(3) to that transaction and the sale or 
exchange of any other principal residence.
    (C) Sale or exchange of vacant land before dwelling unit. If the 
sale or exchange of the dwelling unit occurs in a later taxable year 
than the sale or exchange of the vacant land and after the date 
prescribed by law (including extensions) for the filing of the return 
for the taxable year of the sale or exchange of the vacant land, any 
gain from the sale or exchange of the vacant land must be treated as 
taxable on the taxpayer's return for the taxable year of the sale or 
exchange of the vacant land. If the taxpayer has reported gain from the 
sale or exchange of the vacant land as taxable, after satisfying the 
requirements of this paragraph (b)(3) the taxpayer may claim the section 
121 exclusion with regard to the sale or exchange of the vacant land 
(for any period for which the period of limitation under section 6511 
has not expired) by filing an amended return.
    (4) Examples. The provisions of this paragraph (b) are illustrated 
by the following examples:

    Example 1. Taxpayer A owns 2 residences, one in New York and one in 
Florida. From 1999 through 2004, he lives in the New York residence for 
7 months and the Florida residence for 5 months of each year. In the 
absence of facts and circumstances indicating otherwise, the New York 
residence is A's principal residence. A would be eligible for the 
section 121 exclusion of gain from the sale or exchange of the New York 
residence, but not the Florida residence.
    Example 2. Taxpayer B owns 2 residences, one in Virginia and one in 
Maine. During 1999 and 2000, she lives in the Virginia residence. During 
2001 and 2002, she lives in the Maine residence. During 2003, she lives 
in the Virginia residence. B's principal residence during 1999, 2000, 
and 2003 is the Virginia residence. B's principal residence during 2001 
and 2002 is the Maine residence. B would be eligible for the 121 
exclusion of gain from the sale or exchange of either residence (but not 
both) during 2003.
    Example 3. In 1991 Taxpayer C buys property consisting of a house 
and 10 acres that she uses as her principal residence. In May 2005 C 
sells 8 acres of the land and realizes a gain of $110,000. C does not 
sell the dwelling unit before the due date for filing C's 2005 return, 
therefore C is not eligible to exclude the $110,000 of gain. In March 
2007 C sells the house and remaining 2 acres realizing a gain of 
$180,000 from the sale of the house. C may exclude the $180,000 of gain. 
Because the sale of the 8 acres occurred within 2 years from the date of 
the sale of the dwelling unit, the sale of the 8 acres is treated as a 
sale of the taxpayer's principal residence under paragraph (b)(3) of 
this section. C may file an amended return for 2005 to claim an 
exclusion for $70,000 ($250,000-$180,000 gain previously excluded) of 
the $110,000 gain from the sale of the 8 acres.
    Example 4. In 1998 Taxpayer D buys a house and 1 acre that he uses 
as his principal residence. In 1999 D buys 29 acres adjacent to his 
house and uses the vacant land as part of his principal residence. In 
2003 D sells the house and 1 acre and the 29 acres in 2 separate 
transactions. D sells the house and 1 acre at a loss of $25,000. D 
realizes $270,000 of gain from the sale of the 29 acres. D may exclude 
the $245,000 gain from the 2 sales.

    (c) Ownership and use requirements--(1) In general. The requirements 
of ownership and use for periods aggregating 2 years or more may be 
satisfied by establishing ownership and use for 24 full months or for 
730 days (365 x 2). The requirements of ownership and use may be 
satisfied during nonconcurrent periods if both the ownership and use 
tests are met during the 5-year period ending on the date of the sale or 
exchange.
    (2) Use. (i) In establishing whether a taxpayer has satisfied the 2-
year use requirement, occupancy of the residence is required. However, 
short temporary absences, such as for vacation or other seasonal absence 
(although accompanied with rental of the residence), are counted as 
periods of use.
    (ii) Determination of use during periods of out-of-residence care. 
If a taxpayer has become physically or mentally incapable of self-care 
and the taxpayer sells or exchanges property that the taxpayer owned and 
used as the taxpayer's principal residence for periods aggregating at 
least 1 year during the 5-year period preceding the sale or exchange, 
the taxpayer is treated as using the property as the taxpayer's

[[Page 506]]

principal residence for any period of time during the 5-year period in 
which the taxpayer owns the property and resides in any facility 
(including a nursing home) licensed by a State or political subdivision 
to care for an individual in the taxpayer's condition.
    (3) Ownership--(i) Trusts. If a residence is owned by a trust, for 
the period that a taxpayer is treated under sections 671 through 679 
(relating to the treatment of grantors and others as substantial owners) 
as the owner of the trust or the portion of the trust that includes the 
residence, the taxpayer will be treated as owning the residence for 
purposes of satisfying the 2-year ownership requirement of section 121, 
and the sale or exchange by the trust will be treated as if made by the 
taxpayer.
    (ii) Certain single owner entities. If a residence is owned by an 
eligible entity (within the meaning of Sec. 301.7701-3(a) of this 
chapter) that has a single owner and is disregarded for federal tax 
purposes as an entity separate from its owner under Sec. 301.7701-3 of 
this chapter, the owner will be treated as owning the residence for 
purposes of satisfying the 2-year ownership requirement of section 121, 
and the sale or exchange by the entity will be treated as if made by the 
owner.
    (4) Examples. The provisions of this paragraph (c) are illustrated 
by the following examples. The examples assume that Sec. 1.121-3 
(relating to the reduced maximum exclusion) does not apply to the sale 
of the property. The examples are as follows:

    Example 1. Taxpayer A has owned and used his house as his principal 
residence since 1986. On January 31, 1998, A moves to another state. A 
rents his house to tenants from that date until April 18, 2000, when he 
sells it. A is eligible for the section 121 exclusion because he has 
owned and used the house as his principal residence for at least 2 of 
the 5 years preceding the sale.
    Example 2. Taxpayer B owns and uses a house as her principal 
residence from 1986 to the end of 1997. On January 4, 1998, B moves to 
another state and ceases to use the house. B's son moves into the house 
in March 1999 and uses the residence until it is sold on July 1, 2001. B 
may not exclude gain from the sale under section 121 because she did not 
use the property as her principal residence for at least 2 years out of 
the 5 years preceding the sale.
    Example 3. Taxpayer C lives in a townhouse that he rents from 1993 
through 1996. On January 18, 1997, he purchases the townhouse. On 
February 1, 1998, C moves into his daughter's home. On May 25, 2000, 
while still living in his daughter's home, C sells his townhouse. The 
section 121 exclusion will apply to gain from the sale because C owned 
the townhouse for at least 2 years out of the 5 years preceding the sale 
(from January 19, 1997 until May 25, 2000) and he used the townhouse as 
his principal residence for at least 2 years during the 5-year period 
preceding the sale (from May 25, 1995 until February 1, 1998).
    Example 4. Taxpayer D, a college professor, purchases and moves into 
a house on May 1, 1997. He uses the house as his principal residence 
continuously until September 1, 1998, when he goes abroad for a 1-year 
sabbatical leave. On October 1, 1999, 1 month after returning from the 
leave, D sells the house. Because his leave is not considered to be a 
short temporary absence under paragraph (c)(2) of this section, the 
period of the sabbatical leave may not be included in determining 
whether D used the house for periods aggregating 2 years during the 5-
year period ending on the date of the sale. Consequently, D is not 
entitled to exclude gain under section 121 because he did not use the 
residence for the requisite period.
    Example 5. Taxpayer E purchases a house on February 1, 1998, that he 
uses as his principal residence. During 1998 and 1999, E leaves his 
residence for a 2-month summer vacation. E sells the house on March 1, 
2000. Although, in the 5-year period preceding the date of sale, the 
total time E used his residence is less than 2 years (21 months), the 
section 121 exclusion will apply to gain from the sale of the residence 
because, under paragraph (c)(2) of this section, the 2-month vacations 
are short temporary absences and are counted as periods of use in 
determining whether E used the residence for the requisite period.

    (d) Depreciation taken after May 6, 1997--(1) In general. The 
section 121 exclusion does not apply to so much of the gain from the 
sale or exchange of property as does not exceed the portion of the 
depreciation adjustments (as defined in section 1250(b)(3)) attributable 
to the property for periods after May 6, 1997. Depreciation adjustments 
allocable to any portion of the property to which the section 121 
exclusion does not apply under paragraph (e) of this section are not 
taken into account for this purpose.
    (2) Example. The provisions of this paragraph (d) are illustrated by 
the following example:


[[Page 507]]


    Example. On July 1, 1999, Taxpayer A moves into a house that he owns 
and had rented to tenants since July 1, 1997. A took depreciation 
deductions totaling $14,000 for the period that he rented the property. 
After using the residence as his principal residence for 2 full years, A 
sells the property on August 1, 2001. A's gain realized from the sale is 
$40,000. A has no other section 1231 or capital gains or losses for 
2001. Only $26,000 ($40,000 gain realized--$14,000 depreciation 
deductions) may be excluded under section 121. Under section 121(d)(6) 
and paragraph (d)(1) of this section, A must recognize $14,000 of the 
gain as unrecaptured section 1250 gain within the meaning of section 
1(h).

    (e) Property used in part as a principal residence--(1) Allocation 
required. Section 121 will not apply to the gain allocable to any 
portion (separate from the dwelling unit) of property sold or exchanged 
with respect to which a taxpayer does not satisfy the use requirement. 
Thus, if a portion of the property was used for residential purposes and 
a portion of the property (separate from the dwelling unit) was used for 
non-residential purposes, only the gain allocable to the residential 
portion is excludable under section 121. No allocation is required if 
both the residential and non-residential portions of the property are 
within the same dwelling unit. However, section 121 does not apply to 
the gain allocable to the residential portion of the property to the 
extent provided by paragraph (d) of this section.
    (2) Dwelling unit. For purposes of this paragraph (e), the term 
dwelling unit has the same meaning as in section 280A(f)(1), but does 
not include appurtenant structures or other property.
    (3) Method of allocation. For purposes of determining the amount of 
gain allocable to the residential and non-residential portions of the 
property, the taxpayer must allocate the basis and the amount realized 
between the residential and the non-residential portions of the property 
using the same method of allocation that the taxpayer used to determine 
depreciation adjustments (as defined in section 1250(b)(3)), if 
applicable.
    (4) Examples. The provisions of this paragraph (e) are illustrated 
by the following examples:

    Example 1. Non-residential use of property not within the dwelling 
unit. (i) Taxpayer A owns a property that consists of a house, a stable 
and 35 acres. A uses the stable and 28 acres for non-residential 
purposes for more than 3 years during the 5-year period preceding the 
sale. A uses the entire house and the remaining 7 acres as his principal 
residence for at least 2 years during the 5-year period preceding the 
sale. For periods after May 6, 1997, A claims depreciation deductions of 
$9,000 for the non-residential use of the stable. A sells the entire 
property in 2004, realizing a gain of $24,000. A has no other section 
1231 or capital gains or losses for 2004.
    (ii) Because the stable and the 28 acres used in the business are 
separate from the dwelling unit, the allocation rules under this 
paragraph (e) apply and A must allocate the basis and amount realized 
between the portion of the property that he used as his principal 
residence and the portion of the property that he used for non-
residential purposes. A determines that $14,000 of the gain is allocable 
to the non-residential-use portion of the property and that $10,000 of 
the gain is allocable to the portion of the property used as his 
residence. A must recognize the $14,000 of gain allocable to the non-
residential-use portion of the property ($9,000 of which is unrecaptured 
section 1250 gain within the meaning of section 1(h), and $5,000 of 
which is adjusted net capital gain). A may exclude $10,000 of the gain 
from the sale of the property.
    Example 2. Non-residential use of property not within the dwelling 
unit and rental of the entire property. (i) In 1998 Taxpayer B buys a 
property that includes a house, a barn, and 2 acres. B uses the house 
and 2 acres as her principal residence and the barn for an antiques 
business. In 2002, B moves out of the house and rents it to tenants. B 
sells the property in 2004, realizing a gain of $21,000. Between 1998 
and 2004 B claims depreciation deductions of $4,800 attributable to the 
antiques business. Between 2002 and 2004 B claims depreciation 
deductions of $3,000 attributable to the house. B has no other section 
1231 or capital gains or losses for 2004.
    (ii) Because the portion of the property used in the antiques 
business is separate from the dwelling unit, the allocation rules under 
this paragraph (e) apply. B must allocate basis and amount realized 
between the portion of the property that she used as her principal 
residence and the portion of the property that she used for non-
residential purposes. B determines that $4,000 of the gain is allocable 
to the non-residential portion of the property and that $17,000 of the 
gain is allocable to the portion of the property that she used as her 
principal residence.
    (iii) B must recognize the $4,000 of gain allocable to the non-
residential portion of the property (all of which is unrecaptured 
section 1250 gain within the meaning of section 1(h)). In addition, the 
section 121 exclusion does not apply to the gain allocable to the

[[Page 508]]

residential portion of the property to the extent of the depreciation 
adjustments attributable to the residential portion of the property for 
periods after May 6, 1997 ($3,000). Therefore, B may exclude $14,000 of 
the gain from the sale of the property.
    Example 3. Non-residential use of a separate dwelling unit. (i) In 
2002 Taxpayer C buys a 3-story townhouse and converts the basement 
level, which has a separate entrance, into a separate apartment by 
installing a kitchen and bathroom and removing the interior stairway 
that leads from the basement to the upper floors. After the conversion, 
the property constitutes 2 dwelling units within the meaning of 
paragraph (e)(2) of this section. C uses the first and second floors of 
the townhouse as his principal residence and rents the basement level to 
tenants from 2003 to 2007. C claims depreciation deductions of $2,000 
for that period with respect to the basement apartment. C sells the 
entire property in 2007, realizing gain of $18,000. C has no other 
section 1231 or capital gains or losses for 2007.
    (ii) Because the basement apartment and the upper floors of the 
townhouse are separate dwelling units, C must allocate the gain between 
the portion of the property that he used as his principal residence and 
the portion of the property that he used for non-residential purposes 
under paragraph (e) of this section. After allocating the basis and the 
amount realized between the residential and non-residential portions of 
the property, C determines that $6,000 of the gain is allocable to the 
non-residential portion of the property and that $12,000 of the gain is 
allocable to the portion of the property used as his residence. C must 
recognize the $6,000 of gain allocable to the non-residential portion of 
the property ($2,000 of which is unrecaptured section 1250 gain within 
the meaning of section 1(h), and $4,000 of which is adjusted net capital 
gain). C may exclude $12,000 of the gain from the sale of the property.
    Example 4. Separate dwelling unit converted to residential use. The 
facts are the same as in Example 3 except that in 2007 C incorporates 
the basement of the townhouse into his principal residence by 
eliminating the kitchen and building a new interior stairway to the 
upper floors. C uses all 3 floors of the townhouse as his principal 
residence for 2 full years and sells the townhouse in 2010, realizing a 
gain of $20,000. Under section 121(d)(6) and paragraph (d) of this 
section, C must recognize $2,000 of the gain as unrecaptured section 
1250 gain within the meaning of section 1(h). Because C used the entire 
3 floors of the townhouse as his principal residence for 2 of the 5 
years preceding the sale of the property, C may exclude the remaining 
$18,000 of the gain from the sale of the house.
    Example 5. Non-residential use within the dwelling unit, property 
depreciated. Taxpayer D, an attorney, buys a house in 2003. The house 
constitutes a single dwelling unit but D uses a portion of the house as 
a law office. D claims depreciation deductions of $2,000 during the 
period that she owns the house. D sells the house in 2006, realizing a 
gain of $13,000. D has no other section 1231 or capital gains or losses 
for 2006. Under section 121(d)(6) and paragraph (d) of this section, D 
must recognize $2,000 of the gain as unrecaptured section 1250 gain 
within the meaning of section 1(h). D may exclude the remaining $11,000 
of the gain from the sale of her house because, under paragraph (e)(1) 
of this section, she is not required to allocate gain to the business 
use within the dwelling unit.
    Example 6. Non-residential use within the dwelling unit, property 
not depreciated. The facts are the same as in Example 5, except that D 
is not entitled to claim any depreciation deductions with respect to her 
business use of the house. D may exclude $13,000 of the gain from the 
sale of her house because, under paragraph (e)(1) of this section, she 
is not required to allocate gain to the business use within the dwelling 
unit.

    (f) Effective date. This section is applicable for sales and 
exchanges on or after Decmeber 24, 2002. For rules on electing to apply 
the provisions of this section retroactively, see Sec. 1.121-4(j).

[T.D. 9030, 67 FR 78361, Dec. 24, 2002]



Sec. 1.121-2  Limitations.

    (a) Dollar limitations--(1) In general. A taxpayer may exclude from 
gross income up to $250,000 of gain from the sale or exchange of the 
taxpayer's principal residence. A taxpayer is eligible for only one 
maximum exclusion per principal residence.
    (2) Joint owners. If taxpayers jointly own a principal residence but 
file separate returns, each taxpayer may exclude from gross income up to 
$250,000 of gain that is attributable to each taxpayer's interest in the 
property, if the requirements of section 121 have otherwise been met.
    (3) Special rules for joint returns--(i) In general. A husband and 
wife who make a joint return for the year of the sale or exchange of a 
principal residence may exclude up to $500,000 of gain if--
    (A) Either spouse meets the 2-year ownership requirements of Sec. 
1.121-1(a) and (c);
    (B) Both spouses meet the 2-year use requirements of Sec. 1.121-
1(a) and (c); and

[[Page 509]]

    (C) Neither spouse excluded gain from a prior sale or exchange of 
property under section 121 within the last 2 years (as determined under 
paragraph (b) of this section).
    (ii) Other joint returns. For taxpayers filing jointly, if either 
spouse fails to meet the requirements of paragraph (a)(3)(i) of this 
section, the maximum limitation amount to be claimed by the couple is 
the sum of each spouse's limitation amount determined on a separate 
basis as if they had not been married. For this purpose, each spouse is 
treated as owning the property during the period that either spouse 
owned the property.
    (4) Examples. The provisions of this paragraph (a) are illustrated 
by the following examples. The examples assume that Sec. 1.121-3 
(relating to the reduced maximum exclusion) does not apply to the sale 
of the property. The examples are as follows:

    Example 1. Unmarried Taxpayers A and B own a house as joint owners, 
each owning a 50 percent interest in the house. They sell the house 
after owning and using it as their principal residence for 2 full years. 
The gain realized from the sale is $256,000. A and B are each eligible 
to exclude $128,000 of gain because the amount of realized gain 
allocable to each of them from the sale does not exceed each taxpayer's 
available limitation amount of $250,000.
    Example 2. The facts are the same as in Example 1, except that A and 
B are married taxpayers who file a joint return for the taxable year of 
the sale. A and B are eligible to exclude the entire amount of realized 
gain ($256,000) from gross income because the gain realized from the 
sale does not exceed the limitation amount of $500,000 available to A 
and B as taxpayers filing a joint return.
    Example 3. During 1999, married Taxpayers H and W each sell a 
residence that each had separately owned and used as a principal 
residence before their marriage. Each spouse meets the ownership and use 
tests for his or her respective residence. Neither spouse meets the use 
requirement for the other spouse's residence. H and W file a joint 
return for the year of the sales. The gain realized from the sale of H's 
residence is $200,000. The gain realized from the sale of W's residence 
is $300,000. Because the ownership and use requirements are met for each 
residence by each respective spouse, H and W are each eligible to 
exclude up to $250,000 of gain from the sale of their individual 
residences. However, W may not use H's unused exclusion to exclude gain 
in excess of her limitation amount. Therefore, H and W must recognize 
$50,000 of the gain realized on the sale of W's residence.
    Example 4. Married Taxpayers H and W sell their residence and file a 
joint return for the year of the sale. W, but not H, satisfies the 
requirements of section 121. They are eligible to exclude up to $250,000 
of the gain from the sale of the residence because that is the sum of 
each spouse's dollar limitation amount determined on a separate basis as 
if they had not been married ($0 for H, $250,000 for W).
    Example 5. Married Taxpayers H and W have owned and used their 
principal residence since 1998. On February 16, 2001, H dies. On 
September 24, 2001, W sells the residence and realizes a gain of 
$350,000. Pursuant to section 6013(a)(3), W and H's executor make a 
joint return for 2001. All $350,000 of the gain from the sale of the 
residence may be excluded.
    Example 6. Assume the same facts as Example 5, except that W does 
not sell the residence until January 31, 2002. Because W's filing status 
for the taxable year of the sale is single, the special rules for joint 
returns under paragraph (a)(3) of this section do not apply and W may 
exclude only $250,000 of the gain.

    (b) Application of section 121 to only 1 sale or exchange every 2 
years--(1) In general. Except as otherwise provided in Sec. 1.121-3 
(relating to the reduced maximum exclusion), a taxpayer may not exclude 
from gross income gain from the sale or exchange of a principal 
residence if, during the 2-year period ending on the date of the sale or 
exchange, the taxpayer sold or exchanged other property for which gain 
was excluded under section 121. For purposes of this paragraph (b)(1), 
any sale or exchange before May 7, 1997, is disregarded.
    (2) Example. The following example illustrates the rules of this 
paragraph (b). The example assumes that Sec. 1.121-3 (relating to the 
reduced maximum exclusion) does not apply to the sale of the property. 
The example is as follows:

    Example. Taxpayer A owns a townhouse that he uses as his principal 
residence for 2 full years, 1998 and 1999. A buys a house in 2000 that 
he owns and uses as his principal residence. A sells the townhouse in 
2002 and excludes gain realized on its sale under section 121. A sells 
the house in 2003. Although A meets the 2-year ownership and use 
requirements of section 121, A is not eligible to exclude gain from the 
sale of the house because A excluded gain within the last 2 years under 
section 121 from the sale of the townhouse.


[[Page 510]]


    (c) Effective date. This section is applicable for sales and 
exchanges on or after December 24, 2002. For rules on electing to apply 
the provisions of this section retroactively, see Sec. 1.121-4(j).

[T.D. 9030, 67 FR 78361, Dec. 24, 2002]



Sec. 1.121-3  Reduced maximum exclusion for taxpayers failing to meet 
certain requirements.

    (a) In general. In lieu of the limitation under section 121(b) and 
Sec. 1.121-2, a reduced maximum exclusion limitation may be available 
for a taxpayer who sells or exchanges property used as the taxpayer's 
principal residence but fails to satisfy the ownership and use 
requirements described in Sec. 1.121-1(a) and (c) or the 2-year 
limitation described in Sec. 1.121-2(b).
    (b) Primary reason for sale or exchange. In order for a taxpayer to 
claim a reduced maximum exclusion under section 121(c), the sale or 
exchange must be by reason of a change in place of employment, health, 
or unforeseen circumstances. If a safe harbor described in this section 
applies, a sale or exchange is deemed to be by reason of a change in 
place of employment, health, or unforeseen circumstances. If a safe 
harbor described in this section does not apply, a sale or exchange is 
by reason of a change in place of employment, health, or unforeseen 
circumstances only if the primary reason for the sale or exchange is a 
change in place of employment (within the meaning of paragraph (c) of 
this section), health (within the meaning of paragraph (d) of this 
section), or unforeseen circumstances (within the meaning of paragraph 
(e) of this section). Whether the requirements of this section are 
satisfied depends upon all the facts and circumstances. Factors that may 
be relevant in determining the taxpayer's primary reason for the sale or 
exchange include (but are not limited to) the extent to which--
    (1) The sale or exchange and the circumstances giving rise to the 
sale or exchange are proximate in time;
    (2) The suitability of the property as the taxpayer's principal 
residence materially changes;
    (3) The taxpayer's financial ability to maintain the property is 
materially impaired;
    (4) The taxpayer uses the property as the taxpayer's residence 
during the period of the taxpayer's ownership of the property;
    (5) The circumstances giving rise to the sale or exchange are not 
reasonably foreseeable when the taxpayer begins using the property as 
the taxpayer's principal residence; and
    (6) The circumstances giving rise to the sale or exchange occur 
during the period of the taxpayer's ownership and use of the property as 
the taxpayer's principal residence.
    (c) Sale or exchange by reason of a change in place of employment--
(1) In general. A sale or exchange is by reason of a change in place of 
employment if, in the case of a qualified individual described in 
paragraph (f) of this section, the primary reason for the sale or 
exchange is a change in the location of the individual's employment.
    (2) Distance safe harbor. A sale or exchange is deemed to be by 
reason of a change in place of employment (within the meaning of 
paragraph (c)(1) of this section) if--
    (i) The change in place of employment occurs during the period of 
the taxpayer's ownership and use of the property as the taxpayer's 
principal residence; and
    (ii) The qualified individual's new place of employment is at least 
50 miles farther from the residence sold or exchanged than was the 
former place of employment, or, if there was no former place of 
employment, the distance between the qualified individual's new place of 
employment and the residence sold or exchanged is at least 50 miles.
    (3) Employment. For purposes of this paragraph (c), employment 
includes the commencement of employment with a new employer, the 
continuation of employment with the same employer, and the commencement 
or continuation of self-employment.
    (4) Examples. The following examples illustrate the rules of this 
paragraph (c):

    Example 1. A is unemployed and owns a townhouse that she has owned 
and used as her principal residence since 2003. In 2004 A obtains a job 
that is 54 miles from her townhouse, and she sells the townhouse. 
Because

[[Page 511]]

the distance between A's new place of employment and the townhouse is at 
least 50 miles, the sale is within the safe harbor of paragraph (c)(2) 
of this section and A is entitled to claim a reduced maximum exclusion 
under section 121(c)(2).
    Example 2. B is an officer in the United States Air Force stationed 
in Florida. B purchases a house in Florida in 2002. In May 2003 B moves 
out of his house to take a 3-year assignment in Germany. B sells his 
house in January 2004. Because B's new place of employment in Germany is 
at least 50 miles farther from the residence sold than is B's former 
place of employment in Florida, the sale is within the safe harbor of 
paragraph (c)(2) of this section and B is entitled to claim a reduced 
maximum exclusion under section 121(c)(2).
    Example 3. C is employed by Employer R at R's Philadelphia office. C 
purchases a house in February 2002 that is 35 miles from R's 
Philadelphia office. In May 2003 C begins a temporary assignment at R's 
Wilmington office that is 72 miles from C's house, and moves out of the 
house. In June 2005 C is assigned to work in R's London office. C sells 
her house in August 2005 as a result of the assignment to London. The 
sale of the house is not within the safe harbor of paragraph (c)(2) of 
this section by reason of the change in place of employment from 
Philadelphia to Wilmington because the Wilmington office is not 50 miles 
farther from C's house than is the Philadelphia office. Furthermore, the 
sale is not within the safe harbor by reason of the change in place of 
employment to London because C is not using the house as her principal 
residence when she moves to London. However, C is entitled to claim a 
reduced maximum exclusion under section 121(c)(2) because, under the 
facts and circumstances, the primary reason for the sale is the change 
in C's place of employment.
    Example 4. In July 2003 D, who works as an emergency medicine 
physician, buys a condominium that is 5 miles from her place of 
employment and uses it as her principal residence. In February 2004, D 
obtains a job that is located 51 miles from D's condominium. D may be 
called in to work unscheduled hours and, when called, must be able to 
arrive at work quickly. Because of the demands of the new job, D sells 
her condominium and buys a townhouse that is 4 miles from her new place 
of employment. Because D's new place of employment is only 46 miles 
farther from the condominium than is D's former place of employment, the 
sale is not within the safe harbor of paragraph (c)(2) of this section. 
However, D is entitled to claim a reduced maximum exclusion under 
section 121(c)(2) because, under the facts and circumstances, the 
primary reason for the sale is the change in D's place of employment.

    (d) Sale or exchange by reason of health--(1) In general. A sale or 
exchange is by reason of health if the primary reason for the sale or 
exchange is to obtain, provide, or facilitate the diagnosis, cure, 
mitigation, or treatment of disease, illness, or injury of a qualified 
individual described in paragraph (f) of this section, or to obtain or 
provide medical or personal care for a qualified individual suffering 
from a disease, illness, or injury. A sale or exchange that is merely 
beneficial to the general health or well-being of an individual is not a 
sale or exchange by reason of health.
    (2) Physician's recommendation safe harbor. A sale or exchange is 
deemed to be by reason of health if a physician (as defined in section 
213(d)(4)) recommends a change of residence for reasons of health (as 
defined in paragraph (d)(1) of this section).
    (3) Examples. The following examples illustrate the rules of this 
paragraph (d):

    Example 1. In 2003 A buys a house that she uses as her principal 
residence. A is injured in an accident and is unable to care for 
herself. A sells her house in 2004 and moves in with her daughter so 
that the daughter can provide the care that A requires as a result of 
her injury. Because, under the facts and circumstances, the primary 
reason for the sale of A's house is A's health, A is entitled to claim a 
reduced maximum exclusion under section 121(c)(2).
    Example 2. H's father has a chronic disease. In 2003 H and W 
purchase a house that they use as their principal residence. In 2004 H 
and W sell their house in order to move into the house of H's father so 
that they can provide the care he requires as a result of his disease. 
Because, under the facts and circumstances, the primary reason for the 
sale of their house is the health of H's father, H and W are entitled to 
claim a reduced maximum exclusion under section 121(c)(2).
    Example 3. H and W purchase a house in 2003 that they use as their 
principal residence. Their son suffers from a chronic illness that 
requires regular medical care. Later that year their son begins a new 
treatment that is available at a hospital 100 miles away from their 
residence. In 2004 H and W sell their house so that they can be closer 
to the hospital to facilitate their son's treatment. Because, under the 
facts and circumstances, the primary reason for the sale is to 
facilitate the treatment of their son's chronic illness, H and W are 
entitled to claim a reduced maximum exclusion under section 121(c)(2).

[[Page 512]]

    Example 4. B, who has chronic asthma, purchases a house in Minnesota 
in 2003 that he uses as his principal residence. B's doctor tells B that 
moving to a warm, dry climate would mitigate B's asthma symptoms. In 
2004 B sells his house and moves to Arizona to relieve his asthma 
symptoms. The sale is within the safe harbor of paragraph (d)(2) of this 
section and B is entitled to claim a reduced maximum exclusion under 
section 121(c)(2).
    Example 5. In 2003 H and W purchase a house in Michigan that they 
use as their principal residence. H's doctor tells H that he should get 
more outdoor exercise, but H is not suffering from any disease that can 
be treated or mitigated by outdoor exercise. In 2004 H and W sell their 
house and move to Florida so that H can increase his general level of 
exercise by playing golf year-round. Because the sale of the house is 
merely beneficial to H's general health, the sale of the house is not by 
reason of H's health. H and W are not entitled to claim a reduced 
maximum exclusion under section 121(c)(2).

    (e) Sale or exchange by reason of unforeseen circumstances--(1) In 
general. A sale or exchange is by reason of unforeseen circumstances if 
the primary reason for the sale or exchange is the occurrence of an 
event that the taxpayer could not reasonably have anticipated before 
purchasing and occupying the residence. A sale or exchange by reason of 
unforeseen circumstances (other than a sale or exchange deemed to be by 
reason of unforeseen circumstances under paragraph (e)(2) or (3) of this 
section) does not qualify for the reduced maximum exclusion if the 
primary reason for the sale or exchange is a preference for a different 
residence or an improvement in financial circumstances.
    (2) Specific event safe harbors. A sale or exchange is deemed to be 
by reason of unforeseen circumstances (within the meaning of paragraph 
(e)(1) of this section) if any of the events specified in paragraphs 
(e)(2)(i) through (iii) of this section occur during the period of the 
taxpayer's ownership and use of the residence as the taxpayer's 
principal residence:
    (i) The involuntary conversion of the residence.
    (ii) Natural or man-made disasters or acts of war or terrorism 
resulting in a casualty to the residence (without regard to 
deductibility under section 165(h)).
    (iii) In the case of a qualified individual described in paragraph 
(f) of this section--
    (A) Death;
    (B) The cessation of employment as a result of which the qualified 
individual is eligible for unemployment compensation (as defined in 
section 85(b));
    (C) A change in employment or self-employment status that results in 
the taxpayer's inability to pay housing costs and reasonable basic 
living expenses for the taxpayer's household (including amounts for 
food, clothing, medical expenses, taxes, transportation, court-ordered 
payments, and expenses reasonably necessary to the production of income, 
but not for the maintenance of an affluent or luxurious standard of 
living);
    (D) Divorce or legal separation under a decree of divorce or 
separate maintenance; or
    (E) Multiple births resulting from the same pregnancy.
    (3) Designation of additional events as unforeseen circumstances. 
The Commissioner may designate other events or situations as unforeseen 
circumstances in published guidance of general applicability and may 
issue rulings addressed to specific taxpayers identifying other events 
or situations as unforeseen circumstances with regard to those taxpayers 
(see Sec. 601.601(d)(2) of this chapter).
    (4) Examples. The following examples illustrate the rules of this 
paragraph (e):

    Example 1. In 2003 A buys a house in California. After A begins to 
use the house as her principal residence, an earthquake causes damage to 
A's house. A sells the house in 2004. The sale is within the safe harbor 
of paragraph (e)(2)(ii) of this section and A is entitled to claim a 
reduced maximum exclusion under section 121(c)(2).
    Example 2. H works as a teacher and W works as a pilot. In 2003 H 
and W buy a house that they use as their principal residence. Later that 
year W is furloughed from her job for six months. H and W are unable to 
pay their mortgage and reasonable basic living expenses for their 
household during the period W is furloughed. H and W sell their house in 
2004. The sale is within the safe harbor of paragraph (e)(2)(iii)(C) of 
this section and H and W are entitled to claim a reduced maximum 
exclusion under section 121(c)(2).
    Example 3. In 2003 H and W buy a two-bedroom condominium that they 
use as their

[[Page 513]]

principal residence. In 2004 W gives birth to twins and H and W sell 
their condominium and buy a four-bedroom house. The sale is within the 
safe harbor of paragraph (e)(2)(iii)(E) of this section, and H and W are 
entitled to claim a reduced maximum exclusion under section 121(c)(2).
    Example 4. In 2003 B buys a condominium in a high-rise building and 
uses it as his principal residence. B's monthly condominium fee is $X. 
Three months after B moves into the condominium, the condominium 
association replaces the building's roof and heating system. Six months 
later, B's monthly condominium fee doubles in order to pay for the 
repairs. B sells the condominium in 2004 because he is unable to afford 
the new condominium fee along with a monthly mortgage payment. The safe 
harbors of paragraph (e)(2) of this section do not apply. However, under 
the facts and circumstances, the primary reason for the sale, the 
doubling of the condominium fee, is an unforeseen circumstance because B 
could not reasonably have anticipated that the condominium fee would 
double at the time he purchased and occupied the property. Consequently, 
the sale of the condominium is by reason of unforeseen circumstances and 
B is entitled to claim a reduced maximum exclusion under section 
121(c)(2).
    Example 5. In 2003 C buys a house that he uses as his principal 
residence. The property is located on a heavily traveled road. C sells 
the property in 2004 because C is disturbed by the traffic. The safe 
harbors of paragraph (e)(2) of this section do not apply. Under the 
facts and circumstances, the primary reason for the sale, the traffic, 
is not an unforeseen circumstance because C could reasonably have 
anticipated the traffic at the time he purchased and occupied the house. 
Consequently, the sale of the house is not by reason of unforeseen 
circumstances and C is not entitled to claim a reduced maximum exclusion 
under section 121(c)(2).
    Example 6. In 2003 D and her fiance E buy a house and live in it as 
their principal residence. In 2004 D and E cancel their wedding plans 
and E moves out of the house. Because D cannot afford to make the 
monthly mortgage payments alone, D and E sell the house in 2004. The 
safe harbors of paragraph (e)(2) of this section do not apply. However, 
under the facts and circumstances, the primary reason for the sale, the 
broken engagement, is an unforeseen circumstance because D and E could 
not reasonably have anticipated the broken engagement at the time they 
purchased and occupied the house. Consequently, the sale is by reason of 
unforeseen circumstances and D and E are each entitled to claim a 
reduced maximum exclusion under section 121(c)(2).
    Example 7. In 2003 F buys a small condominium that she uses as her 
principal residence. In 2005 F receives a promotion and a large increase 
in her salary. F sells the condominium in 2004 and purchases a house 
because she can now afford the house. The safe harbors of paragraph 
(e)(2) of this section do not apply. Under the facts and circumstances, 
the primary reason for the sale of the house, F's salary increase, is an 
improvement in F's financial circumstances. Under paragraph (e)(1) of 
this section, an improvement in financial circumstances, even if the 
result of unforeseen circumstances, does not qualify for the reduced 
maximum exclusion by reason of unforeseen circumstances under section 
121(c)(2).
    Example 8. In April 2003 G buys a house that he uses as his 
principal residence. G sells his house in October 2004 because the house 
has greatly appreciated in value, mortgage rates have substantially 
decreased, and G can afford a bigger house. The safe harbors of 
paragraph (e)(2) of this section do not apply. Under the facts and 
circumstances, the primary reasons for the sale of the house, the 
changes in G's house value and in the mortgage rates, are an improvement 
in G's financial circumstances. Under paragraph (e)(1) of this section, 
an improvement in financial circumstances, even if the result of 
unforeseen circumstances, does not qualify for the reduced maximum 
exclusion by reason of unforeseen circumstances under section 121(c)(2).
    Example 9. H works as a police officer for City X. In 2003 H buys a 
condominium that he uses as his principal residence. In 2004 H is 
assigned to City X's K-9 unit and is required to care for the police 
service dog at his home. Because H's condominium association does not 
permit H to have a dog in his condominium, in 2004 he sells the 
condominium and buys a house. The safe harbors of paragraph (e)(2) of 
this section do not apply. However, under the facts and circumstances, 
the primary reason for the sale, H's assignment to the K-9 unit, is an 
unforeseen circumstance because H could not reasonably have anticipated 
his assignment to the K-9 unit at the time he purchased and occupied the 
condominium. Consequently, the sale of the condominium is by reason of 
unforeseen circumstances and H is entitled to claim a reduced maximum 
exclusion under section 121(c)(2).
    Example 10. In 2003, J buys a small house that she uses as her 
principal residence. After J wins the lottery, she sells the small house 
in 2004 and buys a bigger, more expensive house. The safe harbors of 
paragraph (e)(2) of this section do not apply. Under the facts and 
circumstances, the primary reason for the sale of the house, winning the 
lottery, is an improvement in J's financial circumstances. Under 
paragraph (e)(1) of this section, an improvement in financial 
circumstances, even if the result of unforeseen

[[Page 514]]

circumstances, does not qualify for the reduced maximum exclusion under 
section 121(c)(2).

    (f) Qualified individual. For purposes of this section, qualified 
individual means--
    (1) The taxpayer;
    (2) The taxpayer's spouse;
    (3) A co-owner of the residence;
    (4) A person whose principal place of abode is in the same household 
as the taxpayer; or
    (5) For purposes of paragraph (d) of this section, a person bearing 
a relationship specified in sections 152(a)(1) through 152(a)(8) 
(without regard to qualification as a dependent) to a qualified 
individual described in paragraphs (f)(1) through (4) of this section, 
or a descendant of the taxpayer's grandparent.
    (g) Computation of reduced maximum exclusion. (1) The reduced 
maximum exclusion is computed by multiplying the maximum dollar 
limitation of $250,000 ($500,000 for certain joint filers) by a 
fraction. The numerator of the fraction is the shortest of the period of 
time that the taxpayer owned the property during the 5-year period 
ending on the date of the sale or exchange; the period of time that the 
taxpayer used the property as the taxpayer's principal residence during 
the 5-year period ending on the date of the sale or exchange; or the 
period of time between the date of a prior sale or exchange of property 
for which the taxpayer excluded gain under section 121 and the date of 
the current sale or exchange. The numerator of the fraction may be 
expressed in days or months. The denominator of the fraction is 730 days 
or 24 months (depending on the measure of time used in the numerator).
    (2) Examples. The following examples illustrate the rules of this 
paragraph (g):

    Example 1. Taxpayer A purchases a house that she uses as her 
principal residence. Twelve months after the purchase, A sells the house 
due to a change in place of her employment. A has not excluded gain 
under section 121 on a prior sale or exchange of property within the 
last 2 years. A is eligible to exclude up to $125,000 of the gain from 
the sale of her house (12/24 x $250,000).
    Example 2. (i) Taxpayer H owns a house that he has used as his 
principal residence since 1996. On January 15, 1999, H and W marry and W 
begins to use H's house as her principal residence. On January 15, 2000, 
H sells the house due to a change in W's place of employment. Neither H 
nor W has excluded gain under section 121 on a prior sale or exchange of 
property within the last 2 years.
    (ii) Because H and W have not each used the house as their principal 
residence for at least 2 years during the 5-year period preceding its 
sale, the maximum dollar limitation amount that may be claimed by H and 
W will not be $500,000, but the sum of each spouse's limitation amount 
determined on a separate basis as if they had not been married. (See 
Sec. 1.121-2(a)(3)(ii).)
    (iii) H is eligible to exclude up to $250,000 of gain because he 
meets the requirements of section 121. W is not eligible to exclude the 
maximum dollar limitation amount. Instead, because the sale of the house 
is due to a change in place of employment, W is eligible to claim a 
reduced maximum exclusion of up to $125,000 of the gain (365/730 x 
$250,000). Therefore, H and W are eligible to exclude up to $375,000 of 
gain ($250,000 + $125,000) from the sale of the house.

    (h) Effective dates. Paragraphs (a) and (g) of this section are 
applicable for sales and exchanges on or after December 24, 2002. 
Paragraphs (b) through (f) of this section are applicable for sales and 
exchanges on or after August 13, 2004.

[T.D. 9030, 67 FR 78361, Dec. 24, 2002, as amended by T.D. 9152, 69 FR 
50304, Aug. 16, 2004]



Sec. 1.121-4  Special rules.

    (a) Property of deceased spouse--(1) In general. For purposes of 
satisfying the ownership and use requirements of section 121, a taxpayer 
is treated as owning and using property as the taxpayer's principal 
residence during any period that the taxpayer's deceased spouse owned 
and used the property as a principal residence before death if--
    (i) The taxpayer's spouse is deceased on the date of the sale or 
exchange of the property; and
    (ii) The taxpayer has not remarried at the time of the sale or 
exchange of the property.
    (2) Example. The provisions of this paragraph (a) are illustrated by 
the following example. The example assumes that Sec. 1.121-3 (relating 
to the reduced maximum exclusion) does not apply to the sale of the 
property. The example is as follows:


[[Page 515]]


    Example. Taxpayer H has owned and used a house as his principal 
residence since 1987. H and W marry on July 1, 1999 and from that date 
they use H's house as their principal residence. H dies on August 15, 
2000, and W inherits the property. W sells the property on September 1, 
2000, at which time she has not remarried. Although W has owned and used 
the house for less than 2 years, W will be considered to have satisfied 
the ownership and use requirements of section 121 because W's period of 
ownership and use includes the period that H owned and used the property 
before death.

    (b) Property owned by spouse or former spouse--(1) Property 
transferred to individual from spouse or former spouse. If a taxpayer 
obtains property from a spouse or former spouse in a transaction 
described in section 1041(a), the period that the taxpayer owns the 
property will include the period that the spouse or former spouse owned 
the property.
    (2) Property used by spouse or former spouse. A taxpayer is treated 
as using property as the taxpayer's principal residence for any period 
that the taxpayer has an ownership interest in the property and the 
taxpayer's spouse or former spouse is granted use of the property under 
a divorce or separation instrument (as defined in section 71(b)(2)), 
provided that the spouse or former spouse uses the property as his or 
her principal residence.
    (c) Tenant-stockholder in cooperative housing corporation. A 
taxpayer who holds stock as a tenant-stockholder in a cooperative 
housing corporation (as those terms are defined in section 216(b)(1) and 
(2)) may be eligible to exclude gain under section 121 on the sale or 
exchange of the stock. In determining whether the taxpayer meets the 
requirements of section 121, the ownership requirements are applied to 
the holding of the stock and the use requirements are applied to the 
house or apartment that the taxpayer is entitled to occupy by reason of 
the taxpayer's stock ownership.
    (d) Involuntary conversions--(1) In general. For purposes of section 
121, the destruction, theft, seizure, requisition, or condemnation of 
property is treated as a sale of the property.
    (2) Application of section 1033. In applying section 1033 (relating 
to involuntary conversions), the amount realized from the sale or 
exchange of property used as the taxpayer's principal residence is 
treated as being the amount determined without regard to section 121, 
reduced by the amount of gain excluded from the taxpayer's gross income 
under section 121.
    (3) Property acquired after involuntary conversion. If the basis of 
the property acquired as a result of an involuntary conversion is 
determined (in whole or in part) under section 1033(b) (relating to the 
basis of property acquired through an involuntary conversion), then for 
purposes of satisfying the requirements of section 121, the taxpayer 
will be treated as owning and using the acquired property as the 
taxpayer's principal residence during any period of time that the 
taxpayer owned and used the converted property as the taxpayer's 
principal residence.
    (4) Example. The provisions of this paragraph (d) are illustrated by 
the following example:

    Example. (i) On February 18, 1999, fire destroys Taxpayer A's house 
which has an adjusted basis of $80,000. A had owned and used this 
property as her principal residence for 20 years prior to its 
destruction. A's insurance company pays A $400,000 for the house. A 
realizes a gain of $320,000 ($400,000--$80,000). On August 27, 1999, A 
purchases a new house at a cost of $100,000.
    (ii) Because the destruction of the house is treated as a sale for 
purposes of section 121, A will exclude $250,000 of the realized gain 
from A's gross income. For purposes of section 1033, the amount realized 
is then treated as being $150,000 ($400,000--$250,000) and the gain 
realized is $70,000 ($150,000 amount realized--$80,000 basis). A elects 
under section 1033 to recognize only $50,000 of the gain ($150,000 
amount realized--$100,000 cost of new house). The remaining $20,000 of 
gain is deferred and A's basis in the new house is $80,000 ($100,000 
cost--$20,000 gain not recognized).
    (iii) A will be treated as owning and using the new house as A's 
principal residence during the 20-year period that A owned and used the 
destroyed house.

    (e) Sales or exchanges of partial interests--(1) Partial interests 
other than remainder interests--(i) In general. Except as provided in 
paragraph (e)(2) of this section (relating to sales or exchanges of 
remainder interests), a taxpayer may apply the section 121 exclusion to

[[Page 516]]

gain from the sale or exchange of an interest in the taxpayer's 
principal residence that is less than the taxpayer's entire interest if 
the interest sold or exchanged includes an interest in the dwelling 
unit. For rules relating to the sale or exchange of vacant land, see 
Sec. 1.121-1(b)(3).
    (ii) Limitations--(A) Maximum limitation amount. For purposes of 
section 121(b)(1) and (2) (relating to the maximum limitation amount of 
the section 121 exclusion), sales or exchanges of partial interests in 
the same principal residence are treated as one sale or exchange. 
Therefore, only one maximum limitation amount of $250,000 ($500,000 for 
certain joint returns) applies to the combined sales or exchanges of the 
partial interests. In applying the maximum limitation amount to sales or 
exchanges that occur in different taxable years, a taxpayer may exclude 
gain from the first sale or exchange of a partial interest up to the 
taxpayer's full maximum limitation amount and may exclude gain from the 
sale or exchange of any other partial interest in the same principal 
residence to the extent of any remaining maximum limitation amount, and 
each spouse is treated as excluding one-half of the gain from a sale or 
exchange to which section 121(b)(2)(A) and Sec. 1.121-
2(a)(3)(i)(relating to the limitation for certain joint returns) apply.
    (B) Sale or exchange of more than one principal residence in 2-year 
period. For purposes of applying section 121(b)(3) (restricting the 
application of section 121 to only 1 sale or exchange every 2 years), 
each sale or exchange of a partial interest is disregarded with respect 
to other sales or exchanges of partial interests in the same principal 
residence, but is taken into account as of the date of the sale or 
exchange in applying section 121(b)(3) to that sale or exchange and the 
sale or exchange of any other principal residence.
    (2) Sales or exchanges of remainder interests--(i) In general. A 
taxpayer may elect to apply the section 121 exclusion to gain from the 
sale or exchange of a remainder interest in the taxpayer's principal 
residence.
    (ii) Limitations--(A) Sale or exchange of any other interest. If a 
taxpayer elects to exclude gain from the sale or exchange of a remainder 
interest in the taxpayer's principal residence, the section 121 
exclusion will not apply to a sale or exchange of any other interest in 
the residence that is sold or exchanged separately.
    (B) Sales or exchanges to related parties. This paragraph (e)(2) 
will not apply to a sale or exchange to any person that bears a 
relationship to the taxpayer that is described in section 267(b) or 
707(b).
    (iii) Election. The taxpayer makes the election under this paragraph 
(e)(2) by filing a return for the taxable year of the sale or exchange 
that does not include the gain from the sale or exchange of the 
remainder interest in the taxpayer's gross income. A taxpayer may make 
or revoke the election at any time before the expiration of a 3-year 
period beginning on the last date prescribed by law (determined without 
regard to extensions) for the filing of the return for the taxable year 
in which the sale or exchange occurred.
    (3) Example. The provisions of this paragraph (e) are illustrated by 
the following example:

    Example. In 1991 Taxpayer A buys a house that A uses as his 
principal residence. In 2004 A's friend B moves into A's house and A 
sells B a 50% interest in the house realizing a gain of $136,000. A may 
exclude the $136,000 of gain. In 2005 A sells his remaining 50% interest 
in the home to B realizing a gain of $138,000. A may exclude $114,000 
($250,000--$136,000 gain previously excluded) of the $138,000 gain from 
the sale of the remaining interest.

    (f) No exclusion for expatriates. The section 121 exclusion will not 
apply to any sale or exchange by an individual if the provisions of 
section 877(a) (relating to the treatment of expatriates) applies to the 
individual.
    (g) Election to have section not apply. A taxpayer may elect to have 
the section 121 exclusion not apply to a sale or exchange of property. 
The taxpayer makes the election by filing a return for the taxable year 
of the sale or exchange that includes the gain from the sale or exchange 
of the taxpayer's principal residence in the taxpayer's gross income. A 
taxpayer may make an election under this paragraph (g) to have section 
121 not apply (or revoke an election to have section 121 not apply)

[[Page 517]]

at any time before the expiration of a 3-year period beginning on the 
last date prescribed by law (determined without regard to extensions) 
for the filing of the return for the taxable year in which the sale or 
exchange occurred.
    (h) Residences acquired in rollovers under section 1034. If a 
taxpayer acquires property in a transaction that qualifies under section 
1034 (section 1034 property) for the nonrecognition of gain realized on 
the sale or exchange of another property and later sells or exchanges 
such property, in determining the period of the taxpayer's ownership and 
use of the property under section 121 the taxpayer may include the 
periods that the taxpayer owned and used the section 1034 property as 
the taxpayer's principal residence (and each prior residence taken into 
account under section 1223(7) in determining the holding period of the 
section 1034 property).
    (i) [Reserved]
    (j) Election to apply regulations retroactively. Taxpayers who would 
otherwise qualify under Sec. Sec. 1.121-1 through 1.121-4 to exclude 
gain from a sale or exchange of a principal residence before December 
24, 2002 but on or after May 7, 1997, may elect to apply Sec. Sec. 
1.121-1 through 1.121-4 for any years for which the period of limitation 
under section 6511 has not expired. The taxpayer makes the election 
under this paragraph (j) by filing a return for the taxable year of the 
sale or exchange that does not include the gain from the sale or 
exchange of the taxpayer's principal residence in the taxpayer's gross 
income. Taxpayers who have filed a return for the taxable year of the 
sale or exchange may elect to apply the provisions of these regulations 
for any years for which the period of limitation under section 6511 has 
not expired by filing an amended return.
    (k) Audit protection. The Internal Revenue Service will not 
challenge a taxpayer's position that a sale or exchange of a principal 
residence occurring before December 24, 2002 but on or after May 7, 
1997, qualifies for the section 121 exclusion if the taxpayer has made a 
reasonable, good faith effort to comply with the requirements of section 
121. Compliance with the provisions of the regulations project under 
section 121 (REG-105235-99 (2000-2 C.B. 447)) generally will be 
considered a reasonable, good faith effort to comply with the 
requirements of section 121.
    (l) Effective date. This section is applicable for sales and 
exchanges on or after December 24, 2002. For rules on electing to apply 
the provisions retroactively, see paragraph (j) of this section.

[T.D. 9030, 67 FR 78361, Dec. 24, 2002; 68 FR 6350, Feb. 7, 2003]



Sec. 1.121-5  Suspension of 5-year period for certain members of the 
uniformed services and Foreign Service.

    (a) In general. Under section 121(d)(9), a taxpayer who is serving 
(or whose spouse is serving) on qualified official extended duty as a 
member of the uniformed services or Foreign Service of the United States 
may elect to suspend the running of the 5-year period of ownership and 
use during such service but for not more than 10 years. The election 
does not suspend the running of the 5-year period for any period during 
which the running of the 5-year period with respect to any other 
property of the taxpayer is suspended by an election under section 
121(d)(9).
    (b) Manner of making election. The taxpayer makes the election under 
section 121(d)(9) and this section by filing a return for the taxable 
year of the sale or exchange of the taxpayer's principal residence that 
does not include the gain in the taxpayer's gross income.
    (c) Application of election to closed years. A taxpayer who would 
otherwise qualify under Sec. Sec. 1.121-1 through 1.121-4 to exclude 
gain from a sale or exchange of a principal residence on or after May 7, 
1997, may elect to apply section 121(d)(9) and this section for any 
years for which a claim for refund is barred by operation of any law or 
rule of law by filing an amended return before November 11, 2004.
    (d) Example. The provisions of this section are illustrated by the 
following example:

    Example. B purchases a house in Virginia in 2003 that he uses as his 
principal residence for 3 years. For 8 years, from 2006 through 2014, B 
serves on qualified official extended duty as a member of the Foreign 
Service of the United States in Brazil. In 2015 B sells

[[Page 518]]

the house. B did not use the house as his principal residence for 2 of 
the 5 years preceding the sale. Under section 121(d)(9)and this section, 
however, B may elect to suspend the running of the 5-year period of 
ownership and use during his 8-year period of service with the Foreign 
Service in Brazil. If B makes the election, the 8-year period is not 
counted in determining whether B used the house for 2 of the 5 years 
preceding the sale. Therefore, B may exclude the gain from the sale of 
the house under section 121.

    (e) Effective date. This section is applicable for sales and 
exchanges on or after May 7, 1997.

[T.D. 9152, 69 FR 50306, Aug. 16, 2004]



Sec. 1.122-1  Applicable rules relating to certain reduced uniformed 
services retirement pay.

    (a) Rule applicable prior to January 1, 1966. In the case of a 
member or former member of the uniformed services of the United States 
(as defined in 37 U.S.C. 101(3)) who has made an election under 
Subchapter I of Chapter 73 of Title 10 of the U.S. Code (also referred 
to in this section as the Retired Serviceman's Family Protection Plan 
(10 U.S.C. 1431)) to receive a reduced amount of retired or retainer 
pay, gross income shall include the amount of any reduction made in his 
retired or retainer pay before January 1, 1966, by reason of such 
election, unless such reduction, or portion thereof, is otherwise 
excluded from gross income under Part III of Subchapter B of Chapter 1 
of the Internal Revenue Code of 1954 or any other provision of law.
    (b) Rule applicable after December 31, 1965--(1) In a case of a 
member or former member of the uniformed services of the United States 
(as defined in 37 U.S.C. 101(3)), gross income shall not include the 
amount of any reduction made in his or her retired or retainer pay after 
December 31, 1965, by reason of--
    (i) An election made under the Retired Serviceman's Family 
Protection Plan (10 U.S.C. 1431), or
    (ii) The provisions of Subchapter II of Chapter 73 of Title 10 of 
the U.S. Code (also referred to in this section as the Survivor Benefit 
Plan (10 U.S.C. 1447)).
    (2)(i) In a case where a member or former member of the uniformed 
services has, pursuant to the election described in paragraph (a) of 
this section, received before January 1, 1966, a reduced amount of 
retired or retainer pay, he shall, after December 31, 1965, exclude from 
gross income under section 122(b) and this subdivision all amounts 
received as uniformed services retired or retainer pay until there has 
been so excluded an amount of retired or retainer pay equal to the 
``consideration for the contract'' (as described in subdivision (iii) of 
this subparagraph).
    (ii) Upon the death of a member or former member of the uniformed 
services, where the ``consideration for the contract'' (as described in 
subdivision (iii) of this subparagraph) has not been excluded in whole 
or in part from gross income under section 122(b) and subdivision (i) of 
this subparagraph, the survivor of such member who is receiving an 
annuity under Chapter 73 of Title 10 of the U.S. Code shall, after 
December 31, 1965, exclude from gross income under section 72(o) and 
this subdivision such annuity payments received after December 31, 1965, 
until there has been so excluded annuity payments equalling the portion 
of the ``consideration for the contract'' not previously excluded under 
subdivision (i) of this subparagraph.
    (iii) The term ``consideration for the contract'' as used in this 
subparagraph means--
    (a) The total amount of the reductions, if any, before January 1, 
1966, in retired or retainer pay by reason of an election under 
Subchapter I of Chapter 73 of Title 10 of the United States Code, plus
    (b) The total amount, if any, deposited by the serviceman at any 
time pursuant to the provisions of sections 1438 or 1452(d) of Title 10 
of the United States Code, plus
    (c) The total amount, if any, excludable from income under section 
101(b)(2)(D) and paragraph (a)(2) of Sec. 1.101-2 with respect to a 
survivor annuity provided by such retired or retainer pay, minus
    (d) The total amount, if any, excluded from income before January 1, 
1966, pursuant to the provisions of section 72 (b) and (d) with respect 
to a survivor annuity provided by such retired or retainer pay.

[[Page 519]]

    (iv) In determining whether there has been a recovery of the 
``consideration for the contract'' under subdivision (i) of this 
subparagraph, the exclusion of retired pay from income after December 
31, 1965, under sections 104(a)(4) and 105(d) shall not be considered as 
recovery of all or part of the ``consideration for the contract.''
    (c) Special rules. In any of the following situations, the 
computation of the excludable portion of disability retired pay received 
by the member or former member of the uniformed services shall be 
governed by the following rules:
    (1) An exclusion under section 122(a) and paragraph (b)(1) of this 
section is applicable only in the taxable year in which a reduction in 
retired pay is made under the Retired Serviceman's Family Protection 
Plan (10 U.S.C. 1431) or the Survivor Benefit Plan (10 U.S.C. 1447).
    (2) Where the member or former member of the uniformed services is 
entitled to exclude the whole or a portion of his retired pay under the 
provisions of section 104(a)(4) or section 105(d) and under section 
122(a) and paragraph (b)(1) of this section, the exclusion under section 
122(a) and paragraph (b)(1) of this section shall be applied prior to 
the exclusions under sections 104(a)(4) and 105(d).
    (3) Where the member or former member of the uniformed services 
waives a portion of his disability retired pay, or such retired pay 
reduced under the Retired Serviceman's Family Protection Plan (10 U.S.C. 
1431),or the Survivor Benefit Plan (10 U.S.C. 1447) in favor of a 
nontaxable pension or compensation receivable under laws administered by 
the Veterans Administration (38 U.S.C. 3105), the waived amount of such 
disability retired pay, or reduced amount thereof, shall first be 
subtracted from any amounts which are excludable under the provisions of 
sections 104(a)(4) or 105(d) so as to reduce the amounts otherwise 
excludable under those sections.
    (4) Where the member or former member of the uniformed services 
receives (before any forfeiture) disability retired pay (whether or not 
reduced under the Retired Serviceman's Family Protection Plan) or the 
Survivor Benefit Plan which is partially excludable under section 
104(a)(4), and also forfeits a portion of such disability retired pay 
under the Dual Compensation Act of 1964 (5 U.S.C. 5531 or any former 
corresponding provision of law), the amount of the forfeiture under such 
Act shall be applied against disability retired pay (before any 
forfeiture) in the same proportion that the excludable portion of such 
pay under section 104(a)(4) bears to the total amount of such pay after 
subtraction of any reduction under the Retired Serviceman's Family 
Protection Plan (10 U.S.C. 1431) or the Survivor Benefit Plan (10 U.S.C. 
1447).
    (5) The exclusion provided by section 122(b) and paragraph (b)(2)(i) 
of this section shall be available with respect to repayments made upon 
removal from the temporary disability retired list even though such 
repayments were previously excluded from gross income under section 
104(a)(4) or 105(d).

However, the exclusion permitted by the prior sentence will apply only 
to the extent the repaid amount has not been previously excluded under 
section 122(b) and paragraph (b)(2)(i) of this section.
    (d) Examples with respect to the Retired Serviceman's Family 
Protection Plan. The rules discussed in this section relating to the 
Retired Serviceman's Family Protection Plan (10 U.S.C. 1431) may be 
illustrated by the following examples:

    Example (1). A, a member of the uniformed services, retires on 
January 1, 1963, and receives nondisability retired pay computed to be 
60 percent of his active duty pay of $10,000 per year, or $6,000 per 
year, based upon 24 years of service. He elects, under the Retired 
Serviceman's Family Protection Plan (10 U.S.C. 1431), to provide his 
survivor with an annuity equal to one-fourth of his reduced retired pay. 
His retired pay of $6,000 is reduced by $600, to $5,400, in order to 
provide a survivor annuity of $1,350 per year or $112.50 per month. For 
1963, 1964, and 1965, A must include in gross income the unreduced 
amount of retired pay, or $6,000. For 1966 and subsequent years, he may 
exclude under section 122(a) and paragraph (b)(1) of this section the 
$600 total annual reductions to provide the survivor annuity, and may, 
for 1966, further exclude from gross income under section 122(b) and 
paragraph (b)(2)(i) of this section the $1,800 ``consideration for the 
contract'' i.e., the total reductions which were made in 1963, 1964, and 
1965, to provide the

[[Page 520]]

survivor annuity. Accordingly, A will include $3,600 of retired pay in 
gross income for 1966 ($6,000 minus the sum of $600 and $1,800).
    Example (2). Assume the facts in Example (1) except that A retires 
on disability resulting from active service and his disability is rated 
at 40 percent. The entire amount of disability retirement pay, prior to 
and including 1966, is excludable from gross income under sections 
104(a)(4) and 105(d), and in 1966, section 122(a). Assume further that A 
attains retirement age on December 31, 1966, dies on January 1, 1967, 
and his widow then begins receiving a survivor annuity under the Retired 
Serviceman's Family Protection Plan (10 U.S.C. 1431). A's widow may 
exclude from gross income in 1967 and 1968 under section 72(o) and 
paragraph (b)(2)(ii) of this section, the $1,800 of ``consideration for 
the contract'' i.e., the reductions in 1963, 1964, and 1965 to provide 
the survivor annuity. Thus, A's widow will exclude all of the survivor 
annuity she receives in 1967 ($1,350) and $450 of the $1,350 annuity 
received in 1968. In addition, if A had not attained retirement age at 
the time of his death, his widow would, under section 101 and paragraph 
(a)(2) of Sec. 1.101-2, exclude up to $5,000 subject to the limitations 
of paragraph (b)(2)(ii) of this section.
    Example (3). Assume, in the previous example, that A dies on January 
1, 1965, and his widow then begins receiving a survivor annuity. Assume 
further that A's widow is entitled to exclude under section 72(b) $1,000 
of the $1,350 she received in 1965. Under section 72(o) and paragraph 
(b)(2)(ii) of this section, A's widow for 1966 will exclude the $200 
remaining consideration for the contract ($1,200-$1,000) and will 
include $1,150 of the survivor annuity in gross income.
    Example (4). B, a member of the uniformed services, retires on 
January 1, 1966, after 32 years of active military service, and receives 
disability retirement pay under section 1401 of title 10, limited to 75 
percent of his active duty pay of $15,000 per year, or $11,250. His 
disability rating is 30 percent. B has not reached retirement age (as 
defined in Sec. 1.79-2(b)(3)). He elects under the Retired Serviceman's 
Family Protection Plan (10 U.S.C. 1431) to provide his survivor with an 
annuity equal to one-half of his reduced retired pay and, for that 
purpose, his retired pay of $11,250 is reduced by $1,250 to provide an 
annuity of $5,000 per year. B also elects to waive retired pay in the 
amount of $1,000 in order to receive disability compensation in like 
amount under laws administered by the Veterans Administration. In 
addition, B is required to forfeit $4,088 of his retired pay under the 
Dual Compensation Act of 1964 (5 U.S.C. 5532) ($11,250-$1,000 = $10,250 
less one-half of excess thereof over $2,074) and by reason of his 
Federal employment is not entitled to an exclusion of his retired pay 
under section 105(d). B's taxable retired pay for 1966 is $3,002, 
computed as follows:

Gross retired pay............................................   $11,250
  Less: Section 122(a) exclusion.............................    (1,250)
                                                              ----------
Reduced retired pay..........................................    10,000
  Less: Retired pay waived to receive V.A. compensation......    (1,000)
                                                              ----------
Adjusted retired pay--                                            9,000
  Less:
    (i) Excludable retired pay computed under section            $4,500
     104(a)(4) as limited by 10 U.S.C. 1403..................
    (ii) Less: Retired pay, not to exceed (i), waived to         (1,000)
     receive V.A. compensation...............................
                                                              ----------
    (iii) Net disability exclusion...........................    (3,500)
Taxable retired pay before adjustment for Dual Compensation       5,500
 forfeiture..................................................
  Less:
    Adjustment for Dual Compensation forfeiture of $4,088
5500/9000x$4,088 = $2,498 (rounded)..........................    (2,498)
                                                              ----------
Net taxable retired pay......................................     3,002
 

    Example (5). C, a member of the uniformed services retires on 
January 1, 1966, and receives disability retirement pay of $11,250 per 
year, which is reduced by $1,250 to provide a survivor annuity, and 
$1,000 of which is waived in order to receive disability compensation in 
like amount under laws administered by the Veterans Administration. C 
has not reached retirement age for purposes of section 105(d) and is not 
employed by the Federal Government. C's taxable disability retirement 
pay for 1966 is $300 computed as follows:

Adjusted retired pay.............................    $9,000
  Less:
  (i) Excludable retired pay under section (a)(4)    $4,500
   as limited by 10 U.S.C. 1403..................
    (ii) Excludable retired pay under section         5,200
     105(d)......................................
                                                  -----------
    (iii) Total..................................     9,700
    (iv) Less: Retired pay, not to exceed (iii),     (1,000)
     waived to receive V.A. compensation ``sick
     pay'' exclusion.............................
                                                  -----------
    (v) Net disability and ``sick pay'' exclusion  .........     (8,700)
                                                             -----------
Net taxable retired pay..........................       800
 

    Example (6). D, a member of the uniformed services, retires for 
physical disability resulting from active service on January 1, 1966, 
after 35 years of service and with a disability rated at 20 percent. His 
active duty pay is $4,000 per year and he attained retirement age prior 
to retirement. He had an election in effect under the Retired 
Serviceman's Family Protection Plan to provide his survivor with an 
annuity and his retired pay is reduced therefor by $500 per year. He

[[Page 521]]

waives $1,300 of his retired pay in order to receive compensation from 
the Veterans Administration in like amount. His taxable retired pay for 
1966 is $1,200 computed as follows:

Gross retired pay (75%x$4,000)...................    $3,000
  Less: Section 122(a) exclusion.................      (500)
                                                  ------------
Reduced retired pay..............................     2,500
  Less: V.A. waiver..............................    (1,300)
                                                  ------------
Adjusted retired pay.............................     1,200
  Less:
    (i) Section 104(a)(4) exclusion..............      $800
    (ii) Less: Retired pay, not to exceed (i),         (800)
     waived to receive V.A. compensation.........
                                                  -----------
    (iii) Net disability exclusion...............         0
                                                             -----------
Net taxable retired pay..........................  .........      1,200
 

    (e) Principles applicable to the Survivor Benefit Plan. The 
principles illustrated by the examples set forth in paragraph (d) of 
this section apply to an annuity under the Survivor Benefit Plan (10 
U.S.C. 1447).

[T.D. 7043, 35 FR 8478, June 2, 1970, as amended by T.D. 7562, 43 FR 
38819, Aug. 31, 1978]



Sec. 1.123-1  Exclusion of insurance proceeds for reimbursement of 
certain living expenses.

    (a) In general. (1) Gross income does not include insurance proceeds 
received by an individual on or after January 1, 1969, pursuant to the 
terms of an insurance contract for indemnification of the temporary 
increase in living expenses resulting from the loss of use or occupancy 
of his principal residence, or a part thereof, due to damage or 
destruction by fire, storm, or other casualty. The term ``other 
casualty'' has the same meaning assigned to such term under section 
165(c)(3). The exclusion also applies in the case of an individual who 
is denied access to his principal residence by governmental authorities 
because of the occurrence (or threat of occurrence) of such a casualty. 
The amount excludable under this section is subject to the limitation 
set forth in paragraph (b) of this section.
    (2) This exclusion applies to amounts received as reimbursement or 
compensation for the reasonable and necessary increase in living 
expenses incurred by the insured and members of his household to 
maintain their customary standard of living during the loss period.
    (3) This exclusion does not apply to an insurance recovery for the 
loss of rental income. Nor does the exclusion apply to any insurance 
recovery which compensates for the loss of, or damage to, real or 
personal property. See section 165(c)(3) relating to casualty losses; 
section 1231 relating to gain on an involuntary conversion of a capital 
asset held for more than 1 year (6 months for taxable years beginning 
before 1977; 9 months for taxable years beginning in 1977); and section 
1033 relating to recognition of gain on an involuntary conversion. In 
the case of property used by an insured partially as a principal 
residence and partially for other purposes, the exclusion does not apply 
to the amount of insurance proceeds which compensates for the portion of 
increased expenses attributable to the nonresidential use of temporary 
replacement property during the loss period. In the case of denial of 
access to a principal residence by governmental authority, the exclusion 
provided by this section does not apply to an insurance recovery 
received by an individual as reimbursement for living expenses incurred 
by reason of a governmental condemnation or order not related to a 
casualty or the threat of a casualty.
    (4)(i) Subject to the limitation set forth in paragraph (b), the 
amount excludable is the amount which is identified by the insurer as 
being paid exclusively for increased living expenses resulting from the 
loss of use or occupancy of the principal residence and pursuant to the 
terms of the insurance contract.
    (ii) When a lump-sum insurance settlement includes, but does not 
specifically identify, compensation for property damage, loss of rental 
income, and increased living expenses, the amount of such settlement 
allocable to living expenses shall, in the case of uncontested claims, 
be that portion of the settlement which bears the same ratio to the 
total recovery as the amount of claimed increased living expense bears 
to the total amount of

[[Page 522]]

claimed losses and expenses, to the extent not in excess of the coverage 
limitations specified in the contract for such losses and expenses.
    (iii) In the case of a lump-sum settlement involving contested 
claims, the insured shall establish the amount reasonably allocable to 
increased living expenses, consistent with the terms of the contract and 
other facts of the particular case.
    (iv) In no event may the amount of a lump-sum settlement which is 
allocable to increased living expenses exceed the coverage limitation 
specified in the contract for increased living expenses. Where, however, 
a coverage limitation is applicable to the total amount payable for 
increased living expenses and, for example, loss of rental income, the 
amount of an unitemized settlement which is allocable to increased 
living expenses may not exceed the portion of the applicable coverage 
limitation which bears the same ratio to such limitation as the amount 
of increased living expenses bears to the sum of the amount of such 
increased living expenses and the amount, if any, of lost rental income.
    (5) The portion of any insurance recovery for increased living 
expenses which exceeds the limitation set forth in paragraph (b) shall 
be included in gross income under section 61 of the Code.
    (b) Limitation--(1) Amount excludable. The amount excludable under 
this section is limited to amounts received which are not in excess of 
the amount by which (i) total actual living expenses incurred by the 
insured and members of his household which result from the loss of use 
or occupancy of their residence exceed (ii) the total normal living 
expenses which would have been incurred during the loss period but are 
not incurred as a result of the loss of use or occupancy of the 
principal residence. Generally, the excludable amount represents such 
excess expenses actually incurred by reason of a casualty, or threat 
thereof, for renting suitable housing and for extraordinary expenses for 
transportation, food, utilities, and miscellaneous services during the 
period of repair or replacement of the damaged principal residence or 
denial of access by governmental authority.
    (2) Actual living expenses. For purposes of this section, actual 
living expenses are the reasonable and necessary expenses incurred as a 
result of the loss of use or occupancy of the principal residence to 
maintain the insured and members of his household in accordance with 
their customary standard of living. Actual living expenses must be of 
such a nature as to qualify as a reimbursable expense under the terms of 
the applicable insurance contract without regard to monetary limitations 
upon coverage. Generally, actual living expenses include the cost during 
the loss period of temporary housing, utilities furnished at the place 
of temporary housing, meals obtained at restaurants which customarily 
would have been prepared in the residence, transportation, and other 
miscellaneous services. To the extent that the loss of use or occupancy 
of the principal residence results merely in an increase in the amount 
expended for items of living expenses normally incurred, such as food 
and transportation, only the increase in such costs shall be considered 
as actual living expenses in computing the limitation.
    (3) Normal living expenses not incurred. Normal living expenses 
consist of the same categories of expenses comprising actual living 
expenses which would have been incurred but are not incurred as a result 
of the casualty or threat thereof. If the loss of use of the residence 
results in a decrease in the amount normally expended for a living 
expense item during the loss period, the item of normal living expense 
is considered not to have been incurred to the extent of the decrease 
for purposes of computing the limitation.
    (4) Examples. The application of this paragraph (b) may be 
illustrated by the following examples:

    Example (1). On March 1, 1970, A's principal residence, a dwelling 
owned by A no part of which was rented to others or used for 
nonresidential purposes, was extensively damaged by fire. The damaged 
residence was under repair during the entire month of March making it 
necessary for A and his spouse to obtain temporary lodging and to take 
their meals at a restaurant. A and his spouse incur expenses of $200 for 
lodging at a

[[Page 523]]

motel, $180 for meals which customarily would have been prepared in his 
residence, and $25 for commercial laundry service which customarily 
would have been done by A's wife. A makes (directly or through mortgage 
insurance), or remains liable for, the required March payment of $190 on 
the mortgage note on his residence. The mortgage payment results from a 
contractual obligation having no causal relationship to the occurrence 
of the casualty and is not considered as an actual living expense 
resulting from the loss of use of the residence. A's customary commuting 
expense of $40 for bus fares to and from work is decreased by $20 for 
the month because of the motel's closer proximity to his place of 
employment. Other transportation expenses remain stable. Since there has 
been a decrease in the amount of A's customary bus fares, normal 
transportation expenses are considered not to have been incurred to the 
extent of the decrease. Finally, A does not incur customary expenses of 
$150 for food obtained for home preparation, $75 for utilities expenses, 
and $10 for laundry cleansers. The limitation upon the excludable amount 
of an insurance recovery for excess living expenses is $150, computed as 
follows:

                             Living Expenses
------------------------------------------------------------------------
                                       Actual
                                      resulting  Normal not    Increase
                                        from      incurred    (decrease)
                                      casualty
------------------------------------------------------------------------
Housing............................     $200.00  ..........     $200.00
Utilities..........................  ..........      $75.00      (75.00)
Meals..............................      180.00      150.00       30.00
Transportation.....................  ..........       20.00      (20.00)
Laundry............................       25.00       10.00      150.00
                                    ------------------------------------
    Total..........................      405.00      255.00       15.00
------------------------------------------------------------------------

    Example (2). Assume the same facts as in example (1) except that the 
damaged residence is not owned by A but is rented to him for $100 per 
month and that the risk of loss is upon the lessor. Since A would not 
have incurred the normal rental of $100 for March, the excludable amount 
is limited to $50 ($150 as in previous example less $100 normal rent not 
incurred).

    (c) Principal residence. Whether or not property is used by the 
insured taxpayer and members of his household as their principal 
residence depends upon all the facts and circumstances in each case. For 
purposes of this section, a principal residence may be a dwelling or an 
apartment leased to the insured as well as a dwelling or apartment owned 
by the insured.

[T.D. 7118, 36 FR 10729, June 2, 1971, as amended by T.D. 7728, 45 FR 
72650, Nov. 3, 1980]



Sec. 1.125-2T  Question and answer relating to the benefits that may be 
offered under a cafeteria plan (temporary).

    Q-1: What benefits may be offered to participants under a cafeteria 
plan?
    A-1: (a) Generally, for cafeteria plan years beginning on or after 
January 1, 1985, a cafeteria plan is a written plan under which 
participants may choose among two or more benefits consisting of cash 
and certain other permissible benefits. In general, benefits that are 
excludable from the gross income of an employee under a specific section 
of the Internal Revenue Code may be offered under a cafeteria plan. 
However, scholarships and fellowships under section 117, vanpooling 
under section 124, educational assistance under section 127 and certain 
fringe benefits under section 132 may not be offered under a cafeteria 
plan. In addition, meals and lodging under section 119, because they are 
furnished for the convenience of the employer and thus are not elective 
in lieu of other benefits or compensation provided by the employer, may 
not be offered under a cafeteria plan. Thus, a cafeteria plan may offer 
coverage under a group-term life insurance plan of up to $50,000 
(section 79), coverage under an accident or health plan (sections 105 
and 106), coverage under a qualified group legal services plan (section 
120), coverage under a dependent care assistance program (section 129), 
and participation in a qualified cash or deferred arrangement that is 
part of a profit-sharing or stock bonus plan (section 401(k)). In 
addition, a cafeteria plan may offer group-term life insurance coverage 
which is includable in gross income only because it is in excess of 
$50,000 or is on the lives of the participant's spouse and/or children. 
In addition, a cafeteria plan may offer participants the opportunity to 
purchase, with after-tax employee contributions, coverage under a group-
term life insurance plan (section 79), coverage under an accident or 
health plan (section 105(e)), coverage under a

[[Page 524]]

qualified group legal services plan (section 120), or coverage under a 
dependent care assistance program (section 129). Finally, a cafeteria 
plan may offer paid vacation days if the plan precludes any participant 
from using, or receiving cash for, in a subsequent plan year, any of 
such paid vacation days remaining unused as of the end of the plan year. 
For purposes of the preceding sentence, elective vacation days provided 
under a cafeteria plan are not considered to be used until all 
nonelective paid vacation days have been used.
    (b) Note that benefits that may be offered under a cafeteria plan 
may or may not be taxable depending upon whether such benefits qualify 
for an exclusion from gross income. However, a cafeteria plan may not 
offer a benefit that is taxable because such benefit fails to satisfy 
any applicable eligibility, coverage, or nondiscrimination requirement. 
Similarly, a plan may not offer a benefit for purchase with after-tax 
employee contributions if such benefit would fail to satisfy any 
eligibility, coverage, or nondiscrimination requirement that would apply 
if such benefit were designed to be provided on a nontaxable basis with 
employer contributions. Also, note that section 125(d)(2) provides that 
a cafeteria plan may not offer a benefit that defers the receipt of 
compensation (other than the opportunity to make elective contributions 
under a qualified cash or deferred arrangement) and may not operate in a 
manner that enables participants to defer the receipt of compensation.

[T.D. 8073, 51 FR 4318, Feb. 4, 1986]



Sec. 1.125-3  Effect of the Family and Medical Leave Act (FMLA) on the 
operation of cafeteria plans.

    The following questions and answers provide guidance on the effect 
of the Family and Medical Leave Act (FMLA), 29 U.S.C. 2601 et seq., on 
the operation of cafeteria plans:
    Q-1: May an employee revoke coverage or cease payment of his or her 
share of group health plan premiums when taking unpaid FMLA, 29 U.S.C. 
2601 et seq., leave?
    A-1: Yes. An employer must either allow an employee on unpaid FMLA 
leave to revoke coverage, or continue coverage but allow the employee to 
discontinue payment of his or her share of the premium for group health 
plan coverage (including a health flexible spending arrangement (FSA)) 
under a cafeteria plan for the period of the FMLA leave. See 29 CFR 
825.209(e). FMLA does not require that an employer allow an employee to 
revoke coverage if the employer pays the employee's share of premiums. 
As discussed in Q&A-3, if the employer continues coverage during an FMLA 
leave, the employer may recover the employee's share of the premiums 
when the employee returns to work. FMLA also provides the employee a 
right to be reinstated in the group health plan coverage (including a 
health FSA) provided under a cafeteria plan upon returning from FMLA 
leave if the employee's group health plan coverage terminated while on 
FMLA leave (either by revocation or due to nonpayment of premiums). Such 
an employee is entitled, to the extent required under FMLA, to be 
reinstated on the same terms as prior to taking FMLA leave (including 
family or dependent coverage), subject to any changes in benefit levels 
that may have taken place during the period of FMLA leave as provided in 
29 CFR 825.215(d)(1). See 29 CFR 825.209(e) and 825.215(d). In addition, 
such an employee has the right to revoke or change elections under Sec. 
1.125-4 (e.g., because of changes in status or cost or coverage changes 
as provided under Sec. 1.125-4) under the same terms and conditions as 
are available to employees participating in the cafeteria plan who are 
working and not on FMLA leave.
    Q-2: Who is responsible for making premium payments under a 
cafeteria plan when an employee on FMLA leave continues group health 
plan coverage?
    A-2: FMLA provides that an employee is entitled to continue group 
health plan coverage during FMLA leave whether or not that coverage is 
provided under a health FSA or other component of a cafeteria plan. See 
29 CFR 825.209(b). FMLA permits an employer to require an employee who 
chooses to continue group health plan coverage while on FMLA leave to be 
responsible for the share of group health premiums that would be 
allocable to

[[Page 525]]

the employee if the employee were working, and, for this purpose, treats 
amounts paid pursuant to a pre-tax salary reduction agreement as amounts 
allocable to the employee. However, FMLA requires the employer to 
continue to contribute the share of the cost of the employee's coverage 
that the employer was paying before the employee commenced FMLA leave. 
See 29 CFR 825.100(b) and 825.210(a).
    Q-3: What payment options are required or permitted to be offered 
under a cafeteria plan to an employee who continues group health plan 
coverage while on unpaid FMLA leave, and what is the tax treatment of 
these payments?
    A-3: (a) In general. Subject to the limitations described in 
paragraph (b) of this Q&A-3, a cafeteria plan may offer one or more of 
the following payment options, or a combination of these options, to an 
employee who continues group health plan coverage (including a health 
FSA) while on unpaid FMLA leave; provided that the payment options for 
employees on FMLA leave are offered on terms at least as favorable as 
those offered to employees not on FMLA leave. These options are referred 
to in this section as pre-pay, pay-as-you-go, and catch-up. See also the 
FMLA notice requirements at 29 CFR 825.301(b)(1)(iv).
    (1) Pre-pay. (i) Under the pre-pay option, a cafeteria plan may 
permit an employee to pay, prior to commencement of the FMLA leave 
period, the amounts due for the FMLA leave period. However, FMLA 
provides that the employer may not mandate that an employee pre-pay the 
amounts due for the leave period. See 29 CFR 825.210(c)(3) and (4).
    (ii) Contributions under the pre-pay option may be made on a pre-tax 
salary reduction basis from any taxable compensation (including from 
unused sick days or vacation days). However, see Q&A-5 of this section 
regarding additional restrictions on pre-tax salary reduction 
contributions when an employee's FMLA leave spans two cafeteria plan 
years.
    (iii) Contributions under the pre-pay option may also be made on an 
after-tax basis.
    (2) Pay-as-you-go. (i) Under the pay-as-you-go option, employees may 
pay their share of the premium payments on the same schedule as payments 
would have been made if the employee were not on leave or under any 
other payment schedule permitted by the Labor Regulations at 29 CFR 
825.210(c) (e.g., on the same schedule as payments are made under 
section 4980B (relating to coverage under the Consolidated Omnibus 
Budget Reconciliation Act (COBRA), 26 U.S.C. 4980B), under the 
employer's existing rules for payment by employees on leave without pay, 
or under any other system voluntarily agreed to between the employer and 
the employee that is not inconsistent with this section or with 29 CFR 
825.210(c)).
    (ii) Contributions under the pay-as-you-go option are generally made 
by the employee on an after-tax basis. However, contributions may be 
made on a pre-tax basis to the extent that the contributions are made 
from taxable compensation (e.g., from unused sick days or vacation days) 
that is due the employee during the leave period.
    (iii) An employer is not required to continue the group health 
coverage of an employee who fails to make required premium payments 
while on FMLA leave, provided that the employer follows the notice 
procedures required under FMLA. See 29 CFR 825.212. However, if the 
employer chooses to continue the health coverage of an employee who 
fails to pay his or her share of the premium payments while on FMLA 
leave, FMLA permits the employer to recoup the premiums (to the extent 
of the employee's share). See 29 CFR 825.212(b). Such recoupment may be 
made as set forth in paragraphs (a)(3)(i) and (ii) of this Q&A-3. See 
also Q&A-6 of this section regarding coverage under a health FSA when an 
employee fails to make the required premium payments while on FMLA 
leave.
    (3) Catch-up. (i) Under the catch-up option, the employer and the 
employee may agree in advance that the group coverage will continue 
during the period of unpaid FMLA leave, and that the employee will not 
pay premiums until the employee returns from the FMLA leave. Where an 
employee is electing to use the catch-up option, the

[[Page 526]]

employer and the employee must agree in advance of the coverage period 
that: the employee elects to continue health coverage while on unpaid 
FMLA leave; the employer assumes responsibility for advancing payment of 
the premiums on the employee's behalf during the FMLA leave; and these 
advance amounts are to be paid by the employee when the employee returns 
from FMLA leave.
    (ii) When an employee fails to make required premium payments while 
on FMLA leave, an employer is permitted to utilize the catch-up option 
to recoup the employee's share of premium payments when the employee 
returns from FMLA leave. See, e.g., 29 CFR 825.212(b). If the employer 
chooses to continue group coverage under these circumstances, the prior 
agreement of the employee, as set forth in paragraph (a)(3)(i) of this 
Q&A-3, is not required.
    (iii) Contributions under the catch-up option may be made on a pre-
tax salary reduction basis from any available taxable compensation 
(including from unused sick days and vacation days) after the employee 
returns from FMLA leave. The cafeteria plan may provide for the catch-up 
option to apply on a pre-tax salary reduction basis if premiums have not 
been paid on any other basis (i.e., have not been paid under the pre-pay 
or pay-as-you-go options or on a catch-up after-tax basis).
    (iv) Contributions under the catch-up option may also be made on an 
after-tax basis.
    (b) Exceptions. Whatever payment options are offered to employees on 
non-FMLA leave must be offered to employees on FMLA leave. In accordance 
with 29 CFR 825.210(c), cafeteria plans may offer one or more of the 
payment options described in paragraph (a) of this Q&A-3, with the 
following exceptions:
    (1) FMLA does not permit the pre-pay option to be the sole option 
offered to employees on FMLA leave. However, the cafeteria plan may 
include pre-payment as an option for employees on FMLA leave, even if 
such option is not offered to employees on non-FMLA leave-without-pay.
    (2) FMLA allows the catch-up option to be the sole option offered to 
employees on FMLA leave if and only if the catch-up option is the sole 
option offered to employees on non-FMLA leave-without-pay.
    (3) If the pay-as-you-go option is offered to employees on non-FMLA 
leave-without-pay, the option must also be offered to employees on FMLA 
leave. The employer may also offer employees on FMLA leave the pre-pay 
option and/or the catch-up option.
    (c) Voluntary waiver of employee payments. In addition to the 
foregoing payment options, an employer may voluntarily waive, on a 
nondiscriminatory basis, the requirement that employees who elect to 
continue group health coverage while on FMLA leave pay the amounts the 
employees would otherwise be required to pay for the leave period.
    (d) Example. The following example illustrates this Q&A-3:

    Example. (i) Employer Y allows employees to pay premiums for group 
health coverage during an FMLA leave on an after-tax basis while the 
employee is on unpaid FMLA leave. Under the terms of Y's cafeteria plan, 
if an employee elects to continue health coverage during an unpaid FMLA 
leave and fails to pay one or more of the after-tax premium payments due 
for that coverage, the employee's salary after the employee returns from 
FMLA leave is reduced to cover unpaid premiums (i.e. the premiums that 
were to be paid by the employee on an after-tax basis during the FMLA 
leave, but were paid by the employer instead).
    (ii) In this Example, Y's cafeteria plan satisfies the conditions in 
this Q&A-3. Y's cafeteria plan would also satisfy the conditions in this 
Q&A-3 if the plan provided for coverage to cease in the event the 
employee fails to make a premium payment when due during an unpaid FMLA 
leave.

    Q-4: Do the special FMLA requirements concerning payment of premiums 
by an employee who continues group health plan coverage under a 
cafeteria plan apply if the employee is on paid FMLA leave?
    A-4: No. The Labor Regulations provide that, if an employee's FMLA 
leave is paid leave as described at 29 CFR 825.207 and the employer 
mandates that the employee continue group health plan coverage while on 
FMLA leave, the employee's share of the premiums must be paid by the 
method normally used during any paid leave (e.g., by pre-tax salary 
reduction if the employee's share of premiums were paid by pre-tax

[[Page 527]]

salary reduction before the FMLA leave began). See 29 CFR 825.210(b).
    Q-5: What restrictions apply to contributions when an employee's 
FMLA leave spans two cafeteria plan years?
    A-5: (a) No amount will be included in an employee's gross income 
due to participation in a cafeteria plan during FMLA leave, provided 
that the plan complies with other generally applicable cafeteria plan 
requirements. Among other requirements, a plan may not operate in a 
manner that enables employees on FMLA leave to defer compensation from 
one cafeteria plan year to a subsequent cafeteria plan year. See section 
125(d)(2).
    (b) The following example illustrates this Q&A-5:

    Example. (i) Employee A elects group health coverage under a 
calendar year cafeteria plan maintained by Employer X. Employee A's 
premium for health coverage is $100 per month throughout the 12-month 
period of coverage. Employee A takes FMLA leave for 12 weeks beginning 
on October 31 after making 10 months of premium payments totaling $1,000 
(10 months x $100 = $1,000). Employee A elects to continue health 
coverage while on FMLA leave and utilizes the pre-pay option by applying 
his or her unused sick days in order to make the required premium 
payments due while he or she is on FMLA leave.
    (ii) Because A cannot defer compensation from one plan year to a 
subsequent plan year, A may pre-pay the premiums due in November and 
December (i.e., $100 per month) on a pre-tax basis, but A cannot pre-pay 
the premium payment due in January on a pre-tax basis. If A participates 
in the cafeteria plan in the subsequent plan year, A must either pre-pay 
for January on an after-tax basis or use another option (e.g., pay-as-
you-go, catch-up, reduction in unused sick days, etc.) to make the 
premium payment due in January.

    Q-6: Are there special rules concerning employees taking FMLA leave 
who participate in health FSAs offered under a cafeteria plan?
    A-6: (a) In general. (1) A group health plan that is a flexible 
spending arrangement (FSA) offered under a cafeteria plan must conform 
to the generally applicable rules in this section concerning employees 
who take FMLA leave. Thus, to the extent required by FMLA (see 29 CFR 
825.209(b)), an employer must--
    (i) Permit an employee taking FMLA leave to continue coverage under 
a health FSA while on FMLA leave; and
    (ii) If an employee is on unpaid FMLA leave, either--
    (A) Allow the employee to revoke coverage; or
    (B) Continue coverage, but allow the employee to discontinue payment 
of his or her share of the premium for the health FSA under the 
cafeteria plan during the unpaid FMLA leave period.
    (2) Under FMLA, the plan must permit the employee to be reinstated 
in health coverage upon return from FMLA leave on the same terms as if 
the employee had been working throughout the leave period, without a 
break in coverage. See 29 CFR 825.214(a) and 825.215(d)(1) and paragraph 
(b)(2) of this Q&A-6. In addition, under FMLA, a plan may require an 
employee to be reinstated in health coverage upon return from a period 
of unpaid FMLA leave, provided that employees who return from a period 
of unpaid leave not covered by the FMLA are also required to resume 
participation upon return from leave.
    (b) Coverage. (1) Regardless of the payment option selected under 
Q&A-3 of this section, for so long as the employee continues health FSA 
coverage (or for so long as the employer continues the health FSA 
coverage of an employee who fails to make the required contributions as 
described in Q&A-3(a)(2)(iii) of this section), the full amount of the 
elected health FSA coverage, less any prior reimbursements, must be 
available to the employee at all times, including the FMLA leave period.
    (2)(i) If an employee's coverage under the health FSA terminates 
while the employee is on FMLA leave, the employee is not entitled to 
receive reimbursements for claims incurred during the period when the 
coverage is terminated. If an employee subsequently elects or the 
employer requires the employee to be reinstated in the health FSA upon 
return from FMLA leave for the remainder of the plan year, the employee 
may not retroactively elect health FSA coverage for claims incurred 
during the period when the coverage was terminated. Upon reinstatement 
into a health FSA upon return

[[Page 528]]

from FMLA leave (either because the employee elects reinstatement or 
because the employer requires reinstatement), the employee has the right 
under FMLA: to resume coverage at the level in effect before the FMLA 
leave and make up the unpaid premium payments, or to resume coverage at 
a level that is reduced and resume premium payments at the level in 
effect before the FMLA leave. If an employee chooses to resume health 
FSA coverage at a level that is reduced, the coverage is prorated for 
the period during the FMLA leave for which no premiums were paid. In 
both cases, the coverage level is reduced by prior reimbursements.
    (ii) FMLA requires that an employee on FMLA leave have the right to 
revoke or change elections (because of events described in Sec. 1.125-
4) under the same terms and conditions that apply to employees 
participating in the cafeteria plan who are not on FMLA leave. Thus, for 
example, if a group health plan offers an annual open enrollment period 
to active employees, then, under FMLA, an employee on FMLA leave when 
the open enrollment is offered must be offered the right to make 
election changes on the same basis as other employees. Similarly, if a 
group health plan decides to offer a new benefit package option and 
allows active employees to elect the new option, then, under FMLA, an 
employee on FMLA leave must be allowed to elect the new option on the 
same basis as other employees.
    (3) The following examples illustrate the rules in this Q&A-6:

    Example 1. (i) Employee B elects $1,200 worth of coverage under a 
calendar year health FSA provided under a cafeteria plan, with an annual 
premium of $1,200. Employee B is permitted to pay the $1,200 through 
pre-tax salary reduction amounts of $100 per month throughout the 12-
month period of coverage. Employee B incurs no medical expenses prior to 
April 1. On April 1, B takes FMLA leave after making three months of 
contributions totaling $300 (3 months x $100 = $300). Employee B's 
coverage ceases during the FMLA leave. Consequently, B makes no premium 
payments for the months of April, May, and June, and B is not entitled 
to submit claims or receive reimbursements for expenses incurred during 
this period. Employee B returns from FMLA leave and elects to be 
reinstated in the health FSA on July 1.
    (ii) Employee B must be given a choice of resuming coverage at the 
level in effect before the FMLA leave (i.e., $1,200) and making up the 
unpaid premium payments ($300), or resuming health FSA coverage at a 
level that is reduced on a prorata basis for the period during the FMLA 
leave for which no premiums were paid (i.e., reduced for 3 months or 1/4 
of the plan year) less prior reimbursements (i.e., $0) with premium 
payments due in the same monthly amount payable before the leave (i.e., 
$100 per month). Consequently, if B chooses to resume coverage at the 
level in effect before the FMLA leave, B's coverage for the remainder of 
the plan year would equal $1,200 and B's monthly premiums would be 
increased to $150 per month for the remainder of the plan year, to make 
up the $300 in premiums missed ($100 per month plus $50 per month ($300 
divided by the remaining 6 months)). If B chooses prorated coverage, B's 
coverage for the remainder of the plan year would equal $900, and B 
would resume making premium payments of $100 per month for the remainder 
of the plan year.
    Example 2. (i) Assume the same facts as Example 1 except that B 
incurred medical expenses totaling $200 in February and obtained 
reimbursement of these expenses.
    (ii) The results are the same as in Example 1, except that if B 
chooses to resume coverage at the level in effect before the FMLA leave, 
B's coverage for the remainder of the year would equal $1,000 ($1,200 
reduced by $200) and the monthly payments for the remainder of the year 
would still equal $150. If instead B chooses prorated coverage, B's 
coverage for the remainder of the plan year would equal $700 ($1,200 
prorated for 3 months, and then reduced by $200) and the monthly 
payments for the remainder of the year would still equal $100.
    Example 3. (i) Assume the same facts as Example 1 except that, prior 
to taking FMLA leave, B elects to continue health FSA coverage during 
the FMLA leave. The plan permits B (and B elects) to use the catch-up 
payment option described in Q&A-3 of this section, and as further 
permitted under the plan, B chooses to repay the $300 in missed payments 
on a ratable basis over the remaining 6-month period of coverage (i.e., 
$50 per month).
    (ii) Thus, B's monthly premium payments for the remainder of the 
plan year will be $150 ($100 + $50).

    Q-7: Are employees entitled to non-health benefits while taking FMLA 
leave?
    A-7: FMLA does not require an employer to maintain an employee's 
non-health benefits (e.g., life insurance) during FMLA leave. An 
employee's entitlement to benefits other than group

[[Page 529]]

health benefits under a cafeteria plan during a period of FMLA leave is 
to be determined by the employer's established policy for providing such 
benefits when the employee is on non-FMLA leave (paid or unpaid). See 29 
CFR 825.209(h). Therefore, an employee who takes FMLA leave is entitled 
to revoke an election of non-health benefits under a cafeteria plan to 
the same extent as employees taking non-FMLA leave are permitted to 
revoke elections of non-health benefits under a cafeteria plan. For 
example, election changes are permitted due to changes of status or upon 
enrollment for a new plan year. See Sec. 1.125-4. However, FMLA 
provides that, in certain cases, an employer may continue an employee's 
non-health benefits under the employer's cafeteria plan while the 
employee is on FMLA leave in order to ensure that the employer can meet 
its responsibility to provide equivalent benefits to the employee upon 
return from unpaid FMLA. If the employer continues an employee's non-
health benefits during FMLA leave, the employer is entitled to recoup 
the costs incurred for paying the employee's share of the premiums 
during the FMLA leave period. See 29 CFR 825.213(b). Such recoupment may 
be on a pre-tax basis. A cafeteria plan must, as required by FMLA, 
permit an employee whose coverage terminated while on FMLA leave (either 
by revocation or nonpayment of premiums) to be reinstated in the 
cafeteria plan on return from FMLA leave. See 29 CFR 825.214(a) and 
825.215(d).
    Q-8: What is the applicability date of the regulations in this 
section?
    A-8: This section is applicable for cafeteria plan years beginning 
on or after January 1, 2002.

[T.D. 8966, 66 FR 52677, Oct. 17, 2001; 66 FR 63920, Dec. 11, 2001]



Sec. 1.125-4  Permitted election changes.

    (a) Election changes. A cafeteria plan may permit an employee to 
revoke an election during a period of coverage and to make a new 
election only as provided in paragraphs (b) through (g) of this section. 
Section 125 does not require a cafeteria plan to permit any of these 
changes. See paragraph (h) of this section for special provisions 
relating to qualified cash or deferred arrangements, and paragraph (i) 
of this section for special definitions used in this section.
    (b) Special enrollment rights--(1) In general. A cafeteria plan may 
permit an employee to revoke an election for coverage under a group 
health plan during a period of coverage and make a new election that 
corresponds with the special enrollment rights provided in section 
9801(f).
    (2) Examples. The following examples illustrate the application of 
this paragraph (b):

    Example 1. (i) Employer M provides health coverage for its employees 
pursuant to a plan that is subject to section 9801(f). Under the plan, 
employees may elect either employee-only coverage or family coverage. M 
also maintains a calendar year cafeteria plan under which qualified 
benefits, including health coverage, are funded through salary 
reduction. M's employee, A, is married to B and they have a child, C. In 
accordance with M's cafeteria plan, Employee A elects employee-only 
health coverage before the beginning of the calendar year. During the 
year, A and B adopt a child, D. Within 30 days thereafter, A wants to 
revoke A's election for employee-only health coverage and obtain family 
health coverage for A's spouse, C, and D as of the date of D's adoption. 
Employee A satisfies the conditions for special enrollment of an 
employee with a new dependent under section 9801(f)(2), so that A may 
enroll in family coverage under M's accident or health plan in order to 
provide coverage effective as of the date of D's adoption.
    (ii) M's cafeteria plan may permit A to change A's salary reduction 
election to family coverage for salary not yet currently available. The 
increased salary reduction is permitted to reflect the cost of family 
coverage from the date of adoption. (A's adoption of D is also a change 
in status, and the election of family coverage is consistent with that 
change in status. Thus, under paragraph (c) of this section, M's 
cafeteria plan could permit A to elect family coverage prospectively in 
order to cover B, C, and D for the remaining portion of the period of 
coverage.)
    Example 2. (i) The employer plans and permissible coverage are the 
same as in Example 1. Before the beginning of the calendar year, 
Employee E elects employee-only health coverage under M's cafeteria 
plan. Employee E marries F during the plan year. F's employer, N, offers 
health coverage to N's employees, and, prior to the marriage, F had 
elected employee-only coverage. Employee E wants to revoke the election 
for employee-only coverage under M's cafeteria plan, and

[[Page 530]]

is considering electing family health coverage under M's plan or 
obtaining family health coverage under N's plan.
    (ii) M's cafeteria plan may permit E to change E's salary reduction 
election to reflect the change to family coverage under M's accident or 
health plan because the marriage would result in special enrollment 
rights under section 9801(f), pursuant to which an election of family 
coverage under M's accident or health plan would be required to be 
effective no later than the first day of the first calendar month 
beginning after the completed request for enrollment is received by the 
plan. Since no retroactive coverage is required in the event of marriage 
under section 9801(f), E's salary reduction election may only be changed 
on a prospective basis. (E's marriage to F is also a change in status 
under paragraph (c) of this section, as illustrated in Example 1 of 
paragraph (c)(4) of this section.)

    (c) Changes in status--(1) Change in status rule. A cafeteria plan 
may permit an employee to revoke an election during a period of coverage 
with respect to a qualified benefits plan (defined in paragraph (i)(8) 
of this section) to which this paragraph (c) applies and make a new 
election for the remaining portion of the period (referred to in this 
section as an election change) if, under the facts and circumstances--
    (i) A change in status described in paragraph (c)(2) of this section 
occurs; and
    (ii) The election change satisfies the consistency rule of paragraph 
(c)(3) of this section.
    (2) Change in status events. The following events are changes in 
status for purposes of this paragraph (c):
    (i) Legal marital status. Events that change an employee's legal 
marital status, including the following: marriage; death of spouse; 
divorce; legal separation; and annulment.
    (ii) Number of dependents. Events that change an employee's number 
of dependents, including the following: birth; death; adoption; and 
placement for adoption.
    (iii) Employment status. Any of the following events that change the 
employment status of the employee, the employee's spouse, or the 
employee's dependent: a termination or commencement of employment; a 
strike or lockout; a commencement of or return from an unpaid leave of 
absence; and a change in worksite. In addition, if the eligibility 
conditions of the cafeteria plan or other employee benefit plan of the 
employer of the employee, spouse, or dependent depend on the employment 
status of that individual and there is a change in that individual's 
employment status with the consequence that the individual becomes (or 
ceases to be) eligible under the plan, then that change constitutes a 
change in employment under this paragraph (c) (e.g., if a plan only 
applies to salaried employees and an employee switches from salaried to 
hourly-paid with the consequence that the employee ceases to be eligible 
for the plan, then that change constitutes a change in employment status 
under this paragraph (c)(2)(iii)).
    (iv) Dependent satisfies or ceases to satisfy eligibility 
requirements. Events that cause an employee's dependent to satisfy or 
cease to satisfy eligibility requirements for coverage on account of 
attainment of age, student status, or any similar circumstance.
    (v) Residence. A change in the place of residence of the employee, 
spouse, or dependent.
    (vi) Adoption assistance. For purposes of adoption assistance 
provided through a cafeteria plan, the commencement or termination of an 
adoption proceeding.
    (3) Consistency rule--(i) Application to accident or health coverage 
and group-term life insurance. An election change satisfies the 
requirements of this paragraph (c)(3) with respect to accident or health 
coverage or group-term life insurance only if the election change is on 
account of and corresponds with a change in status that affects 
eligibility for coverage under an employer's plan. A change in status 
that affects eligibility under an employer's plan includes a change in 
status that results in an increase or decrease in the number of an 
employee's family members or dependents who may benefit from coverage 
under the plan.
    (ii) Application to other qualified benefits. An election change 
satisfies the requirements of this paragraph (c)(3) with respect to 
other qualified benefits if the election change is on account of and 
corresponds with a change in status that affects eligibility for 
coverage under an employer's plan. An election

[[Page 531]]

change also satisfies the requirements of this paragraph (c)(3) if the 
election change is on account of and corresponds with a change in status 
that effects expenses described in section 129 (including employment-
related expenses as defined in section 21(b)(2)) with respect to 
dependent care assistance, or expenses described in section 137 
(including qualified adoption expenses as defined in section 137(d)) 
with respect to adoption assistance.
    (iii) Application of consistency rule. If the change in status is 
the employee's divorce, annulment or legal separation from a spouse, the 
death of a spouse or dependent, or a dependent ceasing to satisfy the 
eligibility requirements for coverage, an employee's election under the 
cafeteria plan to cancel accident or health insurance coverage for any 
individual other than the spouse involved in the divorce, annulment or 
legal separation, the deceased spouse or dependent, or the dependent 
that ceased to satisfy the eligibility requirements for coverage, 
respectively, fails to correspond with that change in status. Thus, if a 
dependent dies or ceases to satisfy the eligibility requirements for 
coverage, the employee's election to cancel accident or health coverage 
for any other dependent, for the employee, or for the employee's spouse 
fails to correspond with that change in status. In addition, if an 
employee, spouse, or dependent gains eligibility for coverage under a 
family member plan (as defined in paragraph (i)(5) of this section) as a 
result of a change in marital status under paragraph (c)(2)(i) of this 
section or a change in employment status under paragraph (c)(2)(iii) of 
this section, an employee's election under the cafeteria plan to cease 
or decrease coverage for that individual under the cafeteria plan 
corresponds with that change in status only if coverage for that 
individual becomes applicable or is increased under the family member 
plan. With respect to group-term life insurance and disability coverage 
(as defined in paragraph (i)(4) of this section), an election under a 
cafeteria plan to increase coverage (or an election to decrease 
coverage) in response to a change in status described in paragraph 
(c)(2) of this section is deemed to correspond with that change in 
status as required by paragraph (c)(3)(i) of this section.
    (iv) Exception for COBRA. If the employee, spouse, or dependent 
becomes eligible for continuation coverage under the group health plan 
of the employee's employer as provided in section 4980B or any similar 
state law, a cafeteria plan may permit the employee to elect to increase 
payments under the employer's cafeteria plan in order to pay for the 
continuation coverage.
    (4) Examples. The following examples illustrate the application of 
this paragraph (c):

    Example 1. (i) Employer M provides health coverage (including a 
health FSA) for its employees through its cafeteria plan. Before the 
beginning of the calendar year, Employee A elects employee-only health 
coverage under M's cafeteria plan and elects salary reduction 
contributions to fund coverage under the health FSA. Employee A marries 
B during the year. Employee B's employer, N, offers health coverage to 
N's employees (but not including any health FSA), and, prior to the 
marriage, B had elected employee-only coverage. Employee A wants to 
revoke the election for employee-only coverage, and is considering 
electing family health coverage under M's plan or obtaining family 
health coverage under N's plan.
    (ii) Employee A's marriage to B is a change in status under 
paragraph (c)(2)(i) of this section, pursuant to which B has become 
eligible for coverage under M's health plan under paragraph (c)(3)(i) of 
this section. Two possible election changes by A correspond with the 
change in status: Employee A may elect family health coverage under M's 
plan to cover A and B; or A may cancel coverage under M's plan, if B 
elects family health coverage under N's plan to cover A and B. Thus, M's 
cafeteria plan may permit A to make either election change.
    (iii) Employee A may also increase salary reduction contributions to 
fund coverage for B under the health FSA.
    Example 2. (i) Employee C, a single parent, elects family health 
coverage under a calendar year cafeteria plan maintained by Employer O. 
Employee C and C's 21-year old child, D, are covered under O's health 
plan. During the year, D graduates from college. Under the terms of the 
health plan, dependents over the age of 19 must be full-time students to 
receive coverage. Employee C wants to revoke C's election for family 
health coverage and obtain employee-only coverage under O's cafeteria 
plan.
    (ii) D's loss of eligibility for coverage under the terms of the 
health plan is a change in status under paragraph (c)(2)(iv) of

[[Page 532]]

this section. A revocation of C's election for family coverage and new 
election for employee-only coverage corresponds with the change in 
status. Thus, O's cafeteria plan may permit C to elect employee-only 
coverage.
    Example 3. (i) Employee E is married to F and they have one child, 
G. Employee E is employed by Employer P, and P maintains a calendar year 
cafeteria plan that allows employees to elect no health coverage, 
employee-only coverage, employee-plus-one-dependent coverage, or family 
coverage. Under the plan, before the beginning of the calendar year, E 
elects family health coverage for E, F, and G. E and F divorce during 
the year and F loses eligibility for coverage under P's plan. G does not 
lose eligibility for health coverage under P's plan upon the divorce. E 
now wants to revoke E's election under the cafeteria plan and elect no 
coverage.
    (ii) The divorce is a change in status under paragraph (c)(2)(i). A 
change in the cafeteria plan election to cancel health coverage for F is 
consistent with that change in status. However, an election change to 
cancel E's or G's health coverage does not satisfy the consistency rule 
under paragraph (c)(3)(iii) of this section regarding cancellation of 
coverage for an employee's other dependents in the event of divorce. 
Therefore, the cafeteria plan may not permit E to elect no coverage. 
However, an election to change to employee-plus-one-dependent health 
coverage would correspond with the change in status, and thus the 
cafeteria plan may permit E to elect employee-plus-one-dependent health 
coverage.
    (iii) In addition, under paragraph (f)(4) of this section, if F 
makes an election change to cover G under F's employer's plan, then E 
may make a corresponding change to elect employee-only coverage under 
P's cafeteria plan.
    Example 4. (i) Employer R maintains a calendar year cafeteria plan 
under which full-time employees may elect coverage under one of three 
benefit package options provided under an accident or health plan: an 
indemnity option or either of two HMO options for employees who work in 
the respective service areas of the two HMOs. Employee A, who works in 
the service area of HMO 1, elects the HMO 1 option. 
During the year, A is transferred to another work location which is 
outside the HMO 1 service area and inside the HMO 2 
service area.
    (ii) The transfer is a change in status under paragraph (c)(2)(iii) 
of this section (relating to a change in worksite), and, under the 
consistency rule in paragraph (c)(3) of this section, the cafeteria plan 
may permit A to make an election change to elect the indemnity option or 
HMO 2 or to cancel accident or health coverage.
    (iii) The change in work location has no effect on A's eligibility 
under R's health FSA, so no change in A's health FSA is authorized under 
this paragraph (c).
    Example 5. (i) Employer S maintains a calendar year cafeteria plan 
that allows employees to elect coverage under an accident or health plan 
providing indemnity coverage and coverage under a health FSA. Prior to 
the beginning of the calendar year, Employee B elects employee-only 
indemnity coverage, and elects salary reduction contributions of $600 
during the year to fund coverage under the health FSA for up to $600 of 
reimbursements for the year. Employee B's spouse, C, has employee-only 
coverage under an accident or health plan maintained by C's employer. 
During the year, C terminates employment and loses coverage under that 
plan. B now wants to elect family coverage under S's accident or health 
plan and increase B's FSA election.
    (ii) C's termination of employment is a change in status under 
paragraph (c)(2)(iii) of this section, and the election change satisfies 
the consistency rule of paragraph (c)(3) of this section. Therefore, the 
cafeteria plan may permit B to elect family coverage under S's accident 
or health plan and to increase B's FSA coverage.
    Example 6. (i) Employer T provides group-term life insurance 
coverage as described under section 79. Under T's plan, an employee may 
elect life insurance coverage in an amount up to $50,000. T also 
maintains a calendar year cafeteria plan under which qualified benefits, 
including the group-term life insurance coverage, are funded through 
salary reduction. Employee D has a spouse and a child. Before the 
beginning of the year, D elects $10,000 of group-term life insurance 
coverage. During the year, D is divorced.
    (ii) The divorce is a change in status under paragraph (c)(2)(i) of 
this section. Under paragraph (c)(3)(iii) of this section, either an 
increase or a decrease in coverage is consistent with this change in 
status. Thus, T's cafeteria plan may permit D to increase or to decrease 
D's group-term life insurance coverage.
    Example 7. (i) Employee E is married to F and they have one child, 
G. Employee E's employer, U, maintains a cafeteria plan under which 
employees may elect no coverage, employee-only coverage, or family 
coverage under a group health plan maintained by U, and may make a 
separate vision coverage election under the plan. Before the beginning 
of the calendar year, E elects family health coverage and no vision 
coverage under U's cafeteria plan. Employee F's employer, V, maintains a 
cafeteria plan under which employees may elect no coverage, employee-
only coverage, or family coverage under a group health plan maintained 
by V, and may make a separate vision coverage election under the plan. 
Before the beginning

[[Page 533]]

of the calendar year, F elects no health coverage and employee-only 
vision coverage under V's plan. During the year, F terminates employment 
with V and loses vision coverage under V's plan. Employee E now wants to 
elect family vision coverage under U's group health plan.
    (ii) F's termination of employment is a change in status under 
paragraph (c)(2)(iii) of this section, and the election change satisfies 
the consistency rule of paragraph (c)(3) of this section. Therefore, U's 
cafeteria plan may permit E to elect family vision coverage (covering E 
and G as well as F) under U's group health plan.
    Example 8. (i) Before the beginning of the year, Employee H elects 
to participate in a cafeteria plan maintained by H's employer, W. 
However, in order to change the election during the year so as to cancel 
coverage, and by prior understanding with W, H terminates employment and 
resumes employment one week later.
    (ii) In this Example 8, under the facts and circumstances, a 
principal purpose of the termination of employment was to alter the 
election, and reinstatement of employment was understood at the time of 
termination. Accordingly, H does not have a change in status under 
paragraph (c)(2)(iii) of this section.
    (iii) However, H's termination of employment would constitute a 
change in status, permitting a cancellation of coverage during the 
period of unemployment, if H's original cafeteria plan election for the 
period of coverage was reinstated upon resumption of employment (for 
example, if W's cafeteria plan contains a provision requiring an 
employee who resumes employment within 30 days, without any other 
intervening event that would permit a change in election, to return to 
the election in effect prior to termination of employment).
    (iv) If, instead, H terminates employment and cancels coverage 
during a period of unemployment, and then returns to work more than 30 
days following termination of employment, the cafeteria plan may permit 
H the option of returning to the election in effect prior to termination 
of employment or making a new election under the plan. Alternatively, 
the cafeteria plan may prohibit H from returning to the plan during that 
plan year.
    Example 9. (i) Employee A has one child, B. Employee A's employer, 
X, maintains a calendar year cafeteria plan that allows employees to 
elect coverage under a dependent care FSA. Prior to the beginning of the 
calendar year, A elects salary reduction contributions of $4,000 during 
the year to fund coverage under the dependent care FSA for up to $4,000 
of reimbursements for the year. During the year, B reaches the age of 
13, and A wants to cancel coverage under the dependent care FSA.
    (ii) When B turns 13, B ceases to satisfy the definition of 
qualifying individual under section 21(b)(1) of the Internal Revenue 
Code. Accordingly, B's attainment of age 13 is a change in status under 
paragraph (c)(2)(iv) of this section that affects A's employment-related 
expenses as defined in section 21(b)(2). Therefore, A may make a 
corresponding change under X's cafeteria plan to cancel coverage under 
the dependent care FSA.
    Example 10. (i) Employer Y maintains a calendar year cafeteria plan 
under which full-time employees may elect coverage under either an 
indemnity option or an HMO. Employee C elects the employee-only 
indemnity option. During the year, C marries D. D has two children from 
a previous marriage, and has family group health coverage in a cafeteria 
plan sponsored by D's employer, Z. C wishes to change from employee-only 
indemnity coverage to HMO coverage for the family. D wishes to cease 
coverage in Z's group health plan and certifies to Z that D will have 
family coverage under C's plan (and Z has no reason to believe the 
certification is incorrect).
    (ii) The marriage is a change in status under paragraph (c)(2)(i) of 
this section. Under the consistency rule in paragraph (c)(3) of this 
section, Y's cafeteria plan may permit C to change his or her salary 
reduction contributions to reflect the change from employee-only 
indemnity to HMO family coverage, and Z may permit D to revoke coverage 
under Z's cafeteria plan.

    (d) Judgment, decree, or order--(1) Conforming election change. This 
paragraph (d) applies to a judgment, decree, or order (order) resulting 
from a divorce, legal separation, annulment, or change in legal custody 
(including a qualified medical child support order as defined in section 
609 of the Employee Retirement Income Security Act of 1974 (Public Law 
93-406 (88 Stat. 829))) that requires accident or health coverage for an 
employee's child or for a foster child who is a dependent of the 
employee. A cafeteria plan will not fail to satisfy section 125 if it--
    (i) Changes the employee's election to provide coverage for the 
child if the order requires coverage for the child under the employee's 
plan; or
    (ii) Permits the employee to make an election change to cancel 
coverage for the child if:
    (A) The order requires the spouse, former spouse, or other 
individual to provide coverage for the child; and
    (B) That coverage is, in fact, provided.

[[Page 534]]

    (2) Example. The following example illustrates the application of 
this paragraph (d):

    Example. (i) Employer M maintains a calendar year cafeteria plan 
that allows employees to elect no health coverage, employee-only 
coverage, employee-plus-one-dependent coverage, or family coverage. M's 
employee, A, is married to B and they have one child, C. Before the 
beginning of the year, A elects employee-only health coverage. Employee 
A divorces B during the year and, pursuant to A's divorce agreement with 
B, M's health plan receives a qualified medical child support order (as 
defined in section 609 of the Employee Retirement Income Security Act of 
1974) during the plan year. The order requires M's health plan to cover 
C.
    (ii) Under this paragraph (d), M's cafeteria plan may change A's 
election from employee-only health coverage to employee-plus-one-
dependent coverage in order to cover C.

    (e) Entitlement to Medicare or Medicaid. If an employee, spouse, or 
dependent who is enrolled in an accident or health plan of the employer 
becomes entitled to coverage (i.e., becomes enrolled) under Part A or 
Part B of Title XVIII of the Social Security Act (Medicare) (Public Law 
89-97 (79 Stat. 291)) or Title XIX of the Social Security Act (Medicaid) 
(Public Law 89-97 (79 Stat. 343)), other than coverage consisting solely 
of benefits under section 1928 of the Social Security Act (the program 
for distribution of pediatric vaccines), a cafeteria plan may permit the 
employee to make a prospective election change to cancel or reduce 
coverage of that employee, spouse, or dependent under the accident or 
health plan. In addition, if an employee, spouse, or dependent who has 
been entitled to such coverage under Medicare or Medicaid loses 
eligibility for such coverage, the cafeteria plan may permit the 
employee to make a prospective election to commence or increase coverage 
of that employee, spouse, or dependent under the accident or health 
plan.
    (f) Significant cost or coverage changes--(1) In general. Paragraphs 
(f)(2) through (5) of this section set forth rules for election changes 
as a result of changes in cost or coverage. This paragraph (f) does not 
apply to an election change with respect to a health FSA (or on account 
of a change in cost or coverage under a health FSA).
    (2) Cost changes--(i) Automatic changes. If the cost of a qualified 
benefits plan increases (or decreases) during a period of coverage and, 
under the terms of the plan, employees are required to make a 
corresponding change in their payments, the cafeteria plan may, on a 
reasonable and consistent basis, automatically make a prospective 
increase (or decrease) in affected employees' elective contributions for 
the plan.
    (ii) Significant cost changes. If the cost charged to an employee 
for a benefit package option (as defined in paragraph (i)(2) of this 
section) significantly increases or significantly decreases during a 
period of coverage, the cafeteria plan may permit the employee to make a 
corresponding change in election under the cafeteria plan. Changes that 
may be made include commencing participation in the cafeteria plan for 
the option with a decrease in cost, or, in the case of an increase in 
cost, revoking an election for that coverage and, in lieu thereof, 
either receiving on a prospective basis coverage under another benefit 
package option providing similar coverage or dropping coverage if no 
other benefit package option providing similar coverage is available. 
For example, if the cost of an indemnity option under an accident or 
health plan significantly increases during a period of coverage, 
employees who are covered by the indemnity option may make a 
corresponding prospective increase in their payments or may instead 
elect to revoke their election for the indemnity option and, in lieu 
thereof, elect coverage under another benefit package option including 
an HMO option (or drop coverage under the accident or health plan if no 
other benefit package option is offered).
    (iii) Application of cost changes. For purposes of paragraphs 
(f)(2)(i) and (ii) of this section, a cost increase or decrease refers 
to an increase or decrease in the amount of the elective contributions 
under the cafeteria plan, whether that increase or decrease results from 
an action taken by the employee (such as switching between full-time and 
part-time status) or from an action

[[Page 535]]

taken by an employer (such as reducing the amount of employer 
contributions for a class of employees).
    (iv) Application to dependent care. This paragraph (f)(2) applies in 
the case of a dependent care assistance plan only if the cost change is 
imposed by a dependent care provider who is not a relative of the 
employee. For this purpose, a relative is an individual who is related 
as described in section 152(a)(1) through (8), incorporating the rules 
of section 152(b)(1) and (2).
    (3) Coverage changes--(i) Significant curtailment without loss of 
coverage. If an employee (or an employee's spouse or dependent) has a 
significant curtailment of coverage under a plan during a period of 
coverage that is not a loss of coverage as described in paragraph 
(f)(3)(ii) of this section (for example, there is a significant increase 
in the deductible, the copay, or the out-of-pocket cost sharing limit 
under an accident or health plan), the cafeteria plan may permit any 
employee who had been participating in the plan and receiving that 
coverage to revoke his or her election for that coverage and, in lieu 
thereof, to elect to receive on a prospective basis coverage under 
another benefit package option providing similar coverage. Coverage 
under a plan is significantly curtailed only if there is an overall 
reduction in coverage provided under the plan so as to constitute 
reduced coverage generally. Thus, in most cases, the loss of one 
particular physician in a network does not constitute a significant 
curtailment.
    (ii) Significant curtailment with loss of coverage. If an employee 
(or the employee's spouse or dependent) has a significant curtailment 
that is a loss of coverage, the plan may permit that employee to revoke 
his or her election under the cafeteria plan and, in lieu thereof, to 
elect either to receive on a prospective basis coverage under another 
benefit package option providing similar coverage or to drop coverage if 
no similar benefit package option is available. For purposes of this 
paragraph (f)(3)(ii), a loss of coverage means a complete loss of 
coverage under the benefit package option or other coverage option 
(including the elimination of a benefits package option, an HMO ceasing 
to be available in the area where the individual resides, or the 
individual losing all coverage under the option by reason of an overall 
lifetime or annual limitation). In addition, the cafeteria plan may, in 
its discretion, treat the following as a loss of coverage--
    (A) A substantial decrease in the medical care providers available 
under the option (such as a major hospital ceasing to be a member of a 
preferred provider network or a substantial decrease in the physicians 
participating in a preferred provider network or an HMO);
    (B) A reduction in the benefits for a specific type of medical 
condition or treatment with respect to which the employee or the 
employee's spouse or dependent is currently in a course of treatment; or
    (C) Any other similar fundamental loss of coverage.
    (iii) Addition or improvement of a benefit package option. If a plan 
adds a new benefit package option or other coverage option, or if 
coverage under an existing benefit package option or other coverage 
option is significantly improved during a period of coverage, the 
cafeteria plan may permit eligible employees (whether or not they have 
previously made an election under the cafeteria plan or have previously 
elected the benefit package option) to revoke their election under the 
cafeteria plan and, in lieu thereof, to make an election on a 
prospective basis for coverage under the new or improved benefit package 
option.
    (4) Change in coverage under another employer plan. A cafeteria plan 
may permit an employee to make a prospective election change that is on 
account of and corresponds with a change made under another employer 
plan (including a plan of the same employer or of another employer) if--
    (i) The other cafeteria plan or qualified benefits plan permits 
participants to make an election change that would be permitted under 
paragraphs (b) through (g) of this section (disregarding this paragraph 
(f)(4)); or
    (ii) The cafeteria plan permits participants to make an election for 
a period of coverage that is different from the period of coverage under 
the other

[[Page 536]]

cafeteria plan or qualified benefits plan.
    (5) Loss of coverage under other group health coverage. A cafeteria 
plan may permit an employee to make an election on a prospective basis 
to add coverage under a cafeteria plan for the employee, spouse, or 
dependent if the employee, spouse, or dependent loses coverage under any 
group health coverage sponsored by a governmental or educational 
institution, including the following--
    (i) A State's children's health insurance program (SCHIP) under 
Title XXI of the Social Security Act;
    (ii) A medical care program of an Indian Tribal government (as 
defined in section 7701(a)(40)), the Indian Health Service, or a tribal 
organization;
    (iii) A State health benefits risk pool; or
    (iv) A Foreign government group health plan.
    (6) Examples. The following examples illustrate the application of 
this paragraph (f):

    Example 1. (i) A calendar year cafeteria plan is maintained pursuant 
to a collective bargaining agreement for the benefit of Employer M's 
employees. The cafeteria plan offers various benefits, including 
indemnity health insurance and a health FSA. As a result of mid-year 
negotiations, premiums for the indemnity health insurance are reduced in 
the middle of the year, insurance co-payments for office visits are 
reduced under the indemnity plan by an amount which constitutes a 
significant benefit improvement, and an HMO option is added.
    (ii) Under these facts, the reduction in health insurance premiums 
is a reduction in cost. Accordingly, under paragraph (f)(2)(i) of this 
section, the cafeteria plan may automatically decrease the amount of 
salary reduction contributions of affected participants by an amount 
that corresponds to the premium change. However, the plan may not permit 
employees to change their health FSA elections to reflect the mid-year 
change in copayments under the indemnity plan.
    (iii) Also, the decrease in co-payments is a significant benefit 
improvement and the addition of the HMO option is an addition of a 
benefit package option. Accordingly, under paragraph (f)(3)(ii) of this 
section, the cafeteria plan may permit eligible employees to make an 
election change to elect the indemnity plan or the new HMO option. 
However, the plan may not permit employees to change their health FSA 
elections to reflect differences in co-payments under the HMO option.
    Example 2. (i) Employer N sponsors an accident or health plan under 
which employees may elect either employee-only coverage or family health 
coverage. The 12-month period of coverage under N's cafeteria plan 
begins January 1, 2001. N's employee, A, is married to B. Employee A 
elects employee-only coverage under N's plan. B's employer, O, offers 
health coverage to O's employees under its accident or health plan under 
which employees may elect either employee-only coverage or family 
coverage. O's plan has a 12-month period of coverage beginning September 
1, 2001. B maintains individual coverage under O's plan at the time A 
elects coverage under N's plan, and wants to elect no coverage for the 
plan year beginning on September 1, 2001, which is the next period of 
coverage under O's accident or health plan. A certifies to N that B will 
elect no coverage under O's accident or health plan for the plan year 
beginning on September 1, 2001 and N has no reason to believe that A's 
certification is incorrect.
    (ii) Under paragraph (f)(4)(ii) of this section, N's cafeteria plan 
may permit A to change A's election prospectively to family coverage 
under that plan effective September 1, 2001.
    Example 3. (i) Employer P sponsors a calendar year cafeteria plan 
under which employees may elect either employee-only or family health 
coverage. Before the beginning of the year, P's employee, C, elects 
family coverage under P's cafeteria plan. C also elects coverage under 
the health FSA for up to $200 of reimbursements for the year to be 
funded by salary reduction contributions of $200 during the year. C is 
married to D, who is employed by Employer Q. Q does not maintain a 
cafeteria plan, but does maintain an accident or health plan providing 
its employees with employee-only coverage. During the calendar year, Q 
adds family coverage as an option under its health plan. D elects family 
coverage under Q's plan, and C wants to revoke C's election for health 
coverage and elect no health coverage under P's cafeteria plan for the 
remainder of the year.
    (ii) Q's addition of family coverage as an option under its health 
plan constitutes a new coverage option described in paragraph (f)(3)(ii) 
of this section. Accordingly, pursuant to paragraph (f)(4)(i) of this 
section, P's cafeteria plan may permit C to revoke C's health coverage 
election if D actually elects family health coverage under Q's accident 
or health plan. Employer P's plan may not permit C to change C's health 
FSA election.
    Example 4. (i) Employer R maintains a cafeteria plan under which 
employees may elect accident or health coverage under either an 
indemnity plan or an HMO. Before the beginning of the year, R's 
employee, E elects coverage under the HMO at a premium cost of $100 per 
month. During the year, E decides to

[[Page 537]]

switch to the indemnity plan, which charges a premium of $140 per month.
    (ii) E's change from the HMO to indemnity plan is not a change in 
cost or coverage under this paragraph (f), and none of the other 
election change rules under paragraphs (b) through (e) of this section 
apply.
    (iii) Although R's health plan may permit E to make the change from 
the HMO to the indemnity plan, R's cafeteria plan may not permit E to 
make an election change to reflect the increased premium. Accordingly, 
if E switches from the HMO to the indemnity plan, E may pay the $40 per 
month additional cost on an after-tax basis.
    Example 5. (i) Employee A is married to Employee B and they have one 
child, C. Employee A's employer, M, maintains a calendar year cafeteria 
plan that allows employees to elect coverage under a dependent care FSA. 
Child C attends X's on site child care center at an annual cost of 
$3,000. Prior to the beginning of the year, A elects salary reduction 
contributions of $3,000 during the year to fund coverage under the 
dependent care FSA for up to $3,000 of reimbursements for the year. 
Employee A now wants to revoke A's election of coverage under the 
dependent care FSA, because A has found a new child care provider.
    (ii) The availability of dependent care services from the new child 
care provider (whether the new provider is a household employee or 
family member of A or B or a person who is independent of A and B) is a 
significant change in coverage similar to a benefit package option 
becoming available. Because the FSA is a dependent care FSA rather than 
a health FSA, the coverage rules of this section apply and M's cafeteria 
plan may permit A to elect to revoke A's previous election of coverage 
under the dependent care FSA, and make a corresponding new election to 
reflect the cost of the new child care provider.
    Example 6. (i) Employee D is married to Employee E and they have one 
child, F. Employee D's employer, N, maintains a calendar year cafeteria 
plan that allows employees to elect coverage under a dependent care FSA. 
Child F is cared for by Y, D's household employee, who provides child 
care services five days a week from 9 a.m. to 6 p.m. at an annual cost 
in excess of $5,000. Prior to the beginning of the year, D elects salary 
reduction contributions of $5,000 during the year to fund coverage under 
the dependent care FSA for up to $5,000 of reimbursements for the year. 
During the year, F begins school and, as a result, Y's regular hours of 
work are changed to five days a week from 3 p.m. to 6 p.m. Employee D 
now wants to revoke D's election under the dependent care FSA, and make 
a new election under the dependent care FSA to an annual cost of $4,000 
to reflect a reduced cost of child care due to Y's reduced hours.
    (ii) The change in the number of hours of work performed by Y is a 
change in coverage. Thus, N's cafeteria plan may permit D to reduce D's 
previous election under the dependent care FSA to $4,000.
    Example 7. (i) Employee G is married to Employee H and they have one 
child, J. Employee G's employer, O, maintains a calendar year cafeteria 
plan that allows employees to elect coverage under a dependent care FSA. 
Child J is cared for by Z, G's household employee, who is not a relative 
of G and who provides child care services at an annual cost of $4,000. 
Prior to the beginning of the year, G elects salary reduction 
contributions of $4,000 during the year to fund coverage under the 
dependent care FSA for up to $4,000 of reimbursements for the year. 
During the year, G raises Z's salary. Employee G now wants to revoke G's 
election under the dependent care FSA, and make a new election under the 
dependent care FSA to an annual amount of $4,500 to reflect the raise.
    (ii) The raise in Z's salary is a significant increase in cost under 
paragraph (f)(2)(ii) of this section, and an increase in election to 
reflect the raise corresponds with that change in status. Thus, O's 
cafeteria plan may permit G to elect to increase G's election under the 
dependent care FSA.
    Example 8. (i) Employer P maintains a calendar year cafeteria plan 
that allows employees to elect employee-only, employee plus one 
dependent, or family coverage under an indemnity plan. During the middle 
of the year, Employer P gives its employees the option to select 
employee-only or family coverage from an HMO plan. P's employee, J, who 
had elected employee plus one dependent coverage under the indemnity 
plan, decides to switch to family coverage under the HMO plan.
    (ii) Employer P's midyear addition of the HMO option is an addition 
of a benefit package option. Under paragraph (f) of this section, 
Employee J may change his or her salary reduction contributions to 
reflect the change from indemnity to HMO coverage, and also to reflect 
the change from employee plus one dependent to family coverage (however, 
an election of employee-only coverage under the new option would not 
correspond with the addition of a new option). Employer P may not permit 
J to change J's health FSA election.

    (g) Special requirements relating to the Family and Medical Leave 
Act. An employee taking leave under the Family and Medical Leave Act 
(FMLA) (Public Law 103-3 (107 Stat. 6)) may revoke an existing election 
of accident or health plan coverage and make such other election for the 
remaining portion of

[[Page 538]]

the period of coverage as may be provided for under the FMLA. See Sec. 
1.125-3 for additional rules.
    (h) Elective contributions under a qualified cash or deferred 
arrangement. The provisions of this section do not apply with respect to 
elective contributions under a qualified cash or deferred arrangement 
(within the meaning of section 401(k)) or employee contributions subject 
to section 401(m). Thus, a cafeteria plan may permit an employee to 
modify or revoke elections in accordance with section 401(k) and (m) and 
the regulations thereunder.
    (i) Definitions. Unless otherwise provided, the definitions in 
paragraphs (i)(1) though (8) of this section apply for purposes of this 
section.
    (1) Accident or health coverage. Accident or health coverage means 
coverage under an accident or health plan as defined in regulations 
under section 105.
    (2) Benefit package option. A benefit package option means a 
qualified benefit under section 125(f) that is offered under a cafeteria 
plan, or an option for coverage under an underlying accident or health 
plan (such as an indemnity option, an HMO option, or a PPO option under 
an accident or health plan).
    (3) Dependent. A dependent means a dependent as defined in section 
152, except that, for purposes of accident or health coverage, any child 
to whom section 152(e) applies is treated as a dependent of both 
parents, and, for purposes of dependent care assistance provided through 
a cafeteria plan, a dependent means a qualifying individual (as defined 
in section 21(b)(1)) with respect to the employee.
    (4) Disability coverage. Disability coverage means coverage under an 
accident or health plan that provides benefits due to personal injury or 
sickness, but does not reimburse expenses incurred for medical care (as 
defined in section 213(d)) of the employee or the employee's spouse and 
dependents. For purposes of this section, disability coverage includes 
payments described in section 105(c).
    (5) Family member plan. A family member plan means a cafeteria plan 
or qualified benefit plan sponsored by the employer of the employee's 
spouse or the employee's dependent.
    (6) FSA, health FSA. An FSA means a qualified benefits plan that is 
a flexible spending arrangement as defined in section 106(c)(2) . A 
health FSA means a health or accident plan that is an FSA.
    (7) Placement for adoption. Placement for adoption means placement 
for adoption as defined in regulations under section 9801.
    (8) Qualified benefits plan. A qualified benefits plan means an 
employee benefit plan governing the provision of one or more benefits 
that are qualified benefits under section 125(f). A plan does not fail 
to be a qualified benefits plan merely because it includes an FSA, 
assuming that the FSA meets the requirements of section 125 and the 
regulations thereunder.
    (9) Similar coverage. Coverage for the same category of benefits for 
the same individuals (e.g., family to family or single to single). For 
example, two plans that provide coverage for major medical are 
considered to be similar coverage. For purposes of this definition, a 
health FSA is not similar coverage with respect to an accident or health 
plan that is not a health FSA. A plan may treat coverage by another 
employer, such as a spouse's or dependent's employer, as similar 
coverage.
    (j) Effective date--(1) General rule. Except as provided in 
paragraph (j)(2) of this section, this section is applicable for 
cafeteria plan years beginning on or after January 1, 2001.
    (2) Delayed effective date for certain provisions. The following 
provisions are applicable for cafeteria plan years beginning on or after 
January 1, 2002: paragraph (c) of this section to the extent applicable 
to qualified benefits other than an accident or health plan or a group-
term life insurance plan; paragraph (d)(1)(ii)(B) of this section 
(relating to a spouse, former spouse, or other individual obtaining 
accident or health coverage for an employee's child in response to a 
judgment, decree, or order); paragraph (f) of this section (rules for 
election changes as a result

[[Page 539]]

of cost or coverage changes); and paragraph (i)(9) of this section 
(defining similar coverage).

[T.D. 8878, 65 FR 15550, Mar. 23, 2000, as amended by T.D. 8921, 66 FR 
1840, Jan. 10, 2001; T.D. 8921, 66 FR 13013, Mar. 2, 2001; T.D. 8966, 66 
FR 52680, Oct. 17, 2001]



Sec. 1.125-4T  Permitted election changes (temporary).

    (a) Election changes. A cafeteria plan may permit an employee to 
revoke an election during a period of coverage and to make a new 
election only as provided in paragraphs (b) through (i) of this section. 
See paragraph (j) of this section for special provisions relating to 
qualified cash or deferred arrangements.
    (b) Special enrollment rights. A cafeteria plan may permit an 
employee to revoke an election for accident or health coverage during a 
period of coverage and make a new election that corresponds with the 
special enrollment rights provided in section 9801(f), whether or not 
the change in election is permitted under paragraph (c) of this section.
    (c) Changes in status for accident or health coverage and group-term 
life--(1) In general. A cafeteria plan may permit an employee to revoke 
an election for accident or health coverage or group-term life insurance 
coverage during a period of coverage and make a new election for the 
remaining portion of the period if, under the facts and circumstances--
    (i) A change in status occurs; and
    (ii) The election change satisfies the consistency requirement in 
paragraph (c)(3) of this section (consistency rule for accident or 
health coverage) or (c)(4) of this section (consistency rule for group-
term life insurance coverage).
    (2) Change in status events. The following events are changes in 
status for purposes of this paragraph (c):
    (i) Legal marital status. Events that change an employee's legal 
marital status, including marriage, death of spouse, divorce, legal 
separation, or annulment;
    (ii) Number of dependents. Events that change an employee's number 
of dependents (as defined in section 152), including birth, adoption, 
placement for adoption (as defined in regulations under section 9801), 
or death of a dependent;
    (iii) Employment status. A termination or commencement of employment 
by the employee, spouse, or dependent;
    (iv) Work schedule. A reduction or increase in hours of employment 
by the employee, spouse, or dependent, including a switch between part-
time and full-time, a strike or lockout, or commencement or return from 
an unpaid leave of absence;
    (v) Dependent satisfies or ceases to satisfy the requirements for 
unmarried dependents. An event that causes an employee's dependent to 
satisfy or cease to satisfy the requirements for coverage due to 
attainment of age, student status, or any similar circumstance as 
provided in the accident or health plan under which the employee 
receives coverage; and
    (vi) Residence or Worksite. A change in the place of residence or 
work of the employee, spouse, or dependent.
    (3) Consistency rule for accident or health coverage. (i) General 
rule. (A) An employee's revocation of a cafeteria plan election during a 
period of coverage and new election for the remaining portion of the 
period (referred to below as an ``election change'') is consistent with 
a change in status if, and only if--
    (1) The change in status results in the employee, spouse, or 
dependent gaining or losing eligibility for accident or health coverage 
under either the cafeteria plan or an accident or health plan of the 
spouse's or dependent's employer; and
    (2) The election change corresponds with that gain or loss of 
coverage.
    (B) A change in status results in an employee, spouse, or dependent 
gaining (or losing) eligibility for coverage under a plan only if the 
individual becomes eligible (or ineligible) to participate in the plan. 
A cafeteria plan may treat an individual as gaining (or losing) 
eligibility for coverage if the individual becomes eligible (or 
ineligible) for a particular benefit package option under a plan (e.g., 
a change in status results in an individual becoming eligible for a 
managed care option or an indemnity option). If, as a result of a change 
in status, the individual gains

[[Page 540]]

eligibility for elective coverage under a plan of the spouse's or 
dependent's employer, the consistency rule of this paragraph (c)(3)(i) 
is satisfied only if the individual elects the coverage under the 
spouse's or dependent's employer. See the Examples in paragraph (k) of 
this section for illustrations of the consistency rule.
    (ii) Exception for COBRA. Notwithstanding paragraph (c)(3)(i) of 
this section, if the employee, spouse, or dependent becomes eligible for 
continuation coverage under the employer's group health plan as provided 
in section 4980B or any similar State law, the employee may elect to 
increase payments under the employer's cafeteria plan in order to pay 
for the continuation coverage.
    (4) Consistency rule for group-term life insurance coverage. Except 
as provided in this paragraph (c)(4), the provisions of paragraph 
(c)(3)(i) of this section apply to group-term life insurance coverage. 
In the case of marriage, birth, adoption, or placement for adoption, a 
cafeteria plan can allow an election change to increase (but not to 
reduce) the amount of the employee's life insurance coverage. In the 
case of divorce, legal separation, annulment, or death of a spouse or 
dependent, a cafeteria plan may allow an election change to reduce (but 
not to increase) the amount of the employee's life insurance coverage.
    (d) Judgment, decree, or order. This paragraph (d) applies to a 
judgment, decree, or order (``order'') resulting from a divorce, legal 
separation, annulment, or change in legal custody (including a qualified 
medical child support order defined in section 609 of the Employee 
Retirement Income Security Act of 1974) that requires accident or health 
coverage for an employee's child. Notwithstanding the provisions of 
paragraph (c) of this section, a cafeteria plan may--
    (1) Change the employee's election to provide coverage for the child 
if the order requires coverage under the employee's plan; or
    (2) Permit the employee to make an election change to cancel 
coverage for the child if the order requires the former spouse to 
provide coverage.
    (e) Entitlement to Medicare or Medicaid. If an employee, spouse, or 
dependent who is enrolled in an accident or health plan of the employer 
becomes entitled to coverage (i.e., enrolled) under Part A or Part B of 
Title XVIII of the Social Security Act (Medicare) or Title XIX of the 
Social Security Act (Medicaid), other than coverage consisting solely of 
benefits under section 1928 of the Social Security Act (the program for 
distribution of pediatric vaccines), a cafeteria plan may permit the 
employee to make an election change to cancel coverage of that employee, 
spouse or dependent under the accident or health plan.
    (f) Changes in status for other qualified benefits. [Reserved]
    (g) Significant coverage or cost changes. [Reserved]
    (1) Employer's plan. [Reserved]
    (2) Plan of spouse's or dependent's employer. [Reserved]
    (h) Cessation of required contributions. [Reserved]
    (i) Special requirements concerning the Family and Medical Leave 
Act. [Reserved]
    (j) Elective contributions under a qualified cash or deferred 
arrangement. The provisions of this section do not apply with respect to 
elective contributions under a qualified cash or deferred arrangement 
(within the meaning of section 401(k)) or employee contributions subject 
to section 401(m). Thus, a cafeteria plan may permit an employee to 
modify or revoke elections in accordance with sections 401(k) and 401(m) 
and the regulations thereunder.
    (k) Examples. The following examples illustrate the rules of this 
section. In each case involving an accident or health plan, assume that 
the plan is subject to section 9801(f) (providing for special enrollment 
rights under certain group health plans).

    Example 1. (i) Employer M provides health coverage for its employees 
under which employees may elect either employee-only coverage or family 
coverage. M also maintains a calendar year cafeteria plan under which 
qualified benefits, including health coverage, are funded through salary 
reduction. M's employee, A, elects employee-only health coverage before 
the beginning of the calendar year. During the year, A adopts a child, 
C. Within 30 days thereafter, A wants to revoke

[[Page 541]]

A's election for employee-only health coverage and obtain family health 
coverage, as of the date of C's adoption. A satisfies the conditions for 
special enrollment of an employee with a new dependent under section 
9801(f)(2), so that A may enroll in family coverage under M's accident 
or health plan in order to provide coverage for C, effective as of the 
date of C's adoption.
    (ii) In this Example 1, M's cafeteria plan may permit A to change 
the employee's salary reduction election to family coverage for salary 
not yet currently available. The increased salary reduction could 
reflect the cost of family coverage from the date of adoption. (The 
adoption of C is also a change in status, and the election of family 
coverage is consistent with that change in status. Thus, under the 
change in status provisions of paragraph (c) of this section, M's 
cafeteria plan could permit A to elect family coverage prospectively in 
order to cover C for the remaining portion of the coverage period.)
    Example 2. (i) The employer plans and permissible coverage are the 
same as in Example 1. Before the beginning of the calendar year, 
Employee A elects employee-only health coverage under M's cafeteria 
plan. A marries B during the plan year. B's employer, N, offers health 
coverage to N's employees, and, prior to the marriage, B had elected 
employee-only coverage. A wants to revoke the election for employee-only 
coverage, and is considering electing family health coverage under M's 
plan or obtaining family health coverage under N's plan.
    (ii) In this Example 2, A's marriage to B is a change in status. Two 
possible election changes by A would be consistent with the change in 
status: to cover A and B by electing family health coverage under M's 
plan, or to cancel coverage under M's plan (with B electing family 
health coverage under N's plan in order to cover A and B). Thus, M's 
cafeteria plan may permit A to make either change in election. (M's 
cafeteria plan could also permit A to change A's salary reduction 
election to reflect the change to family coverage under M's group health 
plan in accordance with paragraph (b) of this section because the 
marriage would also create special enrollment rights under section 
9801(f), pursuant to which an election of family coverage under M's plan 
would be required to be effective no later than the first day of the 
first calendar month beginning after the completed request for 
enrollment is received by the plan.)
    Example 3. (i) Employee G, a single parent, elects family health 
coverage under a calendar year cafeteria plan maintained by Employer O. 
G and G's 21-year old child, H, are covered under O's health plan. 
During the year, H graduates from college. Under the terms of the health 
plan, dependents over the age of 19 must be full-time students to 
receive coverage. G wants to revoke G's election for family health 
coverage and obtain employee-only coverage under O's cafeteria plan.
    (ii) In this Example 3, H's loss of eligibility for coverage under 
the terms of the health plan is a change in status. A revocation of G's 
election for family coverage and new election of employee-only coverage 
is consistent with the change in status. Thus, O's cafeteria plan may 
permit G to elect employee-only coverage.
    Example 4. (i) Employee J is married to K and they have one child, 
S. A calendar year cafeteria plan maintained by Employer P allows 
employees to elect no health coverage, employee-only coverage, employee-
plus-one-dependent coverage, or family coverage. Under the plan, before 
the beginning of the calendar year, J elects family health coverage for 
J, K, and S. J and K divorce during the year and, under the terms of P's 
accident or health plan, K loses eligibility for P's health coverage. S 
does not lose eligibility for health coverage under P's plan upon the 
divorce. J now wants to revoke J's election under the cafeteria plan and 
elect no coverage.
    (ii) In this Example 4, the divorce is a change in status. A change 
in the cafeteria plan election to cancel health coverage for K is 
consistent with that change in status. However, the divorce does not 
affect J's or S's eligibility for health coverage. Therefore, an 
election change to cancel J's or S's health coverage is not consistent 
with the change in status. The cafeteria plan, however, may permit J to 
elect employee-plus-one-dependent health coverage.
    Example 5. (i) The facts are the same as Example 4, except that, 
before the beginning of the year, Employee J elected employee-only 
health coverage (rather than family coverage). Pursuant to J's divorce 
agreement with K, P's health plan receives a qualified medical child 
support order (as defined in section 609 of the Employee Retirement 
Income Security Act) during the plan year. The order requires P's health 
plan to cover S.
    (ii) In this Example 5, P's cafeteria plan may change J's election 
from employee-only health coverage to employee-plus-one-dependent 
coverage in order to cover S.
    Example 6. (i) Before the beginning of the coverage period, Employee 
L elects to participate in a cafeteria plan maintained by L's Employer, 
Q. However, in order to change the election during the coverage period 
so as to cancel coverage, and by prior understanding with Q, L 
terminates employment and resumes employment one week later.
    (ii) In this Example 6, under the facts and circumstances, in which 
a principal purpose of the termination of employment was to

[[Page 542]]

alter the election and reinstatement of employment was understood at the 
time of termination, L does not have a change in status. However, L's 
termination of employment would constitute a change in status, 
permitting a cancellation of coverage during the period of unemployment, 
if L's original cafeteria plan election was reinstated upon resumption 
of employment (for example, because of a cafeteria plan provision 
requiring an employee who resumes employment within 30 days, without any 
other intervening event that would permit a change in election, to 
return to the election in effect prior to termination of employment).
    Example 7. (i) Employer R maintains a calendar year cafeteria plan 
under which full-time employees may elect coverage under one of three 
benefit package options provided under an accident or health plan: an 
indemnity option or either of two HMO options for employees that work in 
the respective service areas of the two HMOs. Employee T, who works in 
the service area of HMO 1, elects the HMO 1 option. 
During the year, T is transferred to another work location which is 
outside the HMO 1 service area and inside the HMO 2 
service area.
    (ii) In this Example 7, the transfer is a change in status and, 
under the consistency rule, the cafeteria plan may permit T to make an 
election change to either the indemnity option or HMO 2, or to 
cancel accident or health coverage.
    Example 8. (i) A calendar year cafeteria plan maintained by Employer 
S allows employees to elect coverage under an accident or health plan 
providing indemnity coverage and under a flexible spending arrangement 
(FSA). Prior to the beginning of the calendar year, Employee U elects 
employee-only indemnity coverage, and coverage under the FSA for up to 
$600 of reimbursements for the year to be funded by salary reduction 
contributions of $600 during the year. U's spouse, V, has employee-only 
coverage under an accident or health plan maintained by V's employer. 
During the year, V terminates employment and loses coverage under that 
plan. U now wants to elect family coverage under S's accident or health 
plan and increase U's FSA election.
    (ii) In this Example 8, V's termination of employment is a change in 
status. The cafeteria plan may permit U to elect family coverage under 
S's accident or health plan, and to increase U's FSA coverage.
    Example 9. (i) Employer T provides group-term life insurance 
coverage as described under section 79. Under T's plan, an employee may 
elect life insurance coverage in an amount up to the lesser of his or 
her salary or $50,000. T also maintains a calendar year cafeteria plan 
under which qualified benefits, including the group-term life insurance 
coverage, are funded through salary reduction. Before the beginning of 
the calendar year, Employee W elects $10,000 of life insurance coverage, 
with W's spouse, X, as the beneficiary. During the year, a child is 
placed for adoption with W and X. W wants to increase W's election for 
life insurance coverage to $50,000 (without changing the designation of 
X as the beneficiary).
    (ii) In this Example 9, the placement of a child for adoption with W 
is a change in status. The increase in coverage is consistent with the 
change in status. Thus, W's cafeteria plan may permit W to increase W's 
life insurance coverage.

    (1) Effective date. This section is applicable for plan years 
beginning after December 31, 1998, and on or before November 6, 2000.

[T.D. 8738, 62 FR 60166, Nov. 7, 1997; 63 FR 8528, Feb. 19, 1998; T.D. 
8878, 65 FR 15553, Mar. 23, 2000]



Sec. 1.127-1  Amounts received under a qualified educational assistance 
program.

    (a) Exclusion from gross income. The gross income of an employee 
does not include--
    (1) Amounts paid to, or on behalf of the employee under a qualified 
educational assistance program described in Sec. 1.127-2, or
    (2) The value of education provided to the employee under such a 
program.
    (b) Disallowance of excluded amounts as credit or deduction. Any 
amount excluded from the gross income of an employee under paragraph (a) 
of this section shall not be allowed as a credit or deduction to such 
employee under any other provision of this part.
    (c) Amounts received under a nonqualified program. Any amount 
received under an educational assistance program that is not a 
``qualified program'' described in Sec. 1.127-2 will not be excluded 
from gross income under paragraph (a) of this section. All or part of 
the amounts received under such a nonqualified program may, however, be 
excluded under section 117 or deducted under section 162 or section 212 
(as the case may be), if the requirements of such section are satisfied.
    (d) Definitions. For rules relating to the meaning of the terms 
``employee'' and ``employer'', see paragraph (h) of Sec. 1.127-2.

[[Page 543]]

    (e) Effective date. This section is effective for taxable years of 
the employee beginning after December 31, 1978, and before January 1, 
1984.

[T.D. 7898, 48 FR 31017, July 6, 1983]



Sec. 1.127-2  Qualified educational assistance program.

    (a) In general. A qualified educational assistance program is a plan 
established and maintained by an employer under which the employer 
provides educational assistance to employees. To be a qualified program, 
the requirements described in paragraphs (b) through (g) of this section 
must be satisfied. It is not required that a program be funded or that 
the employer apply to the Internal Revenue Service for a determination 
that the plan is a qualified program. However, under Sec. 601.201 
(relating to rulings and determination letters), an employer may request 
that the Service determine whether a plan is a qualified program.
    (b) Separate written plan. The program must be a separate written 
plan of the employer. This requirement means that the terms of the 
program must be set forth in a separate document or documents providing 
only educational assistance within the meaning of paragraph (c) of this 
section. The requirement for a separate plan does not, however, preclude 
an educational assistance program from being part of a more 
comprehensive employer plan that provides a choice of nontaxable 
benefits to employees.
    (c) Educational assistance--(1) In general. The benefits provided 
under the program must consist solely of educational assistance. The 
term ``educational assistance'' means--
    (i) The employer's payment of expenses incurred by or on behalf of 
an employee for education, or
    (ii) The employer's provision of education to an employee.
    (2) Alternative benefits. Benefits will not be considered to consist 
solely of educational assistance if the program, in form or in actual 
operation, provides employees with a choice between educational 
assistance and other remuneration includible in the employee's gross 
income.
    (3) Certain benefits not considered educational assistance. The term 
``educational assistance'' does not include the employer's payment for, 
or provision of--
    (i) Tools or supplies (other than textbooks) that the employee may 
retain after completing a course of instruction,
    (ii) Meals, lodging, or transportation, or
    (iii) Education involving sports, games, or hobbies, unless such 
education involves the business of the employer or is required as part 
of a degree program. The phrase ``sports, games, or hobbies'' does not 
include education that instructs employees how to maintain and improve 
health so long as such education does not involve the use of athletic 
facilities or equipment and is not recreational in nature.
    (4) Education defined. As used in section 127, Sec. 1.127-1, and 
this section, the term ``education'' includes any form of instruction or 
training that improves or develops the capabilities of an individual. 
Education paid for or provided under a qualified program may be 
furnished directly by the employer, either alone or in conjunction with 
other employers, or through a third party such as an educational 
institution. Education is not limited to courses that are job related or 
part of a degree program.
    (d) Exclusive benefit. The program may benefit only the employees of 
the employer, including, at the employer's option, individuals who are 
employees within the meaning of paragraph (h)(1) of this section. A 
program that provides benefits to spouses or dependents of employees is 
not a qualified program within the meaning of this section.
    (e) Prohibited discrimination--(1) Eligibility for benefits. The 
program must benefit the employer's employees generally. Among those 
benefited may be employees who are officers, shareholders, self-employed 
or highly compensated. A program is not for the benefit of employees 
generally, however, if the program discriminates in favor of employees 
described in the preceeding sentence (or in favor of their spouses and 
dependents who are themselves employees) in requirements relating to 
eligibility for benefits. Thus, although a program need not provide 
benefits for all employees, it must benefit those

[[Page 544]]

employees who qualify under a classification of employees that does not 
discriminate in favor of the employees with respect to whom 
discrimination is prohibited. The classification of employees to be 
considered benefited will consist of that group of employees who are 
actually eligible for educational assistance under the program, taking 
into account the eligibility requirements set forth in the written plan, 
the eligibility requirements reflected in the types of educational 
assistance available under the program, and any other conditions that 
may affect the availability of benefits under the program. Thus, for 
example, if an employer's plan provides that all employees are eligible 
for educational assistance, yet limits that assistance to courses of 
study leading to postgraduate degrees in fields relating to the 
employer's business, then only those employees able to pursue such a 
course of study are considered actually eligible for educational 
assistance under the program. Whether any classification of employees 
discriminates in favor of employees with respect to whom discrimination 
is prohibited will generally be determined by applying the same 
standards as are applied under section 410(b)(1)(B) (relating to 
qualified pension, profit-sharing and stock bonus plans), without regard 
to section 401(a)(5). For purposes of making this determination, there 
shall be excluded from consideration employees not covered by the 
program who are included in a unit of employees covered by an agreement 
which the Secretary of Labor finds to be a collective bargaining 
agreement between employee representatives and one or more employers, if 
the Internal Revenue Service finds that educational assistance benefits 
were the subject of good faith bargaining between the employee 
representatives and the employer or employers. For purposes of 
determining whether such bargaining occurred, it is not material that 
the employees are not covered by another educational assistance program 
or that the employer's present program was not considered in the 
bargaining.
    (2) Factors not considered in determining the existence of 
prohibited discrimination. A program shall not be considered 
discriminatory under this paragraph (e) merely because--
    (i) Different types of educational assistance available under the 
program are utilized to a greater degree by employees with respect to 
whom discrimination is prohibited than by other employees, or
    (ii) With respect to a course of study for which benefits are 
otherwise available, successful completion of the course, attaining a 
particular course grade, or satisfying a reasonable condition subsequent 
(such as remaining employed for one year after completing the course) 
are required or considered in determining the availability of benefits.
    (f) Benefit limitation--(1) In general. Under section 127(b)(3), a 
program is a qualified program for a program year only if no more than 
5% of the amounts paid or incurred by the employer for educational 
assistance benefits during the year are provided to the limitation class 
described in subparagraph (2). For purposes of this paragraph (f), the 
program year must be specified in the written plan as either the 
calendar year or the taxable year of the employer.
    (2) Limitation class. The limitation class consists of--
    (i) Shareholders. Individuals who, on any day of the program year, 
own more than 5% of the total number of shares of outstanding stock of 
the employer, or
    (ii) Owners. In the case of an employer's trade or business which is 
not incorporated, individuals who, on any day of the program year, own 
more than 5% of the capital or profits interest in the employer, and
    (iii) Spouses or dependents. Individuals who are spouses or 
dependents of shareholders or owners described in subdivision (i) or 
(ii). For purposes of determining stock ownership, the attribution rules 
described in paragraph (h)(4) of this section apply. The regulations 
prescribed under section 414(c) are applicable in determining an 
individual's interest in the capital or profits of an unincorporated 
trade or business.
    (g) Notification of employees. A program is not a qualified program 
unless employees eligible to participate in the program are given 
reasonable notice of

[[Page 545]]

the terms and availability of the program.
    (h) Definitions. For purposes of this section and Sec. 1.127-1--
    (1) Employee. The term ``employee'' includes--
    (i) A retired, disabled or laid-off employee,
    (ii) A present employee who is on leave, as, for example, in the 
Armed Forces of the United States, or
    (iii) An individual who is self-employed within the meaning of 
section 401(c)(1).
    (2) Employer. An individual who owns the entire interest in an 
unincorporated trade or business shall be treated as his or her own 
employer. A partnership is treated as the employer of each partner who 
is an employee within the meaning of section 401(c)(1).
    (3) Officer. An officer is an individual who is an officer within 
the meaning of regulations prescribed under section 414(c).
    (4) Shareholder. The term ``shareholder'' includes an individual who 
is a shareholder as determined by the attribution rules under section 
1563 (d) and (e), without regard to section 1563(e)(3)(C).
    (5) Highly compensated. The term ``highly compensated'' has the same 
meaning as it does for purposes of section 410(b)(1)(B).
    (i) Substantiation. An employee receiving payments under a qualified 
educational assistance program must be prepared to provide 
substantiation to the employer such that it is reasonable to believe 
that payments or reimbursements made under the program constitute 
educational assistance within the meaning of paragraph (c) of this 
section.

[T.D. 7898, 48 FR 31017, July 6, 1983]



Sec. 1.132-0  Outline of regulations under section 132.

    The following is an outline of regulations in this section relating 
to exclusions from gross income for certain fringe benefits:

         Sec. 1.132-0 Outline of regulations under section 132.

 Sec. 1.132-1 Exclusion from gross income for certain fringe benefits.

Sec. 1.132-1 (a) In general.
Sec. 1.132-1 (b) Definition of employee.
    (1) No-additional-cost services and qualified employee discounts.
    (2) Working condition fringes.
    (3) On-premises athletic facilities.
    (4) De minimis fringes.
    (5) Dependent child.
Sec. 1.132-1 (c) Special rules for employers--Effect of section 414.
Sec. 1.132-1 (d) Customers not to include employees.
Sec. 1.132-1 (e) Treatment of on-premises athletic facilities.
    (1) In general.
    (2) Premises of the employer.
    (3) Application of rules to membership in an athletic facility.
    (4) Operation by the employer.
    (5) Nonapplicability of nondiscrimination rules.
Sec. 1.132-1 (f) Nonapplicability of section 132 in certain cases.
    (1) Tax treatment provided for in another section.
    (2) Limited statutory exclusions.
Sec. 1.132-1 (g) Effective date.
Sec. 1.132-2 No-additional-cost services.
Sec. 1.132-2 (a) In general.
    (1) Definition.
    (2) Excess capacity services.
    (3) Cash rebates.
    (4) Applicability of nondiscrimination rules.
    (5) No substantial additional cost.
    (6) Payments for telephone service.
Sec. 1.132-2 (b) Reciprocal agreements.
Sec. 1.132-2 (c) Example.
Sec. 1.132-3 Qualified employee discounts.
Sec. 1.132-3 (a) In general.
    (1) Definition.
    (2) Qualified property or services.
    (3) No reciprocal agreement exception.
    (4) Property of services provided without charge, at a reduced 
price, or by rebates.
    (5) Property or services provided directly by the employer or 
indirectly through a third party.
    (6) Applicability of nondiscrimination rules.
Sec. 1.132-3 (b) Employee discount.
    (1) Definition.
    (2) Price to customers.
    (3) Damaged, distressed, or returned goods.
Sec. 1.132-3 (c) Gross profit percentage.
    (1) In general.
    (2) Line of business.
    (3) Generally accepted accounting principles.
Sec. 1.132-3 (d) Treatment of leased sections of department stores.
    (1) In general.
    (2) Employees of the leased section.
Sec. 1.132-3 (e) Excess discounts.
Sec. 1.132-4 Line of business limitation.
Sec. 1.132-4 (a) In general.
    (1) Applicability.
    (2) Definition.

[[Page 546]]

    (3) Aggregation of two-digit classifications.
Sec. 1.132-4 (b) Grandfather rule for certain retail stores.
    (1) In general.
    (2) Taxable year of affiliated group.
    (3) Definition of ``sales''.
    (4) Retired and disabled employees.
    (5) Increase of employee discount.
Sec. 1.132-4 (c) Grandfather rule for telephone service provided to 
          pre-divestiture retirees.
Sec. 1.132-4 (d) Special rule for certain affiliates of commercial 
          airlines.
    (1) General rule.
    (2) ``Airline affiliated group'' defined.
    (3) ``Qualified affiliate'' defined.
Sec. 1.132-4 (e) Grandfather rule for affiliated groups operating 
          airlines.
Sec. 1.132-4 (f) Special rule for qualified air transportation 
          organizations.
Sec. 1.132-4 (g) Relaxation of line of business requirement.
Sec. 1.132-4 (h) Line of business requirement does not expand benefits 
          eligible for exclusion.
Sec. 1.132-5 Working condition fringes.
Sec. 1.132-5 (a) In general.
    (1) Definition.
    (2) Trade or business of the employee.
Sec. 1.132-5 (b) Vehicle allocation rules.
    (1) In general.
    (2) Use of different employer-provided vehicles.
    (3) Provision of a vehicle and chauffeur services.
Sec. 1.132-5 (c) Applicability of substantiation requirements of 
          sections 162 and 274(d).
    (1) In general.
    (2) Section 274(d) requirements.
Sec. 1.132-5 (d) Safe harbor substantiation rules.
    (1) In general.
    (2) Period for use of safe harbor rules.
Sec. 1.132-5 (e) Safe harbor substantiation rule for vehicles not used 
          for personal purposes.
Sec. 1.132-5 (f) Safe harbor substantiation rule for vehicles not 
          available to employees for personal use other than commuting.
Sec. 1.132-5 (g) Safe harbor substantiation rule for vehicles used in 
          connection with the business of farming that are available to 
          employees for personal use.
    (1) In general.
    (2) Vehicles available to more than one individual.
    (3) Examples.
Sec. 1.132-5 (h) Qualified nonpersonal use vehicles.
    (1) In general.
    (2) Shared usage of qualified nonpersonal use vehicles.
Sec. 1.132-5 (i) [Reserved]
Sec. 1.132-5 (j) Application of section 280F.
Sec. 1.132-5 (k) Aircraft allocation rule.
Sec. 1.132-5 (l) [Reserved]
Sec. 1.132-5 (m) Employer-provided transportation for security 
          concerns.
    (1) In general.
    (2) Demonstration of bona fide business-oriented security concerns.
    (3) Application of security rules to spouses and dependents.
    (4) Working condition safe harbor for travel on employer-provided 
aircraft.
    (5) Bodyguard/chauffeur provided for a bona fide business-oriented 
security concern.
    (6) Special valuation rule for government employees.
    (7) Government employer and employee defined.
    (8) Examples.
Sec. 1.132-5 (n) Product testing.
    (1) In general.
    (2) Employer-imposed limits.
    (3) Discriminating classifications.
    (4) Factors that negate the existence of a product testing program.
    (5) Failure to meet the requirements of this paragraph (n).
    (6) Example.
Sec. 1.132-5 (o) Qualified automobile demonstration use.
    (1) In general.
    (2) Full-time automobile salesman.
    (3) Demonstration automobile.
    (4) Substantial restrictions on personal use.
    (5) Sales area.
    (6) Applicability of substantiation requirements of sections 162 and 
274(d).
    (7) Special valuation rules.
Sec. 1.132-5 (p) Parking.
    (1) In general.
    (2) Reimbursement of parking expenses.
    (3) Parking on residential property.
    (4) Dates of applicability.
Sec. 1.132-5 (q) Nonapplicability of nondiscrimination rules.
Sec. 1.132-5 (r) Volunteers.
    (1) In general.
    (2) Limit on application of this paragraph.
    (3) Definitions.
    (4) Example.
Sec. 1.132-6 De minimis fringes.
Sec. 1.132-6 (a) In general.
Sec. 1.132-6 (b) Frequency.
    (1) Employee-measured frequency.
    (2) Employer-measured frequency.
Sec. 1.132-6 (c) Administrability.
Sec. 1.132-6 (d) Special rules.
    (1) Transit passes.
    (2) Occasional meal money or local transportation fare.
    (3) Use of special rules or examples to establish a general rule.
    (4) Benefits exceeding value and frequency limits.
Sec. 1.132-6 (e) Examples.
    (1) Benefits excludable from income.
    (2) Benefits not excludable as de minimis fringes.
Sec. 1.132-6 (f) Nonapplicability of nondiscrimination rules.

[[Page 547]]

Sec. 1.132-7 Employer-operated eating facilities.
Sec. 1.132-7 (a) In general.
    (1) Conditions for exclusion.
    (2) Employer-operated eating facility for employees.
    (3) Operation by the employer.
    (4) Example.
Sec. 1.132-7 (b) Direct operating costs.
    (1) In general.
    (2) Multiple dining rooms or cafeterias.
    (3) Payment to operator of facility.
Sec. 1.132-7 (c) Valuation of non-excluded meals provided at an 
          employer-operated eating facility for employees.
Sec. 1.132-8 Fringe benefit nondiscrimination rules.
Sec. 1.132-8 (a) Application of nondiscrimination rules.
    (1) General rule.
    (2) Consequences of discrimination.
    (3) Scope of the nondiscrimination rules provided in this section.
Sec. 1.132-8 (b) Aggregation of Employees.
    (1) Section 132(a) (1) and (2).
    (2) Section 132(e)(2).
    (3) Classes of employees who may be excluded.
Sec. 1.132-8 (c) Availability on substantially the same terms.
    (1) General rule.
    (2) Certain terms relating to priority.
Sec. 1.132-8 (d) Testing for discrimination.
    (1) Classification test.
    (2) Classifications that are per se discriminatory.
    (3) Former employees.
    (4) Restructuring of benefits.
    (5) Employer-operated eating facilities for employees.
Sec. 1.132-8 (e) Cash bonuses or rebates.
Sec. 1.132-8 (f) Highly compensated employee.
    (1) Government and non-government employees.
    (2) Former employees.
Sec. 1.132-9 Qualified transportation fringes.
Sec. 1.132-9 (a) Table of contents.
Sec. 1.132-9 (b) Questions and answers.

[T.D. 8256, 54 FR 28600, July 6, 1989, as amended by T.D. 8457, 57 FR 
62196, Dec. 30, 1992]



Sec. 1.132-1  Exclusion from gross income for certain fringe benefits.

    (a) In general. Gross income does not include any fringe benefit 
which qualifies as a--
    (1) No-additional-cost service,
    (2) Qualified employee discount,
    (3) Working condition fringe, or
    (4) De minimis fringe.

Special rules apply with respect to certain on-premises gyms and other 
athletic facilities (Sec. 1.132-1(e)), demonstration use of employer-
provided automobiles by full-time automobile salesmen (Sec. 1.132-
5(o)), parking provided to an employee on or near the business premises 
of the employer (Sec. 1.132-5(p)), and on-premises eating facilities 
(Sec. 1.132-7).
    (b) Definition of employee--(1) No-additional-cost services and 
qualified employee discounts. For purposes of section 132(a)(1) 
(relating to no-additonal-cost services) and section 132(a)(2) (relating 
to qualified employee discounts), the term ``employee'' (with respect to 
a line of business of an employer means--
    (i) Any individual who is currently employed by the employer in the 
line of business,
    (ii) Any individual who was formerly employed by the employer in the 
line of business and who separated from service with the employer in the 
line of business by reason of retirement or disability, and
    (iii) Any widow or widower of an individual who died while employed 
by the employer in the line of business or who separated from service 
with the employer in the line of business by reason of retirement or 
disability.

For purposes of this paragraph (b)(1), any partner who performs services 
for a partnership is considered employed by the partnership. In 
addition, any use by the spouse or dependent child (as defined in 
paragraph (b)(5) of this section) of the employee will be treated as use 
by the employee. For purposes of section 132(a)(1) (relating to no-
additional-cost services), any use of air transportation by a parent of 
an employee (determined without regard to section 132(f)(1)(B) and 
paragraph (b)(1)(iii) of this section) will be treated as use by the 
employee.
    (2) Working condition fringes. For purposes of section 132(a)(3) 
(relating to working condition fringes), the term ``employee'' means--
    (i) Any individual who is currently employed by the employer,
    (ii) Any partner who performs services for the partnership,
    (iii) Any director of the employer, and
    (iv) Any independent contractor who performs services for the 
employer.

Notwithstanding anything in this paragraph (b)(2) to the contrary, an 
independent contractor who performs services for the employer cannot 
exclude

[[Page 548]]

the value of parking or the use of consumer goods provided pursuant to a 
product testing program under Sec. 1.132-5(n); in addition, any 
director of the employer cannot exclude the value of the use of consumer 
goods provided pursuant to a product testing program under Sec. 1.132-
5(n).
    (3) On-premises athletic facilities. For purposes of section 
132(h)(5) (relating to on-premises athletic facilities), the term 
``employee'' means--
    (i) Any individual who is currently employed by the employer,
    (ii) Any individual who was formerly employed by the employer and 
who separated from service with the employer by reason of retirement or 
disability, and
    (iii) Any widow or widower of an individual who died while employed 
by the employer or who separated from service with the employer by 
reason of retirement or disability.

For purposes of this paragraph (b)(3), any partner who performs services 
for a partnership is considered employed by the partnership. In 
addition, any use by the spouse or dependent child (as defined in 
paragraph (b)(5) of this section) of the employee will be treated as use 
by the employee.
    (4) De minimis fringes. For purposes of section 132(a)(4) (relating 
to de minimis fringes), the term ``employee'' means any recipient of a 
fringe benefit.
    (5) Dependent child. The term ``dependent child'' means any son, 
stepson, daughter, or stepdaughter of the employee who is a dependent of 
the employee, or both of whose parents are deceased and who has not 
attained age 25. Any child to whom section 152(e) applies will be 
treated as the dependent of both parents.
    (c) Special rules for employers--Effect of section 414. All 
employees treated as employed by a single employer under section 414 
(b), (c), (m), or (o) will be treated as employed by a single employer 
for purposes of this section. Thus, employees of one corporation that is 
part of a controlled group of corporations may under certain 
circumstances be eligible to receive section 132 benefits from the other 
corporations that comprise the controlled group. However, the 
aggregation of employers described in this paragraph (c) does not change 
the other requirements for an exclusion, such as the line of business 
requirement. Thus, for example, if a controlled group of corporations 
consists of two corporations that operate in different lines of 
business, the corporations are not treated as operating in the same line 
of business even though the corporations are treated as one employer.
    (d) Customers not to include employees. For purposes of section 132 
and the regulations thereunder, the term ``customer'' means any customer 
who is not an employee. However, the preceding sentence does not apply 
to section 132(c)(2) (relating to the gross profit percentage for 
determining a qualified employee discount). Thus, an employer that 
provides employee discounts cannot exclude sales made to employees in 
determining the aggregate sales to customers.
    (e) Treatment of on-premises athletic facilities--(1) In general. 
Gross income does not include the value of any on-premises athletic 
facility provided by an employer to its employees. For purposes of 
section 132(h)(5) and this paragraph (e), the term ``on-premises 
athletic facility'' means any gym or other athletic facility (such as a 
pool, tennis court, or golf course)--
    (i) Which is located on the premises of the employer, (ii) Which is 
operated by the employer, and (iii) Substantially all of the use of 
which during the calendar year is by employees of the employer, their 
spouses, and their dependent children.

For purposes of paragraph (e) (1) (iii) of this section, the term 
``dependent children'' has the same meaning as the plural of the term 
``dependent child'' in paragraph (b)(5) of this section. The exclusion 
of this paragraph (e) does not apply to any athletic facility if access 
to the facility is made available to the general public through the sale 
of memberships, the rental of the facility, or a similar arrangement.
    (2) Premises of the employer. The athletic facility need not be 
located on the employer's business premises. However, the athletic 
facility must be located on premises of the employer. The exclusion 
provided in this paragraph (e) applies whether the premises are owned or 
leased by the employer; in addition,

[[Page 549]]

the exclusion is available even if the employer is not a named lessee on 
the lease so long as the employer pays reasonable rent. The exclusion 
provided in this paragraph (e) does not apply to any athletic facility 
that is a facility for residential use. Thus, for example, a resort with 
accompanying athletic facilities (such as tennis courts, pool, and gym) 
would not qualify for the exclusion provided in this paragraph (e). An 
athletic facility is considered to be located on the employer's premises 
if the facility is located on the premises of a voluntary employees' 
beneficiary association funded by the employer.
    (3) Application of rules to membership in an athletic facility. The 
exclusion provided in this paragraph (e) does not apply to any 
membership in an athletic facility (including health clubs or country 
clubs) unless the facility is owned (or leased) and operated by the 
employer and substantially all the use of the facility is by employees 
of the employer, their spouses, and their dependent children. Therefore, 
membership in a health club or country club not meeting the rules 
provided in this paragraph (e) would not qualify for the exclusion.
    (4) Operation by the employer. An employer is considered to operate 
the athletic facility if the employer operates the facility through its 
own employees, or if the employer contracts out to another to operate 
the athletic facility. For example, if an employer hires an independent 
contractor to operate the athletic facility for the employer's 
employees, the facility is considered to be operated by the employer. In 
addition, if an athletic facility is operated by more than one employer, 
it is considered to be operated by each employer. For purposes of 
paragraph (e) (1) (iii) of this section, substantially all of the use of 
a facility that is operated by more than one employer must be by 
employees of the various employers, their spouses, and their dependent 
children. Where the facility is operated by more than one employer, an 
employer that pays rent either directly to the owner of the premises or 
to a sublessor of the premises is eligible for the exclusion. If an 
athletic facility is operated by a voluntary employees' beneficiary 
association funded by an employer, the employer is considered to operate 
the facility.
    (5) Nonapplicability of nondiscrimination rules. The 
nondiscrimination rules of section 132 and Sec. 1.132-8 do not apply to 
on-premises athletic facilities.
    (f) Nonapplicability of section 132 in certain cases--(1) Tax 
treatment provided for in another section. If the tax treatment or a 
particular fringe benefit is expressly provided for in another section 
of Chapter 1 of the Internal Revenue Code of 1986, section 132 and the 
applicable regulations (except for section 132 (e) and the regulations 
thereunder) do not apply to such fringe benefit. For example, because 
section 129 provides an exclusion from gross income for amounts paid or 
incurred by an employer for dependent care assistance for an employee, 
the exclusions under section 132 and this section do not apply to the 
provision by an employer to an employee of dependent care assistance. 
Similarly, because section 117 (d) applies to tuition reductions, the 
exclusions under section 132 do not apply to free or discounted tuition 
provided to an employee by an organization operated by the employer, 
whether the tuition is for study at or below the graduate level. Of 
course, if the amounts paid by the employer are for education relating 
to the employee's trade or business of being an employee of the employer 
so that, if the employee paid for the education, the amount paid could 
be deducted under section 162, the costs of the education may be 
eligible for exclusion as a working condition fringe.
    (2) Limited statutory exclusions. If another section of Chapter 1 of 
the Internal Revenue Code of 1986 provides an exclusion from gross 
income based on the cost of the benefit provided to the employee and 
such exclusion is a limited amount, section 132 and the regulations 
thereunder may apply to the extent the cost of the benefit exceeds the 
statutory exclusion.
    (g) Effective date. Sections 1.132-0, 1.132-1, 1.132-2, 1.132-3, 
1.132-4, 1.132-5, 1.132-6, 1.132-7 and 1.132-8 are effective as of 
January 1, 1989, except that Sec. Sec. 1.132-1(b)(1) with respect to 
the use of air transportation by a parent of an employee and 1.132-4(d) 
are effective as of January 1, 1985. Furthermore, in

[[Page 550]]

Sec. 1.132-5, the eleventh sentence of paragraph (m)(1), Examples 6 and 
7 in paragraph (m)(8), and paragraphs (m)(2)(i), (m)(2)(v), (m)(3)(iv), 
(m)(6), (m)(7), and (r) are effective December 30, 1992; however, 
taxpayers may treat the rules as applicable to benefits provided on or 
after January 1, 1989. For the applicable rules relating to employer-
provided transportation for security concerns prior to December 30, 
1992, see Sec. 1.132-5(m) (as contained in 26 CFR part 1 (Sec. Sec. 
1.61 to 1.169) revised April 1, 1992). See Sec. Sec. 1.132-1T, 1.132-
2T, 1.132-3T, 1.132-4T, 1.132-5T, 1.132-6T, 1.132-7T and 1.132-8T for 
rules in effect for benefits received from January 1, 1985, to December 
31, 1988.

[T.D. 8256, 54 FR 28601, July 6, 1989, as amended by T.D. 8457, 57 FR 
62196, Dec. 30, 1992; 58 FR 7296, Feb. 5, 1993]



Sec. 1.132-1T  Exclusion from gross income of certain fringe benefits
--1985 through 1988 (temporary).

    (a) In general. Gross income does not include any fringe benefit 
which qualifies as a--
    (1) No-additional-cost service,
    (2) Qualified employee discount,
    (3) Working condition fringe, or
    (4) De minimis fringe.

Special rules apply with respect to certain on-premises gyms and other 
athletic facilities (Sec. 1.132-1T(e)), demonstration use of employer-
provided automobiles by full-time automobile salesmen (Sec. 1.132-
1T(n)), parking provided to an employee on or near the business premises 
of the employer (Sec. 1.132-5T(o)), and on-premises eating facilities 
(Sec. 1.132-7T).
    (b) Definition of employee--(1) No-additional-cost services and 
qualified employee discounts. For purposes of section 132(a)(1) 
(relating to no-additional-cost services) and section 132(a)(2) 
(relating to qualified employee discounts), the term ``employee'' (with 
respect to a line of business of an employer) means--
    (i) Any individual who is currently employed by the employer in the 
line of business,
    (ii) Any individual who was formerly employed by the employer in the 
line of business and who separated from service with the employer in the 
line of business by reason of retirement or disability, and
    (iii) Any widow or widower of an individual who died while employed 
by the employer in the line of business or who separated from service 
with the employer in the line of business by reason of retirement or 
disability.

For purposes of this paragraph (b)(1), any partner who performs services 
for a partnership is considered employed by the partnership. In 
addition, any use by the spouse or dependent child (as defined in this 
paragraph (b)) of the employee will be treated as use by the employee.
    (2) Working condition fringes. For purposes of section 132(a)(2) 
(relating to working condition fringes), the term ``employee'' means--
    (i) Any individual who is currently employed by the employer,
    (ii) Any partner who performs services for the partnership,
    (iii) Any director of the employer, and
    (iv) Any independent contractor who performs services for the 
employer.

Notwithstanding anything in this paragraph (b)(2) to the contrary, any 
independent contractor who performs services for the employer cannot 
exclude the value of parking or the use of consumer goods provided 
pursuant to a product testing program under Sec. 1.132-5T (n); in 
addition, any director of the employer cannot exclude the value of the 
use of consumer goods provided pursuant to a product testing program 
under Sec. 1.132-5T (n).
    (3) De minimis fringe. For purpose of section 132(a)(4) (relating to 
de minimis fringes), the term ``employee'' means any recipient of a 
fringe benefit.
    (4) Dependent child. For purposes of this paragraph (b), the term 
``dependent child'' means any son, stepson, daughter or stepdaughter of 
the employee who is a dependent of the employee, or both of whose 
parents are deceased. Any child to whom section 152(e) applies will be 
treated as the dependent of both parents.
    (c) Special rules for employers--Effect of section 414. All 
employees treated as employed by a single employer under section 414(b), 
(c) or (m) will be treated as employed by a single employer for

[[Page 551]]

purposes of this section. Thus, employees of one corporation that is 
part of a controlled group of corporations may under certain 
circumstances be eligible to receive section 132 benefits from the other 
corporations that comprise the controlled group. However, the 
aggregation of employers described in this paragraph (c) does not change 
the other requirements for an exclusion, such as the line of business 
requirement. Thus, for example, if a controlled group of corporations 
consists of two corporations that operate in different lines of 
business, the corporations are not treated as operating in the same line 
of business even though the corporations are treated as one employer.
    (d) Customers not to include employees. For purposes of section 132 
and the regulations thereunder, the term ``customer'' means customers 
who are not employees. However, the preceding sentence does not apply to 
section 132(c)(2) (relating to the gross profit percentage for 
determining a qualified employee discount). Thus, an employer that 
provides employee discounts cannot exclude sales made to employees in 
determining the aggregate sales to customers.
    (e) Treatment of on-premises athletic facilities--(1) In general. 
Gross income does not include the value of any on-premises athletic 
facility provided by the employer to its employees. For purposes of 
section 132 and this paragraph (e), the term ``on-premises athletic 
facility'' means any gym or other athletic facility (such as a pool, 
tennis court, or golf course)--
    (i) Which is located on the premises of the employer,
    (ii) Which is operated by the employer, and
    (iii) Where substantially all of the use of which is, during the 
calendar year, by employees of the employer, their spouses, and their 
dependent children.

For purposes of this paragraph (e)(1)(iii), the term ``dependent 
children'' has the same meaning as the plural of the term ``dependent 
child'' in paragraph (b)(4) of this section. The exclusion of this 
paragraph (e) does not apply to any athletic facility if access to the 
facility is made available to the general public through the sale of 
memberships, the rental of the facility, etc.
    (2) Premises of the employer. The athletic facility need not be 
located on the employer's business premises. However, the athletic 
facility must be located on premises of the employer. The exclusion 
provided in this paragraph (e) applies whether the premises are owned or 
leased by the employer; in addition, the exclusion is available even if 
the employer is not a named lesse on the lease so long as the employer 
pays reasonable rent. The exclusion provided in this paragraph (e) does 
not apply to any athletic facility that is a facility for residential 
use. Thus, for example, a resort with accompanying athletic facilities 
(such as tennis courts, pool, and gym) would not qualify for the 
exclusion provided in this paragraph (e).
    (3) Application of rules to membership in an athletic facility. The 
exclusion provided in this paragraph (e) does not apply to any 
membership in an athletic facility (including health clubs or country 
clubs) unless the facility is owned (or leased) and operated by the 
employer and substantially all the use of the facility is by employees 
of the employer, their spouses, and their dependent children. Therefore, 
membership in health club or country club not meeting the rules provided 
in this paragraph (e) would not quality for the exclusion.
    (4) Operation by the employer. An employer is considered to operate 
the athletic facility if the employer itself operates the facility 
through its own employees, or if the employer contracts out to another 
to operate the athletic facility. For example, if an employer hires an 
independent contractor to operate the athletic facility for the 
employer's employees, the facility is considered to be operated by the 
employer. In addition, if an athletic facility is operated by more than 
one employer, it is considered to be operated by each employer. For 
purposes of paragraph (e)(1)(iii) of this section, substantially all the 
use of a facility operated by more than one employer must be by 
employees of all of the employers, their spouses, and their dependent 
children. Where the facility is operated by more than one employer, an 
employer

[[Page 552]]

that either pays rent directly to the owner of the premises or pays rent 
to a named lessor of the premises is eligible for the exclusion.
    (5) Nonapplicability of nondiscrimination rules. The 
nondiscrimination rules of section 132 and Sec. 1.132-8T do not apply 
to on-premises athletic facilities.
    (f) Nonapplicability of section 132. If the tax treatment of a 
particular fringe benefit is expressely provided for in another section 
of Chapter 1, section 132 and the applicable regulations (except for 
section 132 (e) and the regulations thereunder) do not apply to such 
fringe benefits. For example, since section 129 provides an exclusion 
from gross income for amounts paid or incurred by the employer for 
dependent care assistance for an employee, the exclusions under section 
132 and this section do not apply to the provision by an employer to an 
employee of dependent care assistance.

[T.D. 8063, 50 FR 52297, Dec. 23, 1985, as amended by T.D. 8256, 54 FR 
28600, July 6, 1989]



Sec. 1.132-2  No-additional-cost services.

    (a) In general--(1) Definition. Gross income does not include the 
value of a no-additional-cost service. A ``no-additional-cost service'' 
is any service provided by an employer to an employee for the employee's 
personal use if--
    (i) The service is offered for sale by the employer to its customers 
in the ordinary course of the line of business of the employer in which 
the employee performs substantial services, and
    (ii) The employer incurs no substantial additional cost in providing 
the service to the employee (including foregone revenue and excluding 
any amount paid by or on behalf of the employee for the service).

For rules relating to the line of business limitation, see Sec. 1.132-
4. For purposes of this section, a service will not be considered to be 
offered for sale by the employer to its customers if that service is 
primarily provided to employees and not to the employer's customers.
    (2) Excess capacity services. Services that are eligible for 
treatment as no-additional-cost services include excess capacity 
services such as hotel accommodations; transportation by aircraft, 
train, bus, subway, or cruise line; and telephone services. Services 
that are not eligible for treatment as no-additional-cost services are 
non-excess capacity services such as the facilitation by a stock 
brokerage firm of the purchase of stock. Employees who receive non-
excess capacity services may, however, be eligible for a qualified 
employee discount of up to 20 percent of the value of the service 
provided. See Sec. 1.132-3.
    (3) Cash rebates. The exclusion for a no-additional-cost service 
applies whether the service is provided at no charge or at a reduced 
price. The exclusion also applies if the benefit is provided through a 
partial or total cash rebate of an amount paid for the service.
    (4) Applicability of nondiscrimination rules. The exclusion for a 
no-additional-cost service applies to highly compensated employees only 
if the service is available on substantially the same terms to each 
member of a group of employees that is defined under a reasonable 
classification set up by the employer that does not discriminate in 
favor of highly compensated employees. See Sec. 1.132-8.
    (5) No substantial additional cost--(i) In general. The exclusion 
for a no-additional-cost service applies only if the employer does not 
incur substantial additional cost in providing the service to the 
employee. For purposes of the preceding sentence, the term ``cost'' 
includes revenue that is forgone because the service is provided to an 
employee rather than a nonemployee. (For purposes of determining whether 
any revenue is forgone, it is assumed that the employee would not have 
purchased the service unless it were available to the employee at the 
actual price charged to the employee.) Whether an employer incurs 
substantial additional cost must be determined without regard to any 
amount paid by the employee for the service. Thus, any reimbursement by 
the employee for the cost of providing the service does not affect the 
determination of whether the employer incurs substantial additional 
cost.
    (ii) Labor intensive services. An employer must include the cost of 
labor

[[Page 553]]

incurred in providing services to employees when determining whether the 
employer has incurred substantial additional cost. An employer incurs 
substantial additional cost, whether non-labor costs are incurred, if a 
substantial amount of time is spent by the employer or its employees in 
providing the service to employees. This would be the result whether the 
time spent by the employer or its employees in providing the services 
would have been ``idle,'' or if the services were provided outside 
normal business hours. An employer generally incurs no substantial 
additional cost, however, if the services provided to the employee are 
merely incidental to the primary service being provided by the employer. 
For example, the in-flight services of a flight attendant and the cost 
of in-flight meals provided to airline employees traveling on a space-
available basis are merely incidental to the primary service being 
provided (i.e., air transportation). Similarly, maid service provided to 
hotel employees renting hotel rooms on a space-available basis is merely 
incidental to the primary service being provided (i.e., hotel 
accommodations).
    (6) Payments for telephone service. Payment made by an entity 
subject to the modified final judgment (as defined in section 559(c)(5) 
of the Tax Reform Act of 1984) of all or part of the cost of local 
telephone service provided to an employee by a person other than an 
entity subject to the modified final judgment shall be treated as 
telephone service provided to the employee by the entity making the 
payment for purposes of this section. The preceding sentence also 
applies to a rebate of the amount paid by the employee for the service 
and a payment to the person providing the service. This paragraph (a)(6) 
applies only to services and employees described in Sec. 1.132-4 (c). 
For a special line of business rule relating to such services and 
employees, see Sec. 1.132-4 (c).
    (b) Reciprocal agreements. For purposes of the exclusion from gross 
income for a no-additional-cost service, an exclusion is available to an 
employee of one employer for a no-additional-cost service provided by an 
unrelated employer only if all of the following requirements are 
satisfied--
    (1) The service provided to such employee by the unrelated employer 
is the same type of service generally provided to nonemployee customers 
by both the line of business in which the employee works and the line of 
business in which the service is provided to such employee (so that the 
employee would be permitted to exclude from gross income the value of 
the service if such service were provided directly by the employee's 
employer);
    (2) Both employers are parties to a written reciprocal agreement 
under which a group of employees of each employer, all of whom perform 
substantial services in the same line of business, may receive no-
additional-cost services from the other employer; and
    (3) Neither employer incurs any substantial additional cost 
(including forgone revenue) in providing such service to the employees 
of the other employer, or pursuant to such agreement. If one employer 
receives a substantial payment from the other employer with respect to 
the reciprocal agreement, the paying employer will be considered to have 
incurred a substantial additional cost pursuant to the agreement, and 
consequently services performed under the reciprocal agreement will not 
qualify for exclusion as no-additional-cost services.
    (c) Example. The rules of this section are illustrated by the 
following example:

    Example. Assume that a commercial airline permits its employees to 
take personal flights on the airline at no charge and receive reserved 
seating. Because the employer forgoes potential revenue by permitting 
the employees to reserve seats, employees receiving such free flights 
are not eligible for the no-additional-cost exclusion.

[T.D. 8256, 54 FR 28602, July 6, 1989]



Sec. 1.132-2T  No-additional-cost service--1985 through 1988 (temporary).

    (a) In general--(1) Definition. Gross income does not include the 
value of a no-additional-cost service. The term ``no-additional-cost 
service'' means any service provided by an employer to an employee for 
the employee's personal use if--
    (i) The service is offered for sale to customers in the ordinary 
course of the line of business of the employer in

[[Page 554]]

which the employee performs substantial services, and
    (ii) The employer incurs no substantial additional cost in providing 
the service to the employee (including forgone revenue and excluding any 
amount paid by or on behalf of the employee for the service).

For rules relating to the line of business limitation, see Sec. 1.132-
4T.
    (2) Examples. Services that are eligible for treatment as no-
additional-cost services are excess capacity services such as hotel 
accommodations; transportation by aircraft, train, bus, subway, or 
cruise line; and telephone services. Services that are not eligible for 
treatment as no-additonal-cost services are non-excess capacity services 
such as the facilitation by a stock brokerage firm of the purchase of 
stock. Employees who receive non-excess capacity services may, however, 
be eligible for a qualified employee discount of up to 20 percent of the 
value of the service provided. See Sec. 1.132-3T.
    (3) Cash rebates. The exclusion for a no-additional-cost service 
applies whether the service is provided at no charge or at a reduced 
price. The exclusion also applies if the benefit is provided through a 
partial or total cash rebate of an amount paid for the service.
    (4) Applicability of nondiscrimination rules. The exclusion for a 
no-additional-cost service applies to officers, owners, and highly 
compensated employees only if the service is available on substantially 
the same terms to each member of a group of employees that is defined 
under a reasonable classification set up by the employer that does not 
discriminate in favor of officers, owners, or highly compensated 
employees. See Sec. 1.132-8T.
    (5) No substantial additional cost--(i) In general. The exclusion 
for a non-additional-cost service applies only if the employer does not 
incur substantial additional cost in providing the service to the 
employee. For purposes of the preceding sentence, the term ``cost'' 
includes revenue that is forgone because the service is provided to an 
employee rather than a nonemployee. (For purposes of determining whether 
any revenue is forgone, it is assumed that the employee would not have 
purchased the service unless it were available to the employee at the 
actual price charged to the employee.) Whether an employer incurs 
substantial additional cost must be determined without regard to any 
amount paid by the employee for the service. Thus, any reimbursement by 
the employee for the cost of providing the service does not affect the 
determination of whether the employer incurs substantial additional 
cost.
    (ii) Labor intensive services. An employer must include the cost of 
labor incurred in providing services to employees when determining 
whether the employer has incurred substantial additional cost. An 
employer has incurred substantial additional cost. An employer incurs 
substantial additional cost, whether or not non-labor costs are 
incurred, if a substantial amount of time is spent by the employer or 
its employees in providing the service to employees. This would be the 
result whether or not the time spent by the employer or its employees in 
providing the services would have been ``idle'', or if the services were 
provided outside normal business hours. An employer generally incurs no 
substantial additional cost, however, if the employee services provided 
are merely incidental to the primary service being provided by the 
employer. For example, the in-flight services of a flight attendant 
provided to airline employees traveling on a space-available basis are 
merely incidental to the primary service being provided (i.e., air 
transportation). In addition, the cost of in-flight meals provided to 
airline employees is not considered substantial in relation to the air 
transportation being provided.
    (b) Reciprocal agreements. For purposes of the exclusion for a no-
additional-cost service, any service provided by an employer to an 
employee of another employer shall be treated as provided by the 
employer of such employee if all of the following requirements are 
satisfied:
    (1) The service is provided pursuant to a written reciprocal 
agreement between the employers under which a group of employees of each 
employer, all of whom perform substantial services in the same line of 
business, may

[[Page 555]]

receive no-additional-cost services from the other employer;
    (2) The service provided pursuant to the agreement to the employees 
of both employers is the same type of service provided by the employers 
to customers both in the line of business in which the employees perform 
substantial services and the line of business in which the service is 
provided to customers; and
    (3) Neither employer incurs substantial additional cost (including 
forgone revenue) in providing the service to the employees of the other 
employer or pursuant to the agreement.

If one employer receives a substantial payment from the other employer 
with respect to the reciprocal agreement, the paying employer will be 
considered to have incurred a substantial additional cost pursuant to 
the agreement.

[T.D. 8063, 50 FR 52298, Dec. 23, 1985, as amended by T.D. 8256, 54 FR 
28600, July 6, 1989]



Sec. 1.132-3  Qualified employee discounts.

    (a) In general--(1) Definition. Gross income does not include the 
value of a qualified employee discount. A ``qualified employee 
discount'' is any employee discount with respect to qualified property 
or services provided by an employer to an employee for use by the 
employee to the extent the discount does not exceed--
    (i) The gross profit percentage multiplied by the price at which the 
property is offered to customers in the ordinary course of the 
employer's line of business, for discounts on property, or
    (ii) Twenty percent of the price at which the service is offered to 
customers, for discounts on services.
    (2) Qualified property or services--(i) In general. The term 
``qualified property or services'' means any property or services that 
are offered for sale to customers in the ordinary course of the line of 
business of the employer in which the employee performs substantial 
services. For rules relating to the line of business limitation, see 
Sec. 1.132-4.
    (ii) Exception for certain property. The term ``qualified property'' 
does not include real property and it does not include personal property 
(whether tangible or intangible) of a kind commonly held for investment. 
Thus, an employee may not exclude from gross income the amount of an 
employee discount provided on the purchase of securities, commodities, 
or currency, or of either residential or commercial real estate, whether 
or not the particular purchase is made for investment purposes.
    (iii) Property and services not offered in ordinary course of 
business. The term ``qualified property or services'' does not include 
any property or services of a kind that is not offered for sale to 
customers in the ordinary course of the line of business of the 
employer. For example, employee discounts provided on property or 
services that are offered for sale primarily to employees and their 
families (such as merchandise sold at an employee store or through an 
employer-provided catalog service) may not be excluded from gross 
income. For rules relating to employer-operated eating facilities, see 
Sec. 1.132-7, and for rules relating to employer-operated on-premises 
athletic facilities, see Sec. 1.132-1(e).
    (3) No reciprocal agreement exception. The exclusion for a qualified 
employee discount does not apply to property or services provided by 
another employer pursuant to a written reciprocal agreement that exists 
between employers to provide discounts on property and services to 
employees of the other employer.
    (4) Property or services provided without charge, at a reduced 
price, or by rebates. The exclusion for a qualified employee discount 
applies whether the property or service is provided at no charge (in 
which case only part of the discount may be excludable as a qualified 
employee discount) or at a reduced price. The exclusion also applies if 
the benefit is provided through a partial or total cash rebate of an 
amount paid for the property or service.
    (5) Property or services provided directly by the employer or 
indirectly through a third party. A qualified employee discount may be 
provided either directly by the employer or indirectly through a third 
party. For example, an employee of an appliance manufacturer may receive 
a qualified employee discount on the manufacturer's appliances purchased 
at a retail store that offers

[[Page 556]]

such appliances for sale to customers. The employee may exclude the 
amount of the qualified employee discount whether the employee is 
provided the appliance at no charge or purchases it at a reduced price, 
or whether the employee receives a partial or total cash rebate from 
either the employer-manufacturer or the retailer. If an employee 
receives additional rights associated with the property that are not 
provided by the employee's employer to customers in the ordinary course 
of the line of business in which the employee performs substantial 
services (such as the right to return or exchange the property or 
special warranty rights), the employee may only receive a qualified 
employee discount with respect to the property and not the additional 
rights. Receipt of such additional rights may occur, for example, when 
an employee of a manufacturer purchases property manufactured by the 
employee's employer at a retail outlet.
    (6) Applicability of nondiscrimination rules. The exclusion for a 
qualified employee discount applies to highly compensated employees only 
if the discount is available on substantially the same terms to each 
member of a group of employees that is defined under a reasonable 
classification set up by the employer that does not discriminate in 
favor of highly compensated employees. See Sec. 1.132-8.
    (b) Employee discount--(1) Definition. The term ``employee 
discount'' means the excess of--
    (i) The price at which the property or service is being offered by 
the employer for sale to customers, over
    (ii) The price at which the property or service is provided by the 
employer to an employee for use by the employee. A transfer of property 
by an employee without consideration is treated as use by the employee 
for purposes of this section. Thus, for example, if an employee receives 
a discount on property offered for sale by his employer to customers and 
the employee makes a gift of the property to his parent, the property 
will be considered to be provided for use by the employee; thus, the 
discount will be eligible for exclusion as a qualified employee 
discount.
    (2) Price to customers--(i) Determined at time of sale. In 
determining the amount of an employee discount, the price at which the 
property or service is being offered to customers at the time of the 
employee's purchase is controlling. For example, assume that an employer 
offers a product to customers for $20 during the first six months of a 
calendar year, but at the time the employee purchases the product at a 
discount, the price at which the product is being offered to customers 
is $25. In this case, the price from which the employee discount is 
measured is $25. Assume instead that, at the time the employee purchases 
the product at a discount, the price at which the product is being 
offered to customers is $15 and the price charged the employee is $12. 
The employee discount is measured from $15, the price at which the 
product is offered for sale to customers at the time of the employee 
purchase. Thus, the employee discount is $15 -$12, or $3.
    (ii) Quantity discount not reflected. The price at which a property 
or service is being offered to customers cannot reflect any quantity 
discount unless the employee actually purchases the requisite quantity 
of the property or service.
    (iii) Price to employer's customers controls. In determining the 
amount of an employee discount, the price at which a property or service 
is offered to customers of the employee's employer is controlling. Thus, 
the price at which the property is sold to the wholesale customers of a 
manufacturer will generally be lower than the price at which the same 
property is sold to the customers of a retailer. However, see paragraph 
(a)(5) of this section regarding the effect of a wholesaler providing to 
its employees additional rights not provided to customers of the 
wholesaler in the ordinary course of its business.
    (iv) Discounts to discrete customer or consumer groups. Subject to 
paragraph (2)(ii) of this section, if an employer offers for sale 
property or services at one or more discounted prices to discrete 
customer or consumer groups, and

[[Page 557]]

sales at all such discounted prices comprise at least 35 percent of the 
employer's gross sales for a representative period, then in determining 
the amount of an employee discount, the price at which such property or 
service is being offered to customers for purposes of this section is a 
discounted price. The applicable discounted price is the current 
undiscounted price, reduced by the percentage discount at which the 
greatest percentage of the employer's discounted gross sales are made 
for such representative period. If sales at different percentage 
discounts equal the same percentage of the employer's gross sales, the 
price at which the property or service is being provided to customers 
may be reduced by the average of the discounts offered to each of the 
two groups. For purposes of this section, a representative period is the 
taxable year of the employer immediately preceding the taxable year in 
which the property or service is provided to the employee at a discount. 
If more than one employer would be aggregated under section 414 (b), 
(c), (m), or (o), and not all of the employers have the same taxable 
year, the employers required to be aggregated must designate the 12-
month period to be used in determining gross sales for a representative 
period. The 12-month period designated, however, must be used on a 
consistent basis.
    (v) Examples. The rules provided in this paragraph (b)(2) are 
illustrated by the following examples:

    Example (1). Assume that a wholesale employer offers property for 
sale to two discrete customer groups at differing prices. Assume further 
that during the prior taxable year of the employer, 70 percent of the 
employer's gross sales are made at a 15 percent discount and 30 percent 
at no discount. For purposes of this paragraph (b)(2), the current 
undiscounted price at which the property or service is being offered by 
the employer for sale to customers may be reduced by the 15 percent 
discount.
    Example (2). Assume that a retail employer offers a 20 percent 
discount to members of the American Bar Association, a 15 percent 
discount to members of the American Medical Association, and a ten 
percent discount to employees of the Federal Government. Assume further 
that during the prior taxable year of the employer, sales to American 
Bar Association members equal 15 percent of the employer's gross sales, 
sales to American Medical Association members equal 20 percent of the 
employer's gross sales, and sales to Federal Government employees equal 
25 percent of the employer's gross sales. For purposes of this paragraph 
(b)(2), the current undiscounted price at which the property or service 
is being offered by the employer for sale to customers may be reduced by 
the ten percent Federal Government discount.

    (3) Damaged, distressed, or returned goods. If an employee pays at 
least fair market value for damaged, distressed, or returned property, 
such employee will not have income attributable to such purchase.
    (c) Gross profit percentage--(1) In general--(i) General rule. An 
exclusion from gross income for an employee discount on qualified 
property is limited to the price at which the property is being offered 
to customers in the ordinary course of the employer's line of business, 
multiplied by the employer's gross profit percentage. The term ``gross 
profit percentage'' means the excess of the aggregate sales price of the 
property sold by the employer to customers (including employees) over 
the employer's aggregate cost of the property, then divided by the 
aggregate sales price.
    (ii) Calculation of gross profit percentage. The gross profit 
percentage must be calculated separately for each line of business based 
on the aggregate sales price and aggregate cost of property in that line 
of business for a representative period. For purposes of this section, a 
representative period is the taxable year of the employer immediately 
preceding the taxable year in which the discount is available. For 
example, if the aggregate amount of sales of property in an employer's 
line of business for the prior taxable year was $800,000, and the 
aggregate cost of the property for the year was $600,000, the gross 
profit percentage would be 25 percent ($800,000 minus $600,000, then 
divided by $800,000). If two or more employers are required to aggregate 
under section 414 (b), (c), (m), or (o) (aggregated employer), and if 
all of the aggregated employers do not share the same taxable year, then 
the aggregated employers must designate the 12-month period to be used 
in determining the gross profit percentage. The 12-month period 
designated, however, must be used on a consistent basis. If

[[Page 558]]

an employee performs substantial services in more than one line of 
business, the gross profit percentage of the line of business in which 
the property is sold determines the amount of the excludable employee 
discount.
    (iii) Special rule for employers in their first year of existence. 
An employer in its first year of existence may estimate the gross profit 
percentage of a line of business based on its mark-up from cost. 
Alternatively, an employer in its first year of existence may determine 
the gross profit percentage by reference to an appropriate industry 
average.
    (iv) Redetermination of gross profit percentage. If substantial 
changes in an employer's business indicate at any time that it is 
inappropriate for the prior year's gross profit percentage to be used 
for the current year, the employer must, within a reasonable period, 
redetermine the gross profit percentage for the remaining portion of the 
current year as if such portion of the year were the first year of the 
employer's existence.
    (2) Line of business. In general, an employer must determine the 
gross profit percentage on the basis of all property offered to 
customers (including employees) in each separate line of business. An 
employer may instead select a classification of property that is 
narrower than the applicable line of business. However, the 
classification must be reasonable. For example, if an employer computes 
gross profit percentage according to the department in which products 
are sold, such classification is reasonable. Similarly, it is reasonable 
to compute gross profit percentage on the basis of the type of 
merchandise sold (such as high mark-up and low mark-up classifications). 
It is not reasonable, however, for an employer to classify certain low 
mark-up products preferred by certain employees (such as highly 
compensated employees) with high mark-up products or to classify certain 
high mark-up products preferred by other employees with low mark-up 
products.
    (3) Generally accepted accounting principles. In general, the 
aggregate sales price of property must be determined in accordance with 
generally accepted accounting principles. An employer must compute the 
aggregate cost of property in the same manner in which it is computed 
for the employer's Federal income tax liability; thus, for example, 
section 263A and the regulations thereunder apply in determining the 
cost of property.
    (d) Treatment of leased sections of department stores--(1) In 
general--(i) General rule. For purposes of determining whether employees 
of a leased section of a department store may receive qualified employee 
discounts at the department store and whether employees of the 
department store may receive qualified employee discounts at the leased 
section of the department store, the leased section is treated as part 
of the line of business of the person operating the department store, 
and employees of the leased section are treated as employees of the 
person operating the department store as well as employees of their 
employer. The term ``leased section of a department store'' means a 
section of a department store where substantially all of the gross 
receipts of the leased section are from over-the-counter sales of 
property made under a lease, license, or similar arrangement where it 
appears to the general public that individuals making such sales are 
employed by the department store. A leased section of a department store 
which, in connection with the offering of beautician services, 
customarily makes sales of beauty aids in the ordinary course of 
business is deemed to derive substantially all of its gross receipts 
from over-the-counter sales of property.
    (ii) Calculation of gross profit percentage. For purposes of 
paragraph (d) of this section, when calculating the gross profit 
percentage of property and services sold at a department store, sales of 
property and services sold at the department store, as well as sales of 
property and services sold at the leased section, are considered. The 
rule provided in the preceding sentence does not apply, however, if it 
is more reasonable to calculate the gross profit percentage for the 
department store and leased section separately, or if it would be 
inappropriate to combine them (such as where either the department store 
or the leased section but not both provides employee discounts).

[[Page 559]]

    (2) Employees of the leased section--(i) Definition. For purposes of 
this paragraph (d), ``employees of the leased section'' means all 
employees who perform substantial services at the leased section of the 
department store regardless of whether the employees engage in over-the-
counter sales of property or services. The term ``employee'' has the 
same meaning as in section 132(f) and Sec. 1.132-1(b)(1).
    (ii) Discounts offered to either department store employees or 
employees of the leased section. If the requrements of this paragraph 
(d) are satisfied, employees of the leased section may receive qualified 
employee discounts at the department store whether or not employees of 
the department store are offered discounts at the leased section. 
Similarly, employees of the department store may receive a qualified 
employee discount at the leased section whether or not employees of the 
leased section are offered discounts at the department store.
    (e) Excess discounts. Unless excludable under a provision of the 
Internal Revenue Code of 1986 other than section 132(a)(2), an employee 
discount provided on property is excludable to the extent of the gross 
profit percentage multiplied by the price at which the property is being 
offered for sale to customers. If an employee discount exceeds the gross 
profit percentage, the excess discount is includible in the employee's 
income. For example, if the discount on employer-purchased property is 
30 percent and the employer's gross profit percentage for the period in 
the relevant line of business is 25 percent, then 5 percent of the price 
at which the property is being offered for sale to customers is 
includible in the empoyee's income. With respect to services, an 
employee discount of up to 20 percent may be excludable. If an employee 
discount exceeds 20 percent, the excess discount is includible in the 
employee's income. For example, assume that a commercial airline 
provides a pass to each of its employees permitting the employees to 
obtain a free round-trip coach ticket with a confirmed seat to any 
destination the airline services. Neither the exclusion of section 
132(a)(1) (relating to no-additional-cost services) nor any other 
statutory exclusion applies to a flight taken primarily for personal 
purposes by an employee under this program. However, an employee 
discount of up to 20 percent may be excluded as a qualified employee 
discount. Thus, if the price charged to customers for the flight taken 
is $300 (under restrictions comparable to those actually placed on 
travel associated with the employee airline ticket), $60 is excludible 
from gross income as a qualified employee discount and $240 is 
includible in gross income.

[T.D. 8256, 54 FR 28603, July 6, 1989]



Sec. 1.132-3T  Qualified employee discount--1985 through 1988 
(temporary).

    (a) In general--(1) Definition. Gross income does not include the 
value of a qualified employee discount. The term ``qualified employee 
discount'' means any employee discount with respect to qualified 
property or services provided by an employer to an employee for the 
employee's personal use to the extent the discount does not exceed--
    (i) The gross profit percentage of the price at which the property 
is offered to customers, for discounts on property, or
    (ii) 20 percent of the price at which the services are offered to 
customers, for discounts on services.
    (2) Qualified property or services--(i) In general. The term 
``qualified property or services'' means any property or services that 
are offered for sale to customers in the ordinary course of the line of 
business of the employer in which the employee performs substantial 
services. For rules relating to the line of business limitation, see 
Sec. 1.132-4T.
    (ii) Exception for certain property. The term ``qualified property'' 
does not include real property and it does not include personal property 
(whether tangible or intangible) of a kind commonly held for investment. 
Thus, an employee may not exclude from gross income the amount of an 
employee discount provided on the purchase of either residential or 
commercial real estate, securities, commodities, or currency, whether or 
not the particular purchase is made for investment purposes.

[[Page 560]]

    (iii) Property and services not offered in ordinary course of 
business. The term ``qualified property or services'' does not include 
any property or services of a kind that is not offered for sale to 
customers in the ordinary course of the line of business of the 
employer. For example, employee discounts provided on property or 
services that are offered for sale only to employees and their families 
(such as merchandise sold at an employee store or through an employer-
provided catalog service) may not be excluded from gross income.
    (3) No reciprocal agreement exception. The exclusion for a qualified 
employee discount does not apply to property or services provided by 
another employer pursuant to a written reciprocal agreement that exists 
between employers to provide discounts on property and services to 
employees of the other employer.
    (4) Cash or third-party rebates--(i) Property or services provided 
without charge or at a reduced price. The exclusion for a qualified 
employee discount applies whether the property or service is provided at 
no charge (in which case only part of the discount may be excludable as 
a qualified employee discount) or at a reduced price. The exclusion also 
applies if the benefit is provided through a partial or total cash 
rebate of an amount paid for the property or service.
    (ii) Property or services provided directly by the employer or 
indirectly through a third party. A qualified employee discount may be 
provided either directly by the employer or indirectly through a third 
party. For example, an employee of an appliance manufacturer may receive 
a qualified employee discount on the manufacturer's appliances purchased 
at a retail store that offers such appliances for sale to customers. The 
employee may exclude the amount of the qualified employee discount 
whether the employee is provided the appliance at no charge or purchases 
it at a reduced price, or whether the employee receives a partial or 
total cash rebate from either the employer-manufacturer or the retailer. 
If an employee receives additional rights associated with the property 
that are not provided by the employee's employer to customers in the 
ordinary course of the line of business in which the employee performs 
substantial services (such as the right to return or exchange the 
property or special warranty rights), the employee may only receive a 
qualified employee discount with respect to the property and not the 
additional rights. Receipt of such additional rights may occur, for 
example, when an employee of a manufacturer purchases property 
manufactured by the employee's employer at a retail outlet.
    (5) Applicability of nondiscrimination rules. The exclusion for a 
qualified employee discount applies to officers, owners, and highly 
compensated employees only if the discount is available on substantially 
the same terms to each member of a group of employees that is defined 
under a reasonable classification set up by the employer that does not 
discriminate in favor of officers, owners, or highly compensated 
employees. See Sec. 1.132-8T.
    (b) Employee discount--(1) Definition. The term ``employee 
discount'' means the excess of--
    (i) The price at which the property or service is being offered by 
the employer for sale to customers, over
    (ii) The price at which the property or service is provided by the 
employer to an employee for use by the employee.

A transfer of property by an employee without consideration is 
considered use by the employee for purposes of this section. Thus, for 
example, if an employee receives a discount on property offered for sale 
by his employer to customers and the employee makes a gift of the 
property to his parent, the property will be considered to be provided 
for use by the employee, thus enabling the discount to be eligible for 
exclusion as a qualified employee discount.
    (2) Price to customers--(i) Determined at time of sale. In 
determining the amount of an employee discount, the price at which the 
property or service is being offered to customers at the time of the 
employee's purchase is controlling. For example, assume that an employer 
offers a product to customers for $20 during the first six months of a 
calendar year, but at the time the employee purchases the product at a 
discount, the price at which the product is being offered to customers 
is $25. In

[[Page 561]]

this case, the price from which the employee discount is measured is 
$25.
    (ii) Quantity discount not reflected. The price referred to in 
paragraph (b)(2)(i) of this section cannot reflect any quantity discount 
unless the employee actually purchases the requisite quantity of the 
property or service.
    (iii) Customers of employee's employer controls. In determining the 
amount of an employee discount, the price at which the property or 
service is offered to customers of the employee's employer is 
controlling. Thus, the price at which property is sold to the wholesale 
customers of a manufacturer will generally be lower than the price at 
which the same property is sold to the customers of a retailer. However, 
see paragraph (a)(4)(ii) of this section regarding the effect of a 
wholesaler providing to its employees additional rights not provided to 
customers of the wholesaler in the ordinary course of its business.
    (iv) Discounts to discrete customer or consumer groups. In 
determining the amount of an employee discount, if an employer offers 
for sale property or services at one or more discounted prices to 
discrete customer or consumer groups, and sales at all such discounted 
prices comprise at least 35 percent of the employer's gross sales for a 
representative period, then the price at which property or service is 
being offered to customers is a discounted price. The applicable 
discounted price is the current undiscounted price, reduced by the 
percentage discount at which the greatest percentage of the employer's 
gross sales are made for such representative period. If sales at 
different percentage discounts equal the same percentage of the 
employer's gross sales, the price at which the property or service is 
being provided to customers may be reduced by the average of the two 
group discounts. For purposes of this section, a representative period 
is the taxable year of the employer immediately preceding the taxable 
year in which the property or service is provided to the employee at a 
discount. If more than one employer would be aggregated under section 
414 (b), (c), or (m), and all of the employers do not have the same 
taxable year, the employers required to be aggregated must designate the 
12-month period to be used in determining gross sales for a 
representative period.
    (v) Examples. The rules provided in this paragraph (b)(2) are 
illustrated by the following examples:

    Example (1). Assume that a wholesale employer offers property for 
sale to two discrete customer groups at differing prices. Assume further 
that during the prior taxable year of the employer, 70 percent of the 
employer's gross sales are made at a 15-percent discount and 30 percent 
at no discount. The current undiscounted price at which the property or 
service is being offered by the employer for sale to customers may be 
reduced by the 15-percent discount.
    Example (2). Assume that a retail employer offers a 20 percent 
discount to members of the American Bar Association, a 15 percent 
discount to members of the American Medical Association, and a ten 
percent discount to employees of the Federal Government. Assume further 
that during the prior taxable year of the employer, sales to American 
Bar Association members equal 15 percent of the employer's gross sales, 
sales to American Medical Association members equal 20 percent of the 
employer's gross sales, and sales to Federal Government employees equal 
25 percent of the employer's gross sales. The current undiscounted price 
at which the property or service is being offered by the employer for 
sale to customers may be reduced by the ten percent Federal Government 
discount.

    (3) Damaged, distressed, or returned goods. If an employee pays at 
least fair market value for damaged, distressed, or returned property, 
such employee will not have income attributable to such purchase.
    (c) Gross profit percentage--(1) In general--(i) General rule. An 
exclusion from gross income for an employee discount on qualified 
property is limited to the price at which the property is being offered 
to customers in the ordinary course of the employer's line of business, 
multiplied by the employer's gross profit percentage. The term ``gross 
profit percentage'' means the excess of the aggregate sales price of the 
property sold by the employer to customers (including employees) over 
the employer's aggregate cost of the property, then divided by the 
aggregate sales price.
    (ii) Calculation of gross profit percentage. The gross profit 
percentage must be calculated separately for each line of business based 
on the aggregate

[[Page 562]]

sales price and aggregate cost of property in that line of business for 
a representative period. For purposes of this section, a representative 
period is the taxable year of the employer immediately preceding the 
taxable year in which the discount is available. For example, if the 
aggregate sales of property in an employer's line of business for the 
prior taxable year were $800,000, and the aggregate cost of the property 
for the year were $600,000, the gross profit percentage would be 25 
percent ($800,000 minus $600,000, then divided by $800,000). If more 
than one employer would be aggregated under section 414 (b), (c), or 
(m), and all of the employers do not have the same taxable year, the 
employers required to be aggregated must designate the 12-month period 
to be used in determining the gross profit percentage. If an employee 
performs substantial services in more than one line of business, the 
gross profit percentage of the line of business in which the property is 
sold determines the amount of the excludable employee discount.
    (iii) Special rule for employers in their first year of existence. 
An employer in its first year of existence may estimate the gross profit 
percentage of a line of business based on its mark-up from the cost. 
Alternatively, an employer in its first year of existence may determine 
the gross profit percentage by reference to an appropriate industry 
average.
    (iv) Redetermination of gross profit percentage. If substantial 
changes in an employer's business indicate at any time that it is 
inappropriate for the prior years' gross profit percentage to be used 
for the current year, the employer must, within a reasonable period, 
redetermine the gross profit percentage for the remaining portion of the 
current year as if such portion of the year were the first year of the 
employer's existence.
    (2) Line of business. In general, an employer must determine the 
gross profit percentage on the basis of all property offered to 
customers (including employees) in each separate line of business. An 
employer may instead select a classification of property that is 
narrower than the applicable line of business. However, such 
classification must be reasonable. For example, if an employer computes 
gross profit percentage according to the department in which products 
are sold, such classification is reasonable. Similarly, it is reasonable 
to compute gross profit percentage on the basis of the type of 
merchandise sold (such as high mark-up and low mark-up classifications). 
It is not reasonable, however, for an employer to classify certain low 
mark-up products preferred by certain employees (such as officers, 
owners, and highly compensated employees) with high mark-up products or 
to classify certain high mark-up products preferred by other employees 
with low mark-up products.
    (3) Generally accepted accounting principles. In general, the 
aggregate sales price of property must be determined in accordance with 
generally accepted accounting principles. An employer must compute the 
aggregate cost of property in the same manner in which it is computed 
for the employer's Federal income tax liability, pursuant to the 
inventory rules in section 471 and the regulations thereunder.
    (d) Treatment of leased sections of department stores--(1) In 
general--(i) General rule. For purposes of determining whether employees 
of a leased section of a department store may receive qualified 
employees discounts at the department store and whether employees of the 
department store may receive qualified employee discounts at the leased 
section of the department store, the leased section is treated as part 
of the line of business of the person operating the department store, 
and employees of the leased section are treated as employees of the 
person operating the department store as well as employees of their 
employer. The term ``leased section of a department store'' means a 
section of a department store where substantially all of the gross 
receipts of the leased section are over-the-counter sales of property 
made under a lease, license, or similar arrangement where it appears to 
the general public that individuals making such sales are employed by 
the department store. An example of a leased section of a department 
store is a cosmetics firm that leases floor space from a department 
store.

[[Page 563]]

    (ii) Calculation of gross profit percentage. When calculating the 
gross profit percentage of property and services sold at the department 
store under paragraph (c) of this section, sales of property and 
services sold at the department store, as well as sales of property and 
services sold at the leased section, are considered. The rule provided 
in the preceding sentence does not apply, however, if it is reasonable 
to calculate the gross profit percentage for the department store and 
leased section separately, or if it would be inappropriate to combine 
them (such as where either the department store or the leased section, 
but not both, provides employee discounts).
    (2) Employees of the leased section--(i) Definition. For purposes of 
this paragraph (d), ``employees of the leased section'' means all 
employees who perform substantial services at the leased section 
regardless of whether the employees engage in over-the-counter sales of 
property or services. The term ``employee'' has the same meaning as in 
section 133(f).
    (ii) Discounts offered to either department store employees or 
employees of the leased section. If the requirements of this paragraph 
(d) are satisfied, employees of the leased section may receive qualified 
employee discounts at the department store regardless of whether 
employees of the department store are offered discounts at the leased 
section. Similarly, regardless of whether employees of the leased 
section are offered discounts at the department store, employees of the 
department store may receive qualified employee discounts at the leased 
section.
    (e) Excess discounts. Unless excludable under a statutory provision 
other than section 132(a)(2), an employee discount provided on property 
is excludable to the extent of the gross profit percentage multiplied by 
the price at which the property is being offered for sale to customers. 
If an employee discount exceeds the gross profit percentage, the excess 
discount is includible in the employee's income. For example, if the 
discount on property is 30 percent and the employer's gross profit 
percentage for the period in the relevant line of business is 25 
percent, then 5 percent of the price at which the property is being 
offered for sale to customers is includible in the emloyee's income. 
With respect to services, an employee discount of up to 20 percent may 
be excludable. If an employee discount exceeds 20 percent, the excess 
discount is includible in the employee's income.

[T.D. 8063, 50 FR 52299, Dec. 23, 1985, as amended by T.D. 8256, 54 FR 
28600, July 6, 1989]



Sec. 1.132-4  Line of business limitation.

    (a) In general--(1) Applicability--(i) General rule. A no-
additional-cost service or a qualified employee discount provided to an 
employee is only available with respect to property or services that are 
offered for sale to customers in the ordinary course of the same line of 
business in which the employee receiving the property or service 
performs substantial services. Thus, an employee who does not perform 
substantial services in a particular line of business of the employer 
may not exclude from income under section 132 (a)(1) or (a)(2) the value 
of services or employee discounts received on property or services in 
that line of business. For rules that relax the line of business 
requirement, see paragraphs (b) through (g) of this section.
    (ii) Property and services sold to employees rather than customers. 
Because the property or services must be offered for sale to customers 
in the ordinary course of the same line of business in which the 
employee performs substantial services, the line of business limitation 
is not satisfied if the employer's products or services are sold 
primarily to employees of the employer, rather than to customers. Thus, 
for example, an employer in the banking line of business is not 
considered in the variety store line of business if the employer 
establishes an employee store that offers variety store items for sale 
to the employer's employees. See Sec. 1.132-7 for rules relating to 
employer-operated eating facilities, and see Sec. 1.132-1(e) for rules 
relating to employer-operated on-premises athletic facilities.
    (iii) Performance of substantial services in more than one line of 
business. An employee who performs services in more than one of the 
employer's lines of

[[Page 564]]

business may only exclude no-additional-cost services and qualified 
employee discounts in the lines of business in which the employee 
performs substantial services.
    (iv) Performance of services that directly benefit more than one 
line of business--(A) In general. An employee who performs substantial 
services that directly benefit more than one line of business of an 
employer is treated as performing substantial services in all such line 
of business. For example, an employee who maintains accounting records 
for an employer's three lines of business may receive qualified employee 
discounts in all three lines of business. Similarly, if an employee of a 
minor line of business of an employer that is significantly interrelated 
with a major line of business of the employer performs substantial 
services that directly benefit both the major and the minor lines of 
business, the employee is treated as performing substantial services for 
both the major and the minor lines of business.
    (B) Examples. The rules provided in this paragraph (a)(1)(iv) are 
illustrated by the following examples:

    Example (1). Assume that employees of units of an employer provide 
repair or financing services, or sell by catalog, with respect to retail 
merchandise sold by the employer. Such employees may be considered to 
perform substantial services for the retail merchandise line of business 
under paragraph (a)(1)(iv)(A) of this section.
    Example (2). Assume that an employer operates a hospital and a 
laundry service. Assume further that some of the gross receipts of the 
laundry service line of business are from laundry services sold to 
customers other than the hospital employer. Only the employees of the 
laundry service who perform substantial services which directly benefit 
the hospital line of business (through the provision of laundry services 
to the hospital) will be treated as performing substantial services for 
the hospital line of business. Other employees of the laundry service 
line of business will not be treated as employees of the hospital line 
of business.
    Example (3). Assume the same facts as in example (2), except that 
the employer also operates a chain of dry cleaning stores. Employees who 
perform substantial services which directly benefit the dry cleaning 
stores but who do not perform substantial services that directly benefit 
the hospital line of business will not be treated as performing 
substantial services for the hospital line of business.

    (2) Definition--(i) In general. An employer's line of business is 
determined by reference to the Enterprise Standard Industrial 
Classification Manual (ESIC Manual) prepared by the Statistical Policy 
Division of the U.S. Office of Management and Budget. An employer is 
considered to have more than one line of business if the employer offers 
for sale to customers property or services in more than one two-digit 
code classification referred to in the ESIC Manual.
    (ii) Examples. Examples of two-digit classifications are general 
retail merchandise stores; hotels and other lodging places; auto repair, 
services, and garages; and food stores.
    (3) Aggregation of two-digit classifications. If, pursuant to 
paragraph (a)(2) of this section, an employer has more than one line of 
business, such lines of business will be treated as a single line of 
business where and to the extent that one or more of the following 
aggregation rules apply:
    (i) If it is uncommon in the industry of the employer for any of the 
separate lines of business of the employer to be operated without the 
others, the separate lines of business are treated as one line of 
business.
    (ii) If it is common for a substantial number of employees (other 
than those employees who work at the headquarters or main office of the 
employer) to perform substantial services for more than one line of 
business of the employer, so that determination of which employees 
perform substantial services for which line or lines of business would 
be difficult, then the separate lines of business of the employer in 
which such employees perform substantial services are treated as one 
line of business. For example, assume that an employer operates a 
delicatessen with an attached service counter at which food is sold for 
consumption on the premises. Assume further that most but not all 
employees work both at the delicatessen and at the service counter. 
Under the aggregation rule of this paragraph (a)(3)(ii), the 
delicatessen and the service counter are treated as one line of 
business.

[[Page 565]]

    (iii) If the retail operations of an employer that are located on 
the same premises are in separate lines of business but would be 
considered to be within one line of business under paragraph (a)(2) of 
this section if the merchandise offered for sale in such lines of 
business were offered for sale at a department store, then the 
operations are treated as one line of business. For example, assume that 
on the same premises an employer sells both women's apparel and jewelry. 
Because, if sold together at a department store, the operations would be 
part of the same line of business, the operations are treated as one 
line of business.
    (b) Grandfather rule for certain retail stores--(1) In general. The 
line of business limitation may be relaxed under the special grandfather 
rule of this paragraph (b). Under this special grandfather rule, if--
    (i) On October 5, 1983, at least 85 percent of the employees of one 
member of an affiliated group (as defined in section 1504 without regard 
to subsections (b)(2) and (b)(4) thereof) (``first member'') were 
entitled to receive employee discounts at retail department stores 
operated by another member of the affiliated group (``second member''), 
and
    (ii) More than 50 percent of the previous year's sales of the 
affiliated group are attributable to the operation of retail department 
stores, then, for purposes of the exclusion from gross income of a 
qualified employee discount, the first member is treated as engaged in 
the same line of business as the second member (the opeator of the 
retail department stores). Therefore, employees of the first member of 
the affiliated group may exclude from income qualified employee 
discounts received at the retail department stores operated by the 
second member. However, employees of the second member of the affiliated 
group may not under this paragraph (b)(1) exclude any discounts received 
on property or services offered for sale to customers by the first 
member of the affiliated group.
    (2) Taxable year of affiliated group. If not all of the members of 
an affiliated group have the same taxable year, the affiliated group 
must designate the 12-month period to be used in determining the 
``previous year's sales'' (as referred to in the grandfather rule of 
this paragraph (b)). The 12-month period designated, however, must be 
used on a consistent basis.
    (3) Definition of ``sales.'' For purposes of this paragraph (b), the 
term ``sales'' means the gross receipts of an affiliated group, based 
upon the accounting methods used by its members.
    (4) Retired and disabled employees. For purposes of this paragraph 
(b), an employee includes any individual who was, or whose spouse was, 
formerly employed by the first member of an affiliated group and who 
separated from service with the member by reason of retirement or 
disability if the second member of the group provided employee discounts 
to that individual on October 5, 1983.
    (5) Increase of employee discount. If, after October 5, 1983, the 
employee discount described in this paragraph (b) is increased, the 
grandfather rule of this paragraph (b) does not apply to the amount of 
the increase. For example, if on January 1, 1989, the employee discount 
is increased from 10 percent to 15 percent, the grandfather rule will 
not apply to the additional 5 percent discount.
    (c) Grandfather rule for telephone service provided to 
predivestiture retirees. All entities subject to the modified final 
judgment (as defined in section 559(c)(5) of the Tax Reform Act of 1984) 
shall be treated as a single employer engaged in the same line of 
business for purposes of determining whether telephone service provided 
to certain employees is a no-additional-cost service. The preceding 
sentence applies only in the case of an employee who by reason of 
retirement or disability separated before January 1, 1984, from the 
service of an entity subject to the modified final judgment. This 
paragraph (c) only applies to services provided to such employees as of 
January 1, 1984. For a special no-additional-cost service rule relating 
to such employees and such services, see Sec. 1.132-2(a)(6).
    (d) Special rule for certain affiliates of commercial airlines--(1) 
General rule. If a qualified affiliate is a member of an airline 
affiliated group and employees

[[Page 566]]

of the qualified affiliate who are directly engaged in providing 
airline-related services are entitled to no-additional-cost service with 
respect to air transportation provided by such other member, then, for 
purposes of applying Sec. 1.132-2 (relating to no-additional-cost 
services with respect to such air transportation), such qualified 
affiliate shall be treated as engaged in the same line of business as 
such other member.
    (2) ``Airline affiliated group'' defined. An ``airline affiliated 
group'' is an affiliated group (as defined in section 1504 (a)) one of 
whose members operates a commercial airline that provides air 
transportation to customers on a per-seat basis.
    (3) ``Qualified affiliate'' defined. A ``qualified affiliate'' is 
any corporation that is predominantly engaged in providing airline-
related services. The term ``airline-related services'' means any of the 
following services provided in connection with air transportation:
    (i) Catering,
    (ii) Baggage handling,
    (iii) Ticketing and reservations,
    (iv) Flight planning and weather analysis, and
    (v) Restaurants and gift shops located at an airport.
    (e) Grandfather rule for affiliated groups operating airlines. The 
line of business limitation may be relaxed under the special grandfather 
rule of this paragraph (e). Under this special grandfather rule, if, as 
of September 12, 1984--
    (1) An individual--
    (i) Was an employee (within the meaning of Sec. 1.132-1 (b)) of one 
member of an affiliated group (as defined in section 1504(a)) (``first 
corporation''), and
    (ii) Was eligible for no-additional-cost services in the form of air 
transportation provided by another member of such affiliated group 
(``second corporation''),
    (2) At least 50 percent of the individuals performing services for 
the first corporation were, or had been employees of, or had previously 
performed services for, the second corporation, and
    (3) The primary business of the affiliated group was air 
transportation of passengers, then, for purposes of applying sections 
132(a) (1) and (2), with respect to no-additional-cost services and 
qualified employee discounts provided after December 31, 1984, for that 
individual by the second corporation, the first corporation is treated 
as engaged in the same air transporation line of business as the second 
corporation. For purposes of the preceding sentence, an employee of the 
second corporation who is performing services for the first corporation 
is also treated as an employee of the first corporation.
    (f) Special rule for qualified air transportation organizations. A 
qualified air transportation organization is treated as engaged in the 
line of business of providing air transportation with respect to any 
individual who performs services for the organization if those services 
are peformed primarily for persons engaged in providing air 
transportation, and are of a kind which (if performed on September 12, 
1984) would qualify the individual for no-additional-cost services in 
the form of air transportation. The term ``qualified air transportation 
organization'' means any organization--
    (1) If such organization (or a predecessor) was in existence on 
September 12, 1984,
    (2) If such organization is--
    (i) A tax-exempt organization under section(c)(6) whose membership 
is limited to entities engaged in the transportation by air of 
individuals or property for compensation or hire, or
    (ii) Is a corporation all the stock of which is owned entirely by 
entities described in paragraph (f)(2)(i) of this section, and
    (3) If such organization is operated in furtherance of the 
activities of its members or owners.
    (g) Relaxation of line of business requirement. The line of business 
requirement may be relaxed under an elective grandfather rule provided 
in section 4977. For rules relating to the section 4977 election, see 
Sec. 54.4977-1T.
    (h) Line of business requirement does not expand benefits eligible 
for exclusion. The line of business requirement limits the benefits 
eligible for the no-additional-cost service and qualified employee 
discount exclusions to property or services provided by an employer to 
its customers in the ordinary course of the line of business of the 
employer in

[[Page 567]]

which the employee performs substantial services. The requirement is 
intended to ensure that employers do not offer, on a tax-free or reduced 
basis, property or services to employees that are not offered to the 
employer's customers, even if the property or services offered to the 
customers and the employees are within the same line of business (as 
defined in this section).

[T.D. 8256, 54 FR 28606, July 6, 1989]



Sec. 1.132-4T  Line of business limitation--1985 through 1988 
(temporary).

    (a) In general--(1) Applicability--(i) General rule. A no-
additional-cost service or qualified employee discount provided to an 
employee must be for property or services that are offered for sale to 
customers in the ordinary course of the same line of business in which 
the employee receiving the property or service performs substantial 
services. Thus, an employee who does not perform substantial services in 
a particular line of business of the employer may not exclude the value 
of services or employee discounts received on property or services in 
that line of business.
    (ii) Property and services sold to employees rather than customers. 
Since the property or services must be offered for sale to customers in 
the ordinary course of the same line of business in which the employee 
performs substantial services, the line of business limitation is not 
satisfied if the employer's products or services are sold to employees 
of the employer, rather than to customers. Thus, for example, an 
employer in the banking line of business is not considered in the 
variety store line of business if the employer establishes an employee 
store that offers variety store items for sale to the employer's 
employees.
    (iii) Performance of substantial services in more than one line of 
business. An employee who performs services in more than one of the 
employer's lines of business may only exclude no-additional-cost 
services and qualified employee discounts in the lines of business in 
which the employee performs substantial services.
    (iv) Performance of services that directly benefit more than one 
line of business--(A) In general. An employee who performs substantial 
services that directly benefit more than one line of business of an 
employer is treated as performing substantial services in all such lines 
of business. For example, an employee who maintains accounting records 
for an employer's three lines of business may receive qualified employee 
discounts in all three lines of business.
    (B) Significantly interrelated minor line of business. The employees 
of a minor line of business of an employer that is significantly 
interrelated with a major line of business of the employer who perform 
substantial services that directly benefit both the major and the minor 
lines of business are treated as employees of both the major and the 
minor lines of business. Employees of the minor line of business who do 
not perform substantial services which directly benefit the major line 
of business are not treated as employees of the major line of business. 
A minor line of business is significantly interrelated with a major line 
of business when, for example, the activity of the minor line of 
business is directly related to but is a minor part of the major line of 
business (such as laundry services provided at a hospital).
    (C) Examples. The rules provided in this paragraph are illustrated 
in the following examples:

    Example (1). Assume that employees of units of an employer provide 
repair or financing services, or sell by catalog, with respect to retail 
merchandise sold by the employer. Such employees may be considered as 
employees of the retail merchandise line of business under this 
paragraph (a)(1)(iv).
    Example (2). Assume that an employer operates a hospital and a 
laundry service. Assume further that some of the gross receipts of the 
laundry service line of business are from laundry services sold to 
customers other than the hospital employer. Only the employees of the 
laundry service who perform substantial services which directly benefit 
the hospital line of business (through the provision of laundry services 
to the hospital) will be treated as employees of the hospital line of 
business. Other employees of the laundry service line of business will 
not be treated as employees of the hospital line of business.
    Example (3). Assume the same facts as in example (2), except that 
the minor line of

[[Page 568]]

business also operates a chain of dry cleaning stores. Employees who 
perform substantial services which directly benefit the dry cleaning 
stores but who do not perform substantial services that directly benefit 
the hospital line of business will not be treated as employees of the 
hospital line of business.

    (2) Definition--(i) In general. An employer's line of business is 
determined by reference to the Enterprise Standard Industrial 
Classification Manual (ESIC Manual) prepared by the Statistical Policy 
Division of the U.S. Office of Management and Budget. An employer is 
considered to have more than one line of business if the employer offers 
for sale to customers property or services in more than one two-digit 
code classification referred to in the ESIC Manual.
    (ii) Examples. Examples of two-digit classifications are general 
retail merchandise stores; hotels and other lodging places; auto repair, 
services, and garages; and food stores.
    (3) Aggregation of two-digit classifications. If, pursuant to 
paragraph (a)(2) of this section, an employer has more than one line of 
business, such lines of business will be treated as a single line of 
business where and to the extent that one or more of the following 
aggregation rules apply:
    (i) If it is uncommon in the industry of the employer for any of the 
separate lines of business of the employer to be operated without the 
others, the separate lines of business are treated as one line of 
business.
    (ii) If it is common for a substantial number of employees (other 
than those employees who work at the headquarters or main office of the 
employer) to perform substantial services for more than one line of 
business of the employer, so that determination of which employees 
perform substantial services for which line of business would be 
difficult, then the separate lines of business of the employer in which 
such employees perform substantial services are treated as one line of 
business. For example, assume that an employer operates a delicatessen 
with an attached service counter at which food is sold for consumption 
on the premises. Assume further that most but not all employees work 
both at the delicatessen and at the service counter. The delicatessen 
and the service counter are treated as one line of business.
    (iii) If the retail operations of an employer that are located on 
the same premises are in separate lines of business but would be 
considered to be within one line of business under paragraph (a)(2) of 
this section if the merchandise offered for sale in such lines of 
business were offered for sale at a department store, then the 
operations are treated as one line of business. For example, assume that 
on the same premises an employer sells both women's apparel and jewelry. 
Since, if sold together at a department store, the operations would be 
part of the same line of business, the operations are treated as one 
line of business.
    (b) Grandfather rule for certain retail stores--(1) In general. The 
line of business limitation may be relaxed under a special grandfather 
rule. If--
    (i) On October 5, 1983, 85 percent of the employees of one member of 
an affiliated group (as defined in section 1504 without regard to 
subsections (b)(2) and (b)(4) thereof) were entitled to employee 
discounts at retail department stores operated by another member of the 
affiliated group, and
    (ii) More than 50 percent of the current year's sales of the 
affiliated group are attributable to the operation of retail department 
stores,

then for purposes of the exclusion from gross income of a qualified 
employee discount, the first member is treated as engaged in the same 
line of business as the second member (the operator of the retail 
department stores). Therefore, employees of the first member of the 
affiliated group may exclude qualified employee discounts received at 
the retail department stores operated by the second member. However, 
employees of the second member of the affiliated group may not exclude 
any discounts received on property or services offered for sale to 
customers by the first member of the affiliated group.
    (2) Taxable year of affiliated group. If all of the members do not 
have the same taxable year, the affiliated group must designate the 12-
month period to be used in determining the ``current year's sales'' (as 
referred to in this paragraph (b)). The 12-month period

[[Page 569]]

designated, however, must be used consistently.
    (3) Definition of ``sales''. For purposes of this paragraph (b), the 
term ``sales'' means the gross receipts of the affiliated group, based 
upon the accounting methods used by its members.
    (4) Retired and disabled employees. For purposes of this paragraph 
(b), an employee includes any individual who was, or whose spouse was, 
formerly employed by the first member of the affiliated group and who 
separated from service with the member by reason of retirement or 
disability if the second member of the group provided employee discounts 
to such individuals on October 5, 1983.
    (5) Increase of employee discount. If, after October 5, 1983, the 
employee discount described in this paragraph (b) is increased, the 
grandfather rule of this paragraph (b) does not apply to the amount of 
the increase. For example, if on January 1, 1985, the employee discount 
is increased from 10 percent to 15 percent, the grandfather rule will 
not apply to the additional five percent discount.
    (c) Relaxation of line of business requirement. The line of business 
requirement may be relaxed under an elective grandfather rule provided 
in section 4977. For rules relating to the section 4977 election, see 
Sec. 54.4977-1.

[T.D. 8063, 50 FR 52301, Dec. 23, 1985, as amended by T.D. 8256, 54 FR 
28600, July 6, 1989]



Sec. 1.132-5  Working condition fringes.

    (a) In general--(1) Definition. Gross income does not include the 
value of a working condition fringe. A ``working condition fringe'' is 
any property or service provided to an employee of an employer to the 
extent that, if the employee paid for the property or service, the 
amount paid would be allowable as a deduction under section 162 or 167.
    (i) A service or property offered by an employer in connection with 
a flexible spending account is not excludable from gross income as a 
working condition fringe. For purposes of the preceding sentence, a 
flexible spending account is an agreement (whether or not written) 
entered into between an employer and an employee that makes available to 
the employee over a time period a certain level of unspecified non-cash 
benefits with a pre-determined cash value.
    (ii) If, under section 274 or any other section, certain 
substantiation requirements must be met in order for a deduction under 
section 162 or 167 to be allowable, then those substantiation 
requirements apply when determining whether a property or service is 
excludable as a working condition fringe.
    (iii) An amount that would be deductible by the employee under a 
section other than section 162 or 167, such as section 212, is not a 
working condition fringe.
    (iv) A physical examination program provided by the employer is not 
excludable as a working condition fringe even if the value of such 
program might be deductible to the employee under section 213. The 
previous sentence applies without regard to whether the employer makes 
the program mandatory to some or all employees.
    (v) A cash payment made by an employer to an employee will not 
qualify as a working condition fringe unless the employer requires the 
employee to--
    (A) Use the payment for expenses in connection with a specific or 
pre-arranged activity or undertaking for which a deduction is allowable 
under section 162 or 167,
    (B) Verify that the payment is actually used for such expenses, and
    (C) Return to the employer any part of the payment not so used.
    (vi) The limitation of section 67(a) (relating to the two-percent 
floor on miscellaneous itemized deductions) is not considered when 
determining the amount of a working condition fringe. For example, 
assume that an employer provides a $1,000 cash advance to Employee A and 
that the conditions of paragraph (a)(1)(v) of this section are not 
satisfied. Even to the extent A uses the allowance for expenses for 
which a deduction is allowable under section 162 and 167, because such 
cash payment is not a working condition fringe, section 67(a) applies. 
The $1,000 payment is includible in A's gross income and subject to 
income and employment tax withholding. If, however, the conditions of 
paragraph (a)(1)(v) of this section are satisfied with respect to the

[[Page 570]]

payment, then the amount of A's working condition fringe is determined 
without regard to section 67(a). The $1,000 payment is excludible from 
A's gross income and not subject to income and employment tax reporting 
and withholding.
    (2) Trade or business of the employee--(i) General. If the 
hypothetical payment for a property or service would be allowable as a 
deduction with respect to a trade or business of an employee other than 
the employee's trade or business of being an employee of the employer, 
it cannot be taken into account for purposes of determining the amount, 
if any, of the working condition fringe.
    (ii) Examples. The rule of paragraph (a)(2)(i) of this section may 
be illustrated by the following examples:

    Example (1). Assume that, unrelated to company X's trade or business 
and unrelated to employee A's trade or business of being an employee of 
company X, A is a member of the board of directors of company Y. Assume 
further that company X provides A with air transportation to a company Y 
board of director's meeting. A may not exclude from gross income the 
value of the air transportation to the meeting as a working condition 
fringe. A may, however, deduct such amount under section 162 if the 
section 162 requirements are satisfied. The result would be the same 
whether the air transportation was provided in the form of a flight on a 
commercial airline or a seat on a company X airplane.
    Example (2). Assume the same facts as in example (1) except that A 
serves on the board of directors of company Z and company Z regularly 
purchases a significant amount of goods and services from company X. 
Because of the relationship between Company Z and A's employer, A's 
membership on Company Z's board of directors is related to A's trade or 
business of being an employee of Company X. Thus, A may exclude from 
gross income the value of air transportation to board meetings as a 
working condition fringe.
    Example (3). Assume the same facts as in example (1) except that A 
serves on the board of directors of a charitable organization. Assume 
further that the service by A on the charity's board is substantially 
related to company X's trade or business. In this case, A may exclude 
from gross income the value of air transportation to board meetings as a 
working condition fringe.
    Example (4). Assume the same facts as in example (3) except that 
company X also provides A with the use of a company X conference room 
which A uses for monthly meetings relating to the charitable 
organization. Also assume that A uses company X's copy machine and word 
processor each month in connection with functions of the charitable 
organization. Because of the substantial business benefit that company X 
derives from A's service on the board of the charity, A may exclude as a 
working condition fringe the value of the use of company X property in 
connection with the charitable organization.

    (b) Vehicle allocation rules--(1) In general--(i) General rule. In 
general, with respect to an employer-provided vehicle, the amount 
excludable as a working condition fringe is the amount that would be 
allowable as a deduction under section 162 or 167 if the employee paid 
for the availability of the vehicle. For example, assume that the value 
of the availability of an employer-provided vehicle for a full year is 
$2,000, without regard to any working condition fringe (i.e., assuming 
all personal use). Assume Further that the employee drives the vehicle 
6,000 miles for his employer's business and 2,000 miles for reasons 
other than the employer's business. In this situation, the value of the 
working condition fringe is $2,000 multiplied by a fraction, the 
numerator of which is the business-use mileage (6,000 miles) and the 
denominator of which is the total mileage (8,000 miles). Thus, the value 
of the working condition fringe is $1,500. The total amount includible 
in the employee's gross income on account of the availability of the 
vehicle is $500 ($2,000-$1,500). For purposes of this section, the term 
``vehicle'' has the meaning given the term in Sec. 1.61-21(e)(2). 
Generally, when determining the amount of an employee's working 
condition fringe, miles accumulated on the vehicle by all employees of 
the employer during the period in which the vehicle is available to the 
employee are considered. For example, assume that during the year in 
which the vehicle is available to the employee in the above example, 
other employees accumulate 2,000 additional miles on the vehicle (while 
the employee is not in the automobile). In this case, the value of the 
working condition fringe is $2,000 multiplied by a fraction, the 
numerator of which is the business-use mileage by the employee 
(including all mileage

[[Page 571]]

(business and personal) accumulated by other employees) (8,000 miles) 
and the denominator of which is the total mileage (including all mileage 
accumulated by other employees) (10,000 miles). Thus, the value of the 
working condition fringe is $1,600; the total amount includible in the 
employee's gross income on account of the availability of the vehicle is 
$400 ($2,000-$1,600). If, however, substantially all of the use of the 
automobile by other employees in the employer's business is limited to a 
certain period, such as the last three months of the year, the miles 
driven by the other employees during that period would not be considered 
when determining the employee's working condition fringe exclusion. 
Similarly, miles driven by other employees are not considered if the 
pattern of use of the employer-provided automobiles is designed to 
reduce Federal taxes. For example, assume that an employer provides 
employees A and B each with the availability of an employer-provided 
automobile and that A uses the automobile assigned to him 80 percent for 
the employer's business and that B uses the automobile assigned to him 
30 percent for the employer's business. If A and B alternate the use of 
their assigned automobiles each week in such a way as to achieve a 
reduction in federal taxes, then the employer may count only miles 
placed on the automobile by the employee to whom the automobile is 
assigned when determining each employee's working condition fringe.
    (ii) Use by an individual other than the employee. For purposes of 
this section, if the availability of a vehicle to an individual would be 
taxed to an employee, use of the vehicle by the individual is included 
in references to use by the employee.
    (iii) Provision of an expensive vehicle for personal use. If an 
employer provides an employee with a vehicle that an employee may use in 
part for personal purposes, there is no working condition fringe 
exclusion with respect to the personal miles driven by the employee; if 
the employee paid for the availability of the vehicle, he would not be 
entitled to deduct under section 162 or 167 any part of the payment 
attributable to personal miles. The amount of the inclusion is not 
affected by the fact that the employee would have chosen the 
availability of a less expensive vehicle. Moreover, the result is the 
same even though the decision to provide an expensive rather than an 
inexpensive vehicle is made by the employer for bona fide 
noncompensatory business reasons.
    (iv) Total value inclusion. In lieu of excluding the value of a 
working condition fringe with respect of an automobile, an employer 
using the automobile lease valuation rule of Sec. 1.61-21(d) may 
include in an employee's gross income the entire Annual Lease Value of 
the automobile. Any deduction allowable to the employee under section 
162 or 167 with respect to the automobile may be taken on the employee's 
income tax return. The total inclusion rule of this paragraph (b)(1)(iv) 
is not available if the employer is valuing the use or availability of a 
vehicle under general valuation principles or a special valuation rule 
other than the automobile lease valuation rule. See Sec. Sec. 1.162-25 
and 1.162-25T for rules relating to the employee's deduction.
    (v) Shared usage. In calculating the working condition fringe 
benefit exclusion with respect to a vehicle provided for use by more 
than one employee, an employer shall compute the working condition 
fringe in a manner consistent with the allocation of the value of the 
vehicle under section 1.61-21(c)(2)(ii)(B).
    (2) Use of different employer-provided vehicles. The working 
condition fringe exclusion must be applied on a vehicle-by-vehicle 
basis. For example, assume that automobile Y is available to employee D 
for 3 days in January and for 5 days in March, and automobile Z is 
available to D for a week in July. Assume further that the Daily Lease 
Value, as defined in Sec. 1.61-21(d)(4)(ii), of each automobile is $50. 
For the eight days of availability of Y in January and March, D uses Y 
90 percent for business (by mileage). During July, D uses Z 60 percent 
for business (by mileage). The value of the working condition fringe is 
determined separately for each automobile. Therefore, the working 
condition fringe for Y is $360 ($400x.90) leaving an income inclusion

[[Page 572]]

of $40. The working condition fringe for Z is $210 ($350x.60), leaving 
an income inclusion of $140. If the value of the availability of an 
automobile is determined under the Annual Lease Value rule for one 
period and Daily Lease Value rule for a second period (see Sec. 1.61-
21(d)), the working condition fringe exclusion must be calculated 
separately for the two periods.
    (3) Provision of a vehicle and chauffeur services--(i) General rule. 
In general, with respect to the value of chauffeur services provided by 
an employer, the amount excludable as a working condition fringe is the 
amount that would be allowable as a deduction under section 162 and 167 
if the employee paid for the chauffeur services. The working condition 
fringe with respect to a chauffeur is determined separately from the 
working condition fringe with respect to the vehicle. An employee may 
exclude from gross income the excess of the value of the chauffeur 
services over the value of the chauffeur services for personal purposes 
(such as commuting) as determined under Sec. 1.61-21(b)(5). See Sec. 
1.61-21(b)(5) for additional rules and examples concerning the valuation 
of chauffeur services. See Sec. 1.132-5(m)(5) for rules relating to an 
exclusion from gross income for the value of bodyguard/chauffeur 
services. When determining whether miles placed on the vehicle are for 
the employer's business, miles placed on the vehicle by a chauffeur 
between the chauffeur's residence and the place at which the chauffeur 
picks up (or drops off) the employee are with respect to the employee 
(but not the chauffeur) considered to be miles placed on the vehicle for 
the employer's business and thus eligible for the working condition 
fringe exclusion. Thus, because miles placed on the vehicle by a 
chauffeur between the chauffeur's residence and the place at which the 
chauffeur picks up (or drops off) the employee are not considered 
business miles with respect to the chauffeur, the value of the 
availability of the vehicle for commuting is includible in the gross 
income of the chauffeur. For general and special rules concerning the 
valuation of the use of employer-provided vehicles, see paragraphs (b) 
through (f) of Sec. 1.61-21.
    (ii) Examples. The rules of paragraph (b)(3)(i) of this section are 
illustrated by the following examples:

    Example (1). Assume that an employer makes available to an employee 
an automobile and a chauffeur. Assume further that the value of the 
chauffeur services determined in accordance with Sec. 1.61-21 is 
$30,000 and that the chauffeur spends 30 percent of each workday driving 
the employee for personal purposes. There may be excluded from the 
employee's income 70 percent of $30,000, or $21,000, leaving an income 
inclusion with respect to the chauffeur services of $9,000.
    Example (2). Assume that the value of the availability of an 
employer-provided vehicle for a year is $4,850 and that the value of 
employer-provided chauffeur services with respect to the vehicle for the 
year is $20,000. Assume further that 40 percent of the miles placed on 
the vehicle are for the employer's business and that 60 percent are for 
other purposes. In addition, assume that the chauffeur spends 25 percent 
of each workday driving the employee for personal purposes (i.e., 2 
hours). The value of the chauffeur services includible in the employee's 
income is 25 percent of $20,000, or $5,000. The excess of $20,000 over 
$5,000 or $15,000 is excluded from the employee's income as a working 
condition fringe. The amount excludable as a working condition fringe 
with respect to the vehicle is 40 percent of $4,850, or $1,940 and the 
amount includible is $4,850-$1,940, or $2,910.

    (c) Applicability of substantiation requirements of sections 162 and 
274 (d)--(1) In general. The value of property or services provided to 
an employee may not be excluded from the employee's gross income as a 
working condition fringe, by either the employer or the employee, unless 
the applicable substantiation requirements of either section 274(d) or 
section 162 (whichever is applicable) and the regulations thereunder are 
satisfied. The substantiation requirements of section 274(d) apply to an 
employee even if the requirements of section 274 do not apply to the 
employee's employer for deduction purposes (such as when the employer is 
a tax-exempt organization or a governmental unit).
    (2) Section 274(d) requirements. The substantiation requirements of 
section 274(d) are satisfied by ``adequate records or sufficient 
evidence corroborating the [employee's] own statement''. Therefore, such 
records or evidence provided by the employee, and

[[Page 573]]

relied upon by the employer to the extent permitted by the regulations 
promulgated under section 274(d), will be sufficient to substantiate a 
working condition fringe exclusion.
    (d) Safe harbor substantiation rules--(1) In general. Section 1.274-
6T provides that the substantiation requirements of section 274(d) and 
the regulations thereunder may be satisfied, in certain circumstances, 
by using one or more of the safe harbor rules prescribed in Sec. 1.274-
6T. If the employer uses one of the safe harbor rules prescribed in 
Sec. 1.274-6T during a period with respect to a vehicle (as defined in 
Sec. 1.61-21(e)(2)), that rule must be used by the employer to 
substantiate a working condition fringe exclusion with respect to that 
vehicle during the period. An employer that is exempt from Federal 
income tax may still use one of the safe harbor rules (if the 
requirements of that section are otherwise met during a period) to 
substantiate a working condition fringe exclusion with respect to a 
vehicle during the period. If the employer uses one of the methods 
prescribed in Sec. 1.274-6T during a period with respect to an 
employer-provided vehicle, that method may be used by an employee to 
substantiate a working condition fringe exclusion with respect to the 
same vehicle during the period, as long as the employee includes in 
gross income the amount allocated to the employee pursuant to Sec. 
1.274-6T and this section. (See Sec. 1.61-21(c)(2) for other rules 
concerning when an employee must include in income the amount determined 
by the employer.) If, however, the employer uses the safe harbor rule 
prescribed in Sec. 1.274-6T(a) (2) or (3) and the employee without the 
employer's knowledge uses the vehicle for purposes other than de minimis 
personal use (in the case of the rule prescribed in Sec. 1.274-
6T(a)(2)), or for purposes other than de minimis personal use and 
commuting (in the case of the rule prescribed in Sec. 1.274-6T(a)(3)), 
then the employees must include an additional amount in income for the 
unauthorized use of the vehicle.
    (2) Period for use of safe harbor rules. The rules prescribed in 
this paragraph (d) assume that the safe harbor rules prescribed in Sec. 
1.274-6T are used for a one-year period. Accordingly, references to the 
value of the availability of a vehicle, amounts excluded as a working 
condition fringe, etc., are based on a one-year period. If the safe 
harbor rules prescribed in Sec. 1.274-6T are used for a period of less 
than a year, the amounts referred to in the previous sentence must be 
adjusted accordingly. For purposes of this section, the term ``personal 
use'' has the same meaning as prescribed in Sec. 1.274-6T (e)(5).
    (e) Safe harbor substantiation rule for vehicles not used for 
personal purposes. For a vehicle described in Sec. 1.274-6T(a)(2) 
(relating to certain vehicles not used for personal purposes), the 
working condition fringe exclusion is equal to the value of the 
availability of the vehicle if the employer uses the method prescribed 
in Sec. 1.274-6T(a)(2).
    (f) Safe harbor substantiation rule for vehicles not available to 
employees for personal use other than commuting. For a vehicle described 
in Sec. 1.274-6T(a)(3) (relating to certain vehicles not used for 
personal purposes other than commuting), the working condition fringe 
exclusion is equal to the value of the availability of the vehicle for 
purposes other than commuting if the employer uses the method prescribed 
in Sec. 1.274-6T(a)(3). This rule applies only if the special rule for 
valuing commuting use, as prescribed in Sec. 1.61-21(f), is used and 
the amount determined under the special rule is either included in the 
employee's income or reimbursed by the employee.
    (g) Safe harbor substantiation rule for vehicles used in connection 
with the business of farming that are available to employees for 
personal use--(1) In general. For a vehicle described in Sec. 1.274-
6T(b) (relating to certain vehicles used in connection with the business 
of farming), the working condition fringe exclusion is calculated by 
multiplying the value of the availability of the vehicle by 75 percent.
    (2) Vehicles available to more than one individual. If the vehicle 
is available to more than one individual, the employer must allocate the 
gross income inclusion attributable to the vehicle (25 percent of the 
value of the availability of the vehicle) among the employees (and other 
individuals whose use would not be attributed to an employee) to whom

[[Page 574]]

the vehicle was available. This allocation must be done in a reasonable 
manner to reflect the personal use of the vehicle by the individuals. An 
amount that would be allocated to a sole proprietor reduces the amounts 
that may be allocated to employees but is otherwise to be disregarded 
for purposes of this paragraph (g). For purposes of this paragraph (g), 
the value of the availability of a vehicle may be calculated as if the 
vehicle were available to only one employee continuously and without 
regard to any working condition fringe exclusion.
    (3) Examples. The following examples illustrate a reasonable 
allocation of gross income with respect to an employer-provided vehicle 
between two employees:

    Example (1). Assume that two farm employees share the use of a 
vehicle that for a calendar year is regularly used directly in 
connection with the business of farming and qualifies for use of the 
rule in Sec. 1.274-6T(b). Employee A uses the vehicle in the morning 
directly in connection with the business of farming and employee B uses 
the vehicle in the afternoon directly in connection with the business of 
farming. Assume further that employee B takes the vehicle home in the 
evenings and on weekends. The employer should allocate all the income 
attributable to the availability of the vehicle to employee B.
    Example (2). Assume that for a calendar year, farm employees C and D 
share the use of a vehicle that is regularly used directly in connection 
with the business of farming and qualifies for use of the rule in Sec. 
1.2.4-6T(b). Assume further that the employees alternate taking the 
vehicle home in the evening and alternate the availability of the 
vehicle for personal purposes on weekends. The employer should allocate 
the income attributable to the availability of the vehicle for personal 
use (25 percent of the value of the availability of the vehicle) equally 
between the two employees.
    Example (3). Assume the same facts as in example (2) except that C 
is the sole proprietor of the farm. Based on these facts, C should 
allocate the same amount of income to D as was allocated to D in example 
(2). No other income attributable to the availability of the vehicle for 
personal use should be allocated.

    (h) Qualified nonpersonal use vehicles--(1) In general. Except as 
provided in paragraph (h)(2) of this section, 100 percent of the value 
of the use of a qualified nonpersonal use vehicle (as described in Sec. 
1.274-5T(k)) is excluded from gross income as a working condition 
fringe, provided that, in the case of a vehicle described in paragraph 
(k) (3) through (8) of that section, the use of the vehicle conforms to 
the requirements of that paragraph.
    (2) Shared usage of qualified nonpersonal use vehicles. In general, 
a working condition fringe under paragraph (h) of this section is 
available to the driver and all passengers of a qualified nonpersonal 
use vehicle. However, a working condition fringe under this paragraph 
(h) is available only with respect to the driver and not with respect to 
any passengers of a qualified nonpersonal use vehicle described in Sec. 
1.274-5T(k)(2)(ii) (L) or (P). In this case, the passengers must comply 
with provisions of this section (excluding this paragraph (h)) to 
determine the applicability of the working condition fringe exclusion. 
For example, if an employer provides a passenger bus with a capacity of 
25 passengers to its employees for purposes of transporting employees to 
and/or from work, the driver of the bus may exclude from gross income as 
a working condition fringe 100 percent of the value of the use of the 
vehicle. The value of the commuting use of the employer-provided bus by 
the employee-passengers is includible in their gross incomes. See Sec. 
1.61-21(f) for a special rule to value the commuting-only use of 
employer-provided vehicles.
    (i) [Reserved]
    (j) Application of section 280F. In determining the amount, if any, 
of an employee's working condition fringe, section 280F and the 
regulations thereunder do not apply. For example, assume that an 
employee has available for a calendar year an employer-provided 
automobile with a fair market value of $28,000. Assume further that the 
special rule provided in Sec. 1.61-21(d) is used yielding an Annual 
Lease Value, as defined in Sec. 1.61-21(d), of $7,750, and that all of 
the employee's use of the automobile is for the employer's business. The 
employee would be entitled to exclude as a working condition fringe the 
entire Annual Lease Value, despite the fact that if the employee paid 
for the availability of the automobile, an income inclusion

[[Page 575]]

would be required under Sec. 1.280F-6(d)(1). This paragraph (j) does 
not affect the applicability of section 280F to the employer with 
respect to such employer-provided automobile, nor does it affect the 
applicability of section 274 to either the employer or the employee. For 
rules concerning substantiation of an employee's working condition 
fringe, see paragraph (c) of this section.
    (k) Aircraft allocation rule. In general, with respect to a flight 
on an employer-provided aircraft, the amount excludable as a working 
condition fringe is the amount that would be allowable as a deduction 
under section 162 or 167 if the employee paid for the flight on the 
aircraft. For example, if employee P and P's spouse fly on P's 
employer's airplane primarily for business reasons of P's employer so 
that P could deduct the expenses relating to the trip to the extent of 
P's payments, the value of the flights is excludable from gross income 
as a working condition fringe. However, if P's children accompany P on 
the trip primarily for personal reasons, the value of the flights by P's 
children are includible in P's gross income. See Sec. 1.61-21 (g) for 
special rules for valuing personal flights on employer-provided 
aircraft.
    (l) [Reserved]
    (m) Employer-provided transportation for security concerns--(1) In 
general. The amount of a working condition fringe exclusion with respect 
to employer-provided transportation is the amount that would be 
allowable as a deduction under section 162 or 167 if the employee paid 
for the transportation. Generally, if an employee pays for 
transportation taken for primarily personal purposes, the employee may 
not deduct any part of the amount paid. Thus, the employee may not 
generally exclude the value of employer-provided transportation as a 
working condition fringe if such transportation is primarily personal. 
If, however, for bona fide business-oriented security concerns, the 
employee purchases transportation that provides him or her with 
additional security, the employee may generally deduct the excess of the 
amount actually paid for the transportation over the amount the employee 
would have paid for the same mode of transportation absent the bona fide 
business-oriented security concerns. This is the case whether or not the 
employee would have taken the same mode of transportation absent the 
bona fide business-oriented security concerns. With respect to a 
vehicle, the phrase ``the same mode of transportation'' means use of the 
same vehicle without the additional security aspects, such as 
bulletproof glass. With respect to air transportation, the phrase ``the 
same mode of transportation'' means comparable air transportation. These 
same rules apply to the determination of an employee's working condition 
fringe exclusion. For example, if an employer provides an employee with 
a vehicle for commuting and, because of bona fide business-oriented 
security concerns, the vehicle is specially designed for security, then 
the employee may exclude from gross income the value of the special 
security design as a working condition fringe. The employee may not 
exclude the value of the commuting from income as a working condition 
fringe because commuting is a nondeductible personal expense. However, 
if an independent security study meeting the requirements of paragraph 
(m)(2)(v) of this section has been performed with respect to a 
government employee, the government employee may exclude the value of 
the personal use (other than commuting) of the employer-provided vehicle 
that the security study determines to be reasonable and necessary for 
local transportation. Similarly, if an employee travels on a personal 
trip in an employer-provided aircraft for bona fide business-oriented 
security concerns, the employee may exclude the excess, if any, of the 
value of the flight over the amount the employee would have paid for the 
same mode of transportation, but for the bona fide business-oriented 
security concerns. Because personal travel is a nondeductible expense, 
the employee may not exclude the total value of the trip as a working 
condition fringe.
    (2) Demonstration of bona fide business-oriented security concerns--
(i) In general. For purposes of this paragraph (m), a bona fide 
business-oriented security concern exists only if the facts and 
circumstances establish a specific basis for concern regarding the 
safety of the employee. A generalized concern for an

[[Page 576]]

employee's safety is not a bona fide business-oriented security concern. 
Once a bona fide business-oriented security concern is determined to 
exist with respect to a particular employee, the employer must 
periodically evaluate the situation for purposes of determining whether 
the bona fide business-oriented security concern still exists. Example 
of factors indicating a specific basis for concern regarding the safety 
of an employee are--
    (A) A threat of death or kidnapping of, or serious bodily harm to, 
the employee or a similarly situated employee because of either 
employee's status as an employee of the employer; or
    (B) A recent history of violent terrorist activity (such as 
bombings) in the geographic area in which the transportation is 
provided, unless that activity is focused on a group of individuals 
which does not include the employee (or a similarly situated employee of 
an employer), or occurs to a significant degree only in a location 
within the geographic area where the employee does not travel.
    (ii) Establishment of overall security program. Notwithstanding 
anything in paragraph (m)(2)(i) of this section to the contrary, no bona 
fide business-oriented security concern will be deemed to exist unless 
the employee's employer establishes to the satisfaction of the 
Commissioner that an overall security program has been provided with 
respect to the employee involved. An overall security program is deemed 
to exist if the requirements of paragraph (m)(2)(iv) of this section are 
satisfied (relating to an independent security study).
    (iii) Overall security program--(A) Defined. An overall security 
program is one in which security is provided to protect the employee on 
a 24-hour basis. The employee must be protected while at the employee's 
residence, while commuting to and from the employee's workplace, and 
while at the employee's workplace. In addition, the employee must be 
protected while traveling both at home and away from home, whether for 
business or personal purposes. An overall security program must include 
the provision of a bodyguard/chauffeur who is trained in evasive driving 
techniques; an automobile specially equipped for security; guards, metal 
detectors, alarms, or similar methods of controlling access to the 
employee's workplace and residence; and, in appropriate cases, flights 
on the employer's aircraft for business and personal reasons.
    (B) Application. There is no overall security program when, for 
example, security is provided at the employee's workplace but not at the 
employee's residence. In addition, the fact that an employer requires an 
employee to travel on the employer's aircraft, or in an employer-
provided vehicle that contains special security features, does not alone 
constitute an overall security program. The preceding sentence applies 
regardless of the existence of a corporate or other resolution requiring 
the employee to travel in the employer's aircraft or vehicle for 
personal as well as business reasons.
    (iv) Effect of an independent security study. An overall security 
program with respect to an employee is deemed to exist if the conditions 
of this paragraph (m)(2)(iv) are satisfied:
    (A) A security study is performed with respect to the employer and 
the employee (or a similarly situated employee of the employer) by an 
independent security consultant;
    (B) The security study is based on an objective assessment of all 
facts and circumstances;
    (C) The recommendation of the security study is that an overall 
security program (as defined in paragraph (m)(2)(iii) of this section) 
is not necessary and the recommendation is reasonable under the 
circumstances; and
    (D) The employer applies the specific security recommendations 
contained in the security study to the employee on a consistent basis.

The value of transportation-related security provided pursuant to a 
security study that meets the requirements of this paragraph (m)(2)(iv) 
may be excluded from income if the security study conclusions are 
reasonable and, but for the bona fide business-oriented security 
concerns, the employee would not have had such security. No exclusion 
from income applies to security provided by the employer that is not 
recommended in the security study.

[[Page 577]]

Security study conclusions may be reasonable even if, for example, it is 
recommended that security be limited to certain geographic areas, as in 
the case in which air travel security is provided only in certain 
foreign countries.
    (v) Independent security study with respect to government employees. 
For purposes of establishing the existence of an overall security 
program under paragraph (m)(2)(ii) of this section with respect to a 
particular government employee, a security study conducted by the 
government employer (including an agency or instrumentality thereof) 
will be treated as a security study pursuant to paragraph (m)(2)(iv) of 
this section if, in lieu of the conditions of paragraphs (m)(2)(iv)(A) 
through (D) of this section, the following conditions are satisfied:
    (A) The security study is conducted by a person expressly designated 
by the government employer as having the responsibility and independent 
authority to determine both the need for employer-provided security and 
the appropriate protective services in response to that determination;
    (B) The security study is conducted in accordance with written 
internal procedures that require an independent and objective assessment 
of the facts and circumstances, such as the nature of the threat to the 
employee, the appropriate security response to that threat, an estimate 
of the length of time protective services will be necessary, and the 
extent to which employer-provided transportation may be necessary during 
the period of protection;
    (C) With respect to employer-provided transportation, the security 
study evaluates the extent to which personal use, including commuting, 
by the employee and the employee's spouse and dependents may be 
necessary during the period of protection and makes a recommendation as 
to what would be considered reasonable personal use during that period; 
and
    (D) The employer applies the specific security recommendations 
contained in the study to the employee on a consistent basis.
    (3) Application of security rules to spouses and dependents. (i) In 
general. If a bona fide business-oriented security concern exists with 
respect to an employee (because, for example, threats are made on the 
life of an employee), the bona fide business-oriented security concern 
is deemed to exist with respect to the employee's spouse and dependents 
to the extent provided in this paragraph (m)(3).
    (ii) Certain transportation. If a working condition fringe exclusion 
is available under this paragraph (m) for transportation in a vehicle or 
aircraft provided for a bona fide business-oriented security concern 
with respect to an employee, the requirements of this paragraph (m) are 
deemed to be satisfied with respect to transportation in the same 
vehicle or aircraft provided at the same time to the employee's spouse 
and dependent children.
    (iii) Other. Except as provided in paragraph (m)(3)(ii) of this 
section, a bona fide business oriented security concern is deemed to 
exist for the spouse and dependent children of the employer only if the 
requirements of paragraph (m)(2) (iii) or (iv) of this section are 
applied independently to such spouse and dependent children.
    (iv) Spouses and dependents of government employees. The security 
rules of this paragraph (m)(3) apply to the spouse and dependents of a 
government employee. However, the value of local vehicle transportation 
provided to the government employee's spouse and dependents for personal 
purposes, other than commuting, during the period that a bona fide 
business-oriented security concern exists with respect to the government 
employee will not be included in the government employee's gross income 
if the personal use is determined to be reasonable and necessary by the 
security study described in paragraph (m)(2)(v) of this section.
    (4) Working condition safe harbor for travel on employer-provided 
aircraft. Under the safe harbor rule of this paragraph (m)(4), if, for a 
bona fide business-oriented security concern, the employer requires that 
an employee travel on an employer-provided aircraft for a personal trip, 
the employer and the employee may exclude from the employee's gross 
income, as a working condition fringe, the excess value of the aircraft 
trip over the safe harbor airfare without having to show what

[[Page 578]]

method of transportation the employee would have flown but for the bona 
fide business-oriented security concern. For purposes of the safe harbor 
rule of this paragraph (m)(4), the value of the safe harbor airfare is 
determined under the non-commercial flight valuation rule of Sec. 1.61-
21(g) (regardless of whether the employer or employee elects to use such 
valuation rule) by multiplying an aircraft multiple of 200-percent by 
the applicable cents-per-mile rates and the number of miles in the 
flight and then adding the applicable terminal charge. The value of the 
safe harbor airfare determined under this paragraph (m)(4) must be 
included in the employee's income (to the extent not reimbursed by the 
employee) regardless of whether the employee or the employer uses the 
special valuation rule of Sec. 1.61-21(g). The excess of the value of 
the aircraft trip over this amount may be excluded from gross income as 
a working condition fringe. If, for a bona fide business-oriented 
security concern, the employer requires that an employee's spouse and 
dependents travel on an employer-provided aircraft for a personal trip, 
the special rule of this paragraph (m)(4) is available to exclude the 
excess value of the aircraft trips over the safe harbor airfares.
    (5) Bodyguard/chauffeur provided for a bona fide business-oriented 
security concern. If an employer provides an employee with vehicle 
transportation and a bodyguard/chauffeur for a bona fide business-
oriented security concern, and but for the bona fide business-oriented 
security concern the employee would not have had a bodyguard or a 
chauffeur, then the entire value of the services of the bodyguard/
chauffeur is excludable from gross income as a working condition fringe. 
For purposes of this section, a bodyguard/chauffeur must be trained in 
evasive driving techniques. An individual who performs services as a 
driver for an employee is not a bodyguard/chauffeur if the individual is 
not trained in evasive driving techniques. Thus, no part of the value of 
the services of such an individual is excludable from gross income under 
this paragraph (m)(5). (See paragraph (b)(3) of this section for rules 
relating to the determination of the working condition fringe exclusion 
for chauffeur services.)
    (6) Special valuation rule for government employees. If 
transportation is provided to a government employee for commuting during 
the period that a bona fide business-oriented security concern under 
Sec. 1.132-5(m) exists, the commuting use may be valued by reference to 
the values set forth in Sec. 1.61-21(e)(1)(i) or (f)(3) (vehicle cents-
per-mile or commuting valuation of $1.50 per one-way commute, 
respectively) without regard to the additional requirements contained in 
Sec. 1.61-21 (e) or (f) and is deemed to have met the requirements of 
Sec. 1.61-21(c).
    (7) Government employer and employee defined. For purposes of this 
paragraph (m), ``government employer'' includes any Federal, State, or 
local government unit, and any agency or instrumentality thereof. A 
``government employee'' is any individual who is employed by the 
government employer.
    (8) Examples. The provisions of this paragraph (m) may be 
illustrated by the following examples:

    Example (1). Assume that in response to several death threats on the 
life of A, the president of X a multinational company, X establishes an 
overall security program for A, including an alarm system at A's home 
and guards at A's workplace, the use of a vehicle that is specially 
equipped with alarms, bulletproof glass, and armor plating, and a 
bodyguard/chauffeur. Assume further that A is driven for both personal 
and business reasons in the vehicle. Also, assume that but for the bona 
fide business-oriented security concerns, no part of the overall 
security program would have been provided to A. With respect to the 
transportation provided for security reasons, A may exclude as a working 
condition fringe the value of the special security features of the 
vehicle and the value attributable to the bodyguard/chauffeur. Thus, if 
the value of the specially equipped vehicle is $40,000, and the value of 
the vehicle without the security features is $25,000, A may determine 
A's inclusion in income attributable to the vehicle as if the vehicle 
were worth $25,000. A must include in income the value of the 
availability of the vehicle for personal use.
    Example (2). Assume that B is the chief executive officer of Y, a 
multinational corporation. Assume further that there have been 
kidnapping attempts and other terrorist activities in the foreign 
countries in which B performs services and that at least some of such 
activities have been directed against B or similarly situated employees. 
ln response

[[Page 579]]

to these activities, Y provides B with an overall security program, 
including an alarm system at B's home and bodyguards at B's workplace, a 
bodyguard/chauffeur, and a vehicle specially designed for security 
during B's overseas travels. In addition, assume that Y requires B to 
travel in Y's airplane for business and personal trips taken to, from, 
and within these foreign countries. Also, assume that but for bona fide 
business-oriented security concerns, no part of the overall security 
program would have been provided to B. B may exclude as a working 
condition fringe the value of the special security features of the 
automobile and the value attributable to the bodyguards and the 
bodyguard/chauffeur. B may also exclude the excess, if any, of the value 
of the flights over the amount A would have paid for the same mode of 
transportation but for the security concerns. As an alternative to the 
preceding sentence, B may use the working condition safe harbor 
described in paragraph (m)(4) of this section and exclude as a working 
condition fringe the excess, if any, of the value of personal flights in 
the Y airplane over the safe harbor airfare determined under the method 
described in paragraph (m)(4) of this section. If this alternative is 
used, B must include in income the value of the availability of the 
vehicle for personal use and the value of the safe harbor.
    Example (3). Assume the same facts as in example (2) except that Y 
also requires B to travel in Y's airplane within the United States, and 
provides B with a chauffeur-driven limousine for business and personal 
travel in the United States. Assume further that Y also requires B's 
spouse and dependents to travel in Y's airplane for personal flights in 
the United States. If no bona fide business-oriented security concern 
exists with respect to travel in the United States, B may not exclude 
from income any portion of the value of the availability of the 
chauffeur or limousine for personal use in the United States. Thus, B 
must include in income the value of the availability of the vehicle and 
chauffeur for personal use. In addition, B may not exclude any portion 
of the value attributable to personal flights by B or B's spouse and 
dependents on Y's airplane. Thus, B must include in income the value 
attributable to the personal use of Y's airplane. See Sec. 1.61-21 for 
rules relating to the valuation of an employer-provided vehicle and 
chauffeur, and personal flights on employer-provided airplanes.
    Example (4). Assume that company Z retains an independent security 
consultant to perform a security study with respect to its chief 
executive officer. Assume further that, based on an objective assessment 
of the facts and circumstances, the security consultant reasonably 
recommends that 24-hour protection is not necessary but that the 
employee be provided security at his workplace and for ground 
transportation, but not for air transportation. If company Z follows the 
recommendations on a consistent basis, an overall security program will 
be deemed to exist with respect to the workplace and ground 
transportation security only.
    Example (5). Assume the same facts as in example (4) except that 
company Z only provides the employee security while commuting to and 
from work, but not for any other ground transportation. Because the 
recommendations of the independent security study are not applied on a 
consistent basis, an overall security program will not be deemed to 
exist. Thus, the value of commuting to and from work is not excludable 
from income. However, the value of a bodyguard with professional 
security training who does not provide chauffeur or other personal 
services to the employee or any member of the employee's family may be 
excludable as a working condition fringe if such expense would be 
otherwise allowable as a deduction by the employee under section 162 or 
167.
    Example (6). J is a United States District Judge. At the beginning 
of a 3-month criminal trial in J's court, a member of J's family 
receives death threats. M, the division (within government agency W) 
responsible for evaluating threats and providing protective services to 
the Federal judiciary, directs its threat analysis unit to conduct a 
security study with respect to J and J's family. The study is conducted 
pursuant to internal written procedures that require an independent and 
objective assessment of any threats to members of the Federal judiciary 
and their families, a statement of the requisite security response, if 
any, to a particular threat (including the form of transportation to be 
furnished to the employee as part of the security program), and a 
description of the circumstances under which local transportation for 
the employee and the employee's spouse and dependents may be necessary 
for personal reasons during the time protective services are provided. 
M's study concludes that a bona fide business-oriented security concern 
exists with respect to J and J's family and determines that 24-hour 
protection of J and J's family is not necessary, but that protection is 
necessary during the course of the criminal trial whenever J or J's 
family is away from home. Consistent with that recommendation, J is 
transported every day in a government vehicle for both personal and 
business reasons and is accompanied by two bodyguard/chauffeurs who have 
been trained in evasive driving techniques. In addition, J's spouse is 
driven to and from work and J's children are driven to and from school 
and occasional school activities. Shortly after the trial is concluded, 
M's threat analysis unit determines that J and J's family no longer need 
special protection because the danger posed by the threat no longer 
exists

[[Page 580]]

and, accordingly, vehicle transportation is no longer provided. Because 
the security study conducted by M complies with the conditions of Sec. 
1.132-5(m)(2)(v), M has satisfied the requirement for an independent 
security study and an overall security program with respect to J is 
deemed to exist. Thus, with respect to the transportation provided for 
security concerns, J may exclude as a working condition fringe the value 
of any special security features of the government vehicle and the value 
attributable to the two bodyguard/chauffeurs. See Example (1) of this 
paragraph (m)(8). The value of vehicle transportation provided to J and 
J's family for personal reasons, other than commuting, may also be 
excluded during the period of protection, because its provision was 
consistent with the recommendation of the security study.
    Example (7). Assume the same facts as in Example (6) and that J's 
one-way commute between home and work is 10 miles. Under paragraph 
(m)(6) of this section, the Federal Government may value transportation 
provided to J for commuting purposes pursuant to the value set forth in 
either the vehicle cents-per-mile rule of Sec. 1.61-21(e) or the 
commuting valuation rule of Sec. 1.61-21(f). Because the commuting 
valuation rule yields the least amount of taxable income to J under the 
circumstances, W values the transportation provided to J for commuting 
at $1.50 per one-way commute, even though J is a control employee within 
the meaning of Sec. 1.61-21(f)(6).

    (n) Product testing--(1) In general. The fair market value of the 
use of consumer goods, which are manufactured for sale to nonemployees, 
for product testing and evaluation by an employee of the manufacturer 
outside the employer's workplace, is excludible from gross income as a 
working condition fringe if--
    (i) Consumer testing and evaluation of the product is an ordinary 
and necessary business expense of the employer;
    (ii) Business reasons necessitate that the testing and evaluation of 
the product be performed off the employer's business premises by 
employees (i.e., the testing and evaluation cannot be carried out 
adequately in the employer's office or in laboratory testing 
facilities);
    (iii) The product is furnished to the employee for purposes of 
testing and evaluation;
    (iv) The product is made available to the employee for no longer 
than necessary to test and evaluate its performance and (to the extent 
not exhausted) must be returned to the employer at completion of the 
testing and evaluation period;
    (v) The employer imposes limits on the employee's use of the product 
that significantly reduce the value of any personal benefit to the 
employee; and
    (vi) The employee must submit detailed reports to the employer on 
the testing and evaluation. The length of the testing and evaluation 
period must be reasonable in relation to the product being tested.
    (2) Employer-imposed limits. The requirement of paragraph (n)(1)(v) 
of this section is satisfied if--
    (i) The employer places limits on the employee's ability to select 
among different models or varieties of the consumer product that is 
furnished for testing and evaluation purposes; and
    (ii) The employer generally prohibits use of the product by persons 
other than the employee and, in appropriate cases, requires the 
employee, to purchase or lease at the employee's own expense the same 
type of product as that being tested (so that personal use by the 
employee's family will be limited). In addition, any charge by the 
employer for the personal use by an employee of a product being tested 
shall be taken into account in determining whether the requirement of 
paragraph (n)(1)(v) of this section is satisfied.
    (3) Discriminating classifications. If an employer furnishes 
products under a testing and evaluation program only, or presumably, to 
certain classes of employees (such as highly compensated employees, as 
defined in Sec. 1.132-8(g)), this fact may be relevant when determining 
whether the products are furnished for testing and evaluation purposes 
or for compensation purposes, unless the employer can show a business 
reason for the classification of employees to whom the products are 
furnished (e.g., that automobiles are furnished for testing and 
evaluation by an automobile manufacturer to its design engineers and 
supervisory mechanics).
    (4) Factors that negate the existence of a product testing program. 
If an employer fails to tabulate and examine

[[Page 581]]

the results of the detailed reports submitted by employees within a 
reasonable period of time after expiration of the testing period, the 
program will not be considered a product testing program for purposes of 
the exclusion of this paragraph (n). Existence of one or more of the 
following factors may also establish that the program is not a bona fide 
product testing program for purposes of the exclusion of this paragraph 
(n):
    (i) The program is in essence a leasing program under which 
employees lease the consumer goods from the employer for a fee;
    (ii) The nature of the product and other considerations are 
insufficient to justify the testing program; or
    (iii) The expense of the program outweighs the benefits to be gained 
from testing and evaluation.
    (5) Failure to meet the requirements of this paragraph (n). The fair 
market value of the use of property for product testing and evaluation 
by an employee outside the employee's workplace, under a product testing 
program that does not meet all of the requirements of this paragraph 
(n), is not excludable from gross income as a working condition fringe 
under this paragraph (n).
    (6) Example. The rules of this paragraph (n) may be illustrated by 
the following example:

    Example. Assume that an employer that manufactures automobiles 
establishes a product testing program under which 50 of its 5,000 
employees test and evaluate the automobiles for 30 days. Assume further 
that the 50 employees represent a fair cross-section of all of the 
employees of the employer, such employees submit detailed reports to the 
employer on the testing and evaluation, the employer tabulates and 
examines the test results within a reasonable time, and the use of the 
automobiles is restricted to the employees. If the employer imposes the 
limits described in paragraph (n)(2) of this section, the employees may 
exclude the value of the use of the automobile during the testing and 
evaluation period.

    (o) Qualified automobile demonstration use--(1) In general. The 
value of qualified automobile demonstration use is excludable from gross 
income as a working condition fringe. ``Qualified automobile 
demonstration use'' is any use of a demonstration automobile by a full-
time automobile salesman in the sales area in which the automobile 
dealer's sales office is located if--
    (i) Such use is provided primarily to facilitate the salesman's 
performance of services for the employer; and
    (ii) There are substantial restrictions on the personal use of the 
automobile by the salesman.
    (2) Full-time automobile salesman--(i) Defined. The term ``full-time 
automobile salesman'' means any individual who--
    (A) Is employed by an automobile dealer;
    (B) Customarily spends at least half of a normal business day 
performing the functions of a floor salesperson or sales manager;
    (C) Directly engages in substantial promotion and negotiation of 
sales to customers;
    (D) Customarily works a number of hours considered full-time in the 
industry (but at a rate not less than 1,000 hours per year); and
    (E) Derives at least 25 percent of his or her gross income from the 
automobi1e dealership directly as a result of the activities described 
in paragraphs (o)(2)(i) (B) and (C) of this section.


For purposes of paragraph (o)(2)(i) (E) of this section, income is not 
considered to be derived directly as a result of activities described in 
paragraphs (o)(2)(i) (B) and (C) of this section to the extent that the 
income is attributable to an individual's ownership interest in the 
dealership. An individual will not be considered to engage in direct 
sales activities if the individual's sales-related activities are 
substantially limited to review of sales price offers from customers. An 
individual, such as the general manager of an automobi1e dealership, who 
receives a sales commission on the sale of an automobile is not a full-
time automobile salesman unless the requirements of this paragraph 
(o)(2)(i) are met. The exclusion provided in this paragraph (o) is 
available to an individual who meets the definition of this paragraph 
(o)(2)(i) whether the individual performs services in addition to those 
described in this paragraph (o)(2)(i). For example, an individual who is 
an owner of the automobile dealership but who otherwise meets the

[[Page 582]]

requirements of this paragraph (o)(2)(i) may exclude from gross income 
the value of qualified automobile demonstration use. However, the 
exclusion of this paragraph (o) is not available to owners of large 
automobile dealerships who do not customarily engage in significant 
sales activities.
    (ii) Use by an individual other than a full-time automobile 
salesman. Personal use of a demonstration automobile by an individual 
other than a full-time automobile salesman is not treated as a working 
condition fringe. Therefore, any personal use, including commuting use, 
of a demonstration automobile by a part-time salesman, automobile 
mechanic, or other individual who is not a full-time automobile salesman 
is not ``qualified automobile demonstration use'' and thus not 
excludable from gross income. This is the case whether or not the 
personal use is within the sales area (as defined in paragraph (o)(5) of 
this section).
    (3) Demonstration automobile. The exclusion provided in this 
paragraph (o) applies only to qualified use of a demonstration 
automobile. A demonstration automobile is an automobile that is--
    (i) Currently in the inventory of the automobile dealership; and
    (ii) Available for test drives by customers during the normal 
business hours of the employee.
    (4) Substantial restrictions on personal use. Substantial 
restrictions on the personal use of a demonstration automobile exist 
when all of the following conditions are satisfied:
    (i) Use by individuals other than the full-time automobile salesmen 
(e.g., the salesman's family) is prohibited;
    (ii) Use for personal vacation trips is prohibited;
    (iii) The storage of personal possessions in the automobile is 
prohibited; and
    (iv) The total use by mileage of the automobile by the salesman 
outside the salesman's normal working hours is limited.
    (5) Sales area--(i) In general. Qualified automobile demonstration 
use consists of use in the sales area in which the automobile dealer's 
sales office is located. The sales area is the geographic area 
surrounding the automobile dealer's sales office from which the office 
regularly derives customers.
    (ii) Sales area safe harbor. With respect to a particular full-time 
salesman, the automobile dealer's sales area may be treated as the area 
within a radius of the larger of--
    (A) 75 miles or
    (B) The one-way commuting distance (in miles) of the particular 
salesman from the dealer's sales office.
    (6) Applicability of substantiation requirements of sections 162 and 
274(d). Notwithstanding anything in this section to the contrary, the 
value of the use of a demonstration automobile may not be excluded from 
gross income as a working condition fringe, by either the employer or 
the employee, unless, with respect to the restrictions of paragraph 
(o)(4) of this section, the substantiation requirements of section 
274(d) and the regulations thereunder are satisfied. See Sec. 1.132-
5(c) for general and safe harbor rules relating to the applicability of 
the substantiation requirements of section 274(d).
    (7) Special valuation rules. See Sec. 1.61-21(d)(6)(ii) for special 
rules that may be used to value the availability of demonstration 
automobiles.
    (p) Parking--(1) In general. The value of parking provided to an 
employee on or near the business premises of the employer is excludable 
from gross income as a working condition fringe under the special rule 
of this paragraph (p). If the rules of this paragraph (p) are satisfied, 
the value of parking is excludable from gross income whether the amount 
paid by the employee for parking would be deductible under section 162. 
The working condition fringe exclusion applies whether the employer owns 
or rents the parking facility or parking space.
    (2) Reimbursement of parking expenses. A reimbursement to the 
employee of the ordinary and necessary expenses of renting a parking 
space on or near the business premises of the employer is excludable 
from gross income as a working condition fringe, if, but for the parking 
expense, the employee would not have been entitled to receive and retain 
such amount from the employer. If, however an employee is entitled to 
retain a general transportation allowance or a similar benefit whether 
or

[[Page 583]]

not the employee has parking expenses, no portion of that allowance is 
excludable from gross income under this paragraph (p) even if it is used 
for parking expenses.
    (3) Parking on residential property. With respect to an employee, 
this paragraph (p) does not apply to any parking facility or space 
located on property owned or leased by the employee for residential 
purposes.
    (4) Dates of applicability. This paragraph (p) applies to benefits 
provided before January 1, 1993. For benefits provided after December 
31, 1992, see Sec. 1.132-9.
    (q) Nonapplicability of nondiscrimination rules. Except to the 
extent provided in paragraph (n)(3) of this section (relating to 
discriminating classifications of a product testing program), the 
nondiscrimination rules of section 132 (h)(1) and Sec. 1.132-8 do not 
apply in determining the amount, if any, of a working condition fringe.
    (r) Volunteers--(1) In general. Solely for purposes of section 
132(d) and paragraph (a)(1) of this section, a bona fide volunteer 
(including a director or officer) who performs services for an 
organization exempt from tax under section 501(a), or for a government 
employer (as defined in paragraph (m)(7) of this section), is deemed to 
have a profit motive under section 162.
    (2) Limit on application of this paragraph. This paragraph (r) shall 
not be used to support treatment of the bona fide volunteer as having a 
profit motive for purposes of any provision of the Internal Revenue Code 
of 1986 (Code) other than section 132(d). Nothing in this paragraph (r) 
shall be interpreted as determining the employment status of a bona fide 
volunteer for purposes of any section of the Code other than section 
132(d).
    (3) Definitions--(i) Bona fide volunteer. For purposes of this 
paragraph (r), an individual is considered a ``bona fide volunteer'' if 
the individual does not have a profit motive for purposes of section 
162. For example, an individual is considered a ``bona fide volunteer'' 
if the total value of the benefits provided with respect to the 
volunteer services is substantially less than the total value of the 
volunteer services the individual provides to an exempt organization or 
government employer.
    (ii) Liability insurance coverage for a bona fide volunteer. For 
purposes of this paragraph (r), the receipt of liability insurance 
coverage by a volunteer, or an exempt organization or government 
employer's undertaking to indemnify the volunteer for liability, does 
not by itself confer a profit motive on the volunteer, provided the 
insurance coverage or indemnification relates to acts performed by the 
volunteer in the discharge of duties, or the performance of services, on 
behalf of the exempt organization or government employer.
    (4) Example. The following example illustrates the provisions of 
paragraph (r) of this section.

    Example. A is a manager and full-time employee of P, a tax-exempt 
organization described in section 501(c)(3). B is a member of P's board 
of directors. Other than $25 to defray expenses for attending board 
meetings, B receives no compensation for serving as a director and does 
not have a profit motive. Therefore, B is a bona fide volunteer by 
application of paragraph (r)(3)(i) of this section and is deemed to have 
a profit motive under paragraph (r)(1) of this section for purposes of 
section 132(d). In order to provide liability insurance coverage, P 
purchases a policy that covers actions arising from A's and B's 
activities performed as part of their duties to P. The value of the 
policy and payments made to or on behalf of A under the policy are 
excludable for A's gross income as a working condition fringe, because A 
has a profit motive under section 162 and would be able to deduct 
payments for liability insurance coverage had he paid for it himself. 
The receipt of liability insurance coverage by B does not confer a 
profit motive on B by application of paragraph (r)(3)(ii) of this 
section. Thus, the value of the policy and payments made to or on behalf 
of B under the policy are excludable from B's income as a working 
condition fringe. For the year in which the liability insurance coverage 
is provided to A and B, P may exclude the value of the benefit on the 
Form W-2 it issues to A or on any Form 1099 it might otherwise issue to 
B.

    (s) Application of section 274(a)(3)--(1) In general. If an 
employer's deduction under section 162(a) for dues paid or incurred for 
membership in any club organized for business, pleasure, recreation, or 
other social purpose is disallowed by section 274(a)(3), the amount, if 
any, of an employee's working condition fringe benefit relating to

[[Page 584]]

an employer-provided membership in the club is determined without regard 
to the application of section 274(a) to the employee. To be excludible 
as a working condition fringe benefit, however, the amount must 
otherwise qualify for deduction by the employee under section 162(a). If 
an employer treats the amount paid or incurred for membership in any 
club organized for business, pleasure, recreation, or other social 
purpose as compensation under section 274(e)(2), then the expense is 
deductible by the employer as compensation and no amount may be excluded 
from the employee's gross income as a working condition fringe benefit. 
See Sec. 1.274-2(f)(2)(iii)(A).
    (2) Treatment of tax-exempt employers. In the case of an employer 
exempt from taxation under subtitle A of the Internal Revenue Code, any 
reference in this paragraph (s) to a deduction disallowed by section 
274(a)(3) shall be treated as a reference to the amount which would be 
disallowed as a deduction by section 274(a)(3) to the employer if the 
employer were not exempt from taxation under subtitle A of the Internal 
Revenue Code.
    (3) Examples. The following examples illustrate this paragraph (s):

    Example 1. Assume that Company X provides Employee B with a country 
club membership for which it paid $20,000. B substantiates, within the 
meaning of paragraph (c) of this section, that the club was used 40 
percent for business purposes. The business use of the club (40 percent) 
may be considered a working condition fringe benefit, notwithstanding 
that the employer's deduction for the dues allocable to the business use 
is disallowed by section 274(a)(3), if X does not treat the club 
membership as compensation under section 274(e)(2). Thus, B may exclude 
from gross income $8,000 (40 percent of the club dues, which reflects 
B's business use). X must report $12,000 as wages subject to withholding 
and payment of employment taxes (60 percent of the value of the club 
dues, which reflects B's personal use). B must include $12,000 in gross 
income. X may deduct as compensation the amount it paid for the club 
dues which reflects B's personal use provided the amount satisfies the 
other requirements for a salary or compensation deduction under section 
162.
    Example 2. Assume the same facts as Example 1 except that Company X 
treats the $20,000 as compensation to B under section 274(e)(2). No 
portion of the $20,000 will be considered a working condition fringe 
benefit because the section 274(a)(3) disallowance will apply to B. 
Therefore, B must include $20,000 in gross income.

    (t) Application of section 274(m)(3)--(1) In general. If an 
employer's deduction under section 162(a) for amounts paid or incurred 
for the travel expenses of a spouse, dependent, or other individual 
accompanying an employee is disallowed by section 274(m)(3), the amount, 
if any, of the employee's working condition fringe benefit relating to 
the employer-provided travel is determined without regard to the 
application of section 274(m)(3). To be excludible as a working 
condition fringe benefit, however, the amount must otherwise qualify for 
deduction by the employee under section 162(a). The amount will qualify 
for deduction and for exclusion as a working condition fringe benefit if 
it can be adequately shown that the spouse's, dependent's, or other 
accompanying individual's presence on the employee's business trip has a 
bona fide business purpose and if the employee substantiates the travel 
within the meaning of paragraph (c) of this section. If the travel does 
not qualify as a working condition fringe benefit, the employee must 
include in gross income as a fringe benefit the value of the employer's 
payment of travel expenses with respect to a spouse, dependent, or other 
individual accompanying the employee on business travel. See Sec. Sec. 
1.61-21(a)(4) and 1.162-2(c). If an employer treats as compensation 
under section 274(e)(2) the amount paid or incurred for the travel 
expenses of a spouse, dependent, or other individual accompanying an 
employee, then the expense is deductible by the employer as compensation 
and no amount may be excluded from the employee's gross income as a 
working condition fringe benefit. See Sec. 1.274-2(f)(2)(iii)(A).
    (2) Treatment of tax-exempt employers. In the case of an employer 
exempt from taxation under subtitle A of the Internal Revenue Code, any 
reference in this paragraph (t) to a deduction disallowed by section 
274(m)(3) shall be treated as a reference to the amount which would be 
disallowed as a deduction by section 274(m)(3) to the employer if the 
employer were not exempt from taxation

[[Page 585]]

under subtitle A of the Internal Revenue Code.

[T.D. 8256, 54 FR 28608, July 6, 1989, as amended by 8451, 57 FR 57669, 
Dec. 7, 1992; T.D. 8457, 57 FR 62196, Dec. 30, 1992; T.D. 8666, 61 FR 
27006, May 30, 1996; T.D. 8933, 66 FR 2244, Jan. 11, 2001]



Sec. 1.132-5T  Working condition fringe--1985 through 1988 (temporary).

    (a) In general--(1) Definition. Gross income does not include the 
value of a working condition fringe. The term ``working condition 
fringe'' means any property or service provided to an employee of an 
employer to the extent that, if the employee paid for the property or 
service, the amount paid would be allowable as a deduction under section 
162 or 167. If, under section 274 or any other section, certain 
substantiation requirements must be met in order for a deduction under 
section 162 or 167 to be allowable, those substantiation requirements 
apply to the determination of a working condition fringe. An amount that 
would be deductible by the employee under, for example, section 212 is 
not a working condition fringe.
    (2) Trade or business of the employee. If the hypothetical payment 
for the property or service would be allowable as a deduction with 
respect to a trade or business of the employee other than the employee's 
trade or business of being an employee of the employer, it cannot be 
taken into account for purposes of determining the amount, if any, of 
the working condition fringe. For example, assume that, unrelated to 
company X's trade or business and unrelated to company X's employee's 
trade or business of being an employee of company X, the employee is a 
member of the board of directors of company Y. Assume further that 
company X provides the employee with air transportation to a company Y 
board of director's meeting. The employee may not exclude the value of 
the air transportation to the meeting as a working condition fringe. The 
employee may, however, deduct such amount under section 162 if the 
section 162 requirements are satisfied. The result would be the same 
whether the air transportation was provided in the form of a flight on a 
commercial airline or a seat on a company X airplane.
    (b) Vehicle allocation rules--(1) In general--(i) General rule. In 
general, with respect to an employer-provided vehicle, the amount 
excludable as a working condition fringe is the amount that would be 
allowable as a deduction under section 162 or 167 if the employee paid 
for the availability of the vehicle. For example, assume that the value 
of the availability of an employer-provided vehicle for a full year is 
$2,000, without regard to any working condition fringe (i.e., assuming 
all personal use). Assume further that the employee drives the vehicle 
6,000 miles for his employer's business and 2,000 miles for reasons 
other than the employer's business. In this situation, the value of the 
working condition fringe is $2,000 multiplied by a fraction, the 
numerator of which is the business-use mileage (6,000 miles) and the 
denominator of which is the total mileage (8,000 miles). Thus, the value 
of the working condition fringe is $1,500. The total amount includable 
in the employee's gross income on account of the availability of the 
vehicle is $500. For purposes of this section, the term ``vehicle'' has 
the same meaning given the term in Sec. 1.61-2T(e)(2). Generally, when 
determining the amount of an employee's working condition fringe, miles 
accumulated on the vehicle by all employees of the employer during the 
period in which the vehicle is available to the employee must be 
considered. For example, assume that an employee of the employer is 
provided the availability of an automobile for one year. Assume further 
that during the year, the automobile is regularly used in the employer's 
business by other employees. All miles accumulated on the automobile by 
all employees of the employer during the year must be considered. If, 
however, substantially all the use of the automobile by other employees 
in the employer's business is permitted during a certain period, such as 
the last three months of the year, the miles driven by the other 
employees during that period would not be considered when determining 
the employee's working condition fringe exclusion.
    (ii) Use by an individual other than the employee. For purposes of 
this section,

[[Page 586]]

if the availability of a vehicle to an individual would be taxed to an 
employee, use of the vehicle by the individual is included in references 
to use by the employee.
    (iii) Provision of an expensive vehicle for personal use. Assume an 
employer provides an employee with an expensive vehicle that an employee 
may use in part for personal purposes. Even though the decision to 
provide an expensive rather than an inexpensive vehicle is made by the 
employer for bona fide noncompensatory business reasons, there is no 
working condition fringe exclusion with respect to the personal miles 
driven by the employee. If the employee paid for the availability of the 
vehicle, he would not be entitled to deduct any part of the payment 
attributable to personal miles.
    (2) Use of different employer-provided automobiles. The working 
condition fringe exclusion must be applied on an automobile by 
automobile basis. For example, assume that automobile Y is available to 
employee D for 3 days in January and for 5 days in March, and automobile 
Z is available to D for a week in July. Assume further that the Daily 
Lease Value, as defined in Sec. 1.61-2T, of each automobile is $50. For 
the eight days of availability of Y in January and March, D uses Y 90 
percent for business (by mileage). During July, D uses Z 60 percent for 
business (by mileage). The value of the working condition fringe is 
determined separately for each automobile. Therefore, the working 
condition fringe for Y is $360 ($400 x .90) leaving an income inclusion 
of $40. The working condition fringe for Z is $210 ($350 x .60) leaving 
an income inclusion of $140. If the value of the availability of an 
automobile is determined under the Annual Lease Value rule for one 
period and Daily Lease Value rule for a second period (see Sec. 1.61-
2T), the working condition fringe exclusion must be calculated 
separately for the two periods.
    (c) Applicability of sections 162 and 274(d)--(1) In general. The 
value of property or services provided to an employee may not be 
excluded from the employee's gross income as a working condition fringe, 
by either the employer or the employee, unless the applicable 
substantiation requirements of either section 274(d) or section 162 
(whichever is applicable) and the regulations thereunder are statisfied. 
With respect to listed property, the substantiation requirements of 
section 274(d) and the regulations thereunder do not apply to the 
determination of an employee's working condition fringe exclusion prior 
to the date that those requirements apply to the first taxable year of 
the employer beginning after December 31, 1985. For example, if an 
employer's first taxable year beginning after December 31, 1985, begins 
on July 1, 1986, with respect to listed property, the substantiation 
requirements of section 274(d) apply as of that date. The substantiation 
requirements of section 274(d) apply to an employee even if the 
requirements of section 274 do not apply to the employee's employer for 
deduction purposes (such as when the employer is a tax-exempt 
organization or a governmental unit); in these cases, the requirements 
of section 274(d) apply to the employee as of January 1, 1986.
    (2) Section 274(d) requirements. The substantiation requirements of 
section 274(d) are satisfied by ``adequate records or sufficient 
evidence corroborating the [employee's] own statement''. Therefore, such 
records or evidence provided by the employee, and relied upon by the 
employer to the extent permitted by the regulations promulgated under 
section 274(d), will be sufficient to substantiate a working condition 
fringe exclusion.
    (d) Safe harbor rules--(1) In general. Section 1.274-6T provides 
that the substantiation requirements of section 274(d) and the 
regulations thereunder may be satisfied, in certain circumstances, by 
using one or more of the safe harbor rules prescribed in Sec. 1.274-6T. 
If the employer uses one of the safe harbor rules prescribed in Sec. 
1.274-6T during a period with respect to a vehicle (as defined in Sec. 
1.61-2T), that rule must be used by the employer to substantiate a 
working condition fringe exclusion with respect to that vehicle during 
the period. An employer that is exempt from Federal income tax may still 
use one of the safe harbor rules (if the requirements of that section 
are otherwise met during a period) to substantiate a working condition

[[Page 587]]

fringe exclusion with respect to a vehicle during the period. If the 
employer uses one of the methods prescribed in Sec. 1.274-6T during a 
period with respect to an employer-provided vehicle, that method may be 
used by an employee to substantiate a working condition fringe exclusion 
with respect to the same vehicle during the period, as long as the 
employee includes in gross income the amount allocated to the employee 
pursuant to Sec. 1.274-6T and this section. (See Sec. 1.61-2T(c)(2)(i) 
for other rules concerning when an employee must include in income the 
amount determined by the employer.) If, however, the employer uses the 
safe harbor rule prescribed in Sec. 1.274-6T(a) (2) or (3) and the 
employee without the employer's knowledge uses the vehicle for purposes 
other than de minimis personal use (in the case of the rule prescribed 
in Sec. 1.274-6T(a)(2)), or for purposes other than de minimis personal 
use and commuting (in the case of the rule prescribed in Sec. 1.274-
6T(a)(3)), then the employee must include additional income for the 
unauthorized use of the vehicle.
    (2) Period for use of safe harbor rules. The rules prescribed in 
this paragraph (d) assume that the safe harbor rules prescribed in Sec. 
1.274-6T are used for a one-year period. Accordingly, references to the 
value of the availability of a vehicle, amounts excluded as a working 
condition fringe, etc., are based on a one-year period. If the safe 
harbor rules prescribed in Sec. 1.274-6T are used for a period of less 
than a year, the amounts referenced in the previous sentence must be 
adjusted accordingly. For purposes of this section, the term ``personal 
use'' has the same meaning as prescribed in Sec. 1.274-6T(e)(5).
    (e) Vehicles not available to employees for personal use. For a 
vehicle described in Sec. 1.274-6T(a)(2) (relating to certain vehicles 
not used for personal purposes), the working condition fringe exclusion 
is equal to the value of the availability of the vehicle if the employer 
uses the method prescribed in Sec. 1.274-6T(a)(2).
    (f) Vehicles not available to employees for personal use other than 
commuting. For a vehicle described in Sec. 1.274-6T(a)(3) (relating to 
certain vehicles not used for personal purposes other than commuting), 
the working condition fringe exclusion is equal to the value of the 
availability of the vehicle for purposes other than commuting if the 
employer uses the method prescribed in Sec. 1.274-6T(a)(3). This rule 
applies only if the special rule for valuing commuting use, as 
prescribed in Sec. 1.61-2T, is used and the amount determined under the 
special rule is either included in the employee's income or reimbursed 
by the employee.
    (g) Vehicles used in connection with the business of farming that 
are available to employees for personal use--(1) In general. For a 
vehicle described in Sec. 1.274-6T(b) (relating to certain vehicles 
used in connection with the business of farming), the working condition 
fringe exclusion is calculated by multiplying the value of the 
availability of the vehicle by 75 percent.
    (2) Vehicles available to more than one individual. If the vehicle 
is available to more than one individual, the employer must allocate the 
gross income attributable to the vehicle (25 percent of the value of the 
availability of the vehicle) among the employees (and other individuals 
whose use would not be attributed to an employee) to whom the vehicle 
was available. This allocation must be done in a reasonable manner to 
reflect the personal use of the vehicle by the individuals. An amount 
that would be allocated to a sole proprietor reduces the amounts that 
may be allocated to employees but are otherwise to be disregarded for 
purposes of this paragraph (g). For purposes of this paragraph (g), the 
value of the availability of a vehicle may be calculated as if the 
vehicle were available to only one employee continuously and without 
regard to any working condition fringe exclusion.
    (3) Examples. The following examples illustrate a reasonable 
allocation of gross income with respect to an employer-provided vehicle 
between two employees:

    Example (1). Assume that two farm employees share the use of a 
vehicle which for a calendar year is regularly used directly in 
connection with the business of farming and qualifies for use of the 
rule in Sec. 1.274-6T (b). Employee A uses the vehicle in the morning 
directly in connection with the business of farming and employee B uses 
the vehicle in the afternoon directly in connection with the business of 
farming. Assume further that

[[Page 588]]

employee B takes the vehicle home in the evenings and on weekends. The 
employer should allocate all the income attributable to the availability 
of the vehicle to employee B.
    Example (2). Assume that for a calendar year, farm employees C and D 
share the use of a vehicle that is regularly used directly in connection 
with the business of farming and qualifies for use of the rule in Sec. 
1.274-6T (b). Assume further that the employees alternate taking the 
vehicle home in the evening and alternate the availability of the 
vehicle for personal purposes on weekends. The employer should allocate 
the income attributable to the availability of the vehicle for personal 
use (25 percent of the value of the availability of the vehicle) equally 
between the two employees.
    Example (3). Assume the same facts as in example (2) except that C 
is the sole proprietor of the farm. Based on these facts, C should 
allocate the same amount of income to D as was allocated to D in example 
(2). No other income attributable to the availability of the vehicle for 
personal use should be allocated.

    (h) Qualified non-personal use vehicles. Effective January 1, 1985, 
100 percent of the value of the use of a qualified nonpersonal use 
vehicle (as described in Sec. 1.274-5T (k)) is excluded from gross 
income as a working condition fringe, provided that, in the case of a 
vehicle described in paragraph (k) (3) through (7) of that section, the 
use of the vehicles conforms to the requirements of that paragraph.
    (i) [Reserved]
    (j) Application of section 280F. In determining the amount, if any, 
of an employee's working condition fringe, section 280F and the 
regulations thereunder do not apply. For example, assume that an 
employee has available for a calendar year an employer-provided 
automobile with a fair market value of $28,000. Assume further that the 
special rule provided in Sec. 1.61-2T is used and that the Annual Lease 
Value, as defined in Sec. 1.61-2T, is $7,750, and that all of the 
employee's use of the automobile is in the employer's business. The 
employee would be entitled to exclude the entire Annual Lease Value as a 
working condition fringe, despite the fact that if the employee paid for 
the availability of the automobile, an income inclusion would be 
required under Sec. 1.280F-5T(d)(1). This paragraph (j) does not affect 
the applicability of section 280F to the employer with respect to such 
employer-provided automobile, nor does it affect the applicability of 
section 274. For rules concerning substantiation of an employee's 
working condition fringe, see paragraph (c) of this section.
    (k) Aircraft allocation rule. In general, with respect to a flight 
on an employer-provided aircraft, the amount excludable as a working 
condition fringe is the amount that would be allowable as a deduction 
under section 162 or 167 if the employee paid for the flight on the 
aircraft. For example, if employee P flies on P's employer's airplane 
primarily for business reasons of P's employer, the value of P's flight 
is excludable as a working condition fringe. However, if P's spouse and 
children accompany P on such airplane trip primarily for personal 
reasons, the value of the flights by P's spouse and children are 
includable in P's gross income. See Sec. 1.61-2T(g) for special rules 
for valuing personal flights.
    (l) [Reserved]
    (m) Employer-provided transportation for security concerns--(1) In 
general. The amount of a working condition fringe exclusion with respect 
to employer-provided transportation is the amount that would be 
allowable as a deduction under section 162 or 167 if the employee paid 
for the transportation. Generally, if an employee pays for 
transportation taken for primarily personal purposes, the employee may 
not deduct any part of the amount paid. Thus, the employee may not 
generally exclude the value of employer-provided transportation as a 
working condition fringe if such transportation is primarily personal. 
If, however, for bona fide business-oriented security concerns, the 
employee purchases transportation that provides him or her with 
additional security, the employee may generally deduct the excess of the 
amount paid for the transportation over the lesser amount the employee 
would have paid for the same mode of transportation absent the bona fide 
business-oriented security concerns. With respect to a vehicle, the 
phrase ``the same mode of transportation'' means use of the same vehicle 
without the additional security aspects, such as bulletproof glass. With 
respect to air transportation, the phrase ``the same

[[Page 589]]

mode of transportation'' means comparable air transportation. These same 
rules apply to the determination of an employee's working condition 
fringe exclusion. For example, if an employer provides an employee with 
an automobile for commuting and, for bona fide business-oriented 
security concerns, the automobile is specially designed for security, 
then the employee may exclude the value of the special security design 
as a working condition fringe if the employee's automobile would not 
have had such security design but for the bona fide business-oriented 
security concerns. The employee may not exclude the value of the 
commuting from income as a working condition fringe because commuting is 
a nondeductible personal expense. Similarly, if an employee travels on a 
personal trip in an employer-provided aircraft for bona fide business-
oriented security concerns, the employee may exclude the excess, if any, 
of the value of the flight over the amount the employee would have paid 
for comparable air transportation, but for the bona fide business-
oriented security concerns. Because personal travel is a nondeductible 
expense, the employee may not exclude the total value of the trip as a 
working condition fringe.
    (2) Demonstration of bona fide business-oriented security concerns--
(i) In general. For purposes of this paragraph (m), the existence of a 
bona fide business-oriented security concern for the furnishing of a 
specific form of transportation to an employee is determined on the 
basis of all the facts and circumstances within the following 
guidelines:
    (A) Services performed outside the United States. With respect to an 
employee performing services for an employer in a geographic area other 
than the United States, a factor indicating a bona fide business-
oriented security concern is a recent history of violent terrorist 
activity in such geographic area (such as bombings or abductions for 
ransom), unless such activity is focused on a group of individuals which 
does not include the employee or a similarly situated employee or on a 
section of the geographic area which does not incude the employee.
    (B) Services performed in the United States. With respect to an 
employee performing services for an employer in the United States, a 
factor indicating a bona fide business-oriented security concern is 
threats on the life of the employee or on the life of a similarly 
situated employee because of the employee's status as an employee of the 
employer.
    (ii) Establishment of overall security program. Notwithstanding 
anything in paragraph (m)(2)(i) of this section to the contrary, no bona 
fide business-oriented security concern will be deemed to exist unless 
the employee's employer establishes an overall security program with 
respect to the employee involved.
    (iii) Overall security program--(A) Definition. An overall security 
program is one in which security is provided to protect the employee on 
a 24-hour basis. The employee must be protected while at the employee's 
residence, while commuting to and from the employee's workplace, and 
while at the employee's workplace. In addition, the employee must be 
protected while traveling, whether for business or personal purposes. An 
overall security program would include the provision of a bodyguard/
driver who is trained in evasive driving techniques; and automobile 
specially equipped for security; guards, metal detectors, alarms, or 
similar methods of controling access to the employee's workplace and 
residence; and, in appropriate cases, flights on the employer's aircraft 
for business and personal reasons.
    (B) Application. There is no overall security program when, for 
example, security is provided at the employee's workplace but not at the 
employee's residence. In addition, the fact that an employer requires an 
employee to travel on the employer's aircraft, or in an employer-
provided vehicle that contains special security features, does not alone 
constitute an overall security program. The preceding sentence applies 
regardless of the existence of a corporate or other resolution requiring 
the employee to travel in the employer's airplane or vehicle for 
personal as well as business reasons. Similarly, the existence of an 
independent security study particular to the employer and

[[Page 590]]

its employees, or to the employee involved, does not alone constitute an 
overall security program.
    (iv) Effect of an independent security study. An overall security 
program with respect to an employee is deemed to exist even though 
security is not provided to an employee on a 24-hour basis if the 
conditions of this paragraph (m)(2)(iv) are satisfied:
    (A) A security study is performed with respect to the employer and 
the employee (or a similarly situated employee) by an independent 
security consultant;
    (B) The security study is based on an objective assessment of all 
the facts and circumstances;
    (C) The recommendation of the security study is that an overall 
security program (as defined in paragraph (m)(2)(iii) of this section) 
is not necessary and such recommendation is reasonable under the 
circumstances; and
    (D) The employer applies the specific security recommendations 
contained in the security study to the employee on a consistent basis.

The value of the security provided pursuant to a security study that 
meets the requirements of this paragraph (m)(2)(iv) may be excluded from 
income, if the security study conclusions are reasonable and, but for 
the bona fide business-oriented security concerns, the employee would 
not have had such security. No exclusion from income applies to security 
provided by the employer that is not recommended in the security study. 
Security study conclusions may be reasonable even if, for example, it is 
recommended that security be limited to certain geographic areas, as in 
the case where air travel security is provided only in certain foreign 
countries.
    (v) Application of security rules to spouses and dependents. The 
availability of a working condition fringe exclusion based on the 
existence of a bona fide business-oriented security concern with respect 
to the spouse and dependents of an employee is determined separately for 
such spouse and dependents under the rules established in this paragraph 
(m).
    (vi) Working condition safe harbor. Under the special rule of this 
paragraph (m)(2)(vi), if, for a bona fide business-oriented security 
concern, the employer requires that the employee travel on an employer-
provided aircraft for a personal trip, the employer and the employee may 
exclude, as a working condition fringe, the excess value of the trip 
over comparable first-class airfare without having to show that but for 
the bona fide business-oriented security concerns, the employee would 
have flown first-class on a commercial aircraft. If the special 
valuation rule provided in Sec. 1.61-2T is used, the excess over the 
amount determined by multiplying an aircraft multiple of 200-percent by 
the base aircraft valuation formula may be excluded as a working 
condition fringe.
    (3) Examples. The provisions of this paragraph (m) may be 
illustrated by the following examples:

    Example (1). Assume that in response to several death threats on the 
life of A, the president of a multinational company (company X), company 
X establishes an overall security program for A, including an alarm 
system at A's home and guards at A's workplace, the use of a vehicle 
that is specially equipped with alarms, bulletproof glass, and armor 
plating and a bodyguard/driver who is trained in evasive driving 
techniques. Assume further that A is driven for both personal and 
business reasons in the vehicle. Also, assume that but for the bona fide 
business-oriented security concerns, no part of the overall suecurity 
program would been provided to A. With respect to the transportation 
provided for security reasons, A may exclude as a working condition 
fringe the value of the special security features of the vehicle and the 
value attributable to the bodyguard/driver. Thus, if the value of the 
specially equipped vehicle is $40,000, and the value of the vehicle 
without the security features is $25,000, A may determine A's income 
attributable to the vehicle as if the vehicle were worth $25,000. A must 
include in income the value of the availability of the vehicle for 
personal use.
    Example (2). Assume that B is the chief executive officer of a 
multinational corporation (company Y). Assume further that there have 
been kidnapping attempts and other terrorist activities in the foreign 
countries in which B performs services and that at least some of such 
activities have been directed against B or similarly situated employees. 
In response to these activities, company Y provides B with an overall 
security program, including an alarm system at B's home and bodyguards 
at B's workplace, a bodyguard/driver who is trained in evasive

[[Page 591]]

driving techniques, and a vehicle specially designed for security during 
B's overseas travels. In addition, assume that company Y requires B to 
travel in company Y's airplane for business and personal trips taken to, 
from, and within these foreign countries. Also, assume that but for bona 
fide business-oriented security concerns, no part of the overall 
sucurity program would have been provided to B. B may exclude as a 
working condition fringe the value of the special security features of 
the automobile and the value attributable to the bodyguards and the 
bodyguard/driver. B may also exclude as a working condition fringe the 
excess, if any, of the value of personal flights in the company Y 
airplane over first-class airfare (as determined under the special 
valuation rule provided in Sec. 1.61-2T if the safe harbor described in 
paragraph (m)(2)(vi) of this section is used). B must include in income 
the value of the availability of the vehicle for personal use and the 
lesser of the value of first-class airfare or the value of the flight 
determined under Sec. 1.61-2T for each personal flight taken by B in 
company Y's airplane.
    Example (3). Assume the same facts as in example (2) except that 
company Y also requires B to travel in company Y's airplane within the 
United States, and provides B with a chauffeur-driven limousine for 
business and personal travel in the United States. Assume further that 
company Y also requires B's spouse and dependents to travel in company 
Y's airplane for personal flights in the United States. If no bona fide 
business-oriented security concern exists with respect to travel in the 
United States, B may not exclude any portion of the value of the 
availability of the driver or limousine for personal use in the United 
States. Thus, B must include in income the value of the availability of 
the vehicle and driver for personal use. In addition, B may not exclude 
any portion of the value attributable to personal flights by B or B's 
spouse and dependents on company Y's airplane. Thus, B must include in 
income the value attributable to the personal use of company Y's 
airplane. See Sec. 1.61-2T for rules relating to the valuation of 
personal flights on employer-provided airplanes.
    Example (4). Assume that company Z retains an independent security 
consultant to perform a security study with respect to its chief 
executive officer. Assume further that, based on an objective assessment 
of the facts and circumstances, the security consultant reasonably 
recommends that the employee be provided security at his workplace and 
for ground transportation, but not for air transportation. If company Z 
follows the recommendations on a consistent basis, an overall security 
program will be deemed to exist with respect to the workplace and ground 
transportation security only.
    Example (5). Assume the same facts as in example (4) except that 
company Z only provides the employee security while commuting to and 
from work, but not for any other ground transportation. Since the 
recommendations of the independent security study are not applied on a 
consistent basis, an overall security program will not be deemed to 
exist.

    (n) Product testing--(1) In general. The fair market value of the 
use of consumer goods, which are manufactured for sale to nonemployees, 
for product testing and evaluation by an employee outside the employer's 
workplace is excludable as a working condition fringe if--
    (i) Consumer testing and evaluation of the product is an ordinary 
and necessary business expense of the employer,
    (ii) Business reasons necessitate that the testing and evaluation of 
the product be performed off the employer's business premises by 
employees (i.e., the testing and evaluation cannot be carried out 
adequately in the employer's office or in laboratory testing 
facilities),
    (iii) The product is furnished to the employee for purposes of 
testing and evaluation,
    (iv) The product is made available to the employee for no longer 
than necessary to test and evaluate its performance and must be returned 
to the employer at completion of the testing and evaluation period,
    (v) The employer imposes limitations of the employee's use of the 
product which significantly reduce the value of any personal benefit to 
the employee, and
    (vi) The employee must submit detailed reports to the employer on 
the testing and evaluation.

The length of the testing and evaluation period must be reasonable in 
relation to the product being tested.
    (2) Employer-imposed limitations. The requirement of paragraph 
(n)(1)(v) of this section is satisfied if--
    (i) The employer places limitations on the employee's ability to 
select among different models or varieties of the consumer product that 
is furnished for testing and evaluation purposes,
    (ii) The employer's policy provides for the employee, in appropriate 
cases, to purchase or lease at his or her own

[[Page 592]]

expense the same type of product as that being tested (so that personal 
use by the employee's family will be limited), and
    (iii) The employer generally prohibits use of the product by members 
of the employee's family.
    (3) Discriminating classifications. If an employer furnishes 
products under a testing and evaluation program only to officers, 
owners, or highly compensated employees, this fact may be considered in 
a determination of whether the products are furnished for testing and 
evaluation purposes or for compensation purposes, unless the employer 
can show a business reason for the classification of employees to whom 
the products are furnished (e.g., that automobiles are furnished for 
testing and evaluation by an automobile manufacturer to its design 
engineers and supervisory mechanics).
    (4) Factors that negate the existence of a product testing program. 
If an employer fails to tabulate and examine the results of the detailed 
reports within a reasonable period of time after expiration of the 
testing period, the program will not be considered a product testing 
program. Existence of one or more of the following factors may also 
establish that the program is not a bona fide product testing program:
    (i) The program is in essence a leasing program under which 
employees lease the consumer goods from the employer for a fee;
    (ii) The nature of the product and other considerations are 
insufficient to justify the testing program; or
    (iii) The expense of the program outweighs the benefits to be gained 
from testing and evaluation.
    (5) Failure to meet the requirements of this paragraph (n). The fair 
market value of the use of property for product testing and evaluation 
by an employee outside the employee's workplace, under a product testing 
program that does not meet all of the requirements of this paragraph 
(n), is not excludable as a working condition fringe.
    (6) Example. Assume that an employer that manufactures automobiles 
establishes a product testing program under which 50 of its 5,000 
employees test and evaluate the automobiles for 30 days. Assume further 
that the 50 employees represent a fair cross section of all of the 
employees of the employer, such employees submit detailed reports to the 
employer on the testing and evaluation, the employer tabulates and 
examines the test results within a reasonable time, and the use of the 
automobiles is restricted to the employees. If the rules of paragraph 
(n)(2) of this section are also met, the employees may exclude the value 
of the use of the automobile during the testing and evaluation period.
    (o) Qualified automobile demonstration use--(1) In general. The 
value of qualified automobile demonstration use is excludable from gross 
income as a working condition fringe. The term ``qualified automobile 
demonstration use'' means any use of a demonstration automobile by a 
full-time automobile salesman in the sales area in which the automobile 
dealer's sales office is located if--
    (i) Such use is provided primarily to facilitate the salesman's 
performance of services for the employer, and
    (ii) There are substantial restrictions on the personal use of the 
automobile by the salesman.
    (2) Full-time automobile salesman--(i) Definition. The term ``full-
time automobile salesman'' means any individual who--
    (A) Is employed by an automobile dealer,
    (B) Customarily spends substantially all of a normal business day on 
the sales floor selling automobiles to customers of the automobile 
dealership,
    (C) Customarily works a number of hours considered full-time in the 
industry (but at a rate not less than 1,000 hours per year), and
    (D) Derives at least 85 percent of his or her gross income from the 
automobile dealership directly as a result of such automobile sales 
activities.

An individual, such as the general manager of an automobile dealership, 
who receives a sales commission on the sale of an automobile is not a 
full-time automobile salesman unless the requirements of this paragraph 
(o)(2)(i) are met. The exclusion provided in this paragraph (o) is 
available to an individual who meets the definition of this paragraph 
(o)(2)(i) regardless of whether the individual performs services in

[[Page 593]]

addition to those described in this paragraph (o)(2)(i). For example, an 
individual who is an owner of the automobile dealership but who 
otherwise meets the requirements of this paragraph (o)(2)(i) may exclude 
from gross income the value of qualified automobile demonstration use.
    (ii) Use by an individual other than a full-time automobile 
salesman. Personal use of a demonstration automobile by an individual 
other than a full-time automobile salesman is not treated as a working 
condition fringe. Therefore, any personal use, including commuting use, 
of a demonstration automobile by a part-time salesman, automobile 
mechanic, manager, or other individual is not ``qualified automobile 
demonstration use'' and thus not excludable from gross income.
    (3) Demonstration Automobile. The exclusion provided in this 
paragraph (o) applies only to qualified use of a demonstration 
automobile. A demonstration automobile is an automobile that is--
    (i) Currently in the inventory of the automobile dealership, and
    (ii) Available for test drives by customers during the normal 
business hours of the employee.
    (4) Substantial restrictions on personal use. Substantial 
restrictions on the personal use of demonstration automobiles exist when 
all of the following conditions are satisfied:
    (i) Use by individuals other than the full-time automobile salesmen 
(e.g., the salesman's family) is prohibited,
    (ii) Use for personal vacation trips is prohibited,
    (iii) The storage of personal possessions in the automobile is 
prohibited, and
    (iv) The total use by mileage of the automobile by the salesman 
outside the salesman's normal working hours is limited.
    (5) Sales area--(i) In general. Qualified automobile demonstration 
use must be use in the sales area in which the automobile dealer's sales 
office is located. The sales area is the geographic area surrounding the 
automobile dealer's sales office from which the office regularly derives 
customers.
    (ii) Sales area safe harbor. With respect to a particular full-time 
salesman, the automobile dealer's sales area may be treated as the 
larger of the area within a 75 mile radius of the dealer's sales office, 
or the on-way commuting distance (in miles) of the particular salesman.
    (p) Parking--(1) In general. The value of parking provided to an 
employee on or near the business premises of the employer is excludable 
from gross income as a working condition fringe. The working condition 
fringe exclusion applies whether the employer owns or rents the parking 
facility or parking space.
    (2) Reimbursement of parking expenses. Any reimbursement to the 
employee of the ordinary and necessary expenses of renting a parking 
space on or near the business premises of the employer is excludable as 
a working condition fringe. The preceding sentence does not apply, 
however, to cash payments that are not actually used for renting a 
parking space. Thus, that part of a general transportation allowance 
that is not used for parking is not excludable as a working condition 
fringe under this paragraph (p).
    (3) Parking on residential property. With respect to an employee, 
this paragraph (p) does not apply to any parking facility or space 
located on property owned or leased for residential purposes by the 
employee.
    (q) Nonapplicability of nondiscrimination rules. Except to the 
extent provided in paragraph (n)(3) of this section, the 
nondiscrimination rules of section 132(h)(1) and Sec. 1.132-8T do not 
apply in determining the amount, if any, of a working condition fringe.

[T.D. 8063, 50 FR 52303, Dec. 23, 1985, as amended by T.D. 8256, 54 FR 
28600, July 6, 1989]



Sec. 1.132-6  De minimis fringes.

    (a) In general. Gross income does not include the value of a de 
minimis fringe provided to an employee. The term ``de minimis fringe'' 
means any property or service the value of which is (after taking into 
account the frequency with which similar fringes are provided by the 
employer to the employer's employees) so small as to make accounting for 
it unreasonable or administratively impracticable.

[[Page 594]]

    (b) Frequency--(1) Employee-measured frequency. Generally, the 
frequency with which similar fringes are provided by the employer to the 
employer's employees is determined by reference to the frequency with 
which the employer provides the fringes to each individual employee. For 
example, if an employer provides a free meal in kind to one employee on 
a daily basis, but not to any other employee, the value of the meals is 
not de minimis with respect to that one employee even though with 
respect to the employer's entire workforce the meals are provided 
``infrequently.''
    (2) Employer-measured frequency. Notwithstanding the rule of 
paragraph (b)(1) of this section, except for purposes of applying the 
special rules of paragraph (d)(2) of this section, where it would be 
administratively difficult to determine frequency with respect to 
individual employees, the frequency with which similar fringes are 
provided by the employer to the employer's employees is determined by 
reference to the frequency with which the employer provides the fringes 
to the workforce as a whole. Therefore, under this rule, the frequency 
with which any individual employee receives such a fringe benefit is not 
relevant and in some circumstances, the de minimis fringe exclusion may 
apply with respect to a benefit even though a particular employee 
receives the benefit frequently. For example, if an employer exercises 
sufficient control and imposes significant restrictions on the personal 
use of a company copying machine so that at least 85 percent of the use 
of the machine is for business purposes, any personal use of the copying 
machine by particular employees is considered to be a de minimis fringe.
    (c) Administrability. Unless excluded by a provision of chapter 1 of 
the Internal Revenue Code of 1986 other than section 132(a)(4), the 
value of any fringe benefit that would not be unreasonable or 
administratively impracticable to account for is includible in the 
employee's gross income. Thus, except as provided in paragraph (d)(2) of 
this section, the provision of any cash fringe benefit is never 
excludable under section 132(a) as a de minimis fringe benefit. 
Similarly except as otherwise provided in paragraph (d) of this section, 
a cash equivalent fringe benefit (such as a fringe benefit provided to 
an employee through the use of a gift certificate or charge or credit 
card) is generally not excludable under section 132(a) even if the same 
property or service acquired (if provided in kind) would be excludable 
as a de minimis fringe benefit. For example, the provision of cash to an 
employee for a theatre ticket that would itself be excludable as a de 
minimis fringe (see paragraph (e)(1) of this section) is not excludable 
as a de minimis fringe.
    (d) Special rules--(1) Transit passes. A public transit pass 
provided at a discount to defray an employee's commuting costs may be 
excluded from the employee's gross income as a de minimis fringe if such 
discount does not exceed $21 in any month. The exclusion provided in 
this paragraph (d)(1) also applies to the provision of tokens or fare 
cards that enable an individual to travel on the public transit system 
if the value of such tokens and fare cards in any month does not exceed 
by more than $21 the amount the employee paid for the tokens and fare 
cards for such month. Similarly, the exclusion of this paragraph (d)(1) 
applies to the provision of a voucher or similar instrument that is 
exchangeable solely for tokens, fare cards, or other instruments that 
enable the employee to use the public transit system if the value of 
such vouchers and other instruments in any month does not exceed $21. 
The exclusion of this paragraph (d)(1) also applies to reimbursements 
made by an employer to an employee after December 31, 1988, to cover the 
cost of commuting on a public transit system, provided the employee does 
not receive more than $21 in such reimbursements for commuting costs in 
any given month. The reimbursement must be made under a bona fide 
reimbursement arrangement. A reimbursement arrangement will be treated 
as bona fide if the employer establishes appropriate procedures for 
verifying on a periodic basis that the employee's use of public 
transportation for commuting is consistent with the value of the benefit 
provided by the employer for that purpose. The amount of in-kind public 
transit commuting benefits and reimbursements provided during any month

[[Page 595]]

that are excludible under this paragraph (d)(1) is limited to $21. For 
months ending before July 1, 1991, the amount is $15 per month. The 
exclusion provided in this paragraph (d)(1) does not apply to the 
provision of any benefit to defray public transit expenses incurred for 
personal travel other than commuting.
    (2) Occasional meal money or local transportation fare--(i) General 
rule. Meals, meal money or local transportation fare provided to an 
employee is excluded as a de minimis fringe benefit if the benefit 
provided is reasonable and is provided in a manner that satisfies the 
following three conditions:
    (A) Occasional basis. The meals, meal money or local transportation 
fare is provided to the employee on an occasional basis. Whether meal 
money or local transportation fare is provided to an employee on an 
occasional basis will depend upon the frequency i.e., the availability 
of the benefit and regularity with which the benefit is provided by the 
employer to the employee. Thus, meals, meal money, or local 
transportation fare or a combination of such benefits provided to an 
employee on a regular or routine basis is not provided on an occasional 
basis.
    (B) Overtime. The meals, meal money or local transportation fare is 
provided to an employee because overtime work necessitates an extension 
of the employee's normal work schedule. This condition does not fail to 
be satisifed merely because the circumstances giving rise to the need 
for overtime work are reasonably foreseeable.
    (C) Meal money. ln the case of a meal or meal money, the meal or 
meal money is provided to enable the employee to work overtime. Thus, 
for example, meals provided on the employer's premises that are consumed 
during the period that the employee works overtime or meal money 
provided for meals consumed during such period satisfy this condition.

In no event shall meal money or local transportation fare calculated on 
the basis of the number of hours worked (e.g., $1.00 per hour for each 
hour over eight hours) be considered a de minimis fringe benefit.
    (ii) Applicability of other exclusions for certain meals and for 
transportation provided for security concerns. The value of meals 
furnished to an employee, an employee's spouse, or any of the employee's 
dependents by or on behalf of the employee's employer for the 
convenience of the employer is excluded from the employee's gross income 
if the meals are furnished on the business premises of the employer (see 
section 119). (For purposes of the exclusion under section 119, the 
definitions of an employee under Sec. 1.132-1(b) do not apply.) If, for 
a bona fide business-oriented security concern, an employer provides an 
employee vehicle transportation that is specially designed for security 
(for example, the vehicle is equipped with bulletproof glass and armor 
plating), and the conditions of Sec. 1.132-5(m) are satisfied, the 
value of the special security design is excludable from gross income as 
a working condition fringe if the employee would not have had such 
special security design but for the bona fide business-oriented security 
concern.
    (iii) Special rule for employer-provided transportation provided in 
certain circumstances. (A) Partial exclusion of value. If an employer 
provides transportation (such as taxi fare to an employee for use in 
commuting to and/or from work because or unusual circumstances and 
because, based on the facts and circumstances, it is unsafe for the 
employee to use other available means of transportation, the excess of 
the value of each one-way trip over $1.50 per one-way commute is 
excluded from gross income. The rule of this paragraph (d)(2)(iii) is 
not available to a control employee as defined in Sec. 1.61-21(f) (5) 
and (6).
    (B) ``Unusual circumstances''. Unusual circumstances are determined 
with respect to the employee receiving the transportation and are based 
on all facts and circumstances. An example of unusual circumstances 
would be when an employee is asked to work outside of his normal work 
hours (such as being called to the workplace at 1:00 am when the 
employee normally works from 8:00 am to 4:00 pm). Another example of 
unusual circumstances is a temporary change in the employee's work 
schedule (such as working from 12 midnight to 8:00 am rather than from

[[Page 596]]

8:00 am to 4:00 pm for a two-week period).
    (C) ``Unsafe conditions''. Factors indicating whether it is unsafe 
for an employee to use other available means of transportation are the 
history of crime in the geographic area surrounding the employee's 
workplace or residence and the time of day during which the employee 
must commute.
    (3) Use of special rules or examples to establish a general rule. 
The special rules provided in this paragraph (d) or examples provided in 
paragraph (e) of this section may not be used to establish any general 
rule permitting exclusion as a de minimis fringe. For example, the fact 
that $252 (i.e., $21 per month for 12 months) worth of public transit 
passes can be excluded from gross income as a de minimis fringe in 1992 
does not mean that any fringe benefit with a value equal to or less than 
$252 may be excluded as a de minimis fringe. As another example, the 
fact that the commuting use of an employer-provided vehicle more than 
one day a month is an example of a benefit not excludable as a de 
minimis fringe (see paragraph (e)(2) of this section) does not mean that 
the commuting use of a vehicle up to 12 times per year is excludable 
from gross income as a de minimis fringe.
    (4) Benefits exceeding value and frequency limits. If a benefit 
provided to an employee is not de minimis because either the value or 
frequency exceeds a limit provided in this paragraph (d), no amount of 
the benefit is considered to be a de minimis fringe. For example, if, in 
1992, an employer provides a $50 monthly public transit pass, the entire 
$50 must be included in income, not just the excess value over $21.
    (e) Examples--(1) Benefits excludable from income. Examples of de 
minimis fringe benefits are occasional typing of personal letters by a 
company secretary; occasional personal use of an employer's copying 
machine, provided that the employer exercises sufficient control and 
imposes significant restrictions on the personal use of the machine so 
that at least 85 percent of the use of the machine is for business 
purposes; occasional cocktail parties, group meals, or picnics for 
employees and their guests; traditional birthday or holiday gifts of 
property (not cash) with a low fair market value; occasional theater or 
sporting event tickets; coffee, doughnuts, and soft drinks; local 
telephone calls; and flowers, fruit, books, or similar property provided 
to employees under special circumstances (e.g., on account of illness, 
outstanding performance, or family crisis).
    (2) Benefits not excludable as de minimis fringes. Examples of 
fringe benefits that are not excludable from gross income as de minimis 
fringes are: season tickets to sporting or theatrical events; the 
commuting use of an employer-provided automobile or other vehicle more 
than one day a month; membership in a private country club or athletic 
facility, regardless of the frequency with which the employee uses the 
facility; employer-provided group-term life insurance on the life of the 
spouse or child of an employee; and use of employer-owned or leased 
facilities (such as an apartment, hunting lodge, boat, etc.) for a 
weekend. Some amount of the value of certain of these fringe benefits 
may be excluded from income under other statutory provisions, such as 
the exclusion for working condition fringes. See Sec. 1.132-5.
    (f) Nonapplicability of nondiscrimination rules. Except to the 
extent provided in Sec. 1.132-7, the nondiscrimination rules of section 
132(h)(1) and Sec. 1.132-8 do not apply in determining the amount, if 
any, of a de minimis fringe. Thus, a fringe benefit may be excludable as 
a de minimis fringe even if the benefit is provided exclusively to 
highly compensated employees of the employer.

[T.D. 8256, 54 FR 28615, July 6, 1989, as amended by T.D. 8389, 57 FR 
1871, Jan 16, 1992; 57 FR 5982, Feb. 19, 1992]



Sec. 1.132-6T  De minimis fringe--1985 through 1988 (temporary).

    (a) In general. Gross income does not include the value of a de 
minimis fringe provided to an employee. The term ``de minimis fringe'' 
means any property or service the value of which is (after taking into 
account the frequency with which similar fringes are provided by the 
employer to the employer's employees) so small as to make accounting for 
it unreasonable or administratively impracticable.

[[Page 597]]

    (b) Frequency. Generally, the frequency with which similar fringes 
are provided by the employer to the employer's employees is determined 
by reference to the frequency with which the employer provides the 
fringe to each individual employee. For example, if an employer provides 
a free meal to one employee on a daily basis, but not to any other 
employee, the value of the meals is not de minimis with respect to that 
one employee even though with respect to the employer's entire workforce 
the meals are provided ``infrequently.'' However, where it would be 
administratively difficult to determine frequency with respect to 
individual employees, the frequency with which similar fringes are 
provided by the employer to the employer's employees is determined by 
reference to the frequency with which the employer provides the fringes 
to the employees and not the frequency with which individual employees 
receive them. In these cases, if an employer occasionally provides a 
fringe benefit of de minimis value to the employer's employees, the de 
minimis fringe exclusion may apply even though a particular employee 
receives the benefit frequently. For example, if an employer exercises 
sufficient control and imposes significant restrictions on the personal 
use of a company copying machine so that at least 85 percent of the use 
of the machine is for business purposes, any personal use the copying 
machine by particular employees is considered to be a de minimis fringe.
    (c) Administrability. Unless excluded by a statutory provision other 
than section 132(a)(4), the value of any fringe benefit that would not 
be unreasonable or administratively impracticable to account for must be 
included in the employee's gross income. Thus, except as otherwise 
provided in this section, the provision of any cash fringe benefit (or 
any fringe benefit provided to an employee through the use of a charge 
or credit card) is not excludable as a de minimis fringe. For example, 
the provision of cash to an employee for personal entertainment is not 
excludable as a de minimis fringe.
    (d) Special rules--(1) Transit passes. A transit pass provided to an 
employee at a discount not exceeding $15 per month may be excluded as a 
de minimis fringe. The exclusion provided in this paragraph (d) also 
applies to the provision of $15 in tokens or fare cards that enable an 
individual to travel on the transit system. The exclusion provided in 
this paragraph (d) does not apply to any provision of cash or other 
benefit to defray transit expenses incurred for personal travel.
    (2) Occasional meal money or local transportation fare. Occasional 
meal money or local transportation fare provided to an employee because 
overtime work necessitates an extension of the employee's normal workday 
is excluded as a de minimis fringe.
    (3) Use of special rules to establish a general rule. The special 
rules provided in this paragraph (d) may not be used to establish any 
general rule. For example, the fact that $180 ($15 per month for 12 
months) worth of transit passes can be excluded in a year does not mean 
that any fringe benefit with a value equal to or less than $180 may be 
excluded as a de minimis fringe.
    (4) Benefits exceeding value and frequency limitations. If the 
benefit provided to an employee is not de minimis because either the 
value or frequency exceeds a limit provided in this paragraph (d), no 
amount of the benefit is considered to be de minimis. For example, if an 
employer provides a $20 monthly transit pass, the entire $20 must be 
included in income, not just the excess value over $15.
    (e) Nonapplicability of nondiscrimination rules. Except to the 
extent provided in Sec. 1.132-7T, the nondiscrimination rules of 
section 132(h)(1) and Sec. 1.132-8T do not apply. Thus, for example, a 
fringe benefit may be a de minimis fringe even if the benefit is 
provided exclusively to officers of the employer.
    (f) Examples--(1) Benefits excludable from income. Examples of de 
minimis fringe benefits are occasional typing of personal letters by a 
company secretary; occasional personal use of an employer's copying 
machine, provided that the employer exercises sufficient control and 
imposes significant restrictions on the personal use of the machine so 
that at least 85 percent of the use of the machine is for business 
purposes; occasional cocktail parties or

[[Page 598]]

picnics for employees and their guests; traditional holiday gifts of 
property (not cash) with a low fair market value; occasional theatre or 
sporting event tickets; and coffee and doughnuts.
    (2) Benefits not excludable as de minimis fringes. Examples of 
fringe benefits that are not excludable from income as de minimis 
fringes are: season tickets to sporting or theatrical events; the 
commuting use of an employer-provided automobile or other vehicle more 
than once a month; membership in a private country club or athletic 
facility, regardless of the frequency with which the employee uses the 
facility; and use of employer-owned or leased facilities (such as an 
apartment, hunting lodge, boat, etc.) for a weekend. Some amount of the 
value of these fringe benefits may be excluded under other statutory 
provisions, such as the exclusion for working condition fringes. See 
Sec. 1.132-5T.

[T.D. 8063, 50 FR 52308, Dec. 23, 1985, as amended by T.D. 8256, 54 FR 
28600, July 6, 1989]



Sec. 1.132-7  Employer-operated eating facilities.

    (a) In general--(1) Condition for exclusion--(i) General rule. The 
value of meals provided to employees at an employer-operated eating 
facility for employees is excludable from gross income as a de minimis 
fringe only if on an annual basis, the revenue from the facility equals 
or exceeds the direct operating costs of the facility.
    (ii) Additional condition for highly compensated employees. With 
respect to any highly compensated employee, an exclusion is available 
under this section only if the condition set out in paragraph (a)(1)(i) 
of this section is satisfied and access to the facility is available on 
substantially the same terms to each member of a group of employees that 
is defined under a reasonable classification set up by the employer that 
does not discriminate in favor of highly compensated employees. See 
Sec. 1.132-8. For purposes of this paragraph (a)(1)(ii), each dining 
room or cafeteria in which meals are served is treated as a separate 
eating facility, whether each such dining room or cafeteria has its own 
kitchen or other food-preparation area.
    (2) Employer-operated eating facility for employees. An employer-
operated eating facility for employees is a facility that meets all of 
the following conditions--
    (i) The facility is owned or leased by the employer,
    (ii) The facility is operated by the employer,
    (iii) The facility is located on or near the business premises of 
the employer, and
    (iv) The meals furnished at the facility are provided during, or 
immediately before or after, the employee's workday.

For purposes of this section, the term ``meals'' means food, beverages, 
and related services provided at the facility. If an employer can 
reasonably determine the number of meals that are excludable from income 
by the recipient employees under section 119, the employer may, in 
determining whether the requirement of paragraph (a)(1)(i) of this 
section is satisfied, disregard all costs and revenues attributable to 
such meals provided to such employees. lf an employer can reasonably 
determine the number of meals received by volunteers who receive food 
and beverages at a hospital, free or at a discount, the employer may, in 
determining whether the requirement of paragraph (a)(1)(i) of this 
section is satisfied, disregard all costs and revenues attributable to 
such meals provided to such volunteers. If an employer charges 
nonemployees a greater amount than employees, in determining whether the 
requirement of paragraph (a)(1)(i) of this section is satisfied, the 
employer must disregard all costs and revenues attributable to such 
meals provided to such nonemployees.
    (3) Operation by the employer. If an employer contracts with another 
to operate an eating facility for its employees, the facility is 
considered to be operated by the employer for purposes of this section. 
If an eating facility is operated by more than one employer, it is 
considered to be operated by each employer.
    (4) Example. The provisions of this paragraph (a)(2) may be 
illustrated by the following example:

    Example (1). Assume that a not-for-profit hospital system maintains 
cafeterias for the

[[Page 599]]

use of its employees and volunteers. Only the employees are charged for 
food service at the cafeteria and the policy of the hospital is to 
charge the employees only for the costs of food, beverage and labor 
directly attributable to the meal. Most of the cafeterias within the 
system furnish more free meals to volunteers than they serve paid meals 
to employees. For purposes of this paragraph, as long as the employer 
can accurately determine the number of meals received free or at a 
discount by volunteers, the employer may disregard all the costs and 
revenues attributable to such meals provided to volunteers. Therefore, 
for purposes of this paragraph, the costs of the hospital system for 
furnishing meals to employees who pay for them are the costs to be 
compared to determine if the revenues from the facility equal or exceed 
direct operating costs of the facility's service to employees.

    (b) Direct operating costs--(1) In general. For purposes of this 
section, the direct operating costs of an eating facility are--
    (i) The cost of food and beverages, and
    (ii) The cost of labor for personnel whose services relating to the 
facility are performed primarily on the premises of the eating facility. 
Direct operating costs do not include the labor cost attributable to 
personnel whose services relating to the facility are not performed 
primarily on the premises of the eating facility. Thus, for example, the 
labor costs attributable to cooks, waiters, and waitresses are included 
in direct operating costs, but the labor cost attributable to a manager 
of an eating facility whose services relating to the facility are not 
primarily performed on the premises of the eating facility is not 
included in direct operating costs. If an employee performs services 
relating to the facility both on and off the premises of the eating 
facility, only the portion of the total labor cost of the employee 
relating to the facility that bears the same proportion to such total 
labor cost as time spent on the premises bears to total time spent 
performing services relating to the facility is included in direct 
operating costs. For example, assume that 60 percent of the services of 
a cook in the above example are not related to the eating facility. Only 
40 percent of the total labor cost of the cook is includible in direct 
operating costs. For purposes of this section, labor costs include all 
compensation required to be reported on a Form W-2 for income tax 
purposes and related employment taxes paid by the employer. In 
determining the direct operating costs of an eating facility, the 
employer may include as part of the facility, vending machines that are 
provided by the employer and located on the same premises as the other 
eating facilities operated by the employer.
    (2) Multiple dining rooms or cafeterias. The direct operating costs 
test may be applied separately for each dining room or cafeteria. 
Alternatively, the direct operating costs test may be applied with 
respect to all the eating facilities operated by the employer.
    (3) Payment to operator of facility. If an employer contracts with 
another to operate an eating facility for its employees, the direct 
operating costs of the facility consist both of direct operating costs, 
if any, incurred by the employer and the amount paid to the operator of 
the facility to the extent that such amount is attributable to what 
would be direct operating costs if the employer operated the facility 
directly.
    (c) Valuation of non-excluded meals provided at an employer-operated 
eating facility for employees. If the exclusion for meals provided at an 
employer-operated eating facility for employees is not available, the 
recipient of meals provided at such facility must include in income the 
amount by which the fair market value of the meals provided exceeds the 
sum of--
    (1) The amount, if any, paid for the meals, and
    (2) The amount, if any, specifically excluded by another section of 
chapter 1 of this subtitle.

For special valuation rules relating to such meals, see Sec. 1.61-
21(j).

[T.D. 8256, 54 FR 28617, July 6, 1989]



Sec. 1.132-7T  Treatment of employer-operated eating facilities--1985 
through 1988 (temporary).

    (a) In general--(1) General rule. The value of meals provided to 
employees at an employer-operated eating facility for employees is 
excludable from gross income as a de minimis fringe only if--
    (i) On an annual basis, the revenue from the facility equals or 
exceeds the

[[Page 600]]

direct operating costs of the facility, and
    (ii) With respect to any officer, owner or highly compensated 
employee, access to the facility is available on substantially the same 
terms to each member of a group of employees that is defined under a 
reasonable classification set up by the employer that does not 
discriminate in favor of officers, owners, and highly compensated 
employees. See Sec. 1.132-8T.
    (2) Employer-operated eating facility for employees. An employer-
operated eating facility for employees is a facility that meets all of 
the following conditions--
    (i) The facility is owned or leased by the employer,
    (ii) The facility is operated by the employer,
    (iii) The facility is located on or near the business premises of 
the employer,
    (iv) Substantially all of the use of the facility is by employees of 
the employer operating the facility, and
    (v) The meals furnished at the facility are provided during, or 
immediately before or after, the employee's workday.

For purposes of this section, the term ``meals'' means food, beverages, 
and related services provided at the facility. If an employer can 
determine the number of employees who receive meals that are excludable 
from income under section 119, the employer may, in determining whether 
the requirement of paragraph (a)(1)(i) of this section is satisfied, 
disregard all costs and revenues attributable to such meals provided to 
such employees. For purposes of this section, each dining room or 
cafeteria in which meals are served is treated as a separate eating 
facility, regardless of whether each such dining room or cafeteria has 
its own kitchen or other food-preparation area.
    (3) Operation by the employer. If an employer contracts with another 
to operate an eating facility for its employees, the facility is 
considered to be operated by the employer for purposes of this section. 
If an eating facility is operated by more than one employer, it is 
considered to be operated by each employer.
    (b) Direct operating costs. The direct operating costs test must be 
applied separately for each dining room or cafeteria. For purpose of 
this section, the direct operating costs of an eating facilities are: 
(1) The cost of food and beverages and (2) the cost of labor for 
personnel whose services relating to the facility are performed 
primarily on the premises of the eating facility. Direct operating costs 
do not include the cost of labor for personnel whose services relating 
to the facility are not performed primarily on the premises of the 
eating facility. Thus, for example, the labor cost for cooks, waiters, 
and waitresses is included in direct operating costs, but the labor cost 
for a manager of an eating facility whose services relating to the 
facility are not primarily performed on the premises of the eating 
facility is not included in direct operating costs. If an employee 
perfoms services both on and off the premises of the eating facility, 
only the applicable percentage of the total labor cost of the employee 
that bears the same proportion as time spent on the premises bears to 
total time is included in direct operating costs. For example, assume 
that 60 percent of the services of the cooks in the above example are 
not related to the eating facility. Only 40 percent of the total labor 
cost of the cooks is includible in direct operating costs. For purposes 
of this section, labor costs include all compensation required to be 
reported on a Form W-2 for income tax purposes and related employment 
taxes paid by the employer.
    (c) Valuation of non-excluded meals provided at an employer-operated 
eating facility for employees. If the exclusion for meals provided at an 
employer-operated eating facility for employees is not available, the 
recipient of meals provided at such facility must include in income the 
amount by which the fair market value of the meals provided exceeds the 
sume of: (1) The amount, if any, paid for the meals, and (2) the amount, 
if any, specifically excluded by another section of the Code. For 
special valuation rules relating to such meals see Sec. 1.61-2T (j).

[T.D. 8063, 50 FR 52308, Dec. 23, 1985, as amended by T.D. 8256, 54 FR 
28600, July 6, 1989]

[[Page 601]]



Sec. 1.132-8  Fringe benefit nondiscrimination rules.

    (a) Application of nondiscrimination rules--(1) General rule. A 
highly compensated employee who receives a no-additional cost service, a 
qualified employee discount or a meal provided at an employer-operated 
eating facility for employees shall not be permitted to exclude such 
benefit from his or her income unless the benefit is available on 
substantially the same terms to:
    (i) All employees of the employer; or
    (ii) A group of employees of the employer which is defined under a 
reasonable classification set up by the employer that does not 
discriminate in favor of highly compensated employees. See paragraph (f) 
of this section for the definition of a highly compensated employee.
    (2) Consequences of discrimination--(i) In general. If an employer 
maintains more than one fringe benefit program, i.e., either different 
fringe benefits being provided to the same group of employees, or 
different classifications of employees or the same fringe benefit being 
provided to two or more classifications of employees, the 
nondiscrimination requirements of section 132 will generally be applied 
separately to each such program. Thus, a determination that one fringe 
benefit program discriminates in favor of highly compensated employees 
generally will not cause other fringe benefit programs covering the same 
highly compensated employees to be treated as discriminatory. If the 
fringe benefits provided to a highly compensated individual do not 
satisfy the nondiscrimination rules provided in this section, such 
individual shall be unable to exclude from gross income any portion of 
the benefit. For example, if an employer offers a 20 percent discount 
(which otherwise satisfies the requirements for a qualified employee 
discount) to all non-highly compensated employees and a 35 percent 
discount to all highly compensated employees, the entire value of the 35 
percent discount (not just the excess over 20 percent) is includible in 
the gross income and wages of the highly compensated employees who make 
purchases at a discount.
    (ii) Exception--(A) Related fringe benefit programs. If one of a 
group of fringe benefit programs discriminates in favor of highly 
compensated employees, no related fringe benefit provided to such highly 
compensated employees under any other fringe benefit program may be 
excluded from the gross income of such highly compensated employees. For 
example, assume a department store provides a 20 percent merchandise 
discount to all employees under one fringe benefit program. Assume 
further that under a second fringe benefit program, the department store 
provides an additional 15 percent merchandise discount to a group of 
employees defined under a classification which discriminates in favor of 
highly compensated employees. Because the second fringe benefit program 
is discriminatory, the 15 percent merchandise discount provided to the 
highly compensated employees is not a qualified employee discount. In 
addition, because the 20 percent merchandise discount provided under the 
first fringe benefit program is related to the fringe benefit provided 
under the second fringe benefit program, the 20 percent merchandise 
discount provided the highly compensated employees is not a qualified 
employee discount. Thus, the entire 35 percent merchandise discount 
provided to the highly compensated employees is includible in such 
employees' gross incomes.
    (B) Employer operated eating facilities for employees. For purposes 
of paragraph (a)(2)(ii)(A) of this section, meals at different employer-
operated eating facilities for employees are not related fringe 
benefits, so that a highly compensated employee may exclude from gross 
income the value of a meal at a nondiscriminatory facility even though 
any meals provided to him or her at a discriminatory facility cannot be 
excluded.
    (3) Scope of the nondiscrimination rules provided in this section. 
The nondiscrimination rules provided in this section apply only to 
fringe benefits provided pursuant to section 132 (a)(1), (a)(2), and 
(e)(2). These rules have no application to any other employee benefit 
that may be subject to nondiscrimination requirements under any other 
section of the Code.
    (b) Aggregation of employees--(1) Section 132(a) (1) and (2). For 
purposes of

[[Page 602]]

determining whether the exclusions for no-additional-cost services and 
qualified employee discounts are available to highly compensated 
employees, the nondiscrimination rules of this section are applied by 
aggregating the employees of all related employers (as defined in Sec. 
1.132-1(c)), except that employees in different lines of business (as 
defined in Sec. 1.132-4) are not to be aggregated. Thus, in general, 
for purposes of this section, the term ``employees of the employer'' 
refers to all employees of the employer and any other entity that is a 
member of a group described in sections 414 (b), (c), (m), or (o) and 
that performs services within the same line of business as the employer 
which provides the particular fringe benefit. Employees in different 
lines of business will be aggregated, however, if the line of business 
limitation has been relaxed pursuant to paragraphs (b) through (g) of 
Sec. 1.132-4.
    (2) Section 132 (e) (2). For purposes of determining whether the 
exclusions for meals provided at employer-operated eating facilities are 
available to highly compensated, the nondiscrimination rules of this 
section are applied by aggregating the employees of all related 
employers (as defined in section Sec. 1.132-1(c)) who regularly work at 
or near the premises on which the eating facility is located, except 
that employees in different lines of business (as defined in Sec. 
1.132-4) are not to be aggregated. The nondiscrimination rules of this 
section are applied separately to each eating facility. Each dining room 
or cafeteria in which meals are served is treated as a separate eating 
facility, regardless of whether each such dining room or cafeteria has 
its own kitchen or other food-preparation area.
    (3) Classes of employees who may be excluded. For purposes of 
applying the nondiscrimination rules of this section to a particular 
fringe benefit program, there may be excluded from consideration 
employees who may be excluded from consideration under section 89(h), as 
enacted by the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085 
(1986) and amended by the Technical and Miscellaneous Revenue Act of 
1988, Pub. L. 100-647, 102 Stat. 3342 (1988).
    (c) Availability on substantially the same terms--(1) General rule. 
The determination of whether a benefit is available on substantially the 
same terms shall be made upon the basis of the facts and circumstances 
of each situation. In general, however, if any one of the terms or 
conditions governing the availability of a particular benefit to one or 
more employees varies from any one of the terms or conditions governing 
the availability of a benefit made available to one or more other 
employees, such benefit shall not be considered to be available on 
substantially the same terms except to the extent otherwise provided in 
paragraph (c)(2) of this section. For example, if a department store 
provides a 20 percent qualified employee discount to all of its 
employees on all merchandise, the substantially the same terms 
requirement will be satisfied. Similarly, if the discount provided to 
all employees is 30 percent on certain merchandise (such as apparel), 
and 20 percent on all other merchandise, the substantially the same 
terms requirement will be satisfied. However, if a department store 
provides a 20 percent qualified employee discount to all employees, but 
as to the employees in certain departments, the discount is available 
upon hire, and as to the remaining departments, the discount is only 
available when an employee has completed a specified term of services, 
the 20 percent discount is not available on substantially the same terms 
to all of the employees of the employer. Similarly, if a greater 
discount is given to employees with more seniority, full-time work 
status, or a particular job description, such benefit (i.e., the 
discount) would not be available to all employees eligible for the 
discount on substantially the same terms, except to the extent otherwise 
provided in paragraph (c)(2) of this section. These examples also apply 
to no-additional-cost-services. Thus, if an employer charges non-highly 
compensated employees for a no-additional-cost service and does not 
charge highly compensated employees (or charges highly compensated 
employees a lesser amount), the substantially the same terms requirement 
will not be satisfied.
    (2) Certain terms relating to priority. Certain fringe benefits made 
available

[[Page 603]]

to employees are available only in limited quantities that may be 
insufficient to meet employee demand. This situation may occur either 
because of employer policy (such as where an employer determines that 
only a certain number of units of a specific product will be made 
available to employees each year) or because of the nature of the fringe 
benefit (such as where an employer provides a no-additional-cost 
transportation service that is limited to the number of seats available 
just before departure). Under these circumstances, an employer may find 
it necessary to establish some method of allocating the limited fringe 
benefits among the employees eligible to receive the fringe benefits. 
The employer may establish the priorities described below.
    (i) Priority on a first come, first served, or similar basis. A 
benefit shall not fail to be treated as available to a group of 
employees on substantially the same terms merely because the employer 
allocates the benefit among such employees on a ``first come, first 
served'' or lottery basis, provided that the same notice of the terms of 
availability is given to all employees in the group and the terms under 
which the benefit is provided to employees within the group are 
otherwise the same with respect to all employees. For purposes of the 
preceding sentence, a program that gives priority to employees who are 
the first to submit written requests for the benefit will constitute 
priority on a ``first come, first served'' basis. Similarly, if the 
employer regularly engages in the practice of allocating benefits on a 
priority basis to employees demonstrating a critical need, such benefit 
shall not fail to be treated as available on substantially the same 
terms to all of the employees with respect to whom such priority status 
is available as long as the determination is based upon uniform and 
objective criteria which have been communicated to all employees in the 
group of eligible employees. An example of a critical need would be 
priority transportation given to an employee in the event of a medical 
emergency involving the employee (or a member of the employee's 
immediate family) or a recent death in the employee's immediate family. 
Frustrated vacation plans or forfeited deposits would not be treated as 
giving rise to particularly critical needs.
    (ii) Priority on the basis of seniority. Solely for purposes of 
Sec. 1.132-8, a benefit shall not fail to be treated as available to a 
group of employees of the employer on substantially the same terms 
merely because the employer allocates the benefit among such employees 
on a seniority basis provided that:
    (A) The same notice of the terms of availability is given to all 
employees in the group; and
    (B) The average value of the benefit provided for each nonhighly 
compensated employee is at least 75% of that provided for each highly 
compensated employee. For purposes of this test, the average value of 
the benefit provided for each nonhighly compensated (highly compensated) 
employee is determined by taking the sum of the fair market values of 
such benefit provided to all the nonhighly compensated (highly 
compensated) employees, determined in accordance with Sec. 1.61-21, and 
then dividing that sum by the total number of nonhighly compensated 
(highly compensated) employees of the employer. For purposes of 
determining the average value of the benefit provided for each employee, 
all employee's of the employer are counted, including those who are not 
eligible to receive the benefit from the employer.
    (d) Testing for discrimination--(1) Classification test. In the 
event that a benefit described in section 132 (a)(1), (a)(2) or (e)(2) 
is not available on substantially the same terms to all of the employees 
of the employer, no exclusion shall be available to a highly compensated 
employee for such benefit unless the program under which the benefit is 
provided satisfies the nondiscrimination standards set forth in this 
section. The nondiscrimination standard of this section will be 
satisfied only if the benefit is available on substantially the same 
terms to a group of employees of the employer which is defined under a 
reasonable classification established by the employer that does not 
discriminate in favor of highly compensated employees. The determination 
of whether a

[[Page 604]]

particular classification is discriminatory will generally depend upon 
the facts and circumstances involved, based upon principles similar to 
those applied for purposes of section 410(b)(2)(A)(i) or, for years 
commencing prior to January 1, 1988, section 410(b)(1)(B). Thus, in 
general, except as otherwise provided in this section, if a benefit is 
available on substantially the same terms to a group of employees which, 
when compared with all of the other employees of the employer, 
constitutes a nondiscriminatory classification under section 
410(b)(2)(A)(i) (or, if applicable, section 410(b)(1)(B)), it shall be 
deemed to be nondiscriminatory.
    (2) Classifications that are per se discriminatory. A classification 
that, on its face, makes fringe benefits available principally to highly 
compensated employees is per se discriminatory. In addition, a 
classification that is based on either an amount or rate of compensation 
is per se discriminatory if it favors those with the higher amount or 
rate of compensation. On the other hand, a classification that is based 
on factors such as seniority, full-time vs. part-time employment, or job 
description is not per se discriminatory but may be discriminatory as 
applied to the workforce of a particular employer.
    (3) Former employees. When determining whether a classification is 
discriminatory, former employees shall be tested separately from other 
employees of the employer. Therefore, a classification is not 
discriminatory solely because the employer does not make fringe benefits 
available to any former employee. Whether a classification of former 
employees discriminates in favor of highly compensated employees will 
depend upon the particular facts and circumstances.
    (4) Restructuring of benefits. For purposes of testing whether a 
particular group of employees would constitute a discriminatory 
classification for purposes of this section, an employer may restructure 
its fringe benefit program as described in this paragraph. If a fringe 
benefit is provided to more than one group of employees, and one or more 
such groups would constitute a discriminatory classification if 
considered by itself, then for purposes of this section, the employer 
may restructure its fringe benefit program so that all or some of the 
members of such group may be aggregated with another group, provided 
that each member of the restructured group will have available to him or 
her the same benefit upon the same terms and conditions. For example, 
assume that all highly compensated employees of an employer have fewer 
than five years of service and all nonhighly compensated employees have 
over five years of service. If the employer provided a five percent 
discount to employees with under five years of service and a ten percent 
discount to employees with over five years of service, the discount 
program available to the highly compensated employees would not satisfy 
the nondiscriminatory classification test; however, as a result of the 
rule described in this paragraph (d)(4), the employer could structure 
the program to consist of a five percent discount for all employees and 
a five percent additional discount for nonhighly compensated employees.
    (5) Employer-operated eating facilities for employees--(i) General 
rule. If access to an employer-operated eating facility for employees is 
available to a classification of employees that discriminates in favor 
of highly compensated employees, then the classification will not be 
treated as discriminating in favor of highly compensated employees 
unless the facility is used by one or more executive group employees 
more than a de minimis amount.
    (ii) Executive group employee. For purposes of this paragraph 
(d)(5), an employee is an ``executive group employee'' if the definition 
of paragraph (f)(1) of this section is satisfied. For purposes of 
identifying such employees, the phrase ``top one percent of the 
employees'' is substituted for the phrase ``top ten percent of the 
employees'' in section 414(q)(4) (relating to the definition of ``top-
paid group'').
    (e) Cash bonuses or rebates. A cash bonus or rebate provided to an 
employee by an employer that is determined with reference to the value 
of employer-provided property or services purchased by the employee, is 
treated as an equivalent employee discount. For example, assume a 
department

[[Page 605]]

store provides a 20 percent merchandise discount to all employees under 
a fringe benefit program. In addition, assume that the department store 
provides cash bonuses to a group of employees defined under a 
classification which discriminates in favor of highly compensated 
employees. Assume further that such cash bonuses equal 15 percent of the 
value of merchandise purchased by each employee. This arrangement is 
substantively identical to the example described in paragraph (e)(2)(i) 
of this section concerning related fringe benefit programs. Thus, both 
the 20 percent merchandise discount and the 15 percent cash bonus 
provided to the highly compensated employees are includible in such 
employees' gross incomes.
    (f) Highly compensated employee--(1) Government and nongovernment 
employees. A highly compensated employee of any employer is any employee 
who, during the year or the preceding year--
    (i) Was a 5-percent owner,
    (ii) Received compensation from the employer in excess of $75,000,
    (iii) Received compensation from the employer in excess of $50,000 
and was in the top-paid group of employees for such year, or
    (iv) Was at any time an officer and received compensation greater 
than 150 percent of the amount in effect under section 415(c)(1)(A) for 
such year.

For purposes of determining whether an employee is a highly compensated 
employee, the rules of sections 414 (q), (s), and (t) apply.
    (2) Former employees. A former employee shall be treated as a highly 
compensated employee if--
    (i) The employee was a highly compensated employee when the employee 
separated from service, or
    (ii) The employee was a highly compensated employee at any time 
after attaining age 55.

[T.D. 8256, 54 FR 28618, July 6, 1989]



Sec. 1.132-8T  Nondiscrimination rules--1985 through 1988 (temporary).

    (a) Application of nondiscrimination rules--(1) General rule. To 
qualify under section 132 for the exclusions for non-additional-cost 
services, qualified employee discounts, or meals provided at employer-
operated eating facilities for employees, the fringe benefit must be 
available on substantially the same terms to each member of a group of 
employees which is defined under a reasonable classification set up by 
the employer that does not discriminate in favor of officers, owners, or 
highly compensated employees (the ``prohibited group employees'').
    (2) Consequences of discrimination. If the availability of or the 
provision of the fringe benefit does not satisfy the nondiscrimination 
rules provided in this section, the exclusion applies only to those 
employees (if any) who receive the benefit and who are not prohibited 
group employees. For example, if an employer offers a 20 percent 
discount (which otherwise satisfies the requirements for a qualified 
employee discount) to all nonprohibited group employees and a 35 percent 
discount to all prohibited group employees, the entire value of the 35 
percent discount (not just the excess over 20 percent) is includible in 
the gross income and wages of the prohibited group employees who make 
purchases at a discount.
    (3) Scope of the nondiscrimination rules provided in this section. 
The nondiscrimination rules provided in this section apply only to 
fringe benefits provided pursuant to section 132 (a)(1), (a)(2), and 
(e)(2). These rules have no application to any other employee benefit 
that may be subject to nondiscrimination requirements under any other 
section of the Code.
    (b) Coverage requirement--(1) Section 132 (a)(1) and (2). For 
purposes of the exclusions for no-additional-cost services and qualified 
employee discounts, the nondiscrimination rules of this section are 
applied by aggregating the employees of all related employers (as 
defined in Sec. 1.132-1T (c)), but without aggregating employees in 
different lines of business (as defined in Sec. 1.132-4T). Employees in 
different lines of business will be aggregated, however, if the line of 
business limitation has been relaxed pursuant to either section 1.132-4T 
(b) or (c). Except as provided in paragraph (e) of this section, the 
nondiscrimination rules of this section are generally applied separately 
to each fringe benefit program of an employer.

[[Page 606]]

    (2) Section 132(e)(2). For purposes of the exclusion for meals 
provided at employer-operated eating facilities for employees, the 
nondiscrimination rules of this section are applied by aggregating the 
employees of all related employers, without regard to different lines of 
business, who regularly work at or near the premises on which the eating 
facility is located. The nondiscrimination rules of this section are 
applied separately to each eating facility. Each dining room or 
cafeteria in which meals are served is treated as a separate eating 
facility, regardless of whether each such dining room or cafeteria has 
its own kitchen or other food-preparation area.
    (3) Classes of employees who may be excluded. Except as otherwise 
provided in this section, for purposes of applying the nondiscrimination 
rules of this section to a particular fringe benefit program, there may 
be excluded from consideration the following classes of employees 
provided that, with respect to each class (other than the class 
described in paragraph (b)(3)(iii) of this section), all employees in 
the class are excluded from participating in the particular fringe 
benefit program--
    (i) All part-time or seasonal employees who are (or who are 
reasonably expected to be) credited with less than 1,000 hours (or such 
lesser number required for the program) of service during a calendar 
year;
    (ii) All employees who are included in a unit of employees covered 
by an agreement with the Secretary of Labor finds to be a collective 
bargaining agreement between employee representatives and one or more 
employers, if there is evidence that the particular fringe benefit 
program was the subject of good faith bargaining between such employee 
representatives and such employer or employers (and if, after March 31, 
1984, the additional condition of section 7701(a)(46) is satisfied);
    (iii) All employees who are nonresident aliens and who receive no 
earned income (within the meaning of section 911(d)(2)) from the 
employer which constitutes income from services within the United States 
(within the meaning of section 861(a)(3));
    (iv) All employees who have not completed at least one year (or such 
lesser period required for the program) of service with the employer;
    (v) All employees who have separated from the service of the 
employer in a year prior to the current year (regardless of the reason 
for the separation);
    (vi) All employees who have separated from the service of the 
employer in a year prior to the current year except for retired and/or 
disabled employees (either with or without a time limit based on a set 
number of years since separation from the service of the employer); and
    (vii) All employees of a leased section of a department store.
    (c) Classification requirement--(1) General rule. The determination 
of whether a particular classification established by an employer 
discriminates in favor of the prohibited group will depend on the facts 
and circumstances involved, based on principles similar to those applied 
in the qualified plan area (see section 410(b)(1)(B) and the regulations 
thereunder). In general, except as otherwise provided in this section, a 
classification that would be determined to be nondiscriminatory pursuant 
to the application of the nondiscrimination standards that are applied 
in the qualified plan area shall be deemed to be nondiscriminatory for 
purposes of section 132.
    (2) Classifications that are per se discriminatory. A classification 
that, on its face, makes fringe benefits available only to prohibited 
group employees is per se discriminatory, and no exclusion from gross 
income is available to any prohibited group employee under section 132. 
In addition, a classification that is based on either an amount or rate 
of compensation is per se discriminatory if it favors those with the 
higher amount or rate of compensation. On the other hand, a 
classification that is based on factors such as seniority, full-time vs. 
part-time employment, or job description is not per se discriminatory 
but may be discriminatory as applied to the workforce of a particular 
employer.
    (3) Former employees. When determining whether a classification is 
discriminatory, former employees shall not be considered together with 
other

[[Page 607]]

employees of the employer. Therefore, a classification is not 
discriminatory if the employer does not make the fringe benefits 
available to any former employee. Whether a classification of former 
employees discriminates in favor of prohibited group employees will 
depend on the facts and circumstances. The rules of this section shall 
apply separately to the former employee classification.
    (4) Employer-operated eating facilities for employees--(i) General 
rule. If access to an employer-operated eating facility for employees is 
available to a classification of employees that discriminates in favor 
of highly compensated employees, the classification will not be treated 
as discriminating in favor of the prohibited group employees unless the 
facility is used, more than a de minimis amount, by any executive group 
employee.
    (ii) Executive group employees. For purposes of this paragraph 
(c)(4), the term ``executive group employees'' has the same meaning as 
the term ``prohibited group employees'' (as defined in paragraph (g) of 
this section), except that for purposes of identifying highly 
compensated employees--
    (A) The exception provided in paragraph (g)(1)(i)(A) of this section 
does not apply, and
    (B) The phrase ``highest-paid one percent of all employees of an 
employer'' is substituted for the phrase ``highest-paid ten percent of 
all employees of an employer'' in paragraph (g)(1)(ii)(A) of this 
section.
    (d) Substantially-the-same-terms requirement--(1) General rule. 
Fringe benefits available to a particular classification of employees 
must be available to each employee in the classification on 
substantially the same terms. The determination of whether this 
requirement is met shall depend on the facts and circumstances involved. 
For example, if a department store provides a 20 percent qualified 
employee discount to its employees on all merchandise, the 
substantially-the-same-terms requirement will be satisfied. Similarly, 
if the discount provided to all employees is 30 percent on certain 
merchandise (such as apparel), and 20 percent on all other merchandise, 
the substantially-the-same-terms requirement will be satisfied. However, 
if the discount provided is 20 percent on all merchandise for hourly 
employees and 30 percent on all merchandise for salaried employees, the 
substantially-the-same-terms requirement will not be satisfied. In 
addition, if the percentage discount varies depending on either an 
employee's amount or rate of compensation, or volume of purchases, the 
substantially-the-same-terms requirement will not be satisfied. In order 
to determine whether such a discount program satisfies the 
nondiscrimination requirements of section 132, each group of employees 
that does receive fringe benefits on substantially the same terms must 
be treated as a separate classification. However, subject to the rules 
of paragraph (e)(2) of this section, an employer may divide a fringe 
benefit program into two programs for purposes of aggregating groups of 
employees. See Example (1) of paragraph (d)(3) of this section.
    (2) Terms relating to priority. Certain fringe benefits made 
available to employees are available only in limited quantities that may 
be insufficient to meet employee demand. This may occur either because 
of employer policy (such as where an employer determines that only a 
certain number of units of a specific product will be made available to 
employees each year) or because of the nature of the fringe benefit 
(such as where an employer provides a no-additional-cost transportation 
service that is limited to the number of seats available just before 
departure). Under these circumstances, an employer may find it necessary 
to establish some method of allocating the limited fringe benefits among 
the employees eligible to receive the fringe benefits. An allocation 
among employees on a ``first-come, first-served'' basis will not violate 
the substantially-the-same-terms requirement provided that such an 
allocation is not discriminatory in practice. In addition, an allocation 
among employees on a lottery basis will not violate the substantially-
the-same-terms requirement provided that such an allocation is 
nondiscriminatory in practice. For example, assume that an employer has 
a limited number of a particular benefit to offer to its employees. 
Assume further that

[[Page 608]]

the employees interested in receiving the benefit submit their names to 
the employer who then selects a number of names, at random, equal to the 
number of fringe benefits available. This lottery system would not 
violate the substantially-the-same-terms requirement. An allocation 
among employees on other than a ``first-come, first-served'', lottery, 
or similar basis will violate the substantially-the-same-terms 
requirement. Therefore, an allocation based on seniority, full-time vs. 
part-time employment, or job description will violate the substantially-
the-same-terms requirement. In order to determine whether such a fringe 
benefit program satisfies the nondiscrimination requirements of section 
132, each group of employees that does receive fringe benefits on 
substantially the same terms must be treated as a separate 
classification. For purposes of this rule, the last two sentences of 
paragraph (d)(1) of this section apply.
    (3) Examples. The followings examples illustrate the provisions of 
this paragraph (d):

    Example 1. Assume that with respect to a benefit available in 
limited quantities an employer provides priority to employees based on 
seniority. Assume further that all non-prohibited group employees have 
ten years of seniority and all prohibited group employees have nine 
years seniority. If each of these groups were tested separately, the 
benefits offered to prohibited group employees would be discriminatory 
under this section. In this case, the employer could divide the fringe 
benefit program provided to non-prohibited group employees into two 
parts: one relating to nine years of seniority and one relating to an 
additional year of seniority. As restructured in this manner, all 
employees receive the benefit relating to nine years seniority and only 
non-prohibited group employees receive the benefit relating to an 
additional year of seniority. Both groups (all employees and all non-
prohibited group employees) are nondiscriminatory groups.
    Example 2. Assume that prices charged to prohibited group employees 
at an employer-operated eating facility for employees are lower than 
prices charged to non-prohibited group employees. The substantially-the-
same requirement is not satisfied.

    (4) Disproportionate use of eating facility. If access to an 
employer-operated eating facility for employees is technically available 
on substantially-the-same-terms (to (i) all employees who regularly work 
at or near the premises on which the eating facility is located (the 
employee group), or (ii) a nondiscriminatory classification of the 
employee group, but in practice a highly disproportionate number of the 
prohibited group employees in the employee group, compared to the non-
prohibited group employees in the employee group, use the facility, the 
substantially-the-same-terms requirement will not be satisfied unless no 
member of the executive group eats there more than a de minimis amount.
    (e) Aggregation of separate fringe benefit programs--(1) General 
rule. If an employer maintains more than one fringe benefit program, 
i.e., two or more classifications of employees providing either 
identical or different fringe benefits, the nondiscrimination 
requirements of section 132 will generally be applied separately to each 
such program. Thus, a determination that one fringe benefit program 
discriminates in favor of prohibited group employees generally will not 
cause other fringe benefit programs covering the same prohibited group 
employees to be treated as discriminatory.
    (2) Exception--(i) Related fringe benefit programs. If one of a 
group of fringe benefit programs discriminates in favor of prohibited 
group employees, no related fringe benefit provided to such prohibited 
group employees under any other fringe benefit program may be excluded 
from the gross income of such prohibited group employees. For example, 
assume a department store provides a 20 percent merchandise discount to 
all employees under one fringe benefit program. Assume further that 
under a second fringe benefit program, the department store provides an 
additional 15 percent merchandise discount to a group of employees 
defined under a classification which discriminates in favor of the 
prohibited group. Because the second fringe benefit program is 
discriminatory, the 15 percent merchandise discount provided to the 
prohibited group employees is not a qualified employee discount. In 
addition, because the 20 percent merchandise discount provided under the 
first fringe benefit program is related to the fringe benefit provided 
under the second

[[Page 609]]

fringe benefit program, the 20 percent merchandise discount provided the 
prohibited group employees is not a qualified employee discount. Thus, 
the entire 35 percent merchandise discount provided to the prohibited 
group employees is includible in such employees' gross incomes.
    (ii) Employer-operated eating facilities for employees. For purposes 
of paragraph (e)(2)(i) of this section, meals at different employer-
operated eating facilities for employees are not related fringe 
benefits, so that a prohibited group employee may exclude the value of a 
meal at a nondiscriminatory facility even though any meals provided to 
him or her at the discriminatory facility cannot be excluded.
    (f) Cash bonuses or rebates. A cash bonus or rebate provided to an 
employee by an employer that is determined pursuant to the value of 
employer-provided property or services purchased by the employee, is 
treated as an equivalent employee discount. For example, assume a 
department store provides a 20 percent merchandise discount to all 
employees under a fringe benefit program. In addition, assume that the 
department store provides cash bonuses to a group of employees defined 
under a classification which discriminates in favor of the prohibited 
group. Assume further that such cash bonuses equal 15 percent of the 
value of merchandise purchased by each employee. This arrangement is 
substantively identical to the example described in paragraph (e)(2) of 
this section. Thus, both the 20 percent merchandise discount and the 15 
percent cash bonus provided to the prohibited group employees are 
includible in such employees' gross incomes.
    (g) Prohibited group employees--(1) Highly compensated--(i) General 
rule. Except as otherwise provided in this paragraph (g)(1)(i), any 
employee of an employer who has (or is reasonably expected to have) 
compensation during a calendar year equal to or greater than the 
employer's base compensation amount is highly compensated. There are two 
exceptions to this rule:
    (A) Any employee who has (or is reasonably expected to have) 
compensation during a calendar year equal to or greater than $50,000 is 
highly compensated, regardless of whether such compensation is in excess 
of the base compensation amount, and
    (B) Any employee who is reasonably expected to have compensation 
during a calendar year equal to or less than $20,000 is not highly 
compensated, unless no employee of the employer is reasonably expected 
to have compensation equal to or greater than $35,000.

The determination of whether an employee is a highly compensated 
employee will be determined based on the entire employee workforce of 
all employers aggregated pursuant to the rules of section 414 (b), (c), 
or (m) without regard to the regular workplace of the employees.
    (ii) Base compensation amount--(A) General rule. The term ``base 
compensation amount'' is defined as that amount corresponding to the 
lowest annual compensation amount received by the highest-paid ten 
percent of all employees of an employer (the number of employees in the 
top ten percent will be increased to the next highest integer if 
necessary), determined on the basis of the preceding calendar year. For 
purposes of this paragraph (g)(1)(ii), the term ``employer'' includes 
all entities that would be aggregated pursuant to the rules of section 
414 (b), (c), or (m).
    (B) Employees that are excluded. For purposes of determining the 
base compensation amount with respect to a fringe benefit program, 
employees described in paragraph (b)(3) of this section are excluded 
whether or not they are covered under the fringe benefit program, except 
that: (1) Employees described in paragraph (b)(3)(ii) of this section 
are taken into account with respect to the program even if they are 
excluded under paragraph (b)(3), and (2) employees described in 
paragraph (b)(3) (i) and (iv) of this section are taken into account 
with respect to the program unless they are excluded under paragraph 
(b)(3).
    (C) Exception to preceding calendar year rule. In the case of an 
employer's first year of operation, or where an employer's business has 
changed significantly from the prior calendar year (e.g., due to an 
acquisition or merger), the employer must make a good faith attempt to 
either determine or adjust

[[Page 610]]

the base compensation amount for the current year based on reasonable 
estimates of current year compensation.
    (iii) Compensation. The term ``compensation'' is defined as the 
amount reportable on a Form W-2 as income. Amounts that would be 
excluded from income but for section 132(h)(1) are not included in 
compensation for purposes of this paragraph (g)(1). Compensation 
includes amounts received from all entities which would be treated as a 
single employer under section 414 (b), (c), or (m) and is not restricted 
to amounts received with respect to any one line of business.
    (iv) Employee. Generally, for purposes of determining whether an 
employee is highly compensated under this paragraph (g)(1), the term 
``employee'' does not include any individual who does not perform 
services for the employer as an employee during the calendar year. For 
example, if an employer has active employees, retired or disabled 
employees, and widows or widowers who are ``employees'' under section 
132(f)(1)(B), the general rule (described in paragraph (g)(1)(i) of this 
section) applies only to the active employees.
    (2) Owner--(i) General rule. For purposes of this section, the term 
``owner'' means any employee who owns a one percent or greater interest 
in either the employer or in any entity that would be aggregated with 
the employer pursuant to the rules of section 414 (b), (c), or (m). In 
addition, such an employee shall be treated as an owner of all entities 
that would be aggregated with the employer pursuant to the rules of 
section 414 (b), (c), or (m).
    (ii) Determining ownership. Ownership in a corporation shall be 
determined pursuant to the rules of section 318(a). For purposes of 
determining ownership in an entity other than a corporation, the rules 
of section 318(a) shall apply in a manner similar to the way in which 
they apply for purposes of determining ownership in a corporation. For 
non-corporate interests, capital or profits interest must be substituted 
for stock.
    (3) Officer--(i) Non-government. For purposes of this section, an 
officer of a non-government employer is any employee who is appointed, 
confirmed, or elected by the Board or shareholders of the employer. An 
employee who is an officer of an employer shall be treated as an officer 
of all entities treated as a single employer pursuant to section 414 
(b), (c), or (m). The number of officers is not to exceed one-percent of 
the total number of employees of all entities treated as a single 
employer pursuant to section 414 (b), (c), or (m) (increased to the next 
highest integer, if necessary). If the number of officers exceeds one-
percent of all employees, then the limitation is to be applied to 
employees in descending order of compensation (as defined in paragraph 
(g)(1)(iii) of this section). Thus, if an employer with 1,000 employees 
has 11 board-appointed officers, the employee with the least 
compensation of those officers would not be an officer under this 
paragraph (g)(3)(i). In determining the total number of employees with 
respect to a fringe benefit program, employees described in paragraph 
(b)(3) of this section are excluded whether or not they are covered 
under the fringe benefit program, except that (A) employees described in 
paragraph (b)(3)(ii) of this section are taken into account with respect 
to the program even if they are excluded under paragraph (b)(3), and (B) 
employees described in paragraph (b)(3) (i) and (iv) of this section are 
taken into account with respect to the program unless they are excluded 
under paragraph (b)(3).
    (ii) Government. For purposes of this section, an officer of a 
government employer is any--
    (A) Elected official,
    (B) Federal employee appointed by the President and confirmed by the 
Senate. However, in the case of any commissioned officer of the United 
States Armed Forces, an officer is any employee with the rank of 
brigadier general or rear admiral (lower half) or above, and
    (C) State or local executive officer comparable to individuals 
described in paragraphs (g)(3)(ii) (A) and (B) of this section.


For purposes of this paragraph (g)(3)(ii), the term ``government'' 
includes any Federal, state, or local governmental unit, and any agency 
or instrumentality thereof.

[[Page 611]]

    (4) Former employees. [Reserved]

[T.D. 8063, 50 FR 52309, Dec. 23, 1985, as amended by T.D. 8256, 54 FR 
28600, July 6, 1989]



Sec. 1.132-9  Qualified transportation fringes.

    (a) Table of contents. This section contains a list of the questions 
and answers in Sec. 1.132-9.

    (1) General rules.
    Q-1. What is a qualified transportation fringe?
    Q-2. What is transportation in a commuter highway vehicle?
    Q-3. What are transit passes?
    Q-4. What is qualified parking?
    Q-5. May qualified transportation fringes be provided to individuals 
who are not employees?
    Q-6. Must a qualified transportation fringe benefit plan be in 
writing?
    (2) Dollar limitations.
    Q-7. Is there a limit on the value of qualified transportation 
fringes that may be excluded from an employee's gross income?
    Q-8. What amount is includible in an employee's wages for income and 
employment tax purposes if the value of the qualified transportation 
fringe exceeds the applicable statutory monthly limit?
    Q-9. Are excludable qualified transportation fringes calculated on a 
monthly basis?
    Q-10. May an employee receive qualified transportation fringes from 
more than one employer?
    (3) Compensation reduction.
    Q-11. May qualified transportation fringes be provided to employees 
pursuant to a compensation reduction agreement?
    Q-12. What is a compensation reduction election for purposes of 
section 132(f)?
    Q-13. Is there a limit to the amount of the compensation reduction?
    Q-14. When must the employee have made a compensation reduction 
election and under what circumstances may the amount be paid in cash to 
the employee?
    Q-15. May an employee whose qualified transportation fringe costs 
are less than the employee's compensation reduction carry over this 
excess amount to subsequent periods?
    (4) Expense reimbursements.
    Q-16. How does section 132(f) apply to expense reimbursements?
    Q-17. May an employer provide nontaxable cash reimbursement under 
section 132(f) for periods longer than one month?
    Q-18. What are the substantiation requirements if an employer 
distributes transit passes?
    Q-19. May an employer choose to impose substantiation requirements 
in addition to those described in this regulation?
    (5) Special rules for parking and vanpools.
    Q-20. How is the value of parking determined?
    Q-21. How do the qualified transportation fringe rules apply to van 
pools?
    (6) Reporting and employment taxes.
    Q-22. What are the reporting and employment tax requirements for 
qualified transportation fringes?
    (7) Interaction with other fringe benefits.
    Q-23. How does section 132(f) interact with other fringe benefit 
rules?
    (8) Application to individuals who are not employees.
    Q-24. May qualified transportation fringes be provided to 
individuals who are partners, 2-percent shareholders of S-corporations, 
or independent contractors?
    (9) Effective date.
    Q-25. What is the effective date of this section?

    (b) Questions and answers.
    Q-1. What is a qualified transportation fringe?
    A-1. (a) The following benefits are qualified transportation fringe 
benefits:
    (1) Transportation in a commuter highway vehicle.
    (2) Transit passes.
    (3) Qualified parking.
    (b) An employer may simultaneously provide an employee with any one 
or more of these three benefits.
    Q-2. What is transportation in a commuter highway vehicle?
    A-2. Transportation in a commuter highway vehicle is transportation 
provided by an employer to an employee in connection with travel between 
the employee's residence and place of employment. A commuter highway 
vehicle is a highway vehicle with a seating capacity of at least 6 
adults (excluding the driver) and with respect to which at least 80 
percent of the vehicle's mileage for a year is reasonably expected to 
be--
    (a) For transporting employees in connection with travel between 
their residences and their place of employment; and
    (b) On trips during which the number of employees transported for 
commuting is at least one-half of the adult seating capacity of the 
vehicle (excluding the driver).
    Q-3. What are transit passes?
    A-3. A transit pass is any pass, token, farecard, voucher, or 
similar item (including an item exchangeable

[[Page 612]]

for fare media) that entitles a person to transportation--
    (a) On mass transit facilities (whether or not publicly owned); or
    (b) Provided by any person in the business of transporting persons 
for compensation or hire in a highway vehicle with a seating capacity of 
at least 6 adults (excluding the driver).
    Q-4. What is qualified parking?
    A-4. (a) Qualified parking is parking provided to an employee by an 
employer--
    (1) On or near the employer's business premises; or
    (2) At a location from which the employee commutes to work 
(including commuting by carpool, commuter highway vehicle, mass transit 
facilities, or transportation provided by any person in the business of 
transporting persons for compensation or hire).
    (b) For purposes of section 132(f), parking on or near the 
employer's business premises includes parking on or near a work location 
at which the employee provides services for the employer. However, 
qualified parking does not include--
    (1) The value of parking provided to an employee that is excludable 
from gross income under section 132(a)(3) (as a working condition 
fringe), or
    (2) Reimbursement paid to an employee for parking costs that is 
excludable from gross income as an amount treated as paid under an 
accountable plan. See Sec. 1.62-2.
    (c) However, parking on or near property used by the employee for 
residential purposes is not qualified parking.
    (d) Parking is provided by an employer if--
    (1) The parking is on property that the employer owns or leases;
    (2) The employer pays for the parking; or
    (3) The employer reimburses the employee for parking expenses (see 
Q/A-16 of this section for rules relating to cash reimbursements).
    Q-5. May qualified transportation fringes be provided to individuals 
who are not employees?
    A-5. An employer may provide qualified transportation fringes only 
to individuals who are currently employees of the employer at the time 
the qualified transportation fringe is provided. The term employee for 
purposes of qualified transportation fringes is defined in Sec. 1.132-
1(b)(2)(i). This term includes only common law employees and other 
statutory employees, such as officers of corporations. See Q/A-24 of 
this section for rules regarding partners, 2-percent shareholders, and 
independent contractors.
    Q-6. Must a qualified transportation fringe benefit plan be in 
writing?
    A-6. No. Section 132(f) does not require that a qualified 
transportation fringe benefit plan be in writing.
    Q-7. Is there a limit on the value of qualified transportation 
fringes that may be excluded from an employee's gross income?
    A-7. (a) Transportation in a commuter highway vehicle and transit 
passes. Before January 1, 2002, up to $65 per month is excludable from 
the gross income of an employee for transportation in a commuter highway 
vehicle and transit passes provided by an employer. On January 1, 2002, 
this amount is increased to $100 per month.
    (b) Parking. Up to $175 per month is excludable from the gross 
income of an employee for qualified parking.
    (c) Combination. An employer may provide qualified parking benefits 
in addition to transportation in a commuter highway vehicle and transit 
passes.
    (d) Cost-of-living adjustments. The amounts in paragraphs (a) and 
(b) of this Q/A-7 are adjusted annually, beginning with 2000, to reflect 
cost-of-living. The adjusted figures are announced by the Service before 
the beginning of the year.
    Q-8. What amount is includible in an employee's wages for income and 
employment tax purposes if the value of the qualified transportation 
fringe exceeds the applicable statutory monthly limit?
    A-8. (a) Generally, an employee must include in gross income the 
amount by which the fair market value of the benefit exceeds the sum of 
the amount, if any, paid by the employee and any amount excluded from 
gross income under section 132(a)(5). Thus, assuming no other statutory 
exclusion applies, if an employer provides an employee with a qualified 
transportation fringe that exceeds the applicable statutory

[[Page 613]]

monthly limit and the employee does not make any payment, the value of 
the benefits provided in excess of the applicable statutory monthly 
limit is included in the employee's wages for income and employment tax 
purposes. See Sec. 1.61-21(b)(1).
    (b) The following examples illustrate the principles of this Q/A-8:

    Example 1. (i) For each month in a year in which the statutory 
monthly transit pass limit is $100 (i.e., a year after 2001), Employer M 
provides a transit pass valued at $110 to Employee D, who does not pay 
any amount to Employer M for the transit pass.
    (ii) In this Example 1, because the value of the monthly transit 
pass exceeds the statutory monthly limit by $10, $120 ($110--$100, times 
12 months) must be included in D's wages for income and employment tax 
purposes for the year with respect to the transit passes.
    Example 2. (i) For each month in a year in which the statutory 
monthly qualified parking limit is $175, Employer M provides qualified 
parking valued at $195 to Employee E, who does not pay any amount to M 
for the parking.
    (ii) In this Example 2, because the fair market value of the 
qualified parking exceeds the statutory monthly limit by $20, $240 
($195--$175, times 12 months) must be included in Employee E's wages for 
income and employment tax purposes for the year with respect to the 
qualified parking.
    Example 3. (i) For each month in a year in which the statutory 
monthly qualified parking limit is $175, Employer P provides qualified 
parking with a fair market value of $220 per month to its employees, but 
charges each employee $45 per month.
    (ii) In this Example 3, because the sum of the amount paid by an 
employee ($45) plus the amount excludable for qualified parking ($175) 
is not less than the fair market value of the monthly benefit, no amount 
is includible in the employee's wages for income and employment tax 
purposes with respect to the qualified parking.

    Q-9. Are excludable qualified transportation fringes calculated on a 
monthly basis?
    A-9. (a) In general. Yes. The value of transportation in a commuter 
highway vehicle, transit passes, and qualified parking is calculated on 
a monthly basis to determine whether the value of the benefit has 
exceeded the applicable statutory monthly limit on qualified 
transportation fringes. Except in the case of a transit pass provided to 
an employee, the applicable statutory monthly limit applies to qualified 
transportation fringes used by the employee in a month. Monthly 
exclusion amounts are not combined to provide a qualified transportation 
fringe for any month exceeding the statutory limit. A month is a 
calendar month or a substantially equivalent period applied 
consistently.
    (b) Transit passes. In the case of transit passes provided to an 
employee, the applicable statutory monthly limit applies to the transit 
passes provided by the employer to the employee in a month for that 
month or for any previous month in the calendar year. In addition, 
transit passes distributed in advance for more than one month, but not 
for more than twelve months, are qualified transportation fringes if the 
requirements in paragraph (c) of this Q/A-9 are met (relating to the 
income tax and employment tax treatment of advance transit passes). The 
applicable statutory monthly limit under section 132(f)(2) on the 
combined amount of transportation in a commuter highway vehicle and 
transit passes may be calculated by taking into account the monthly 
limits for all months for which the transit passes are distributed. In 
the case of a pass that is valid for more than one month, such as an 
annual pass, the value of the pass may be divided by the number of 
months for which it is valid for purposes of determining whether the 
value of the pass exceeds the statutory monthly limit.
    (c) Rule if employee's employment terminates--(1) Income tax 
treatment. The value of transit passes provided in advance to an 
employee with respect to a month in which the individual is not an 
employee is included in the employee's wages for income tax purposes.
    (2) Reporting and employment tax treatment. Transit passes 
distributed in advance to an employee are excludable from wages for 
employment tax purposes under sections 3121, 3306, and 3401 (FICA, FUTA, 
and income tax withholding) if the employer distributes transit passes 
to the employee in advance for not more than three months and, at the 
time the transit passes are distributed, there is not an established 
date that the employee's employment will terminate (for example, if the 
employee has given notice of retirement) which will occur before the 
beginning

[[Page 614]]

of the last month of the period for which the transit passes are 
provided. If the employer distributes transit passes to an employee in 
advance for not more than three months and at the time the transit 
passes are distributed there is an established date that the employee's 
employment will terminate, and the employee's employment does terminate 
before the beginning of the last month of the period for which the 
transit passes are provided, the value of transit passes provided for 
months beginning after the date of termination during which the employee 
is not employed by the employer is included in the employee's wages for 
employment tax purposes. If transit passes are distributed in advance 
for more than three months, the value of transit passes provided for the 
months during which the employee is not employed by the employer is 
includible in the employee's wages for employment tax purposes 
regardless of whether at the time the transit passes were distributed 
there was an established date of termination of the employee's 
employment.
    (d) Examples. The following examples illustrate the principles of 
this Q/A-9:

    Example 1. (i) Employee E incurs $150 for qualified parking used 
during the month of June of a year in which the statutory monthly 
parking limit is $175, for which E is reimbursed $150 by Employer R. 
Employee E incurs $180 in expenses for qualified parking used during the 
month of July of that year, for which E is reimbursed $180 by Employer 
R.
    (ii) In this Example 1, because monthly exclusion amounts may not be 
combined to provide a benefit in any month greater than the applicable 
statutory limit, the amount by which the amount reimbursed for July 
exceeds the applicable statutory monthly limit ($180 minus $175 equals 
$5) is includible in Employee E's wages for income and employment tax 
purposes.
    Example 2. (i) Employee F receives transit passes from Employer G 
with a value of $195 in March of a year (for which the statutory monthly 
transit pass limit is $65) for January, February, and March of that 
year. F was hired during January and has not received any transit passes 
from G.
    (ii) In this Example 2, the value of the transit passes (three 
months times $65 equals $195) is excludable from F's wages for income 
and employment tax purposes.
    Example 3. (i) Employer S has a qualified transportation fringe 
benefit plan under which its employees receive transit passes near the 
beginning of each calendar quarter for that calendar quarter. All 
employees of Employer S receive transit passes from Employer S with a 
value of $195 on March 31 for the second calendar quarter covering the 
months April, May, and June (of a year in which the statutory monthly 
transit pass limit is $65).
    (ii) In this Example 3, because the value of the transit passes may 
be calculated by taking into account the monthly limits for all months 
for which the transit passes are distributed, the value of the transit 
passes (three months times $65 equals $195) is excludable from the 
employees' wages for income and employment tax purposes.
    Example 4. (i) Same facts as in Example 3, except that Employee T, 
an employee of Employer S, terminates employment with S on May 31. There 
was not an established date of termination for Employee T at the time 
the transit passes were distributed.
    (ii) In this Example 4, because at the time the transit passes were 
distributed there was not an established date of termination for 
Employee T, the value of the transit passes provided for June ($65) is 
excludable from T's wages for employment tax purposes. However, the 
value of the transit passes distributed to Employee T for June ($65) is 
not excludable from T's wages for income tax purposes.
    (iii) If Employee T's May 31 termination date was established at the 
time the transit passes were provided, the value of the transit passes 
provided for June ($65) is included in T's wages for both income and 
employment tax purposes.
    Example 5. (i) Employer F has a qualified transportation fringe 
benefit plan under which its employees receive transit passes semi-
annually in advance of the months for which the transit passes are 
provided. All employees of Employer F, including Employee X, receive 
transit passes from F with a value of $390 on June 30 for the 6 months 
of July through December (of a year in which the statutory monthly 
transit pass limit is $65). Employee X's employment terminates and his 
last day of work is August 1. Employer F's other employees remain 
employed throughout the remainder of the year.
    (ii) In this Example 5, the value of the transit passes provided to 
Employee X for the months September, October, November, and December 
($65 times 4 months equals $260) of the year is included in X's wages 
for income and employment tax purposes. The value of the transit passes 
provided to Employer F's other employees is excludable from the 
employees' wages for income and employment tax purposes.
    Example 6. (i) Each month during a year in which the statutory 
monthly transit pass limit is $65, Employer R distributes transit passes 
with a face amount of $70 to each of

[[Page 615]]

its employees. Transit passes with a face amount of $70 can be purchased 
from the transit system by any individual for $65.
    (ii) In this Example 6, because the value of the transit passes 
distributed by Employer R does not exceed the applicable statutory 
monthly limit ($65), no portion of the value of the transit passes is 
included as wages for income and employment tax purposes.

    Q-10. May an employee receive qualified transportation fringes from 
more than one employer?
    A-10. (a) General rule. Yes. The statutory monthly limits described 
in Q/A-7 of this section apply to benefits provided by an employer to 
its employees. For this purpose, all employees treated as employed by a 
single employer under section 414(b), (c), (m), or (o) are treated as 
employed by a single employer. See section 414(t) and Sec. 1.132-1(c). 
Thus, qualified transportation fringes paid by entities under common 
control under section 414(b), (c), (m), or (o) are combined for purposes 
of applying the applicable statutory monthly limit. In addition, an 
individual who is treated as a leased employee of the employer under 
section 414(n) is treated as an employee of that employer for purposes 
of section 132. See section 414(n)(3)(C).
    (b) Examples. The following examples illustrate the principles of 
this Q/A-10:

    Example 1. (i) During a year in which the statutory monthly 
qualified parking limit is $175, Employee E works for Employers M and N, 
who are unrelated and not treated as a single employer under section 
414(b), (c), (m), or (o). Each month, M and N each provide qualified 
parking benefits to E with a value of $100.
    (ii) In this Example 1, because M and N are unrelated employers, and 
the value of the monthly parking benefit provided by each is not more 
than the applicable statutory monthly limit, the parking benefits 
provided by each employer are excludable as qualified transportation 
fringes assuming that the other requirements of this section are 
satisfied.
    Example 2. (i) Same facts as in Example 1, except that Employers M 
and N are treated as a single employer under section 414(b).
    (ii) In this Example 2, because M and N are treated as a single 
employer, the value of the monthly parking benefit provided by M and N 
must be combined for purposes of determining whether the applicable 
statutory monthly limit has been exceeded. Thus, the amount by which the 
value of the parking benefit exceeds the monthly limit ($200 minus the 
monthly limit amount of $175 equals $25) for each month in the year is 
includible in E's wages for income and employment tax purposes.

    Q-11. May qualified transportation fringes be provided to employees 
pursuant to a compensation reduction agreement?
    A-11. Yes. An employer may offer employees a choice between cash 
compensation and any qualified transportation fringe. An employee who is 
offered this choice and who elects qualified transportation fringes is 
not required to include the cash compensation in income if--
    (a) The election is pursuant to an arrangement described in Q/A-12 
of this section;
    (b) The amount of the reduction in cash compensation does not exceed 
the limitation in Q/A-13 of this section;
    (c) The arrangement satisfies the timing and reimbursement rules in 
Q/A-14 and 16 of this section; and
    (d) The related fringe benefit arrangement otherwise satisfies the 
requirements set forth elsewhere in this section.
    Q-12. What is a compensation reduction election for purposes of 
section 132(f)?
    A-12. (a) Election requirements generally. A compensation reduction 
arrangement is an arrangement under which the employer provides the 
employee with the right to elect whether the employee will receive 
either a fixed amount of cash compensation at a specified future date or 
a fixed amount of qualified transportation fringes to be provided for a 
specified future period (such as qualified parking to be used during a 
future calendar month). The employee's election must be in writing or 
another form, such as electronic, that includes, in a permanent and 
verifiable form, the information required to be in the election. The 
election must contain the date of the election, the amount of the 
compensation to be reduced, and the period for which the benefit will be 
provided. The election must relate to a fixed dollar amount or fixed 
percentage of compensation reduction. An election to reduce compensation 
for a period by a set amount for such period may be automatically 
renewed for subsequent periods.

[[Page 616]]

    (b) Automatic election permitted. An employer may provide under its 
qualified transportation fringe benefit plan that a compensation 
reduction election will be deemed to have been made if the employee does 
not elect to receive cash compensation in lieu of the qualified 
transportation fringe, provided that the employee receives adequate 
notice that a compensation reduction will be made and is given adequate 
opportunity to choose to receive the cash compensation instead of the 
qualified transportation fringe.
    Q-13. Is there a limit to the amount of the compensation reduction?
    A-13. Yes. Each month, the amount of the compensation reduction may 
not exceed the combined applicable statutory monthly limits for 
transportation in a commuter highway vehicle, transit passes, and 
qualified parking. For example, for a year in which the statutory 
monthly limit is $65 for transportation in a commuter highway vehicle 
and transit passes, and $175 for qualified parking, an employee could 
elect to reduce compensation for any month by no more than $240 ($65 
plus $175) with respect to qualified transportation fringes. If an 
employee were to elect to reduce compensation by $250 for a month, the 
excess $10 ($250 minus $240) would be includible in the employee's wages 
for income and employment tax purposes.
    Q-14. When must the employee have made a compensation reduction 
election and under what circumstances may the amount be paid in cash to 
the employee?
    A-14. (a) The compensation reduction election must satisfy the 
requirements set forth under paragraphs (b), (c), and (d) of this Q/A-
14.
    (b) Timing of election. The compensation reduction election must be 
made before the employee is able currently to receive the cash or other 
taxable amount at the employee's discretion. The determination of 
whether the employee is able currently to receive the cash does not 
depend on whether it has been constructively received for purposes of 
section 451. The election must specify that the period (such as a 
calendar month) for which the qualified transportation fringe will be 
provided must not begin before the election is made. Thus, a 
compensation reduction election must relate to qualified transportation 
fringes to be provided after the election. For this purpose, the date a 
qualified transportation fringe is provided is--
    (1) The date the employee receives a voucher or similar item; or
    (2) In any other case, the date the employee uses the qualified 
transportation fringe.
    (c) Revocability of elections. The employee may not revoke a 
compensation reduction election after the employee is able currently to 
receive the cash or other taxable amount at the employee's discretion. 
In addition, the election may not be revoked after the beginning of the 
period for which the qualified transportation fringe will be provided.
    (d) Compensation reduction amounts not refundable. Unless an 
election is revoked in a manner consistent with paragraph (c) of this Q/
A-14, an employee may not subsequently receive the compensation (in cash 
or any form other than by payment of a qualified transportation fringe 
under the employer's plan). Thus, an employer's qualified transportation 
fringe benefit plan may not provide that an employee who ceases to 
participate in the employer's qualified transportation fringe benefit 
plan (such as in the case of termination of employment) is entitled to 
receive a refund of the amount by which the employee's compensation 
reductions exceed the actual qualified transportation fringes provided 
to the employee by the employer.
    (e) Examples. The following examples illustrate the principles of 
this Q/A-14:

    Example 1. (i) Employer P maintains a qualified transportation 
fringe benefit arrangement during a year in which the statutory monthly 
limit is $100 for transportation in a commuter highway vehicle and 
transit passes (2002 or later) and $180 for qualified parking. Employees 
of P are paid cash compensation twice per month, with the payroll dates 
being the first and the fifteenth day of the month. Under P's 
arrangement, an employee is permitted to elect at any time before the 
first day of a month to reduce his or her compensation payable during 
that month in an amount up to the applicable statutory monthly limit 
($100 if the employee elects coverage for transportation in a commuter 
highway vehicle or a mass transit pass, or

[[Page 617]]

$180 if the employee chooses qualified parking) in return for the right 
to receive qualified transportation fringes up to the amount of the 
election. If such an election is made, P will provide a mass transit 
pass for that month with a value not exceeding the compensation 
reduction amount elected by the employee or will reimburse the cost of 
other qualified transportation fringes used by the employee on or after 
the first day of that month up to the compensation reduction amount 
elected by the employee. Any compensation reduction amount elected by 
the employee for the month that is not used for qualified transportation 
fringes is not refunded to the employee at any future date.
    (ii) In this Example 1, the arrangement satisfies the requirements 
of this Q/A-14 because the election is made before the employee is able 
currently to receive the cash and the election specifies the future 
period for which the qualified transportation fringes will be provided. 
The arrangement would also satisfy the requirements of this Q/A-14 and 
Q/A-13 of this section if employees are allowed to elect to reduce 
compensation up to $280 per month ($100 plus $180).
    (iii) The arrangement would also satisfy the requirements of this Q/
A-14 (and Q/A-13 of this section) if employees are allowed to make an 
election at any time before the first or the fifteenth day of the month 
to reduce their compensation payable on that payroll date by an amount 
not in excess of one-half of the applicable statutory monthly limit 
(depending on the type of qualified transportation fringe elected by the 
employee) and P provides a mass transit pass on or after the applicable 
payroll date for the compensation reduction amount elected by the 
employee for the payroll date or reimburses the cost of other qualified 
transportation fringes used by the employee on or after the payroll date 
up to the compensation reduction amount elected by the employee for that 
payroll date.
    Example 2. (i) Employee Q elects to reduce his compensation payable 
on March 1 of a year (for which the statutory monthly mass transit limit 
is $65) by $195 in exchange for a mass transit voucher to be provided in 
March. The election is made on the preceding February 27. Employee Q was 
hired in January of the year. On March 10 of the year, the employer of 
Employee Q delivers to Employee Q a mass transit voucher worth $195 for 
the months of January, February, and March.
    (ii) In this Example 2, $65 is included in Employee Q's wages for 
income and employment tax purposes because the compensation reduction 
election fails to satisfy the requirement in this Q/A-14 and Q/A-12 of 
this section that the period for which the qualified transportation 
fringe will be provided not begin before the election is made to the 
extent the election relates to $65 worth of transit passes for January 
of the year. The $65 for February is not taxable because the election 
was for a future period that includes at least one day in February.
    (iii) However, no amount would be included in Employee Q's wages as 
a result of the election if $195 worth of mass transit passes were 
instead provided to Q for the months of February, March, and April 
(because the compensation reduction would relate solely to fringes to be 
provided for a period not beginning before the date of the election and 
the amount provided does not exceed the aggregate limit for the period, 
i.e., the sum of $65 for each of February, March, and April). See Q/A-9 
of this section for rules governing transit passes distributed in 
advance for more than one month.
    Example 3. (i) Employee R elects to reduce his compensation payable 
on March 1 of a year (for which the statutory monthly parking limit is 
$175) by $185 in exchange for reimbursement by Employer T of parking 
expenses incurred by Employee R for parking on or near Employer T's 
business premises during the period beginning after the date of the 
election through March. The election is made on the preceding February 
27. Employee R incurs $10 in parking expenses on February 28 of the 
year, and $175 in parking expenses during the month of March. On April 5 
of the year, Employer T reimburses Employee R $185 for the parking 
expenses incurred on February 28, and during March, of the year.
    (ii) In this Example 3, no amount would be includible in Employee 
R's wages for income and employment tax purposes because the 
compensation reduction related solely to parking on or near Employer R's 
business premises used during a period not beginning before the date of 
the election and the amount reimbursed for parking used in any one month 
does not exceed the statutory monthly limitation.

    Q-15. May an employee whose qualified transportation fringe costs 
are less than the employee's compensation reduction carry over this 
excess amount to subsequent periods?
    A-15. (a) Yes. An employee may carry over unused compensation 
reduction amounts to subsequent periods under the plan of the employee's 
employer.
    (b) The following example illustrates the principles of this Q/A-15:

    Example. (i) By an election made before November 1 of a year for 
which the statutory monthly mass transit limit is $65, Employee E elects 
to reduce compensation in the amount of $65 for the month of November. E 
incurs $50 in employee-operated commuter highway vehicle expenses during 
November for which E is reimbursed $50 by Employer R,

[[Page 618]]

E's employer. By an election made before December, E elects to reduce 
compensation by $65 for the month of December. E incurs $65 in employee-
operated commuter highway vehicle expenses during December for which E 
is reimbursed $65 by R. Before the following January, E elects to reduce 
compensation by $50 for the month of January. E incurs $65 in employee-
operated commuter highway vehicle expenses during January for which E is 
reimbursed $65 by R because R allows E to carry over to the next year 
the $15 amount by which the compensation reductions for November and 
December exceeded the employee-operated commuter highway vehicle 
expenses incurred during those months.
    (ii) In this Example, because Employee E is reimbursed in an amount 
not exceeding the applicable statutory monthly limit, and the 
reimbursement does not exceed the amount of employee-operated commuter 
highway vehicle expenses incurred during the month of January, the 
amount reimbursed ($65) is excludable from E's wages for income and 
employment tax purposes.

    Q-16. How does section 132(f) apply to expense reimbursements?
    A-16. (a) In general. The term qualified transportation fringe 
includes cash reimbursement by an employer to an employee for expenses 
incurred or paid by an employee for transportation in a commuter highway 
vehicle or qualified parking. The term qualified transportation fringe 
also includes cash reimbursement for transit passes made under a bona 
fide reimbursement arrangement, but, in accordance with section 
132(f)(3), only if permitted under paragraph (b) of this Q/A-16. The 
reimbursement must be made under a bona fide reimbursement arrangement 
which meets the rules of paragraph (c) of this Q/A-16. A payment made 
before the date an expense has been incurred or paid is not a 
reimbursement. In addition, a bona fide reimbursement arrangement does 
not include an arrangement that is dependent solely upon an employee 
certifying in advance that the employee will incur expenses at some 
future date.
    (b) Special rule for transit passes--(1) In general. The term 
qualified transportation fringe includes cash reimbursement for transit 
passes made under a bona fide reimbursement arrangement, but, in 
accordance with section 132(f)(3), only if no voucher or similar item 
that may be exchanged only for a transit pass is readily available for 
direct distribution by the employer to employees. If a voucher is 
readily available, the requirement that a voucher be distributed in-kind 
by the employer is satisfied if the voucher is distributed by the 
employer or by another person on behalf of the employer (for example, if 
a transit operator credits amounts to the employee's fare card as a 
result of payments made to the operator by the employer).
    (2) Voucher or similar item. For purposes of the special rule in 
paragraph (b) of this Q/A-16, a transit system voucher is an instrument 
that may be purchased by employers from a voucher provider that is 
accepted by one or more mass transit operators (e.g., train, subway, and 
bus) in an area as fare media or in exchange for fare media. Thus, for 
example, a transit pass that may be purchased by employers directly from 
a voucher provider is a transit system voucher.
    (3) Voucher provider. The term voucher provider means any person in 
the trade or business of selling transit system vouchers to employers, 
or any transit system or transit operator that sells vouchers to 
employers for the purpose of direct distribution to employees. Thus, a 
transit operator might or might not be a voucher provider. A voucher 
provider is not, for example, a third-party employee benefits 
administrator that administers a transit pass benefit program for an 
employer using vouchers that the employer could obtain directly.
    (4) Readily available. For purposes of this paragraph (b), a voucher 
or similar item is readily available for direct distribution by the 
employer to employees if and only if an employer can obtain it from a 
voucher provider that--
    (i) does not impose fare media charges that cause vouchers to not be 
readily available as described in paragraph (b)(5) of this section; and
    (ii) does not impose other restrictions that cause vouchers to not 
be readily available as described in paragraph (b)(6) of this section.
    (5) Fare media charges. For purposes of paragraph (b)(4) of this 
section, fare media charges relate only to fees paid by the employer to 
voucher providers for vouchers. The determination of

[[Page 619]]

whether obtaining a voucher would result in fare media charges that 
cause vouchers to not be readily available as described in this 
paragraph (b) is made with respect to each transit system voucher. If 
more than one transit system voucher is available for direct 
distribution to employees, the employer must consider the fees imposed 
for the lowest cost monthly voucher for purposes of determining whether 
the fees imposed by the voucher provider satisfy this paragraph. 
However, if transit system vouchers for multiple transit systems are 
required in an area to meet the transit needs of the individual 
employees in that area, the employer has the option of averaging the 
costs applied to each transit system voucher for purposes of determining 
whether the fare media charges for transit system vouchers satisfy this 
paragraph. Fare media charges are described in this paragraph (b)(5), 
and therefore cause vouchers to not be readily available, if and only if 
the average annual fare media charges that the employer reasonably 
expects to incur for transit system vouchers purchased from the voucher 
provider (disregarding reasonable and customary delivery charges imposed 
by the voucher provider, e.g., not in excess of $15) are more than 1 
percent of the average annual value of the vouchers for a transit 
system.
    (6) Other restrictions. For purposes of paragraph (b)(4) of this 
section, restrictions that cause vouchers to not be readily available 
are restrictions imposed by the voucher provider other than fare media 
charges that effectively prevent the employer from obtaining vouchers 
appropriate for distribution to employees. Examples of such restrictions 
include--
    (i) Advance purchase requirements. Advance purchase requirements 
cause vouchers to not be readily available only if the voucher provider 
does not offer vouchers at regular intervals or fails to provide the 
voucher within a reasonable period after receiving payment for the 
voucher. For example, a requirement that vouchers may be purchased only 
once per year may effectively prevent an employer from obtaining 
vouchers for distribution to employees. An advance purchase requirement 
that vouchers be purchased not more frequently than monthly does not 
effectively prevent the employer from obtaining vouchers for 
distribution to employees.
    (ii) Purchase quantity requirements. Purchase quantity requirements 
cause vouchers to not be readily available if the voucher provider does 
not offer vouchers in quantities that are reasonably appropriate to the 
number of the employer's employees who use mass transportation (for 
example, the voucher provider requires a $1,000 minimum purchase and the 
employer seeks to purchase only $200 of vouchers).
    (iii) Limitations on denominations of vouchers that are available. 
If the voucher provider does not offer vouchers in denominations 
appropriate for distribution to the employer's employees, vouchers are 
not readily available. For example, vouchers provided in $5 increments 
up to the monthly limit are appropriate for distribution to employees, 
while vouchers available only in a denomination equal to the monthly 
limit are not appropriate for distribution to employees if the amount of 
the benefit provided to the employer's employees each month is normally 
less than the monthly limit.
    (7) Example. The following example illustrates the principles of 
this paragraph (b):

    Example. (i) Company C in City X sells mass transit vouchers to 
employers in the metropolitan area of X in various denominations 
appropriate for distribution to employees. Employers can purchase 
vouchers monthly in reasonably appropriate quantities. Several different 
bus, rail, van pool, and ferry operators service X, and a number of the 
operators accept the vouchers either as fare media or in exchange for 
fare media. To cover its operating expenses, C imposes on each voucher a 
50 cents charge, plus a reasonable and customary $15 charge for delivery 
of each order of vouchers. Employer M disburses vouchers purchased from 
C to its employees who use operators that accept the vouchers and M 
reasonably expects that $55 is the average value of the voucher it will 
purchase from C for the next calendar year.
    (ii) In this Example, vouchers for X are readily available for 
direct distribution by the employer to employees because the expected 
cost of the vouchers disbursed to M's employees for the next calendar 
year is not more than 1 percent of the value of the vouchers (50 cents 
divided by $55 equals 0.91

[[Page 620]]

percent), the delivery charges are disregarded because they are 
reasonable and customary, and there are no other restrictions that cause 
the vouchers to not be readily available. Thus, any reimbursement of 
mass transportation costs in X would not be a qualified transportation 
fringe.

    (c) Substantiation requirements. Employers that make cash 
reimbursements must establish a bona fide reimbursement arrangement to 
establish that their employees have, in fact, incurred expenses for 
transportation in a commuter highway vehicle, transit passes, or 
qualified parking. For purposes of section 132(f), whether cash 
reimbursements are made under a bona fide reimbursement arrangement may 
vary depending on the facts and circumstances, including the method or 
methods of payment utilized within the mass transit system. The employer 
must implement reasonable procedures to ensure that an amount equal to 
the reimbursement was incurred for transportation in a commuter highway 
vehicle, transit passes, or qualified parking. The expense must be 
substantiated within a reasonable period of time. An expense 
substantiated to the payor within 180 days after it has been paid will 
be treated as having been substantiated within a reasonable period of 
time. An employee certification at the time of reimbursement in either 
written or electronic form may be a reasonable reimbursement procedure 
depending on the facts and circumstances. Examples of reasonable 
reimbursement procedures are set forth in paragraph (d) of this Q/A-16.
    (d) Illustrations of reasonable reimbursement procedures. The 
following are examples of reasonable reimbursement procedures for 
purposes of paragraph (c) of this Q/A-16. In each case, the 
reimbursement is made at or within a reasonable period after the end of 
the events described in paragraphs (d)(1) through (d)(3) of this 
section.
    (1) An employee presents to the employer a parking expense receipt 
for parking on or near the employer's business premises, the employee 
certifies that the parking was used by the employee, and the employer 
has no reason to doubt the employee's certification.
    (2) An employee either submits a used time-sensitive transit pass 
(such as a monthly pass) to the employer and certifies that he or she 
purchased it or presents an unused or used transit pass to the employer 
and certifies that he or she purchased it and the employee certifies 
that he or she has not previously been reimbursed for the transit pass. 
In both cases, the employer has no reason to doubt the employee's 
certification.
    (3) If a receipt is not provided in the ordinary course of business 
(e.g., if the employee uses metered parking or if used transit passes 
cannot be returned to the user), the employee certifies to the employer 
the type and the amount of expenses incurred, and the employer has no 
reason to doubt the employee's certification.
    Q-17. May an employer provide nontaxable cash reimbursement under 
section 132(f) for periods longer than one month?
    A-17. (a) General rule. Yes. Qualified transportation fringes 
include reimbursement to employees for costs incurred for transportation 
in more than one month, provided the reimbursement for each month in the 
period is calculated separately and does not exceed the applicable 
statutory monthly limit for any month in the period. See Q/A-8 and 9 of 
this section if the limit for a month is exceeded.
    (b) Example. The following example illustrates the principles of 
this Q/A-17:

    Example. (i) Employee R pays $100 per month for qualified parking 
used during the period from April 1 through June 30 of a year in which 
the statutory monthly qualified parking limit is $175. After receiving 
adequate substantiation from Employee R, R's employer reimburses R $300 
in cash on June 30 of that year.
    (ii) In this Example, because the value of the reimbursed expenses 
for each month did not exceed the applicable statutory monthly limit, 
the $300 reimbursement is excludable from R's wages for income and 
employment tax purposes as a qualified transportation fringe.

    Q-18. What are the substantiation requirements if an employer 
distributes transit passes?
    A-18. There are no substantiation requirements if the employer 
distributes transit passes. Thus, an employer may distribute a transit 
pass for each month with a value not more than the

[[Page 621]]

statutory monthly limit without requiring any certification from the 
employee regarding the use of the transit pass.
    Q-19. May an employer choose to impose substantiation requirements 
in addition to those described in this regulation?
    A-19. Yes.
    Q-20. How is the value of parking determined?
    A-20. Section 1.61-21(b)(2) applies for purposes of determining the 
value of parking.
    Q-21. How do the qualified transportation fringe rules apply to van 
pools?
    A-21. (a) Van pools generally. Employer and employee-operated van 
pools, as well as private or public transit-operated van pools, may 
qualify as qualified transportation fringes. The value of van pool 
benefits which are qualified transportation fringes may be excluded up 
to the applicable statutory monthly limit for transportation in a 
commuter highway vehicle and transit passes, less the value of any 
transit passes provided by the employer for the month.
    (b) Employer-operated van pools. The value of van pool 
transportation provided by or for an employer to its employees is 
excludable as a qualified transportation fringe, provided the van 
qualifies as a commuter highway vehicle as defined in section 
132(f)(5)(B) and Q/A-2 of this section. A van pool is operated by or for 
the employer if the employer purchases or leases vans to enable 
employees to commute together or the employer contracts with and pays a 
third party to provide the vans and some or all of the costs of 
operating the vans, including maintenance, liability insurance and other 
operating expenses.
    (c) Employee-operated van pools. Cash reimbursement by an employer 
to employees for expenses incurred for transportation in a van pool 
operated by employees independent of their employer are excludable as 
qualified transportation fringes, provided that the van qualifies as a 
commuter highway vehicle as defined in section 132(f)(5)(B) and Q/A-2 of 
this section. See Q/A-16 of this section for the rules governing cash 
reimbursements.
    (d) Private or public transit-operated van pool transit passes. The 
qualified transportation fringe exclusion for transit passes is 
available for travel in van pools owned and operated either by public 
transit authorities or by any person in the business of transporting 
persons for compensation or hire. In accordance with paragraph (b) of Q/
A-3 of this section, the van must seat at least 6 adults (excluding the 
driver). See Q/A-16(b) and (c) of this section for a special rule for 
cash reimbursement for transit passes and the substantiation 
requirements for cash reimbursement.
    (e) Value of van pool transportation benefits. Section 1.61-21(b)(2) 
provides that the fair market value of a fringe benefit is based on all 
the facts and circumstances. Alternatively, transportation in an 
employer-provided commuter highway vehicle may be valued under the 
automobile lease valuation rule in Sec. 1.61-21(d), the vehicle cents-
per-mile rule in Sec. 1.61-21(e), or the commuting valuation rule in 
Sec. 1.61-21(f). If one of these special valuation rules is used, the 
employer must use the same valuation rule to value the use of the 
commuter highway vehicle by each employee who share the use. See Sec. 
1.61-21(c)(2)(i)(B).
    (f) Qualified parking prime member. If an employee obtains a 
qualified parking space as a result of membership in a car or van pool, 
the applicable statutory monthly limit for qualified parking applies to 
the individual to whom the parking space is assigned. This individual is 
the prime member. In determining the tax consequences to the prime 
member, the statutory monthly limit amounts of each car pool member may 
not be combined. If the employer provides access to the space and the 
space is not assigned to a particular individual, then the employer must 
designate one of its employees as the prime member who will bear the tax 
consequences. The employer may not designate more than one prime member 
for a car or van pool during a month. The employer of the prime member 
is responsible for including the value of the qualified parking in 
excess of the statutory monthly limit in the prime member's wages for 
income and employment tax purposes.

[[Page 622]]

    Q-22. What are the reporting and employment tax requirements for 
qualified transportation fringes?
    A-22. (a) Employment tax treatment generally. Qualified 
transportation fringes not exceeding the applicable statutory monthly 
limit described in Q/A-7 of this section are not wages for purposes of 
the Federal Insurance Contributions Act (FICA), the Federal Unemployment 
Tax Act (FUTA), and federal income tax withholding. Any amount by which 
an employee elects to reduce compensation as provided in Q/A-11 of this 
section is not subject to the FICA, the FUTA, and federal income tax 
withholding. Qualified transportation fringes exceeding the applicable 
statutory monthly limit described in Q/A-7 of this section are wages for 
purposes of the FICA, the FUTA, and federal income tax withholding and 
are reported on the employee's Form W-2, Wage and Tax Statement.
    (b) Employment tax treatment of cash reimbursement exceeding monthly 
limits. Cash reimbursement to employees (for example, cash reimbursement 
for qualified parking) in excess of the applicable statutory monthly 
limit under section 132(f) is treated as paid for employment tax 
purposes when actually or constructively paid. See Sec. Sec. 
31.3121(a)-2(a), 31.3301-4, 31.3402(a)-1(b) of this chapter. Employers 
must report and deposit the amounts withheld in addition to reporting 
and depositing other employment taxes. See Q/A-16 of this section for 
rules governing cash reimbursements.
    (c) Noncash fringe benefits exceeding monthly limits. If the value 
of noncash qualified transportation fringes exceeds the applicable 
statutory monthly limit, the employer may elect, for purposes of the 
FICA, the FUTA, and federal income tax withholding, to treat the noncash 
taxable fringe benefits as paid on a pay period, quarterly, semi-annual, 
annual, or other basis, provided that the benefits are treated as paid 
no less frequently than annually.
    Q-23. How does section 132(f) interact with other fringe benefit 
rules?
    A-23. For purposes of section 132, the terms working condition 
fringe and de minimis fringe do not include any qualified transportation 
fringe under section 132(f). If, however, an employer provides local 
transportation other than transit passes (without any direct or indirect 
compensation reduction election), the value of the benefit may be 
excludable, either totally or partially, under fringe benefit rules 
other than the qualified transportation fringe rules under section 
132(f). See Sec. Sec. 1.132-6(d)(2)(i) (occasional local transportation 
fare), 1.132-6(d)(2)(iii) (transportation provided under unusual 
circumstances), and 1.61-21(k) (valuation of local transportation 
provided to qualified employees). See also Q/A-4(b) of this section.
    Q-24. May qualified transportation fringes be provided to 
individuals who are partners, 2-percent shareholders of S-corporations, 
or independent contractors?
    A-24. (a) General rule. Section 132(f)(5)(E) states that self-
employed individuals who are employees within the meaning of section 
401(c)(1) are not employees for purposes of section 132(f). Therefore, 
individuals who are partners, sole proprietors, or other independent 
contractors are not employees for purposes of section 132(f). In 
addition, under section 1372(a), 2-percent shareholders of S 
corporations are treated as partners for fringe benefit purposes. Thus, 
an individual who is both a 2-percent shareholder of an S corporation 
and a common law employee of that S corporation is not considered an 
employee for purposes of section 132(f). However, while section 132(f) 
does not apply to individuals who are partners, 2-percent shareholders 
of S corporations, or independent contractors, other exclusions for 
working condition and de minimis fringes may be available as described 
in paragraphs (b) and (c) of this Q/A-24. See Sec. Sec. 1.132-1(b)(2) 
and 1.132-1(b)(4).
    (b) Transit passes. The working condition and de minimis fringe 
exclusions under section 132(a)(3) and (4) are available for transit 
passes provided to individuals who are partners, 2-percent shareholders, 
and independent contractors. For example, tokens or farecards provided 
by a partnership to an individual who is a partner that enable the 
partner to commute on a public transit system (not including privately-
operated van pools) are excludable from the

[[Page 623]]

partner's gross income if the value of the tokens and farecards in any 
month does not exceed the dollar amount specified in Sec. 1.132-
6(d)(1). However, if the value of a pass provided in a month exceeds the 
dollar amount specified in Sec. 1.132-6(d)(1), the full value of the 
benefit provided (not merely the amount in excess of the dollar amount 
specified in Sec. 1.132-6(d)(1)) is includible in gross income.
    (c) Parking. The working condition fringe rules under section 132(d) 
do not apply to commuter parking. See Sec. 1.132-5(a)(1). However, the 
de minimis fringe rules under section 132(e) are available for parking 
provided to individuals who are partners, 2-percent shareholders, or 
independent contractors that qualifies under the de minimis rules. See 
Sec. 1.132-6(a) and (b).
    (d) Example. The following example illustrates the principles of 
this Q/A-24:

    Example. (i) Individual G is a partner in partnership P. Individual 
G commutes to and from G's office every day and parks free of charge in 
P's lot.
    (ii) In this Example, the value of the parking is not excluded under 
section 132(f), but may be excluded under section 132(e) if the parking 
is a de minimis fringe under Sec. 1.132-6.

    Q-25. What is the effective date of this section?
    A-25. (a) Except as provided in paragraph (b) of this Q/A-25, this 
section is applicable for employee taxable years beginning after 
December 31, 2001. For this purpose, an employer may assume that the 
employee taxable year is the calendar year.
    (b) The last sentence of paragraph (b)(5) of Q/A-16 of this section 
(relating to whether transit system vouchers for transit passes are 
readily available) is applicable for employee taxable years beginning 
after December 31, 2003. For this purpose, an employer may assume that 
the employee taxable year is the calendar year.

[T.D. 8933, 66 FR 2244, Jan. 11, 2001; 66 FR 18190, Apr. 6, 2001]



Sec. 1.133-1T  Questions and answers relating to interest on certain 
loans used to acquire employer securities (temporary).

    Q-1: What does section 133 provide?
    A-1: In general, section 133 provides that certain commercial 
lenders may exclude from gross income fifty percent of the interest 
received with respect to securities acquisition loans. A securities 
acquisition loan is any loan to an employee stock ownership plan (ESOP) 
(as defined in section 4975(e)(7)) that qualifies as an exempt loan 
under Sec. Sec. 54.4975-7 and -11 to the extent that the proceeds are 
used to acquire employer securities (within the meaning of section 
409(l)) for the ESOP. A loan made to a corporation sponsoring an ESOP 
(or to a person related to such corporation under section 133(b)(2)) may 
also qualify as a securities acquisition loan to the extent and for the 
period that the proceeds are (a) loaned to the corporation's ESOP under 
a loan that qualifies as an exempt loan under Sec. Sec. 54.4975-7 and -
11 and that has substantially similar terms as the loan from the 
commercial lender to the sponsoring corporation, and (b) used to acquire 
employer securities for the ESOP. The terms of the loan between the 
commercial lender and the sponsoring corporation (or a related 
corporation) and the loan between such corporation and the ESOP shall be 
treated as substantially similar only if the timing and rate at which 
employer securities would be released from encumbrance if the loan from 
the commercial lender were the exempt loan under the applicable rule of 
Sec. 54.4975-7(b)(8) are substantially similar to the timing and rate 
at which employer securities will actually be released from encumbrance 
in accordance with such rule. For this purpose, if the loan from the 
commercial lender to the sponsoring corporation states a variable rate 
of interest and the loan between the corporation and the ESOP states a 
fixed rate of interest, whether the terms of the loans are substantially 
similar shall be determined at the time the obligations are initially 
issued by taking into account the adjustment interval on the variable 
rate loan and the maturity of the fixed rate loan. For example, if the 
rate on the loan from the commercial lender to the sponsoring 
corporation adjusts each six months and the loan from the corporation to 
the ESOP has a ten year term, the initial interest rate on the variable 
rate

[[Page 624]]

loan could be compared to the rate on the fixed rate loan by comparing 
the yields on 6 month and ten year Treasury obligations. Similarly, if 
the rates on the two loans are based on different compounding 
assumptions, whether the terms of the loans are substantially similar 
shall be determined by taking into account the different compounding 
assumptions. A securities acquisition loan may be evidenced by any note, 
bond, debenture, or certificate. Also, section 133(b)(2) provides that 
certain loans between related persons are not securities acquisition 
loans. In addition, a loan from a commercial lender to an ESOP or 
sponsoring corporation to purchase employer securities will not be 
treated as a securities acquisition loan to the extent that such loan is 
used, either directly or indirectly, to purchase employer securities 
from any other qualified plan, including any other ESOP, maintained by 
the employer or any other corporation which is a member of the same 
controlled group (as defined in section 409(l)(4)).
    Q-2: What lenders are eligible to receive the fifty percent interest 
exclusion?
    A-2: Under section 133(a), a bank (within the meaning of section 
581), an insurance company to which subchapter L applies, or a 
corporation (other than a subchapter S corporation) actively engaged in 
the business of lending money may exclude from gross income fifty 
percent of the interest received with respect to a securities 
acquisition loan (as defined in Q&A-1 of Sec. 1.133-1T). For purposes 
of section 133(a)(3), a corporation is actively engaged in the business 
of lending money if it lends money to the public on a regular and 
continuing basis (other than in connection with the purchase by the 
public of goods and services from the lender or a related party). A 
corporation is not actively engaged in the business of lending money if 
a predominant share of the original value of the loans it makes to 
unrelated parties (other than in connection with the purchase by the 
public of goods and services from the lender or a related party) are 
securities acquisition loans.
    Q-3: May loans which qualify for the fifty percent interest 
exclusion under section 133 be syndicated to other lending institutions?
    A-3: Securities acquisition loans under section 133 may be 
syndicated to other lending institutions provided that such lending 
institutions are described in section 133(a) (1), (2) or (3) and the 
loan was originated by a qualified holder. Subsequent holders of the 
debt instrument may qualify for the partial interest exclusion of 
section 133 if such holders satisfy the requirements of section 133 and 
such loan does not fail to be a securities acquisition loan under 
section 133(b)(2).
    Q-4: When is section 133 effective?
    A-4: Section 133 applies to securities acquisition loans made after 
July 18, 1984, and used to acquire employer securities after July 18, 
1984. The provision does not apply to loans made after July 18, 1984, to 
the extent that such loans are renegotiations, directly or indirectly, 
of loans outstanding on such date. A loan extended to an ESOP or 
sponsoring corporation after July 18, 1984, will be treated as a 
renegotiation of an outstanding loan if the loan proceeds are used to 
refinance acquisitions of employer securities made prior to July 19, 
1984. For example, if an ESOP borrowed money prior to July 19, 1984, to 
purchase employer securities and after July 18, 1984, borrows other 
funds from the same or a different commercial lender to repay the first 
loan, the second loan will be treated as a renegotiation of an 
outstanding loan to the extent of the repaid amount. Similarly, if, 
after July 18, 1984, an ESOP sells employer securities, uses the 
proceeds to retire a pre-July 19, 1984, loan and obtains a second loan 
to acquire replacement employer securities, the second loan will be 
treated as a renegotiation of an outstanding loan.

[T.D. 8073, 51 FR 4319, Feb. 4, 1986]



Sec. 1.141-0  Table of contents.

    This section lists the captioned paragraphs contained in Sec. Sec. 
1.141-1 through 1.141-16.

       Sec. 1.141-1 Definitions and rules of general application.

    (a) In general.
    (b) Certain general definitions.
    (c) Elections.
    (d) Related parties.

[[Page 625]]

               Sec. 1.141-2 Private activity bond tests.

    (a) Overview.
    (b) Scope.
    (c) General definition of private activity bond.
    (d) Reasonable expectations and deliberate actions.
    (1) In general.
    (2) Reasonable expectations test.
    (3) Deliberate action defined.
    (4) Special rule for dispositions of personal property in the 
ordinary course of an established governmental program.
    (5) Special rule for general obligation bond programs that finance a 
large number of separate purposes.
    (e) When a deliberate action occurs.
    (f) Certain remedial actions.
    (g) Examples.

            Sec. 1.141-3 Definition of private business use.

    (a) General rule.
    (1) In general.
    (2) Indirect use.
    (3) Aggregation of private business use.
    (b) Types of private business use arrangements.
    (1) In general.
    (2) Ownership.
    (3) Leases.
    (4) Management contracts.
    (5) Output contracts.
    (6) Research agreements.
    (7) Other actual or beneficial use.
    (c) Exception for general public use.
    (1) In general.
    (2) Use on the same basis.
    (3) Long-term arrangements not treated as general public use.
    (4) Relation to other use.
    (d) Other exceptions.
    (1) Agents.
    (2) Use incidental to financing arrangements.
    (3) Exceptions for arrangements other than arrangements resulting in 
ownership of financed property by a nongovernmental person.
    (4) Temporary use by developers.
    (5) Incidental use.
    (6) Qualified improvements.
    (e) Special rule for tax assessment bonds.
    (f) Examples.
    (g) Measurement of private business use.
    (1) In general.
    (2) Measurement period.
    (3) Determining average percentage of private business use.
    (4) Determining the average amount of private business use for a 1-
year period.
    (5) Common areas.
    (6) Allocation of neutral costs.
    (7) Commencement of measurement of private business use.
    (8) Examples.

             Sec. 1.141-4 Private security or payment test.

    (a) General rule.
    (1) Private security or payment.
    (2) Aggregation of private payments and security.
    (3) Underlying arrangement.
    (b) Measurement of private payments and security.
    (1) Scope.
    (2) Present value measurement.
    (c) Private payments.
    (1) In general.
    (2) Payments taken into account.
    (3) Allocation of payments.
    (d) Private security.
    (1) In general.
    (2) Security taken into account.
    (3) Pledge of unexpended proceeds.
    (4) Secured by any interest in property or payments.
    (5) Payments in respect of property.
    (6) Allocation of security among issues.
    (e) Generally applicable taxes.
    (1) General rule.
    (2) Definition of generally applicable taxes.
    (3) Special charges.
    (4) Manner of determination and collection.
    (5) Payments in lieu of taxes.
    (f) Certain waste remediation bonds.
    (1) Scope.
    (2) Persons that are not private users.
    (3) Persons that are private users.
    (g) Examples.

               Sec. 1.141-5 Private loan financing test.

    (a) In general.
    (b) Measurement of test.
    (c) Definition of private loan.
    (1) In general.
    (2) Application only to purpose investments.
    (3) Grants.
    (4) Hazardous waste remediation bonds.
    (d) Tax assessment loan exception.
    (1) General rule.
    (2) Tax assessment loan defined.
    (3) Mandatory tax or other assessment.
    (4) Specific essential governmental function.
    (5) Equal basis requirement.
    (6) Coordination with private business tests.
    (e) Examples.

             Sec. 1.141-6 Allocation and accounting rules.

    (a) Allocation of proceeds to expenditures.
    (b) Allocation of proceeds to property. [Reserved]
    (c) Special rules for mixed use facilities. [Reserved]
    (d) Allocation of proceeds to common areas. [Reserved]
    (e) Allocation of proceeds to bonds. [Reserved]
    (f) Treatment of partnerships. [Reserved]

[[Page 626]]

    (g) Examples. [Reserved]

           Sec. 1.141-7 Special rules for output facilities.

    (a) Overview.
    (b) Definitions.
    (1) Available output.
    (2) Measurement period.
    (3) Sale at wholesale.
    (4) Take contract and take or pay contract.
    (5) Requirements contract.
    (6) Nonqualified amount.
    (c) Output contracts.
    (1) General rule.
    (2) Take contract or take or pay contract.
    (3) Requirements contract.
    (4) Output contract properly characterized as a lease.
    (d) Measurement of private business use.
    (e) Measurement of private security or payment.
    (f) Exceptions for certain contracts.
    (1) Small purchases of output.
    (2) Swapping and pooling arrangements.
    (3) Short-term output contracts.
    (4) Certain conduit parties disregarded.
    (g) Special rules for electric output facilities used to provide 
open access.
    (1) Operation of transmission facilities by nongovernmental persons.
    (2) Certain use by nongovernmental persons under output contracts.
    (3) Ancillary services.
    (4) Exceptions to deliberate action rules.
    (5) Additional transactions as permitted by the Commissioner.
    (h) Allocations of output facilities and systems.
    (1) Facts and circumstances analysis.
    (2) Illustrations.
    (3) Transmission and distribution contracts.
    (4) Allocation of payments.
    (i) Examples.

       Sec. 1.141-8 $15 million limitation for output facilities.

    (a) In general.
    (1) General rule.
    (2) Reduction in $15 million output limitation for outstanding 
issues.
    (3) Benefits and burdens test applicable.
    (b) Definition of project.
    (1) General rule.
    (2) Separate ownership.
    (3) Generating property.
    (4) Transmission and distribution.
    (5) Subsequent improvements.
    (6) Replacement property.
    (c) Examples.

          Sec. 1.141-9 Unrelated or disproportionate use test.

    (a) General rules.
    (1) Description of test.
    (2) Application of unrelated or disproportionate use test.
    (b) Unrelated use.
    (1) In general.
    (2) Use for the same purpose as government use.
    (c) Disproportionate use.
    (1) Definition of disproportionate use.
    (2) Aggregation of related uses.
    (3) Allocation rule.
    (d) Maximum use taken into account.
    (e) Examples.

         Sec. 1.141-10 Coordination with volume cap.[Reserved]

Sec. 1.141-11 Acquisition of nongovernmental output property.[Reserved]

                    Sec. 1.141-12 Remedial actions.

    (a) Conditions to taking remedial action.
    (1) Reasonable expectations test met.
    (2) Maturity not unreasonably long.
    (3) Fair market value consideration.
    (4) Disposition proceeds treated as gross proceeds for arbitrage 
purposes.
    (5) Proceeds expended on a governmental purpose.
    (b) Effect of a remedial action.
    (1) In general.
    (2) Effect on bonds that have been advance refunded.
    (c) Disposition proceeds.
    (1) Definition.
    (2) Allocating disposition proceeds to an issue.
    (3) Allocating disposition proceeds to different sources of funding.
    (d) Redemption or defeasance of nonqualified bonds.
    (1) In general.
    (2) Special rule for dispositions for cash.
    (3) Notice of defeasance.
    (4) Special limitation.
    (5) Defeasance escrow defined.
    (e) Alternative use of disposition proceeds.
    (1) In general.
    (2) Special rule for use by 501(c)(3) organizations.
    (f) Alternative use of facility.
    (g) Rules for deemed reissuance.
    (h) Authority of Commissioner to provide for additional remedial 
actions.
    (i) Effect of remedial action on continuing compliance.
    (j) Nonqualified bonds.
    (1) Amount of nonqualified bonds.
    (2) Allocation of nonqualified bonds.
    (k) Examples.

                    Sec. 1.141-13 Refunding issues.

    (a) In general.
    (b) Application of private business use test and private loan 
financing test.
    (1) Allocation of proceeds.
    (2) Determination of amount of private business use.
    (c) Application of private security or payment test.
    (1) Separate issue treatment.

[[Page 627]]

    (2) Combined issue treatment.
    (3) Special rule for arrangements not entered into in contemplation 
of the refunding issue.
    (d) Multipurpose issue allocations.
    (1) In general.
    (2) Exceptions.
    (e) Application of reasonable expectations test to certain refunding 
bonds.
    (f) Special rule for refundings of certain general obligation bonds.
    (g) Examples.

                    Sec. 1.141-14 Anti-abuse rules.

    (a) Authority of Commissioner to reflect substance of transactions.
    (b) Examples.

                     Sec. 1.141-15 Effective dates.

    (a) Scope.
    (b) Effective dates.
    (1) In general.
    (2) Certain short-term arrangements.
    (3) Certain prepayments.
    (c) Refunding bonds.
    (d) Permissive application of regulations.
    (e) Permissive retroactive application of certain sections.
    (f) Effective dates for certain regulations relating to output 
facilities.
    (1) General rule.
    (2) Transition rule for requirements contracts.
    (g) Refunding bonds for output facilities.
    (h) Permissive retroactive application.
    (i) Permissive application of certain regulations relating to output 
facilities.
    (j) Effective dates for certain regulations relating to refundings.

   Sec. 1.141-16 Effective dates for qualified private activity bond 
                               provisions.

    (a) Scope.
    (b) Effective dates.
    (c) Permissive application.
    (d) Certain remedial actions.
    (1) General rule.
    (2) Special rule for allocations of nonqualified bonds.

[T.D. 8712, 62 FR 2283, Jan. 16, 1997, as amended by T.D. 8757, 63 FR 
3259, Jan. 22, 1998; T.D. 8941, 66 FR 4664, Jan. 18, 2001; T.D. 9016, 67 
FR 59759, Sept. 23, 2002; T.D. 9085, 68 FR 45775, Aug. 4, 2003; T.D. 
9150, 69 FR 50066, Aug. 13, 2004; T.D. 9234, 70 FR 75031, Dec. 19, 2005]

          Tax Exemption Requirements for State and Local Bonds



Sec. 1.141-1  Definitions and rules of general application.

    (a) In general. For purposes of Sec. Sec. 1.141-0 through 1.141-16, 
the following definitions and rules apply: the definitions in this 
section, the definitions in Sec. 1.150-1, the definition of placed in 
service under Sec. 1.150-2(c), the definition of grant under Sec. 
1.148-6(d)(4)(iii), the definition of reasonably required reserve or 
replacement fund in Sec. 1.148-2(f), and the following definitions 
under Sec. 1.148-1: bond year, commingled fund, fixed yield issue, 
higher yielding investments, investment, investment proceeds, issue 
price, issuer, nonpurpose investment, purpose investment, qualified 
guarantee, qualified hedge, reasonable expectations or reasonableness, 
rebate amount, replacement proceeds, sale proceeds, variable yield 
issue, and yield.
    (b) Certain general definitions.
    Common areas means portions of a facility that are equally available 
to all users of a facility on the same basis for uses that are 
incidental to the primary use of the facility. For example, hallways and 
elevators generally are treated as common areas if they are used by the 
different lessees of a facility in connection with the primary use of 
that facility.
    Consistently applied means applied uniformly to account for proceeds 
and other amounts.
    Deliberate action is defined in Sec. 1.141-2(d)(3).
    Discrete portion means a portion of a facility that consists of any 
separate and discrete portion of a facility to which use is limited, 
other than common areas. A floor of a building and a portion of a 
building separated by walls, partitions, or other physical barriers are 
examples of a discrete portion.
    Disposition is defined in Sec. 1.141-12(c)(1).
    Disposition proceeds is defined in Sec. 1.141-12(c)(1).
    Essential governmental function is defined in Sec. 1.141-
5(d)(4)(ii).
    Financed means constructed, reconstructed, or acquired with proceeds 
of an issue.
    Governmental bond has the same meaning as in Sec. 1.150-1(b), 
except that, for purposes of Sec. 1.141-13, governmental bond is 
defined in Sec. 1.141-13(b)(2)(iv).
    Governmental person means a state or local governmental unit as 
defined in Sec. 1.103-1 or any instrumentality thereof. It does not 
include the United

[[Page 628]]

States or any agency or instrumentality thereof.
    Hazardous waste remediation bonds is defined in Sec. 1.141-4(f)(1).
    Measurement period is defined in Sec. 1.141-3(g)(2).
    Nongovernmental person means a person other than a governmental 
person.
    Output facility means electric and gas generation, transmission, 
distribution, and related facilities, and water collection, storage, and 
distribution facilities.
    Private business tests means the private business use test and the 
private security or payment test of section 141(b).
    Proceeds means the sale proceeds of an issue (other than those sale 
proceeds used to retire bonds of the issue that are not deposited in a 
reasonably required reserve or replacement fund). Proceeds also include 
any investment proceeds from investments that accrue during the project 
period (net of rebate amounts attributable to the project period). 
Disposition proceeds of an issue are treated as proceeds to the extent 
provided in Sec. 1.141-12. The Commissioner may treat any replaced 
amounts as proceeds.
    Project period means the period beginning on the issue date and 
ending on the date that the project is placed in service. In the case of 
a multipurpose issue, the issuer may elect to treat the project period 
for the entire issue as ending on either the expiration of the temporary 
period described in Sec. 1.148-2(e)(2) or the end of the fifth bond 
year after the issue date.
    Public utility property means public utility property as defined in 
section 168(i)(10).
    Qualified bond means a qualified bond as defined in section 141(e).
    Renewal option means a provision under which either party has a 
legally enforceable right to renew the contract. Thus, for example, a 
provision under which a contract is automatically renewed for 1-year 
periods absent cancellation by either party is not a renewal option 
(even if it is expected to be renewed).
    Replaced amounts means replacement proceeds other than amounts that 
are treated as replacement proceeds solely because they are sinking 
funds or pledged funds.
    Weighted average maturity is determined under section 147(b).
    Weighted average reasonably expected economic life is determined 
under section 147(b). The reasonably expected economic life of property 
may be determined by reference to the class life of the property under 
section 168.
    (c) Elections. Elections must be made in writing on or before the 
issue date and retained as part of the bond documents, and, once made, 
may not be revoked without the permission of the Commissioner.
    (d) Related parties. Except as otherwise provided, all related 
parties are treated as one person and any reference to ``person'' 
includes any related party.

[T.D. 8712, 62 FR 2284, Jan. 16, 1997, as amended by T.D. 9234, 70 FR 
75032, Dec. 19, 2005]



Sec. 1.141-2  Private activity bond tests.

    (a) Overview. Interest on a private activity bond is not excludable 
from gross income under section 103(a) unless the bond is a qualified 
bond. The purpose of the private activity bond tests of section 141 is 
to limit the volume of tax-exempt bonds that finance the activities of 
nongovernmental persons, without regard to whether a financing actually 
transfers benefits of tax-exempt financing to a nongovernmental person. 
The private activity bond tests serve to identify arrangements that have 
the potential to transfer the benefits of tax-exempt financing, as well 
as arrangements that actually transfer these benefits. The regulations 
under section 141 may not be applied in a manner that is inconsistent 
with these purposes.
    (b) Scope. Sections 1.141-0 through 1.141-16 apply generally for 
purposes of the private activity bond limitations under section 141.
    (c) General definition of private activity bond. Under section 141, 
bonds are private activity bonds if they meet either the private 
business use test and private security or payment test of section 141(b) 
or the private loan financing test of section 141(c). The private 
business use and private security or payment tests are described in 
Sec. Sec. 1.141-3 and 1.141-4. The private loan financing test is 
described in Sec. 1.141-5.

[[Page 629]]

    (d) Reasonable expectations and deliberate actions--(1) In general. 
An issue is an issue of private activity bonds if the issuer reasonably 
expects, as of the issue date, that the issue will meet either the 
private business tests or the private loan financing test. An issue is 
also an issue of private activity bonds if the issuer takes a deliberate 
action, subsequent to the issue date, that causes the conditions of 
either the private business tests or the private loan financing test to 
be met.
    (2) Reasonable expectations test--(i) In general. In general, the 
reasonable expectations test must take into account reasonable 
expectations about events and actions over the entire stated term of an 
issue.
    (ii) Special rule for issues with mandatory redemption provisions. 
An action that is reasonably expected, as of the issue date, to occur 
after the issue date and to cause either the private business tests or 
the private loan financing test to be met may be disregarded for 
purposes of those tests if--
    (A) The issuer reasonably expects, as of the issue date, that the 
financed property will be used for a governmental purpose for a 
substantial period before the action;
    (B) The issuer is required to redeem all nonqualifying bonds 
(regardless of the amount of disposition proceeds actually received) 
within 6 months of the date of the action;
    (C) The issuer does not enter into any arrangement with a 
nongovernmental person, as of the issue date, with respect to that 
specific action; and
    (D) The mandatory redemption of bonds meets all of the conditions 
for remedial action under Sec. 1.141-12(a).
    (3) Deliberate action defined--(i) In general. Except as otherwise 
provided in this paragraph (d)(3), a deliberate action is any action 
taken by the issuer that is within its control. An intent to violate the 
requirements of section 141 is not necessary for an action to be 
deliberate.
    (ii) Safe harbor exceptions. An action is not treated as a 
deliberate action if--
    (A) It would be treated as an involuntary or compulsory conversion 
under section 1033; or
    (B) It is taken in response to a regulatory directive made by the 
federal government. See Sec. 1.141-7(g)(4).
    (4) Special rule for dispositions of personal property in the 
ordinary course of an established governmental program--(i) In general. 
Dispositions of personal property in the ordinary course of an 
established governmental program are not treated as deliberate actions 
if--
    (A) The weighted average maturity of the bonds financing that 
personal property is not greater than 120 percent of the reasonably 
expected actual use of that property for governmental purposes;
    (B) The issuer reasonably expects on the issue date that the fair 
market value of that property on the date of disposition will be not 
greater than 25 percent of its cost; and
    (C) The property is no longer suitable for its governmental purposes 
on the date of disposition.
    (ii) Reasonable expectations test. The reasonable expectation that a 
disposition described in paragraph (d)(4)(i) of this section may occur 
in the ordinary course while the bonds are outstanding will not cause 
the issue to meet the private activity bond tests if the issuer is 
required to deposit amounts received from the disposition in a 
commingled fund with substantial tax or other governmental revenues and 
the issuer reasonably expects to spend the amounts on governmental 
programs within 6 months from the date of commingling.
    (iii) Separate issue treatment. An issuer may treat the bonds 
properly allocable to the personal property eligible for this exception 
as a separate issue under Sec. 1.150-1(c)(3).
    (5) Special rule for general obligation bond programs that finance a 
large number of separate purposes. The determination of whether bonds of 
an issue are private activity bonds may be based solely on the issuer's 
reasonable expectations as of the issue date if all of the requirements 
of paragraphs (d)(5)(i) through (vii) of this section are met.
    (i) The issue is an issue of general obligation bonds of a general 
purpose governmental unit that finances at least 25 separate purposes 
(as defined in Sec. 1.150-1(c)(3)) and does not predominantly finance 
fewer than 4 separate purposes.

[[Page 630]]

    (ii) The issuer has adopted a fund method of accounting for its 
general governmental purposes that makes tracing the bond proceeds to 
specific expenditures unreasonably burdensome.
    (iii) The issuer reasonably expects on the issue date to allocate 
all of the net proceeds of the issue to capital expenditures within 6 
months of the issue date and adopts reasonable procedures to verify that 
net proceeds are in fact so expended. A program to randomly spot check 
that 10 percent of the net proceeds were so expended generally is a 
reasonable verification procedure for this purpose.
    (iv) The issuer reasonably expects on the issue date to expend all 
of the net proceeds of the issue before expending proceeds of a 
subsequent issue of similar general obligation bonds.
    (v) The issuer reasonably expects on the issue date that it will not 
make any loans to nongovernmental persons with the proceeds of the 
issue.
    (vi) The issuer reasonably expects on the issue date that the 
capital expenditures that it could make during the 6-month period 
beginning on the issue date with the net proceeds of the issue that 
would not meet the private business tests are not less than 125 percent 
of the capital expenditures to be financed with the net proceeds of the 
issue.
    (vii) The issuer reasonably expects on the issue date that the 
weighted average maturity of the issue is not greater than 120 percent 
of the weighted average reasonably expected economic life of the capital 
expenditures financed with the issue. To determine reasonably expected 
economic life for this purpose an issuer may use reasonable estimates 
based on the type of expenditures made from a fund.
    (e) When a deliberate action occurs. A deliberate action occurs on 
the date the issuer enters into a binding contract with a 
nongovernmental person for use of the financed property that is not 
subject to any material contingencies.
    (f) Certain remedial actions. See Sec. 1.141-12 for certain 
remedial actions that prevent a deliberate action with respect to 
property financed by an issue from causing that issue to meet the 
private business use test or the private loan financing test.
    (g) Examples. The following examples illustrate the application of 
this section:

    Example 1. Involuntary action. City B issues bonds to finance the 
purchase of land. On the issue date, B reasonably expects that it will 
be the sole user of the land for the entire term of the bonds. 
Subsequently, the federal government acquires the land in a condemnation 
action. B sets aside the condemnation proceeds to pay debt service on 
the bonds but does not redeem them on their first call date. The bonds 
are not private activity bonds because B has not taken a deliberate 
action after the issue date. See, however, Sec. 1.141-14(b), Example 2.
    Example 2. Reasonable expectations test--involuntary action. The 
facts are the same as in Example 1, except that, on the issue date, B 
reasonably expects that the federal government will acquire the land in 
a condemnation action during the term of the bonds. On the issue date, 
the present value of the amount that B reasonably expects to receive 
from the federal government is greater than 10 percent of the present 
value of the debt service on the bonds. The terms of the bonds do not 
require that the bonds be redeemed within 6 months of the acquisition by 
the federal government. The bonds are private activity bonds because the 
issuer expects as of the issue date that the private business tests will 
be met.
    Example 3. Reasonable expectations test--mandatory redemption. City 
C issues bonds to rehabilitate an existing hospital that it currently 
owns. On the issue date of the bonds, C reasonably expects that the 
hospital will be used for a governmental purpose for a substantial 
period. On the issue date, C also plans to construct a new hospital, but 
the placed in service date of that new hospital is uncertain. C 
reasonably expects that, when the new hospital is placed in service, it 
will sell or lease the rehabilitated hospital to a private hospital 
corporation. The bond documents require that the bonds must be redeemed 
within 6 months of the sale or lease of the rehabilitated hospital 
(regardless of the amount actually received from the sale). The bonds 
meet the reasonable expectations requirement of the private activity 
bond tests if the mandatory redemption of bonds meets all of the 
conditions for a remedial action under Sec. 1.141-12(a).
    Example 4. Dispositions in the ordinary course of an established 
governmental program. City D issues bonds with a weighted average 
maturity of 6 years for the acquisition of police cars. D reasonably 
expects on the issue date that the police cars will be used solely by 
its police department, except that, in the ordinary course of its police 
operations, D sells its police cars to a taxicab corporation after

[[Page 631]]

5 years of use because they are no longer suitable for police use. 
Further, D reasonably expects that the value of the police cars when 
they are no longer suitable for police use will be no more than 25 
percent of cost. D subsequently sells 20 percent of the police cars 
after only 3 years of actual use. At that time, D deposits the proceeds 
from the sale of the police cars in a commingled fund with substantial 
tax revenues and reasonably expects to spend the proceeds on 
governmental programs within 6 months of the date of deposit. D does not 
trace the actual use of these commingled amounts. The sale of the police 
cars does not cause the private activity bond tests to be met because 
the requirements of paragraph (d)(4) of this section are met.

[T.D. 8712, 62 FR 2284, Jan. 16, 1997, as amended by T.D. 8757, 63 FR 
3260, Jan. 22, 1998; T.D. 9016, 67 FR 59759, Sept. 23, 2002]



Sec. 1.141-3  Definition of private business use.

    (a) General rule--(1) In general. The private business use test 
relates to the use of the proceeds of an issue. The 10 percent private 
business use test of section 141(b)(1) is met if more than 10 percent of 
the proceeds of an issue is used in a trade or business of a 
nongovernmental person. For this purpose, the use of financed property 
is treated as the direct use of proceeds. Any activity carried on by a 
person other than a natural person is treated as a trade or business. 
Unless the context or a provision clearly requires otherwise, this 
section also applies to the private business use test under sections 
141(b)(3) (unrelated or disproportionate use), 141(b)(4) ($15 million 
limitation for certain output facilities), and 141(b)(5) (the 
coordination with the volume cap where the nonqualified amount exceeds 
$15 million).
    (2) Indirect use. In determining whether an issue meets the private 
business use test, it is necessary to look to both the indirect and 
direct uses of proceeds. For example, a facility is treated as being 
used for a private business use if it is leased to a nongovernmental 
person and subleased to a governmental person or if it is leased to a 
governmental person and then subleased to a nongovernmental person, 
provided that in each case the nongovernmental person's use is in a 
trade or business. Similarly, the issuer's use of the proceeds to engage 
in a series of financing transactions for property to be used by 
nongovernmental persons in their trades or businesses may cause the 
private business use test to be met. In addition, proceeds are treated 
as used in the trade or business of a nongovernmental person if a 
nongovernmental person, as a result of a single transaction or a series 
of related transactions, uses property acquired with the proceeds of an 
issue.
    (3) Aggregation of private business use. The use of proceeds by all 
nongovernmental persons is aggregated to determine whether the private 
business use test is met.
    (b) Types of private business use arrangements--(1) In general. Both 
actual and beneficial use by a nongovernmental person may be treated as 
private business use. In most cases, the private business use test is 
met only if a nongovernmental person has special legal entitlements to 
use the financed property under an arrangement with the issuer. In 
general, a nongovernmental person is treated as a private business user 
of proceeds and financed property as a result of ownership; actual or 
beneficial use of property pursuant to a lease, or a management or 
incentive payment contract; or certain other arrangements such as a take 
or pay or other output-type contract.
    (2) Ownership. Except as provided in paragraph (d)(1) or (d)(2) of 
this section, ownership by a nongovernmental person of financed property 
is private business use of that property. For this purpose, ownership 
refers to ownership for federal income tax purposes.
    (3) Leases. Except as provided in paragraph (d) of this section, the 
lease of financed property to a nongovernmental person is private 
business use of that property. For this purpose, any arrangement that is 
properly characterized as a lease for federal income tax purposes is 
treated as a lease. In determining whether a management contract is 
properly characterized as a lease, it is necessary to consider all of 
the facts and circumstances, including the following factors--
    (i) The degree of control over the property that is exercised by a 
nongovernmental person; and

[[Page 632]]

    (ii) Whether a nongovernmental person bears risk of loss of the 
financed property.
    (4) Management contracts--(i) Facts and circumstances test. Except 
as provided in paragraph (d) of this section, a management contract 
(within the meaning of paragraph (b)(4)(ii) of this section) with 
respect to financed property may result in private business use of that 
property, based on all of the facts and circumstances. A management 
contract with respect to financed property generally results in private 
business use of that property if the contract provides for compensation 
for services rendered with compensation based, in whole or in part, on a 
share of net profits from the operation of the facility.
    (ii) Management contract defined. For purposes of this section, a 
management contract is a management, service, or incentive payment 
contract between a governmental person and a service provider under 
which the service provider provides services involving all, a portion 
of, or any function of, a facility. For example, a contract for the 
provision of management services for an entire hospital, a contract for 
management services for a specific department of a hospital, and an 
incentive payment contract for physician services to patients of a 
hospital are each treated as a management contract.
    (iii) Arrangements generally not treated as management contracts. 
The arrangements described in paragraphs (b)(4)(iii)(A) through (D) of 
this section generally are not treated as management contracts that give 
rise to private business use.
    (A) Contracts for services that are solely incidental to the primary 
governmental function or functions of a financed facility (for example, 
contracts for janitorial, office equipment repair, hospital billing, or 
similar services).
    (B) The mere granting of admitting privileges by a hospital to a 
doctor, even if those privileges are conditioned on the provision of de 
minimis services, if those privileges are available to all qualified 
physicians in the area, consistent with the size and nature of its 
facilities.
    (C) A contract to provide for the operation of a facility or system 
of facilities that consists predominantly of public utility property, if 
the only compensation is the reimbursement of actual and direct expenses 
of the service provider and reasonable administrative overhead expenses 
of the service provider.
    (D) A contract to provide for services, if the only compensation is 
the reimbursement of the service provider for actual and direct expenses 
paid by the service provider to unrelated parties.
    (iv) Management contracts that are properly treated as other types 
of private business use. A management contract with respect to financed 
property results in private business use of that property if the service 
provider is treated as the lessee or owner of financed property for 
federal income tax purposes, unless an exception under paragraph (d) of 
this section applies to the arrangement.
    (5) Output contracts. See Sec. 1.141-7 for special rules for 
contracts for the purchase of output of output facilities.
    (6) Research agreements--(i) Facts and circumstances test. Except as 
provided in paragraph (d) of this section, an agreement by a 
nongovernmental person to sponsor research performed by a governmental 
person may result in private business use of the property used for the 
research, based on all of the facts and circumstances.
    (ii) Research agreements that are properly treated as other types of 
private business use. A research agreement with respect to financed 
property results in private business use of that property if the sponsor 
is treated as the lessee or owner of financed property for federal 
income tax purposes, unless an exception under paragraph (d) of this 
section applies to the arrangement.
    (7) Other actual or beneficial use--(i) In general. Any other 
arrangement that conveys special legal entitlements for beneficial use 
of bond proceeds or of financed property that are comparable to special 
legal entitlements described in paragraphs (b)(2), (3), (4), (5), or (6) 
of this section results in private business use. For example, an 
arrangement that conveys priority rights to the use or capacity of a 
facility generally results in private business use.

[[Page 633]]

    (ii) Special rule for facilities not used by the general public. In 
the case of financed property that is not available for use by the 
general public (within the meaning of paragraph (c) of this section), 
private business use may be established solely on the basis of a special 
economic benefit to one or more nongovernmental persons, even if those 
nongovernmental persons have no special legal entitlements to use of the 
property. In determining whether special economic benefit gives rise to 
private business use it is necessary to consider all of the facts and 
circumstances, including one or more of the following factors--
    (A) Whether the financed property is functionally related or 
physically proximate to property used in the trade or business of a 
nongovernmental person;
    (B) Whether only a small number of nongovernmental persons receive 
the special economic benefit; and
    (C) Whether the cost of the financed property is treated as 
depreciable by any nongovernmental person.
    (c) Exception for general public use--(1) In general. Use as a 
member of the general public (general public use) is not private 
business use. Use of financed property by nongovernmental persons in 
their trades or businesses is treated as general public use only if the 
property is intended to be available and in fact is reasonably available 
for use on the same basis by natural persons not engaged in a trade or 
business.
    (2) Use on the same basis. In general, use under an arrangement that 
conveys priority rights or other preferential benefits is not use on the 
same basis as the general public. Arrangements providing for use that is 
available to the general public at no charge or on the basis of rates 
that are generally applicable and uniformly applied do not convey 
priority rights or other preferential benefits. For this purpose, rates 
may be treated as generally applicable and uniformly applied even if--
    (i) Different rates apply to different classes of users, such as 
volume purchasers, if the differences in rates are customary and 
reasonable; or
    (ii) A specially negotiated rate arrangement is entered into, but 
only if the user is prohibited by federal law from paying the generally 
applicable rates, and the rates established are as comparable as 
reasonably possible to the generally applicable rates.
    (3) Long-term arrangements not treated as general public use. An 
arrangement is not treated as general public use if the term of the use 
under the arrangement, including all renewal options, is greater than 
200 days. For this purpose, a right of first refusal to renew use under 
the arrangement is not treated as a renewal option if--
    (i) The compensation for the use under the arrangement is 
redetermined at generally applicable, fair market value rates that are 
in effect at the time of renewal; and
    (ii) The use of the financed property under the same or similar 
arrangements is predominantly by natural persons who are not engaged in 
a trade or business.
    (4) Relation to other use. Use of financed property by the general 
public does not prevent the proceeds from being used for a private 
business use because of other use under this section.
    (d) Other exceptions--(1) Agents. Use of proceeds by nongovernmental 
persons solely in their capacity as agents of a governmental person is 
not private business use. For example, use by a nongovernmental person 
that issues obligations on behalf of a governmental person is not 
private business use to the extent the nongovernmental person's use of 
proceeds is in its capacity as an agent of the governmental person.
    (2) Use incidental to financing arrangements. Use by a 
nongovernmental person that is solely incidental to a financing 
arrangement is not private business use. A use is solely incidental to a 
financing arrangement only if the nongovernmental person has no 
substantial rights to use bond proceeds or financed property other than 
as an agent of the bondholders. For example, a nongovernmental person 
that acts solely as an owner of title in a sale and leaseback financing 
transaction with a city generally is not a private business user of the 
property leased to the city, provided that the nongovernmental person 
has assigned all of its rights to use the leased facility to the trustee 
for the bondholders upon default by the

[[Page 634]]

city. Similarly, bond trustees, servicers, and guarantors are generally 
not treated as private business users.
    (3) Exceptions for arrangements other than arrangements resulting in 
ownership of financed property by a nongovernmental person--(i) 
Arrangements not available for use on the same basis by natural persons 
not engaged in a trade or business. Use by a nongovernmental person 
pursuant to an arrangement, other than an arrangement resulting in 
ownership of financed property by a nongovernmental person, is not 
private business use if--
    (A) The term of the use under the arrangement, including all renewal 
options, is not longer than 100 days;
    (B) The arrangement would be treated as general public use, except 
that it is not available for use on the same basis by natural persons 
not engaged in a trade or business because generally applicable and 
uniformly applied rates are not reasonably available to natural persons 
not engaged in a trade or business; and
    (C) The property is not financed for a principal purpose of 
providing that property for use by that nongovernmental person.
    (ii) Negotiated arm's-length arrangements. Use by a nongovernmental 
person pursuant to an arrangement, other than an arrangement resulting 
in ownership of financed property by a nongovernmental person, is not 
private business use if--
    (A) The term of the use under the arrangement, including all renewal 
options, is not longer than 50 days;
    (B) The arrangement is a negotiated arm's-length arrangement, and 
compensation under the arrangement is at fair market value; and
    (C) The property is not financed for a principal purpose of 
providing that property for use by that nongovernmental person.
    (4) Temporary use by developers. Use during an initial development 
period by a developer of an improvement that carries out an essential 
governmental function is not private business use if the issuer and the 
developer reasonably expect on the issue date to proceed with all 
reasonable speed to develop the improvement and property benefited by 
that improvement and to transfer the improvement to a governmental 
person, and if the improvement is in fact transferred to a governmental 
person promptly after the property benefited by the improvement is 
developed.
    (5) Incidental use--(i) General rule. Incidental uses of a financed 
facility are disregarded, to the extent that those uses do not exceed 
2.5 percent of the proceeds of the issue used to finance the facility. A 
use of a facility by a nongovernmental person is incidental if--
    (A) Except for vending machines, pay telephones, kiosks, and similar 
uses, the use does not involve the transfer to the nongovernmental 
person of possession and control of space that is separated from other 
areas of the facility by walls, partitions, or other physical barriers, 
such as a night gate affixed to a structural component of a building (a 
nonpossessory use);
    (B) The nonpossessory use is not functionally related to any other 
use of the facility by the same person (other than a different 
nonpossessory use); and
    (C) All nonpossessory uses of the facility do not, in the aggregate, 
involve the use of more than 2.5 percent of the facility.
    (ii) Illustrations. Incidental uses may include pay telephones, 
vending machines, advertising displays, and use for television cameras, 
but incidental uses may not include output purchases.
    (6) Qualified improvements. Proceeds that provide a governmentally 
owned improvement to a governmentally owned building (including its 
structural components and land functionally related and subordinate to 
the building) are not used for a private business use if--
    (i) The building was placed in service more than 1 year before the 
construction or acquisition of the improvement is begun;
    (ii) The improvement is not an enlargement of the building or an 
improvement of interior space occupied exclusively for any private 
business use;
    (iii) No portion of the improved building or any payments in respect 
of the improved building are taken into

[[Page 635]]

account under section 141(b)(2)(A) (the private security test); and
    (iv) No more than 15 percent of the improved building is used for a 
private business use.
    (e) Special rule for tax assessment bonds. In the case of a tax 
assessment bond that satisfies the requirements of Sec. 1.141-5(d), the 
loan (or deemed loan) of the proceeds to the borrower paying the 
assessment is disregarded in determining whether the private business 
use test is met. However, the use of the loan proceeds is not 
disregarded in determining whether the private business use test is met.
    (f) Examples. The following examples illustrate the application of 
paragraphs (a) through (e) of this section. In each example, assume that 
the arrangements described are the only arrangements with 
nongovernmental persons for use of the financed property.

    Example 1. Nongovernmental ownership. State A issues 20-year bonds 
to purchase land and equip and construct a factory. A then enters into 
an arrangement with Corporation X to sell the factory to X on an 
installment basis while the bonds are outstanding. The issue meets the 
private business use test because a nongovernmental person owns the 
financed facility. See also Sec. 1.141-2 (relating to the private 
activity bond tests), and Sec. 1.141-5 (relating to the private loan 
financing test).
    Example 2. Lease to a nongovernmental person. (i) The facts are the 
same as in Example 1, except that A enters into an arrangement with X to 
lease the factory to X for 3 years rather than to sell it to X. The 
lease payments will be made annually and will be based on the tax-exempt 
interest rate on the bonds. The issue meets the private business use 
test because a nongovernmental person leases the financed facility. See 
also Sec. 1.141-14 (relating to anti-abuse rules).
    (ii) The facts are the same as in Example 2(i), except that the 
annual payments made by X will equal fair rental value of the facility 
and exceed the amount necessary to pay debt service on the bonds for the 
3 years of the lease. The issue meets the private business use test 
because a nongovernmental person leases the financed facility and the 
test does not require that the benefits of tax-exempt financing be 
passed through to the nongovernmental person.
    Example 3. Management contract in substance a lease. City L issues 
30-year bonds to finance the construction of a city hospital. L enters 
into a 15-year contract with M, a nongovernmental person that operates a 
health maintenance organization relating to the treatment of M's members 
at L's hospital. The contract provides for reasonable fixed compensation 
to M for services rendered with no compensation based, in whole or in 
part, on a share of net profits from the operation of the hospital. 
However, the contract also provides that 30 percent of the capacity of 
the hospital will be exclusively available to M's members and M will 
bear the risk of loss of that portion of the capacity of the hospital so 
that, under all of the facts and circumstances, the contract is properly 
characterized as a lease for federal income tax purposes. The issue 
meets the private business use test because a nongovernmental person 
leases the financed facility.
    Example 4. Ownership of title in substance a leasehold interest. 
Nonprofit Corporation R issues bonds on behalf of City P to finance the 
construction of a hospital. R will own legal title to the hospital. In 
addition, R will operate the hospital, but R is not treated as an agent 
of P in its capacity as operator of the hospital. P has certain rights 
to the hospital that establish that it is properly treated as the owner 
of the property for federal income tax purposes. P does not have rights, 
however, to directly control operation of the hospital while R owns 
legal title to it and operates it. The issue meets the private business 
use test because the arrangement provides a nongovernmental person an 
interest in the financed facility that is comparable to a leasehold 
interest. See paragraphs (a)(2) and (b)(7)(i) of this section.
    Example 5. Rights to control use of property treated as private 
business use--parking lot. Corporation C and City D enter into a plan to 
finance the construction of a parking lot adjacent to C's factory. 
Pursuant to the plan, C conveys the site for the parking lot to D for a 
nominal amount, subject to a covenant running with the land that the 
property be used only for a parking lot. In addition, D agrees that C 
will have the right to approve rates charged by D for use of the parking 
lot. D issues bonds to finance construction of the parking lot on the 
site. The parking lot will be available for use by the general public on 
the basis of rates that are generally applicable and uniformly applied. 
The issue meets the private business use test because a nongovernmental 
person has special legal entitlements for beneficial use of the financed 
facility that are comparable to an ownership interest. See paragraph 
(b)(7)(i) of this section.
    Example 6. Other actual or beneficial use--hydroelectric 
enhancements. J, a political subdivision, owns and operates a 
hydroelectric generation plant and related facilities. Pursuant to a 
take or pay contract, J sells 15 percent of the output of the plant to 
Corporation K, an investor-owned utility. K is treated as a private 
business user of the plant. Under the license issued to J for operation 
of the plant, J is required by federal

[[Page 636]]

regulations to construct and operate various facilities for the 
preservation of fish and for public recreation. J issues its obligations 
to finance the fish preservation and public recreation facilities. K has 
no special legal entitlements for beneficial use of the financed 
facilities. The fish preservation facilities are functionally related to 
the operation of the plant. The recreation facilities are available to 
natural persons on a short-term basis according to generally applicable 
and uniformly applied rates. Under paragraph (c) of this section, the 
recreation facilities are treated as used by the general public. Under 
paragraph (b)(7) of this section, K's use is not treated as private 
business use of the recreation facilities because K has no special legal 
entitlements for beneficial use of the recreation facilities. The fish 
preservation facilities are not of a type reasonably available for use 
on the same basis by natural persons not engaged in a trade or business. 
Under all of the facts and circumstances (including the functional 
relationship of the fish preservation facilities to property used in K's 
trade or business) under paragraph (b)(7)(ii) of this section, K derives 
a special economic benefit from the fish preservation facilities. 
Therefore, K's private business use may be established solely on the 
basis of that special economic benefit, and K's use of the fish 
preservation facilities is treated as private business use.
    Example 7. Other actual or beneficial use--pollution control 
facilities. City B issues obligations to finance construction of a 
specialized pollution control facility on land that it owns adjacent to 
a factory owned by Corporation N. B will own and operate the pollution 
control facility, and N will have no special legal entitlements to use 
the facility. B, however, reasonably expects that N will be the only 
user of the facility. The facility will not be reasonably available for 
use on the same basis by natural persons not engaged in a trade or 
business. Under paragraph (b)(7)(ii) of this section, because under all 
of the facts and circumstances the facility is functionally related and 
is physically proximate to property used in N's trade or business, N 
derives a special economic benefit from the facility. Therefore, N's 
private business use may be established solely on the basis of that 
special economic benefit, and N's use is treated as private business use 
of the facility. See paragraph (b)(7)(ii) of this section.
    Example 8. General public use--airport runway. (i) City I issues 
bonds and uses all of the proceeds to finance construction of a runway 
at a new city-owned airport. The runway will be available for take-off 
and landing by any operator of an aircraft desiring to use the airport, 
including general aviation operators who are natural persons not engaged 
in a trade or business. It is reasonably expected that most of the 
actual use of the runway will be by private air carriers (both charter 
airlines and commercial airlines) in connection with their use of the 
airport terminals leased by those carriers. These leases for the use of 
terminal space provide no priority rights or other preferential benefits 
to the air carriers for use of the runway. Moreover, under the leases 
the lease payments are determined without taking into account the 
revenues generated by runway landing fees (that is, the lease payments 
are not determined on a ``residual'' basis). Although the lessee air 
carriers receive a special economic benefit from the use of the runway, 
this economic benefit is not sufficient to cause the air carriers to be 
private business users, because the runway is available for general 
public use. The issue does not meet the private business use test. See 
paragraphs (b)(7)(ii) and (c) of this section.
    (ii) The facts are the same as in Example 8(i), except that the 
runway will be available for use only by private air carriers. The use 
by these private air carriers is not for general public use, because the 
runway is not reasonably available for use on the same basis by natural 
persons not engaged in a trade or business. Depending on all of the 
facts and circumstances, including whether there are only a small number 
of lessee private air carriers, the issue may meet the private business 
use test solely because the private air carriers receive a special 
economic benefit from the runway. See paragraph (b)(7)(ii) of this 
section.
    (iii) The facts are the same as in Example 8(i), except that the 
lease payments under the leases with the private air carriers are 
determined on a residual basis by taking into account the net revenues 
generated by runway landing fees. These leases cause the private 
business use test to be met with respect to the runway because they are 
arrangements that convey special legal entitlements to the financed 
facility to nongovernmental persons. See paragraph (b)(7)(i) of this 
section.
    Example 9. General public use--airport parking garage. City S issues 
bonds and uses all of the proceeds to finance construction of a city-
owned parking garage at the city-owned airport. S reasonably expects 
that more than 10 percent of the actual use of the parking garage will 
be by employees of private air carriers (both charter airlines and 
commercial airlines) in connection with their use of the airport 
terminals leased by those carriers. The air carriers' use of the parking 
garage, however, will be on the same basis as passengers and other 
members of the general public using the airport. The leases for the use 
of the terminal space provide no priority rights to the air carriers for 
use of the parking garage, and the lease payments are determined without 
taking into account the revenues generated by the parking garage.

[[Page 637]]

Although the lessee air carriers receive a special economic benefit from 
the use of the parking garage, this economic benefit is not sufficient 
to cause the air carriers to be private business users, because the 
parking garage is available for general public use. The issue does not 
meet the private business use test. See paragraphs (b)(7)(ii) and (c) of 
this section.
    Example 10. Long-term arrangements not treated as general public 
use--insurance fund. Authority T deposits all of the proceeds of its 
bonds in its insurance fund and invests all of those proceeds in tax-
exempt bonds. The insurance fund provides insurance to a large number of 
businesses and natural persons not engaged in a trade or business. Each 
participant receives insurance for a term of 1 year. The use by the 
participants, other than participants that are natural persons not 
engaged in a trade or business, is treated as private business use of 
the proceeds of the bonds because the participants have special legal 
entitlements to the use of bond proceeds, even though the contractual 
rights are not necessarily properly characterized as ownership, 
leasehold, or similar interests listed in paragraph (b) of this section. 
Use of the bond proceeds is not treated as general public use because 
the term of the insurance is greater than 200 days. See paragraphs 
(b)(7)(i) and (c)(3) of this section.
    Example 11. General public use--port road. Highway Authority W uses 
all of the proceeds of its bonds to construct a 25-mile road to connect 
an industrial port owned by Corporation Y with existing roads owned and 
operated by W. Other than the port, the nearest residential or 
commercial development to the new road is 12 miles away. There is no 
reasonable expectation that development will occur in the area 
surrounding the new road. W and Y enter into no arrangement (either by 
contract or ordinance) that conveys special legal entitlements to Y for 
the use of the road. Use of the road will be available without 
restriction to all users, including natural persons who are not engaged 
in a trade or business. The issue does not meet the private business use 
test because the road is treated as used only by the general public.
    Example 12. General public use of governmentally owned hotel. State 
Q issues bonds to purchase land and construct a hotel for use by the 
general public (that is, tourists, visitors, and business travelers). 
The bond documents provide that Q will own and operate the project for 
the term of the bonds. Q will not enter into a lease or license with any 
user for use of rooms for a period longer than 200 days (although users 
may actually use rooms for consecutive periods in excess of 200 days). 
Use of the hotel by hotel guests who are travelling in connection with 
trades or businesses of nongovernmental persons is not a private 
business use of the hotel by these persons because the hotel is intended 
to be available and in fact is reasonably available for use on the same 
basis by natural persons not engaged in a trade or business. See 
paragraph (c)(1) of this section.
    Example 13. General public use with rights of first refusal. 
Authority V uses all of the proceeds of its bonds to construct a parking 
garage. At least 90 percent of the spaces in the garage will be 
available to the general public on a monthly first-come, first-served 
basis. V reasonably expects that the spaces will be predominantly leased 
to natural persons not engaged in a trade or business who have priority 
rights to renew their spaces at then current fair market value rates. 
More than 10 percent of the spaces will be leased to nongovernmental 
persons acting in a trade or business. These leases are not treated as 
arrangements with a term of use greater than 200 days. The rights to 
renew are not treated as renewal options because the compensation for 
the spaces is redetermined at generally applicable, fair market value 
rates that will be in effect at the time of renewal and the use of the 
spaces under similar arrangements is predominantly by natural persons 
who are not engaged in a trade or business. The issue does not meet the 
private business use test because at least 90 percent of the use of the 
parking garage is general public use. See paragraph (c)(3) of this 
section.
    Example 14. General public use with a specially negotiated rate 
agreement with agency of United States. G, a sewage collection and 
treatment district, operates facilities that were financed with its 
bonds. F, an agency of the United States, has a base located within G. 
Approximately 20 percent of G's facilities are used to treat sewage 
produced by F under a specially negotiated rate agreement. Under the 
specially negotiated rate agreement, G uses its best efforts to charge F 
as closely as possible the same amount for its use of G's services as 
its other customers pay for the same amount of services, although those 
other customers pay for services based on standard district charges and 
tax levies. F is prohibited by federal law from paying for the services 
based on those standard district charges and tax levies. The use of G's 
facilities by F is on the same basis as the general public. See 
paragraph (c)(2)(ii) of this section.
    Example 15. Arrangements not available for use by natural persons 
not engaged in a trade or business--federal use of prisons. Authority E 
uses all of the proceeds of its bonds to construct a prison. E contracts 
with federal agency F to house federal prisoners on a space-available, 
first-come, first-served basis, pursuant to which F will be charged 
approximately the same amount for each prisoner as other persons that 
enter into similar transfer agreements. It is reasonably expected that 
other persons will enter into similar agreements. The term of the use

[[Page 638]]

under the contract is not longer than 100 days, and F has no right to 
renew, although E reasonably expects to renew the contract indefinitely. 
The prison is not financed for a principal purpose of providing the 
prison for use by F. It is reasonably expected that during the term of 
the bonds, more than 10 percent of the prisoners at the prison will be 
federal prisoners. F's use of the facility is not general public use 
because this type of use (leasing space for prisoners) is not available 
for use on the same basis by natural persons not engaged in a trade or 
business. The issue does not meet the private business use test, 
however, because the leases satisfy the exception of paragraph (d)(3)(i) 
of this section.
    Example 16. Negotiated arm's-length arrangements--auditorium 
reserved in advance (i) City Z issues obligations to finance 
the construction of a municipal auditorium that it will own and operate. 
The use of the auditorium will be open to anyone who wishes to use it 
for a short period of time on a rate-scale basis. Z reasonably expects 
that the auditorium will be used by schools, church groups, sororities, 
and numerous commercial organizations. Corporation H, a nongovernmental 
person, enters into an arm's-length arrangement with Z to use the 
auditorium for 1 week for each year for a 10-year period (a total of 70 
days), pursuant to which H will be charged a specific price reflecting 
fair market value. On the date the contract is entered into, Z has not 
established generally applicable rates for future years. Even though the 
auditorium is not financed for a principal purpose of providing use of 
the auditorium to H, H is not treated as using the auditorium as a 
member of the general public because its use is not on the same basis as 
the general public. Because the term of H's use of the auditorium is 
longer than 50 days, the arrangement does not meet the exception under 
paragraph (d)(3)(ii) of this section.
    (ii) The facts are the same as in Example 16(i), except that H will 
enter into an arm's-length arrangement with Z to use the auditorium for 
1 week for each year for a 4-year period (a total of 28 days), pursuant 
to which H will be charged a specific price reflecting fair market 
value. H is not treated as a private business user of the auditorium 
because its contract satisfies the exception of paragraph (d)(3)(ii) of 
this section for negotiated arm's-length arrangements.

    (g) Measurement of private business use--(1) In general. In general, 
the private business use of proceeds is allocated to property under 
Sec. 1.141-6. The amount of private business use of that property is 
determined according to the average percentage of private business use 
of that property during the measurement period.
    (2) Measurement period--(i) General rule. Except as provided in this 
paragraph (g)(2), the measurement period of property financed by an 
issue begins on the later of the issue date of that issue or the date 
the property is placed in service and ends on the earlier of the last 
date of the reasonably expected economic life of the property or the 
latest maturity date of any bond of the issue financing the property 
(determined without regard to any optional redemption dates). In 
general, the period of reasonably expected economic life of the property 
for this purpose is based on reasonable expectations as of the issue 
date.
    (ii) Special rule for refundings of short-term obligations. For an 
issue of short-term obligations that the issuer reasonably expects to 
refund with a long-term financing (such as bond anticipation notes), the 
measurement period is based on the latest maturity date of any bond of 
the last refunding issue with respect to the financed property 
(determined without regard to any optional redemption dates).
    (iii) Special rule for reasonably expected mandatory redemptions. If 
an issuer reasonably expects on the issue date that an action will occur 
during the term of the bonds to cause either the private business tests 
or the private loan financing test to be met and is required to redeem 
bonds to meet the reasonable expectations test of Sec. 1.141-2(d)(2), 
the measurement period ends on the reasonably expected redemption date.
    (iv) Special rule for ownership by a nongovernmental person. The 
amount of private business use resulting from ownership by a 
nongovernmental person is the greatest percentage of private business 
use in any 1-year period.
    (v) Anti-abuse rule. If an issuer establishes the term of an issue 
for a period that is longer than is reasonably necessary for the 
governmental purposes of the issue for a principal purpose of increasing 
the permitted amount of private business use, the Commissioner may 
determine the amount of private business use according to the greatest 
percentage of private business use in any 1-year period.

[[Page 639]]

    (3) Determining average percentage of private business use. The 
average percentage of private business use is the average of the 
percentages of private business use during the 1-year periods within the 
measurement period. Appropriate adjustments must be made for beginning 
and ending periods of less than 1 year.
    (4) Determining the average amount of private business use for a 1-
year period--(i) In general. The percentage of private business use of 
property for any 1-year period is the average private business use 
during that year. This average is determined by comparing the amount of 
private business use during the year to the total amount of private 
business use and use that is not private business use (government use) 
during that year. Paragraphs (g)(4) (ii) through (v) of this section 
apply to determine the average amount of private business use for a 1-
year period.
    (ii) Uses at different times. For a facility in which actual 
government use and private business use occur at different times (for 
example, different days), the average amount of private business use 
generally is based on the amount of time that the facility is used for 
private business use as a percentage of the total time for all actual 
use. In determining the total amount of actual use, periods during which 
the facility is not in use are disregarded.
    (iii) Simultaneous use. In general, for a facility in which 
government use and private business use occur simultaneously, the entire 
facility is treated as having private business use. For example, a 
governmentally owned facility that is leased or managed by a 
nongovernmental person in a manner that results in private business use 
is treated as entirely used for a private business use. If, however, 
there is also private business use and actual government use on the same 
basis, the average amount of private business use may be determined on a 
reasonable basis that properly reflects the proportionate benefit to be 
derived by the various users of the facility (for example, reasonably 
expected fair market value of use). For example, the average amount of 
private business use of a garage with unassigned spaces that is used for 
government use and private business use is generally based on the number 
of spaces used for private business use as a percentage of the total 
number of spaces.
    (iv) Discrete portion. For purposes of this paragraph (g), 
measurement of the use of proceeds allocated to a discrete portion of a 
facility is determined by treating that discrete portion as a separate 
facility.
    (v) Relationship to fair market value. For purposes of paragraphs 
(g)(4) (ii) through (iv) of this section, if private business use is 
reasonably expected as of the issue date to have a significantly greater 
fair market value than government use, the average amount of private 
business use must be determined according to the relative reasonably 
expected fair market values of use rather than another measure, such as 
average time of use. This determination of relative fair market value 
may be made as of the date the property is acquired or placed in service 
if making this determination as of the issue date is not reasonably 
possible (for example, if the financed property is not identified on the 
issue date). In general, the relative reasonably expected fair market 
value for a period must be determined by taking into account the amount 
of reasonably expected payments for private business use for the period 
in a manner that properly reflects the proportionate benefit to be 
derived from the private business use.
    (5) Common areas. The amount of private business use of common areas 
within a facility is based on a reasonable method that properly reflects 
the proportionate benefit to be derived by the users of the facility. 
For example, in general, a method that is based on the average amount of 
private business use of the remainder of the entire facility reflects 
proportionate benefit.
    (6) Allocation of neutral costs. Proceeds that are used to pay costs 
of issuance, invested in a reserve or replacement fund, or paid as fees 
for a qualified guarantee or a qualified hedge must be allocated ratably 
among the other purposes for which the proceeds are used.
    (7) Commencement of measurement of private business use. Generally, 
private business use commences on the first date on which there is a 
right to actual use by the nongovernmental person.

[[Page 640]]

However, if an issuer enters into an arrangement for private business 
use a substantial period before the right to actual private business use 
commences and the arrangement transfers ownership or is an arrangement 
for other long-term use (such as a lease for a significant portion of 
the remaining economic life of financed property), private business use 
commences on the date the arrangement is entered into, even if the right 
to actual use commences after the measurement period. For this purpose, 
10 percent of the measurement period is generally treated as a 
substantial period.
    (8) Examples. The following examples illustrate the application of 
this paragraph (g):

    Example 1. Research facility. University U, a state owned and 
operated university, owns and operates a research facility. U proposes 
to finance general improvements to the facility with the proceeds of an 
issue of bonds. U enters into sponsored research agreements with 
nongovernmental persons that result in private business use because the 
sponsors will own title to any patents resulting from the research. The 
governmental research conducted by U and the research U conducts for the 
sponsors take place simultaneously in all laboratories within the 
research facility. All laboratory equipment is available continuously 
for use by workers who perform both types of research. Because it is not 
possible to predict which research projects will be successful, it is 
not reasonably practicable to estimate the relative revenues expected to 
result from the governmental and nongovernmental research. U contributed 
90 percent of the cost of the facility and the nongovernmental persons 
contributed 10 percent of the cost. Under this section, the 
nongovernmental persons are using the facility for a private business 
use on the same basis as the government use of the facility. The 
portions of the costs contributed by the various users of the facility 
provide a reasonable basis that properly reflects the proportionate 
benefit to be derived by the users of the facility. The nongovernmental 
persons are treated as using 10 percent of the proceeds of the issue.
    Example 2. Stadium. (i) City L issues bonds and uses all of the 
proceeds to construct a stadium. L enters into a long-term contract with 
a professional sports team T under which T will use the stadium 20 times 
during each year. These uses will occur on nights and weekends. L 
reasonably expects that the stadium will be used more than 180 other 
times each year, none of which will give rise to private business use. 
This expectation is based on a feasibility study and historical use of 
the old stadium that is being replaced by the new stadium. There is no 
significant difference in the value of T's uses when compared to the 
other uses of the stadium, taking into account the payments that T is 
reasonably expected to make for its use. Assuming no other private 
business use, the issue does not meet the private business use test 
because not more than 10 percent of the use of the facility is for a 
private business use.
    (ii) The facts are the same as in Example 2(i), except that L 
reasonably expects that the stadium will be used not more than 60 other 
times each year, none of which will give rise to private business use. 
The issue meets the private business use test because 25 percent of the 
proceeds are used for a private business use.
    Example 3. Airport terminal areas treated as common areas. City N 
issues bonds to finance the construction of an airport terminal. Eighty 
percent of the leasable space of the terminal will be leased to private 
air carriers. The remaining 20 percent of the leasable space will be 
used for the term of the bonds by N for its administrative purposes. The 
common areas of the terminal, including waiting areas, lobbies, and 
hallways are treated as 80 percent used by the air carriers for purposes 
of the private business use test.

[T.D. 8712, 62 FR 2286, Jan. 16, 1997, as amended by T.D. 8967, 66 FR 
58062, Nov. 20, 2001]



Sec. 1.141-4  Private security or payment test.

    (a) General rule--(1) Private security or payment. The private 
security or payment test relates to the nature of the security for, and 
the source of, the payment of debt service on an issue. The private 
payment portion of the test takes into account the payment of the debt 
service on the issue that is directly or indirectly to be derived from 
payments (whether or not to the issuer or any related party) in respect 
of property, or borrowed money, used or to be used for a private 
business use. The private security portion of the test takes into 
account the payment of the debt service on the issue that is directly or 
indirectly secured by any interest in property used or to be used for a 
private business use or payments in respect of property used or to be 
used for a private business use. For additional rules for output 
facilities, see Sec. 1.141-7.
    (2) Aggregation of private payments and security. For purposes of 
the private security or payment test, payments

[[Page 641]]

taken into account as private payments and payments or property taken 
into account as private security are aggregated. However, the same 
payments are not taken into account as both private security and private 
payments.
    (3) Underlying arrangement. The security for, and payment of debt 
service on, an issue is determined from both the terms of the bond 
documents and on the basis of any underlying arrangement. An underlying 
arrangement may result from separate agreements between the parties or 
may be determined on the basis of all of the facts and circumstances 
surrounding the issuance of the bonds. For example, if the payment of 
debt service on an issue is secured by both a pledge of the full faith 
and credit of a state or local governmental unit and any interest in 
property used or to be used in a private business use, the issue meets 
the private security or payment test.
    (b) Measurement of private payments and security--(1) Scope. This 
paragraph (b) contains rules that apply to both private security and 
private payments.
    (2) Present value measurement--(i) Use of present value. In 
determining whether an issue meets the private security or payment test, 
the present value of the payments or property taken into account is 
compared to the present value of the debt service to be paid over the 
term of the issue.
    (ii) Debt service--(A) Debt service paid from proceeds. Debt service 
does not include any amount paid or to be paid from sale proceeds or 
investment proceeds. For example, debt service does not include payments 
of capitalized interest funded with proceeds.
    (B) Adjustments to debt service. Debt service is adjusted to take 
into account payments and receipts that adjust the yield on an issue for 
purposes of section 148(f). For example, debt service includes fees paid 
for qualified guarantees under Sec. 1.148-4(f) and is adjusted to take 
into account payments and receipts on qualified hedges under Sec. 
1.148-4(h).
    (iii) Computation of present value--(A) In general. Present values 
are determined by using the yield on the issue as the discount rate and 
by discounting all amounts to the issue date. See, however, Sec. 1.141-
13 for special rules for refunding bonds.
    (B) Fixed yield issues. For a fixed yield issue, yield is determined 
on the issue date and is not adjusted to take into account subsequent 
events.
    (C) Variable yield issues. The yield on a variable yield issue is 
determined over the term of the issue. To determine the reasonably 
expected yield as of any date, the issuer may assume that the future 
interest rate on a variable yield bond will be the then-current interest 
rate on the bonds determined under the formula prescribed in the bond 
documents. A deliberate action requires a recomputation of the yield on 
the variable yield issue to determine the present value of payments 
under that arrangement. In that case, the issuer must use the yield 
determined as of the date of the deliberate action for purposes of 
determining the present value of payments under the arrangement causing 
the deliberate action. See paragraph (g) of this section, Example 3.
    (iv) Application to private security. For purposes of determining 
the present value of debt service that is secured by property, the 
property is valued at fair market value as of the first date on which 
the property secures bonds of the issue.
    (c) Private payments--(1) In general. This paragraph (c) contains 
rules that apply to private payments.
    (2) Payments taken into account--(i) Payments for use--(A) In 
general. Both direct and indirect payments made by any nongovernmental 
person that is treated as using proceeds of the issue are taken into 
account as private payments to the extent allocable to the proceeds used 
by that person. Payments are taken into account as private payments only 
to the extent that they are made for the period of time that proceeds 
are used for a private business use. Payments for a use of proceeds 
include payments (whether or not to the issuer) in respect of property 
financed (directly or indirectly) with those proceeds, even if not made 
by a private business user. Payments are not made in respect of financed 
property if those payments are directly allocable to other property 
being directly used by the person making the

[[Page 642]]

payment and those payments represent fair market value compensation for 
that other use. See paragraph (g) of this section, Example 4 and Example 
5. See also paragraph (c)(3) of this section for rules relating to 
allocation of payments to the source or sources of funding of property.
    (B) Payments not to exceed use. Payments with respect to proceeds 
that are used for a private business use are not taken into account to 
the extent that the present value of those payments exceeds the present 
value of debt service on those proceeds. Payments need not be directly 
derived from a private business user, however, to be taken into account. 
Thus, if 7 percent of the proceeds of an issue is used by a person over 
the measurement period, payments with respect to the property financed 
with those proceeds are taken into account as private payments only to 
the extent that the present value of those payments does not exceed the 
present value of 7 percent of the debt service on the issue.
    (C) Payments for operating expenses. Payments by a person for a use 
of proceeds do not include the portion of any payment that is properly 
allocable to the payment of ordinary and necessary expenses (as defined 
under section 162) directly attributable to the operation and 
maintenance of the financed property used by that person. For this 
purpose, general overhead and administrative expenses are not directly 
attributable to those operations and maintenance. For example, if an 
issuer receives $5,000 rent during the year for use of space in a 
financed facility and during the year pays $500 for ordinary and 
necessary expenses properly allocable to the operation and maintenance 
of that space and $400 for general overhead and general administrative 
expenses properly allocable to that space, $500 of the $5,000 received 
would not be considered a payment for the use of the proceeds allocable 
to that space (regardless of the manner in which that $500 is actually 
used).
    (ii) Refinanced debt service. Payments of debt service on an issue 
to be made from proceeds of a refunding issue are taken into account as 
private payments in the same proportion that the present value of the 
payments taken into account as private payments for the refunding issue 
bears to the present value of the debt service to be paid on the 
refunding issue. For example, if all the debt service on a note is paid 
with proceeds of a refunding issue, the note meets the private security 
or payment test if (and to the same extent that) the refunding issue 
meets the private security or payment test. This paragraph (c)(2)(ii) 
does not apply to payments that arise from deliberate actions that occur 
more than 3 years after the retirement of the prior issue that are not 
reasonably expected on the issue date of the refunding issue. For 
purposes of this paragraph (c)(2)(ii), whether an issue is a refunding 
issue is determined without regard to Sec. 1.150-1(d)(2)(i) (relating 
to certain payments of interest).
    (3) Allocation of payments--(i) In general. Private payments for the 
use of property are allocated to the source or different sources of 
funding of property. The allocation to the source or different sources 
of funding is based on all of the facts and circumstances, including 
whether an allocation is consistent with the purposes of section 141. In 
general, a private payment for the use of property is allocated to a 
source of funding based upon the nexus between the payment and both the 
financed property and the source of funding. For this purpose, different 
sources of funding may include different tax-exempt issues, taxable 
issues, and amounts that are not derived from a borrowing, such as 
revenues of an issuer (equity).
    (ii) Payments for use of discrete property. Payments for the use of 
a discrete facility (or a discrete portion of a facility) are allocated 
to the source or different sources of funding of that discrete property.
    (iii) Allocations among two or more sources of funding. In general, 
except as provided in paragraphs (c)(3)(iv) and (v) of this section, if 
a payment is made for the use of property financed with two or more 
sources of funding (for example, equity and a tax-exempt issue), that 
payment must be allocated to those sources of funding in a manner that 
reasonably corresponds to the relative amounts of those sources of 
funding that are expended on that property.

[[Page 643]]

If an issuer has not retained records of amounts expended on the 
property (for example, records of costs of a building that was built 30 
years before the allocation), an issuer may use reasonable estimates of 
those expenditures. For this purpose, costs of issuance and other 
similar neutral costs are allocated ratably among expenditures in the 
same manner as in Sec. 1.141-3(g)(6). A payment for the use of property 
may be allocated to two or more issues that finance property according 
to the relative amounts of debt service (both paid and accrued) on the 
issues during the annual period for which the payment is made, if that 
allocation reasonably reflects the economic substance of the 
arrangement. In general, allocations of payments according to relative 
debt service reasonably reflect the economic substance of the 
arrangement if the maturity of the bonds reasonably corresponds to the 
reasonably expected economic life of the property and debt service 
payments on the bonds are approximately level from year to year.
    (iv) Payments made under an arrangement entered into in connection 
with issuance of bonds. A private payment for the use of property made 
under an arrangement that is entered into in connection with the 
issuance of the issue that finances that property generally is allocated 
to that issue. Whether an arrangement is entered into in connection with 
the issuance of an issue is determined on the basis of all of the facts 
and circumstances. An arrangement is ordinarily treated as entered into 
in connection with the issuance of an issue if--
    (A) The issuer enters into the arrangement during the 3-year period 
beginning 18 months before the issue date; and
    (B) The amount of payments reflects all or a portion of debt service 
on the issue.
    (v) Allocations to equity. A private payment for the use of property 
may be allocated to equity before payments are allocated to an issue 
only if--
    (A) Not later than 60 days after the date of the expenditure of 
those amounts, the issuer adopts an official intent (in a manner 
comparable to Sec. 1.150-2(e)) indicating that the issuer reasonably 
expects to be repaid for the expenditure from a specific arrangement; 
and
    (B) The private payment is made not later than 18 months after the 
later of the date the expenditure is made or the date the project is 
placed in service.
    (d) Private security--(1) In general. This paragraph (d) contains 
rules that relate to private security.
    (2) Security taken into account. The property that is the security 
for, or the source of, the payment of debt service on an issue need not 
be property financed with proceeds. For example, unimproved land or 
investment securities used, directly or indirectly, in a private 
business use that secures an issue provides private security. Private 
security (other than financed property and private payments) for an 
issue is taken into account under section 141(b), however, only to the 
extent it is provided, directly or indirectly, by a user of proceeds of 
the issue.
    (3) Pledge of unexpended proceeds. Proceeds qualifying for an 
initial temporary period under Sec. 1.148-2(e)(2) or (3) or deposited 
in a reasonably required reserve or replacement fund (as defined in 
Sec. 1.148-2(f)(2)(i)) are not taken into account under this paragraph 
(d) before the date on which those amounts are either expended or loaned 
by the issuer to an unrelated party.
    (4) Secured by any interest in property or payments. Property used 
or to be used for a private business use and payments in respect of that 
property are treated as private security if any interest in that 
property or payments secures the payment of debt service on the bonds. 
For this purpose, the phrase any interest in is to be interpreted 
broadly and includes, for example, any right, claim, title, or legal 
share in property or payments.
    (5) Payments in respect of property. The payments taken into account 
as private security are payments in respect of property used or to be 
used for a private business use. Except as otherwise provided in this 
paragraph (d)(5) and paragraph (d)(6) of this section, the rules in 
paragraphs (c)(2)(i)(A) and (B) and (c)(2)(ii) of this section apply to 
determine the amount of payments treated as payments in respect of 
property

[[Page 644]]

used or to be used for a private business use. Thus, payments made by 
members of the general public for use of a facility used for a private 
business use (for example, a facility that is the subject of a 
management contract that results in private business use) are taken into 
account as private security to the extent that they are made for the 
period of time that property is used by a private business user.
    (6) Allocation of security among issues. In general, property or 
payments from the disposition of that property that are taken into 
account as private security are allocated to each issue secured by the 
property or payments on a reasonable basis that takes into account 
bondholders' rights to the payments or property upon default.
    (e) Generally applicable taxes--(1) General rule. For purposes of 
the private security or payment test, generally applicable taxes are not 
taken into account (that is, are not payments from a nongovernmental 
person and are not payments in respect of property used for a private 
business use).
    (2) Definition of generally applicable taxes. A generally applicable 
tax is an enforced contribution exacted pursuant to legislative 
authority in the exercise of the taxing power that is imposed and 
collected for the purpose of raising revenue to be used for governmental 
purposes. A generally applicable tax must have a uniform tax rate that 
is applied to all persons of the same classification in the appropriate 
jurisdiction and a generally applicable manner of determination and 
collection.
    (3) Special charges. A payment for a special privilege granted or 
service rendered is not a generally applicable tax. Special assessments 
paid by property owners benefiting from financed improvements are not 
generally applicable taxes. For example, a tax or a payment in lieu of 
tax that is limited to the property or persons benefited by an 
improvement is not a generally applicable tax.
    (4) Manner of determination and collection--(i) In general. A tax 
does not have a generally applicable manner of determination and 
collection to the extent that one or more taxpayers make any 
impermissible agreements relating to payment of those taxes. An 
impermissible agreement relating to the payment of a tax is taken into 
account whether or not it is reasonably expected to result in any 
payments that would not otherwise have been made. For example, if an 
issuer uses proceeds to make a grant to a taxpayer to improve property, 
agreements that impose reasonable conditions on the use of the grant do 
not cause a tax on that property to fail to be a generally applicable 
tax. If an agreement by a taxpayer causes the tax imposed on that 
taxpayer not to be treated as a generally applicable tax, the entire tax 
paid by that taxpayer is treated as a special charge, unless the 
agreement is limited to a specific portion of the tax.
    (ii) Impermissible agreements. The following are examples of 
agreements that cause a tax to fail to have a generally applicable 
manner of determination and collection: an agreement to be personally 
liable on a tax that does not generally impose personal liability, to 
provide additional credit support such as a third party guarantee, or to 
pay unanticipated shortfalls; an agreement regarding the minimum market 
value of property subject to property tax; and an agreement not to 
challenge or seek deferral of the tax.
    (iii) Permissible agreements. The following are examples of 
agreements that do not cause a tax to fail to have a generally 
applicable manner of determination and collection: an agreement to use a 
grant for specified purposes (whether or not that agreement is secured); 
a representation regarding the expected value of the property following 
the improvement; an agreement to insure the property and, if damaged, to 
restore the property; a right of a grantor to rescind the grant if 
property taxes are not paid; and an agreement to reduce or limit the 
amount of taxes collected to further a bona fide governmental purpose. 
For example, an agreement to abate taxes to encourage a property owner 
to rehabilitate property in a distressed area is a permissible 
agreement.
    (5) Payments in lieu of taxes. A tax equivalency payment and any 
other payment in lieu of a tax is treated as a generally applicable tax 
if--
    (i) The payment is commensurate with and not greater than the 
amounts

[[Page 645]]

imposed by a statute for a tax of general application; and
    (ii) The payment is designated for a public purpose and is not a 
special charge (as described in paragraph (e)(3) of this section). For 
example, a payment in lieu of taxes made in consideration for the use of 
property financed with tax-exempt bonds is treated as a special charge.
    (f) Certain waste remediation bonds--(1) Scope. This paragraph (f) 
applies to bonds issued to finance hazardous waste clean-up activities 
on privately owned land (hazardous waste remediation bonds).
    (2) Persons that are not private users. Payments from 
nongovernmental persons who are not (other than coincidentally) either 
users of the site being remediated or persons potentially responsible 
for disposing of hazardous waste on that site are not taken into account 
as private security. This paragraph (f)(2) applies to payments that 
secure (directly or indirectly) the payment of principal of, or interest 
on, the bonds under the terms of the bonds. This paragraph (f)(2) 
applies only if the payments are made pursuant to either a generally 
applicable state or local taxing statute or a state or local statute 
that regulates or restrains activities on an industry-wide basis of 
persons who are engaged in generating or handling hazardous waste, or in 
refining, producing, or transporting petroleum, provided that those 
payments do not represent, in substance, payment for the use of 
proceeds. For this purpose, a state or local statute that imposes 
payments that have substantially the same character as those described 
in Chapter 38 of the Code are treated as generally applicable taxes.
    (3) Persons that are private users. If payments from nongovernmental 
persons who are either users of the site being remediated or persons 
potentially responsible for disposing of hazardous waste on that site do 
not secure (directly or indirectly) the payment of principal of, or 
interest on, the bonds under the terms of the bonds, the payments are 
not taken into account as private payments. This paragraph (f)(3) 
applies only if at the time the bonds are issued the payments from those 
nongovernmental persons are not material to the security for the bonds. 
For this purpose, payments are not material to the security for the 
bonds if--
    (i) The payments are not required for the payment of debt service on 
the bonds;
    (ii) The amount and timing of the payments are not structured or 
designed to reflect the payment of debt service on the bonds;
    (iii) The receipt or the amount of the payment is uncertain (for 
example, as of the issue date, no final judgment has been entered into 
against the nongovernmental person);
    (iv) The payments from those nongovernmental persons, when and if 
received, are used either to redeem bonds of the issuer or to pay for 
costs of any hazardous waste remediation project; and
    (v) In the case when a judgment (but not a final judgment) has been 
entered by the issue date against a nongovernmental person, there are, 
as of the issue date, costs of hazardous waste remediation other than 
those financed with the bonds that may be financed with the payments.
    (g) Examples. The following examples illustrate the application of 
this section:
    Example 1. Aggregation of payments. State B issues bonds with 
proceeds of $10 million. B uses $9.7 million of the proceeds to 
construct a 10-story office building. B uses the remaining $300,000 of 
proceeds to make a loan to Corporation Y. In addition, Corporation X 
leases 1 floor of the building for the term of the bonds. Under all of 
the facts and circumstances, it is reasonable to allocate 10 percent of 
the proceeds to that 1 floor. As a percentage of the present value of 
the debt service on the bonds, the present value of Y's loan repayments 
is 3 percent and the present value of X's lease payments is 8 percent. 
The bonds meet the private security or payment test because the private 
payments taken into account are more than 10 percent of the present 
value of the debt service on the bonds.
    Example 2. Indirect private payments. J, a political subdivision of 
a state, will issue several series of bonds from time to time and will 
use the proceeds to rehabilitate urban areas. Under all of the facts and 
circumstances, the private business use test will be met with respect to 
each issue that will be used for the rehabilitation and construction of 
buildings that will be leased or sold to nongovernmental persons for use 
in their trades or businesses. Nongovernmental persons will make 
payments for these sales

[[Page 646]]

and leases. There is no limitation either on the number of issues or the 
aggregate amount of bonds that may be outstanding. No group of 
bondholders has any legal claim prior to any other bondholders or 
creditors with respect to specific revenues of J, and there is no 
arrangement whereby revenues from a particular project are paid into a 
trust or constructive trust, or sinking fund, or are otherwise 
segregated or restricted for the benefit of any group of bondholders. 
There is, however, an unconditional obligation by J to pay the principal 
of, and the interest on, each issue. Although not directly pledged under 
the terms of the bond documents, the leases and sales are underlying 
arrangements. The payments relating to these leases and sales are taken 
into account as private payments to determine whether each issue of 
bonds meets the private security or payment test.
    Example 3. Computation of payment in variable yield issues. (i) City 
M issues general obligation bonds with proceeds of $10 million to 
finance a 5-story office building. The bonds bear interest at a variable 
rate that is recomputed monthly according to an index that reflects 
current market yields. The yield that the interest index would produce 
on the issue date is 6 percent. M leases 1 floor of the office building 
to Corporation T, a nongovernmental person, for the term of the bonds. 
Under all of the facts and circumstances, T is treated as using more 
than 10 percent of the proceeds. Using the 6 percent yield as the 
discount rate, M reasonably expects on the issue date that the present 
value of lease payments to be made by T will be 8 percent of the present 
value of the total debt service on the bonds. After the issue date of 
the bonds, interest rates decline significantly, so that the yield on 
the bonds over their entire term is 4 percent. Using this actual 4 
percent yield as the discount rate, the present value of lease payments 
made by T is 12 percent of the present value of the actual total debt 
service on the bonds. The bonds are not private activity bonds because M 
reasonably expected on the issue date that the bonds would not meet the 
private security or payment test and because M did not take any 
subsequent deliberate action to meet the private security or payment 
test.
    (ii) The facts are the same as Example 3(i), except that 5 years 
after the issue date M leases a second floor to Corporation S, a 
nongovernmental person, under a long-term lease. Because M has taken a 
deliberate action, the present value of the lease payments must be 
computed. On the date this lease is entered into, M reasonably expects 
that the yield on the bonds over their entire term will be 5.5 percent, 
based on actual interest rates to date and the then-current rate on the 
variable yield bonds. M uses this 5.5 percent yield as the discount 
rate. Using this 5.5 percent yield as the discount rate, as a percentage 
of the present value of the debt service on the bonds, the present value 
of the lease payments made by S is 3 percent. The bonds are private 
activity bonds because the present value of the aggregate private 
payments is greater than 10 percent of the present value of debt 
service.
    Example 4. Payments not in respect of financed property. In order to 
further public safety, City Y issues tax assessment bonds the proceeds 
of which are used to move existing electric utility lines underground. 
Although the utility lines are owned by a nongovernmental utility 
company, that company is under no obligation to move the lines. The debt 
service on the bonds will be paid using assessments levied by City Y on 
the customers of the utility. Although the utility lines are privately 
owned and the utility customers make payments to the utility company for 
the use of those lines, the assessments are payments in respect of the 
cost of relocating the utility line. Thus, the assessment payments are 
not made in respect of property used for a private business use. Any 
direct or indirect payments to Y by the utility company for the 
undergrounding are, however, taken into account as private payments.
    Example 5. Payments from users of proceeds that are not private 
business users taken into account. City P issues general obligation 
bonds to finance the renovation of a hospital that it owns. The hospital 
is operated for P by D, a nongovernmental person, under a management 
contract that results in private business use under Sec. 1.141-3. P will 
use the revenues from the hospital (after the required payments to D and 
the payment of operation and maintenance expenses) to pay the debt 
service on the bonds. The bonds meet the private security or payment 
test because the revenues from the hospital are payments in respect of 
property used for a private business use.
    Example 6. Limitation of amount of payments to amount of private 
business use not determined annually. City Q issues bonds with a term of 
15 years and uses the proceeds to construct an office building. The debt 
service on the bonds is level throughout the 15-year term. Q enters into 
a 5-year lease with Corporation R under which R is treated as a user of 
11 percent of the proceeds. R will make lease payments equal to 20 
percent of the annual debt service on the bonds for each year of the 
lease. The present value of R's lease payments is equal to 12 percent of 
the present value of the debt service over the entire 15-year term of 
the bonds. If, however, the lease payments taken into account as private 
payments were limited to 11 percent of debt service paid in each year of 
the lease, the present value of these payments would be only 8 percent 
of the debt service on the bonds over the entire term of the bonds. The

[[Page 647]]

bonds meet the private security or payment test, because R's lease 
payments are taken into account as private payments in an amount not to 
exceed 11 percent of the debt service of the bonds.
    Example 7. Allocation of payments to funds not derived from a 
borrowing. City Z purchases property for $1,250,000 using $1,000,000 of 
proceeds of its tax increment bonds and $250,000 of other revenues that 
are in its redevelopment fund. Within 60 days of the date of purchase, Z 
declared its intent to sell the property pursuant to a redevelopment 
plan and to use that amount to reimburse its redevelopment fund. The 
bonds are secured only by the incremental property taxes attributable to 
the increase in value of the property from the planned redevelopment of 
the property. Within 18 months after the issue date, Z sells the 
financed property to Developer M for $250,000, which Z uses to reimburse 
the redevelopment fund. The property that M uses is financed both with 
the proceeds of the bonds and Z's redevelopment fund. The payments by M 
are properly allocable to the costs of property financed with the 
amounts in Z's redevelopment fund. See paragraphs (c)(3) (i) and (v) of 
this section.
    Example 8. Allocation of payments to different sources of funding--
improvements. In 1997, City L issues bonds with proceeds of $8 million 
to finance the acquisition of a building. In 2002, L spends $2 million 
of its general revenues to improve the heating system and roof of the 
building. At that time, L enters into a 10-year lease with Corporation M 
for the building providing for annual payments of $1 million to L. The 
lease payments are at fair market value, and the lease payments do not 
otherwise have a significant nexus to either the issue or to the 
expenditure of general revenues. Eighty percent of each lease payment is 
allocated to the issue and is taken into account under the private 
payment test because each lease payment is properly allocated to the 
sources of funding in a manner that reasonably corresponds to the 
relative amounts of the sources of funding that are expended on the 
building.
    Example 9. Security not provided by users of proceeds not taken into 
account. County W issues certificates of participation in a lease of a 
building that W owns and covenants to appropriate annual payments for 
the lease. A portion of each payment is specified as interest. More than 
10 percent of the building is used for private business use. None of the 
proceeds of the obligations are used with respect to the building. W 
uses the proceeds of the obligations to make a grant to Corporation Y 
for the construction of a factory that Y will own. Y makes no payments 
to W, directly or indirectly, for its use of proceeds, and Y has no 
relationship to the users of the leased building. If W defaults under 
the lease, the trustee for the holders of the certificates of 
participation has a limited right of repossession under which the 
trustee may not foreclose but may lease the property to a new tenant at 
fair market value. The obligations are secured by an interest in 
property used for a private business use. However, because the property 
is not provided by a private business user and is not financed property, 
the obligations do not meet the private security or payment test.
    Example 10. Allocation of payments among issues. University L, a 
political subdivision, issued three separate series of revenue bonds 
during 1989, 1991, and 1993 under the same bond resolution. L used the 
proceeds to construct facilities exclusively for its own use. Bonds 
issued under the resolution are equally and ratably secured and payable 
solely from the income derived by L from rates, fees, and charges 
imposed by L for the use of the facilities. The bonds issued in 1989, 
1991, and 1993 are not private activity bonds. In 1997, L issues another 
series of bonds under the resolution to finance additional facilities. L 
leases 20 percent of the new facilities for the term of the 1997 bonds 
to nongovernmental persons who will use the facilities in their trades 
or businesses. The present value of the lease payments from the 
nongovernmental users will equal 15 percent of the present value of the 
debt service on the 1997 bonds. L will commingle all of the revenues 
from all its bond-financed facilities in its revenue fund. The present 
value of the portion of the lease payments from nongovernmental lessees 
of the new facilities allocable to the 1997 bonds under paragraph (d) of 
this section is less than 10 percent of the present value of the debt 
service on the 1997 bonds because the bond documents provide that the 
bonds are equally and ratably secured. Accordingly, the 1997 bonds do 
not meet the private security test. The 1997 bonds meet the private 
payment test, however, because the private lease payments for the new 
facility are properly allocated to those bonds (that is, because none of 
the proceeds of the prior issues were used for the new facilities). See 
paragraph (c) of this section.
    Example 11. Generally applicable tax. (i) Authority N issues bonds 
to finance the construction of a stadium. Under a long-term lease, 
Corporation X, a professional sports team, will use more than 10 percent 
of the stadium. X will not, however, make any payments for this private 
business use. The security for the bonds will be a ticket tax imposed on 
each person purchasing a ticket for an event at the stadium. The portion 
of the ticket tax attributable to tickets purchased by persons attending 
X's events will, on a present value basis, exceed 10 percent of the 
present value of the debt service on N's bonds. The bonds meet the 
private security or payment test. The ticket tax is not a generally 
applicable tax and, to the extent that the tax receipts relate to X's 
events, the

[[Page 648]]

taxes are payments in respect of property used for a private business 
use.
    (ii) The facts are the same as Example 11(i), except that the ticket 
tax is imposed by N on tickets purchased for events at a number of large 
entertainment facilities within the N's jurisdiction (for example, other 
stadiums, arenas, and concert halls), some of which were not financed 
with tax-exempt bonds. The ticket tax is a generally applicable tax and 
therefore the revenues from this tax are not payments in respect of 
property used for a private business use. The receipt of the ticket tax 
does not cause the bonds to meet the private security or payment test.

[T.D. 8712, 62 FR 2291, Jan. 16, 1997]



Sec. 1.141-5  Private loan financing test.

    (a) In general. Bonds of an issue are private activity bonds if more 
than the lesser of 5 percent or $5 million of the proceeds of the issue 
is to be used (directly or indirectly) to make or finance loans to 
persons other than governmental persons. Section 1.141-2(d) applies in 
determining whether the private loan financing test is met. In 
determining whether the proceeds of an issue are used to make or finance 
loans, indirect, as well as direct, use of the proceeds is taken into 
account.
    (b) Measurement of test. In determining whether the private loan 
financing test is met, the amount actually loaned to a nongovernmental 
person is not discounted to reflect the present value of the loan 
repayments.
    (c) Definition of private loan--(1) In general. Any transaction that 
is generally characterized as a loan for federal income tax purposes is 
a loan for purposes of this section. In addition, a loan may arise from 
the direct lending of bond proceeds or may arise from transactions in 
which indirect benefits that are the economic equivalent of a loan are 
conveyed. Thus, the determination of whether a loan is made depends on 
the substance of a transaction rather than its form. For example, a 
lease or other contractual arrangement (for example, a management 
contract or an output contract) may in substance constitute a loan if 
the arrangement transfers tax ownership of the facility to a 
nongovernmental person. Similarly, an output contract or a management 
contract with respect to a financed facility generally is not treated as 
a loan of proceeds unless the agreement in substance shifts significant 
burdens and benefits of ownership to the nongovernmental purchaser or 
manager of the facility.
    (2) Application only to purpose investments--(i) In general. A loan 
may be either a purpose investment or a nonpurpose investment. A loan 
that is a nonpurpose investment does not cause the private loan 
financing test to be met. For example, proceeds invested in loans, such 
as obligations of the United States, during a temporary period, as part 
of a reasonably required reserve or replacement fund, as part of a 
refunding escrow, or as part of a minor portion (as each of those terms 
are defined in Sec. 1.148-1 or Sec. 1.148-2) are generally not treated 
as loans under the private loan financing test.
    (ii) Certain prepayments treated as loans. Except as otherwise 
provided, a prepayment for property or services, including a prepayment 
for property or services that is made after the date that the contract 
to buy the property or services is entered into, is treated as a loan 
for purposes of the private loan financing test if a principal purpose 
for prepaying is to provide a benefit of tax-exempt financing to the 
seller. A prepayment is not treated as a loan for purposes of the 
private loan financing test if--
    (A) Prepayments on substantially the same terms are made by a 
substantial percentage of persons who are similarly situated to the 
issuer but who are not beneficiaries of tax-exempt financing;
    (B) The prepayment is made within 90 days of the reasonably expected 
date of delivery to the issuer of all of the property or services for 
which the prepayment is made; or
    (C) The prepayment meets the requirements of Sec. 1.148-
1(e)(2)(iii)(A) or (B) (relating to certain prepayments to acquire a 
supply of natural gas or electricity).
    (iii) Customary prepayments. The determination of whether a 
prepayment satisfies paragraph (c)(2)(ii)(A) of this section is 
generally made based on all the facts and circumstances. In addition, a 
prepayment is deemed to satisfy paragraph (c)(2)(ii)(A) of this section 
if--
    (A) The prepayment is made for--

[[Page 649]]

    (1) Maintenance, repair, or an extended warranty with respect to 
personal property (for example, automobiles or electronic equipment); or
    (2) Updates or maintenance or support services with respect to 
computer software; and
    (B) The same maintenance, repair, extended warranty, updates or 
maintenance or support services, as applicable, are regularly provided 
to nongovernmental persons on the same terms.
    (iv) Additional prepayments as permitted by the Commissioner. The 
Commissioner may, by published guidance, set forth additional 
circumstances in which a prepayment is not treated as a loan for 
purposes of the private loan financing test.
    (3) Grants--(i) In general. A grant of proceeds is not a loan. 
Whether a transaction may be treated as a grant or a loan depends on all 
of the facts and circumstances.
    (ii) Tax increment financing--(A) In general. Generally, a grant 
using proceeds of an issue that is secured by generally applicable taxes 
attributable to the improvements to be made with the grant is not 
treated as a loan, unless the grantee makes any impermissible agreements 
relating to the payment that results in the taxes imposed on that 
taxpayer not to be treated as generally applicable taxes under Sec. 
1.141-4(e).
    (B) Amount of loan. If a grant is treated as a loan under this 
paragraph (c)(3), the entire grant is treated as a loan unless the 
impermissible agreement is limited to a specific portion of the tax. For 
this purpose, an arrangement with each unrelated grantee is treated as a 
separate grant.
    (4) Hazardous waste remediation bonds. In the case of an issue of 
hazardous waste remediation bonds, payments from nongovernmental persons 
that are either users of the site being remediated or persons 
potentially responsible for disposing of hazardous waste on that site do 
not establish that the transaction is a loan for purposes of this 
section. This paragraph (c)(4) applies only if those payments do not 
secure the payment of principal of, or interest on, the bonds (directly 
or indirectly), under the terms of the bonds and those payments are not 
taken into account under the private payment test pursuant to Sec. 
1.141-4(f)(3).
    (d) Tax assessment loan exception--(1) General rule. For purposes of 
this section, a tax assessment loan that satisfies the requirements of 
this paragraph (d) is not a loan for purposes of the private loan 
financing test.
    (2) Tax assessment loan defined. A tax assessment loan is a loan 
that arises when a governmental person permits or requires property 
owners to finance any governmental tax or assessment of general 
application for an essential governmental function that satisfies each 
of the requirements of paragraphs (d) (3) through (5) of this section.
    (3) Mandatory tax or other assessment. The tax or assessment must be 
an enforced contribution that is imposed and collected for the purpose 
of raising revenue to be used for a specific purpose (that is, to defray 
the capital cost of an improvement). Taxes and assessments do not 
include fees for services. The tax or assessment must be imposed 
pursuant to a state law of general application that can be applied 
equally to natural persons not acting in a trade or business and persons 
acting in a trade or business. For this purpose, taxes and assessments 
that are imposed subject to protest procedures are treated as enforced 
contributions.
    (4) Specific essential governmental function--(i) In general. A 
mandatory tax or assessment that gives rise to a tax assessment loan 
must be imposed for one or more specific, essential governmental 
functions.
    (ii) Essential governmental functions. For purposes of paragraph (d) 
of this section, improvements to utilities and systems that are owned by 
a governmental person and that are available for use by the general 
public (such as sidewalks, streets and street-lights; electric, 
telephone, and cable television systems; sewage treatment and disposal 
systems; and municipal water facilities) serve essential governmental 
functions. For other types of facilities, the extent to which the 
service provided by the facility is customarily performed (and financed 
with governmental bonds) by governments with general taxing powers is a 
primary factor in determining whether the facility

[[Page 650]]

serves an essential governmental function. For example, parks that are 
owned by a governmental person and that are available for use by the 
general public serve an essential governmental function. Except as 
otherwise provided in this paragraph (d)(4)(ii), commercial or 
industrial facilities and improvements to property owned by a 
nongovernmental person do not serve an essential governmental

function. Permitting installment payments of property taxes or other 
taxes is not an essential governmental function.
    (5) Equal basis requirement--(i) In general. Owners of both business 
and nonbusiness property benefiting from the financed improvements must 
be eligible, or required, to make deferred payments of the tax or 
assessment giving rise to a tax assessment loan on an equal basis (the 
equal basis requirement). A tax or assessment does not satisfy the equal 
basis requirement if the terms for payment of the tax or assessment are 
not the same for all taxed or assessed persons. For example, the equal 
basis requirement is not met if certain property owners are permitted to 
pay the tax or assessment over a period of years while others must pay 
the entire tax or assessment immediately or if only certain property 
owners are required to prepay the tax or assessment when the property is 
sold.
    (ii) General rule for guarantees. A guarantee of debt service on 
bonds, or of taxes or assessments, by a person that is treated as a 
borrower of bond proceeds violates the equal basis requirement if it is 
reasonable to expect on the date the guarantee is entered into that 
payments will be made under the guarantee.
    (6) Coordination with private business tests. See Sec. Sec. 1.141-3 
and 1.141-4 for rules for determining whether tax assessment loans cause 
the bonds financing those loans to be private activity bonds under the 
private business use and the private security or payment tests.
    (e) Examples. The following examples illustrate the application of 
this section:
    Example 1. Turnkey contract not treated as a loan. State agency Z 
and federal agency H will each contribute to rehabilitate a project 
owned by Z. H can only provide its funds through a contribution to Z to 
be used to acquire the rehabilitated project on a turnkey basis from an 
approved developer. Under H's turnkey program, the developer must own 
the project while it is rehabilitated. Z issues its notes to provide 
funds for construction. A portion of the notes will be retired using the 
H contribution, and the balance of the notes will be retired through the 
issuance by Z of long-term bonds. Z lends the proceeds of its notes to 
Developer B as construction financing and transfers title to B for a 
nominal amount. The conveyance is made on condition that B rehabilitate 
the property and reconvey it upon completion, with Z retaining the right 
to force reconveyance if these conditions are not satisfied. B must name 
Z as an additional insured on all insurance. Upon completion, B must 
transfer title to the project back to Z at a set price, which price 
reflects B's costs and profit, not fair market value. Further, this 
price is adjusted downward to reflect any cost-underruns. For purposes 
of section 141(c), this transaction does not involve a private loan.
    Example 2. Essential government function requirement not met. City D 
creates a special taxing district consisting of property owned by 
nongovernmental persons that requires environmental clean-up. D imposes 
a special tax on each parcel within the district in an amount that is 
related to the expected environmental clean-up costs of that parcel. The 
payment of the tax over a 20-year period is treated as a loan by the 
property owners for purposes of the private loan financing test. The 
special district issues bonds, acting on behalf of D, that are payable 
from the special tax levied within the district, and uses the proceeds 
to pay for the costs of environmental clean-up on the property within 
the district. The bonds meet the private loan financing test because 
more than 5 percent of the proceeds of the issue are loaned to 
nongovernmental persons. The issue does not meet the tax assessment loan 
exception because the improvements to property owned by a 
nongovernmental person are not an essential governmental function under 
section 141(c)(2). The issue also meets the private business tests of 
section 141(b).

[T.D. 8712, 62 FR 2296, Jan. 16, 1997, as amended by T.D. 9085, 68 FR 
45775, Aug. 4, 2003]



Sec. 1.141-6  Allocation and accounting rules.

    (a) Allocation of proceeds to expenditures. For purposes of 
Sec. Sec. 1.141-1 through 1.141-15, the provisions of Sec. 1.148-6(d) 
apply for purposes of allocating proceeds to expenditures. Thus, 
allocations generally may be made using any reasonable, consistently 
applied accounting method, and allocations

[[Page 651]]

under section 141 and section 148 must be consistent with each other.
    (b) Allocation of proceeds to property. [Reserved]
    (c) Special rules for mixed use facilities. [Reserved]
    (d) Allocation of proceeds to common areas. [Reserved]
    (e) Allocation of proceeds to bonds. [Reserved]
    (f) Treatment of partnerships. [Reserved]
    (g) Examples. [Reserved]

[T.D. 8712, 62 FR 2297, Jan. 16, 1997]



Sec. 1.141-7  Special rules for output facilities.

    (a) Overview. This section provides special rules to determine 
whether arrangements for the purchase of output from an output facility 
cause an issue of bonds to meet the private business tests. For this 
purpose, unless otherwise stated, water facilities are treated as output 
facilities. Sections 1.141-3 and 1.141-4 generally apply to determine 
whether other types of arrangements for use of an output facility cause 
an issue to meet the private business tests.
    (b) Definitions. For purposes of this section and Sec. 1.141-8, the 
following definitions and rules apply:
    (1) Available output. The available output of a facility financed by 
an issue is determined by multiplying the number of units produced or to 
be produced by the facility in one year by the number of years in the 
measurement period of that facility for that issue.
    (i) Generating facilities. The number of units produced or to be 
produced by a generating facility in one year is determined by reference 
to its nameplate capacity or the equivalent (or where there is no 
nameplate capacity or the equivalent, its maximum capacity), which is 
not reduced for reserves, maintenance or other unutilized capacity.
    (ii) Transmission and other output facilities--(A) In general. For 
transmission, distribution, cogeneration, and other output facilities, 
available output must be measured in a reasonable manner to reflect 
capacity.
    (B) Electric transmission facilities. Measurement of the available 
output of all or a portion of electric transmission facilities may be 
determined in a manner consistent with the reporting rules and 
requirements for transmission networks promulgated by the Federal Energy 
Regulatory Commission (FERC). For example, for a transmission network, 
the use of aggregate load and load share ratios in a manner consistent 
with the requirements of the FERC may be reasonable. In addition, 
depending on the facts and circumstances, measurement of the available 
output of transmission facilities using thermal capacity or transfer 
capacity may be reasonable.
    (iii) Special rule for facilities with significant unutilized 
capacity. If an issuer reasonably expects on the issue date that persons 
that are treated as private business users will purchase more than 30 
percent of the actual output of the facility financed with the issue, 
the Commissioner may determine the number of units produced or to be 
produced by the facility in one year on a reasonable basis other than by 
reference to nameplate or other capacity, such as the average expected 
annual output of the facility. For example, the Commissioner may 
determine the available output of a financed peaking electric generating 
unit by reference to the reasonably expected annual output of that unit 
if the issuer reasonably expects, on the issue date of bonds that 
finance the unit, that an investor-owned utility will purchase more than 
30 percent of the actual output of the facility during the measurement 
period under a take or pay contract, even if the amount of output 
purchased is less than 10 percent of the available output determined by 
reference to nameplate capacity. The reasonably expected annual output 
of the generating facility must be consistent with the capacity reported 
for prudent reliability purposes.
    (iv) Special rule for facilities with a limited source of supply. If 
a limited source of supply constrains the output of an output facility, 
the number of units produced or to be produced by the facility must be 
determined by reasonably taking into account those constraints. For this 
purpose, a limited source of supply shall include a physical limitation 
(for example, flow of water), but

[[Page 652]]

not an economic limitation (for example, cost of coal or gas). For 
example, the available output of a hydroelectric unit must be determined 
by reference to the reasonably expected annual flow of water through the 
unit.
    (2) Measurement period. The measurement period of an output facility 
financed by an issue is determined under Sec. 1.141-3(g).
    (3) Sale at wholesale. A sale at wholesale means a sale of output to 
any person for resale.
    (4) Take contract and take or pay contract. A take contract is an 
output contract under which a purchaser agrees to pay for the output 
under the contract if the output facility is capable of providing the 
output. A take or pay contract is an output contract under which a 
purchaser agrees to pay for the output under the contract, whether or 
not the output facility is capable of providing the output.
    (5) Requirements contract. A requirements contract is an output 
contract, other than a take contract or a take or pay contract, under 
which a nongovernmental person agrees to purchase all or part of its 
output requirements.
    (6) Nonqualified amount. The nonqualified amount with respect to an 
issue is determined under section 141(b)(8).
    (c) Output contracts--(1) General rule. The purchase pursuant to a 
contract by a nongovernmental person of available output of an output 
facility (output contract) financed with proceeds of an issue is taken 
into account under the private business tests if the purchase has the 
effect of transferring the benefits of owning the facility and the 
burdens of paying the debt service on bonds used (directly or 
indirectly) to finance the facility (the benefits and burdens test). See 
paragraph (c)(4) of this section for the treatment of an output contract 
that is properly characterized as a lease for Federal income tax 
purposes. See paragraphs (d) and (e) of this section for rules regarding 
measuring the use of, and payments of debt service for, an output 
facility for determining whether the private business tests are met. See 
also Sec. 1.141-8 for rules for when an issue that finances an output 
facility (other than a water facility) meets the private business tests 
because the nonqualified amount of the issue exceeds $15 million.
    (2) Take contract or take or pay contract. The benefits and burdens 
test is met if a nongovernmental person agrees pursuant to a take 
contract or a take or pay contract to purchase available output of a 
facility.
    (3) Requirements contract--(i) In general. A requirements contract 
may satisfy the benefits and burdens test under paragraph (c)(3)(ii) or 
(iii) of this section. See Sec. 1.141-15(f)(2) for special effective 
dates for the application of this paragraph (c)(3) to issues financing 
facilities subject to requirements contracts.
    (ii) Requirements contract similar to take contract or take or pay 
contract. A requirements contract generally meets the benefits and 
burdens test to the extent that it contains contractual terms that 
obligate the purchaser to make payments that are not contingent on the 
output requirements of the purchaser or that obligate the purchaser to 
have output requirements. For example, a requirements contract with an 
industrial purchaser meets the benefits and burdens test if the 
purchaser enters into additional contractual obligations with the issuer 
or another governmental unit not to cease operations. A requirements 
contract does not meet the benefits and burdens test, however, by reason 
of a provision that requires the purchaser to pay reasonable and 
customary damages (including liquidated damages) in the event of a 
default, or a provision that permits the purchaser to pay a specified 
amount to terminate the contract while the purchaser has requirements, 
in each case if the amount of the payment is reasonably related to the 
purchaser's obligation to buy requirements that is discharged by the 
payment.
    (iii) Wholesale requirements contract--(A) In general. A 
requirements contract that is a sale at wholesale (a wholesale 
requirements contract) may satisfy the benefits and burdens test, 
depending on all the facts and circumstances.
    (B) Significant factors. Significant factors that tend to establish 
that a wholesale requirements contract meets the benefits and burdens 
test include, but are not limited to--

[[Page 653]]

    (1) The term of the contract is substantial relative to the term of 
the issue or issues that finance the facility; and
    (2) The amount of output to be purchased under the contract 
represents a substantial portion of the available output of the 
facility.
    (C) Safe harbors. A wholesale requirements contract does not meet 
the benefits and burdens test if--
    (1) The term of the contract, including all renewal options, does 
not exceed the lesser of 5 years or 30 percent of the term of the issue; 
or
    (2) The amount of output to be purchased under the contract (and any 
other requirements contract with the same purchaser or a related party 
with respect to the facility) does not exceed 5 percent of the available 
output of the facility.
    (iv) Retail requirements contract. Except as otherwise provided in 
this paragraph (c)(3), a requirements contract that is not a sale at 
wholesale does not meet the benefits and burdens test.
    (4) Output contract properly characterized as a lease. 
Notwithstanding any other provision of this section, an output contract 
that is properly characterized as a lease for Federal income tax 
purposes shall be tested under the rules contained in Sec. Sec. 1.141-3 
and 1.141-4 to determine whether it is taken into account under the 
private business tests.
    (d) Measurement of private business use. If an output contract 
results in private business use under this section, the amount of 
private business use generally is the amount of output purchased under 
the contract.
    (e) Measurement of private security or payment. The measurement of 
payments made or to be made by nongovernmental persons under output 
contracts as a percent of the debt service of an issue is determined 
under the rules provided in Sec. 1.141-4.
    (f) Exceptions for certain contracts--(1) Small purchases of output. 
An output contract for the use of a facility is not taken into account 
under the private business tests if the average annual payments to be 
made under the contract do not exceed 1 percent of the average annual 
debt service on all outstanding tax-exempt bonds issued to finance the 
facility, determined as of the effective date of the contract.
    (2) Swapping and pooling arrangements. An agreement that provides 
for swapping or pooling of output by one or more governmental persons 
and one or more nongovernmental persons does not result in private 
business use of the output facility owned by the governmental person to 
the extent that--
    (i) The swapped output is reasonably expected to be approximately 
equal in value (determined over periods of three years or less); and
    (ii) The purpose of the agreement is to enable each of the parties 
to satisfy different peak load demands, to accommodate temporary 
outages, to diversify supply, or to enhance reliability in accordance 
with prudent reliability standards.
    (3) Short-term output contracts. An output contract with a 
nongovernmental person is not taken into account under the private 
business tests if--
    (i) The term of the contract, including all renewal options, is not 
longer than 3 years;
    (ii) The contract either is a negotiated, arm's-length arrangement 
that provides for compensation at fair market value, or is based on 
generally applicable and uniformly applied rates; and
    (iii) The output facility is not financed for a principal purpose of 
providing that facility for use by that nongovernmental person.
    (4) Certain conduit parties disregarded. A nongovernmental person 
acting solely as a conduit for the exchange of output among 
governmentally owned and operated utilities is disregarded in 
determining whether the private business tests are met with respect to 
financed facilities owned by a governmental person.
    (g) Special rules for electric output facilities used to provide 
open access--(1) Operation of transmission facilities by nongovernmental 
persons--(i) In general. The operation of an electric transmission 
facility by a nongovernmental person may result in private business use 
of the facility under Sec. 1.141-3 and this section based on all the 
facts and circumstances. For example, a transmission facility is 
generally used for a

[[Page 654]]

private business use if a nongovernmental person enters into a contract 
to operate the facility and receives compensation based, in whole or in 
part, on a share of net profits from the operation of the facility.
    (ii) Certain use by independent transmission operators. A contract 
for the operation of an electric transmission facility by an independent 
entity, such as a regional transmission organization or an independent 
system operator (independent transmission operator), does not constitute 
private business use of the facility if--
    (A) The facility is owned by a governmental person;
    (B) The operation of the facility by the independent transmission 
operator is approved by the FERC under one or more provisions of the 
Federal Power Act (16 U.S.C. 791a through 825r) (or by a state authority 
under comparable provisions of state law);
    (C) No portion of the compensation of the independent transmission 
operator is based on a share of net profits from the operation of the 
facility; and
    (D) The independent transmission operator does not bear risk of loss 
of the facility.
    (2) Certain use by nongovernmental persons under output contracts--
(i) Transmission facilities. The use of an electric transmission 
facility by a nongovernmental person pursuant to an output contract does 
not constitute private business use of the facility if--
    (A) The facility is owned by a governmental person;
    (B) The facility is operated by an independent transmission operator 
in a manner that satisfies paragraph (g)(1)(ii) of this section; and
    (C) The facility is not financed for a principal purpose of 
providing that facility for use by that nongovernmental person.
    (ii) Distribution facilities. The use of an electric distribution 
facility by a nongovernmental person pursuant to an output contract does 
not constitute private business use of the facility if--
    (A) The facility is owned by a governmental person;
    (B) The facility is available for use on a nondiscriminatory, open 
access basis by buyers and sellers of electricity in accordance with 
rates that are generally applicable and uniformly applied within the 
meaning of Sec. 1.141-3(c)(2); and
    (C) The facility is not financed for a principal purpose of 
providing that facility for use by that nongovernmental person (other 
than a retail end-user).
    (3) Ancillary services. The use of an electric output facility to 
provide ancillary services required to be offered as part of an open 
access transmission tariff under rules promulgated by the FERC under the 
Federal Power Act (16 U.S.C. 791a through 825r) (or by a state 
regulatory authority under comparable provisions of state law) does not 
result in private business use.
    (4) Exceptions to deliberate action rules--(i) Mandated wheeling. 
Entering into a contract for the use of electric transmission or 
distribution facilities is not treated as a deliberate action under 
Sec. 1.141-2(d) if--
    (A) The contract is entered into in response to (or in anticipation 
of) an order by the United States under sections 211 and 212 of the 
Federal Power Act (16 U.S.C. 824j and 824k) (or a state regulatory 
authority under comparable provisions of state law); and
    (B) The terms of the contract are bona fide and arm's-length, and 
the consideration paid is consistent with the provisions of section 
212(a) of the Federal Power Act.
    (ii) Actions taken to implement non-discriminatory, open access. An 
action is not treated as a deliberate action under Sec. 1.141-2(d) if 
it is taken to implement the offering of non-discriminatory, open access 
tariffs for the use of electric transmission or distribution facilities 
in a manner consistent with rules promulgated by the FERC under sections 
205 and 206 of the Federal Power Act (16 U.S.C. 824d and 824e) (or 
comparable provisions of state law). This paragraph (g)(4)(ii) does not 
apply, however, to the sale, exchange, or other disposition (within the 
meaning of section 1001(a)) of transmission or distribution facilities 
to a nongovernmental person.
    (iii) Application of reasonable expectations test to certain current 
refunding bonds. An action taken or to be taken with respect to electric 
transmission or distribution facilities refinanced by an issue is not 
taken into account under

[[Page 655]]

the reasonable expectations test of Sec. 1.141-2(d) if--
    (A) The action is described in paragraph (g)(4)(i) or (ii) of this 
section;
    (B) The bonds of the issue are current refunding bonds that refund 
bonds originally issued before February 23, 1998; and
    (C) The weighted average maturity of the refunding bonds is not 
greater than the remaining weighted average maturity of the prior bonds.
    (5) Additional transactions as permitted by the Commissioner. The 
Commissioner may, by published guidance, set forth additional 
circumstances in which the use of electric output facilities in a 
restructured electric industry does not constitute private business use.
    (h) Allocations of output facilities and systems--(1) Facts and 
circumstances analysis. Whether output sold under an output contract is 
allocated to a particular facility (for example, a generating unit), to 
the entire system of the seller of that output (net of any uses of that 
system output allocated to a particular facility), or to a portion of a 
facility is based on all the facts and circumstances. Significant 
factors to be considered in determining the allocation of an output 
contract to financed property are the following:
    (i) The extent to which it is physically possible to deliver output 
to or from a particular facility or system.
    (ii) The terms of a contract relating to the delivery of output 
(such as delivery limitations and options or obligations to deliver 
power from additional sources).
    (iii) Whether a contract is entered into as part of a common plan of 
financing for a facility.
    (iv) The method of pricing output under the contract, such as the 
use of market rates rather than rates designed to pay debt service of 
tax-exempt bonds used to finance a particular facility.
    (2) Illustrations. The following illustrate the factors set forth in 
paragraph (h)(1) of this section:
    (i) Physical possibility. Output from a generating unit that is fed 
directly into a low voltage distribution system of the owner of that 
unit and that cannot physically leave that distribution system generally 
must be allocated to those receiving electricity through that 
distribution system. Output may be allocated without regard to physical 
limitations, however, if exchange or similar agreements provide output 
to a purchaser where, but for the exchange agreements, it would not be 
possible for the seller to provide output to that purchaser.
    (ii) Contract terms relating to performance. A contract to provide a 
specified amount of electricity from a system, but only when at least 
that amount of electricity is being generated by a particular unit, is 
allocated to that unit. For example, a contract to buy 20 MW of system 
power with a right to take up to 40 percent of the actual output of a 
specific 50 MW facility whenever total system output is insufficient to 
meet all of the seller's obligations generally is allocated to the 
specific facility rather than to the system.
    (iii) Common plan of financing. A contract entered into as part of a 
common plan of financing for a facility generally is allocated to the 
facility if debt service for the issue of bonds is reasonably expected 
to be paid, directly or indirectly, from payments under the contract.
    (iv) Pricing method. Pricing based on the capital and generating 
costs of a particular turbine tends to indicate that output under the 
contract is properly allocated to that turbine.
    (3) Transmission and distribution contracts. Whether use under an 
output contract for transmission or distribution is allocated to a 
particular facility or to a transmission or distribution network is 
based on all the facts and circumstances, in a manner similar to 
paragraphs (h)(1) and (2) of this section. In general, the method used 
to determine payments under a contract is a more significant contract 
term for this purpose than nominal contract path. In general, if 
reasonable and consistently applied, the determination of use of 
transmission or distribution facilities under an output contract may be 
based on a method used by third parties, such as reliability councils.
    (4) Allocation of payments. Payments for output provided by an 
output facility financed with two or more sources of funding are 
generally allocated under the rules in Sec. 1.141-4(c).

[[Page 656]]

    (i) Examples. The following examples illustrate the application of 
this section:

    Example 1. Joint ownership. Z, an investor-owned electric utility, 
and City H agree to construct an electric generating facility of a size 
sufficient to take advantage of the economies of scale. H will issue $50 
million of its 24-year bonds, and Z will use $100 million of its funds 
for construction of a facility they will jointly own as tenants in 
common. Each of the participants will share in the ownership, output, 
and operating expenses of the facility in proportion to its contribution 
to the cost of the facility, that is, one-third by H and two-thirds by 
Z. H's bonds will be secured by H's ownership interest in the facility 
and by revenues to be derived from its share of the annual output of the 
facility. H will need only 50 percent of its share of the annual output 
of the facility during the first 20 years of operations. It agrees to 
sell 10 percent of its share of the annual output to Z for a period of 
20 years pursuant to a contract under which Z agrees to take that power 
if available. The facility will begin operation, and Z will begin to 
receive power, 4 years after the H bonds are issued. The measurement 
period for the property financed by the issue is 20 years. H also will 
sell the remaining 40 percent of its share of the annual output to 
numerous other private utilities under contracts of three years or less 
that satisfy the exception under paragraph (f)(3) of this section. No 
other contracts will be executed obligating any person to purchase any 
specified amount of the power for any specified period of time. No 
person (other than Z) will make payments that will result in a transfer 
of the burdens of paying debt service on bonds used directly or 
indirectly to provide H's share of the facilities. The bonds are not 
private activity bonds, because H's one-third interest in the facility 
is not treated as used by the other owners of the facility. Although 10 
percent of H's share of the annual output of the facility will be used 
in the trade or business of Z, a nongovernmental person, under this 
section, that portion constitutes not more than 10 percent of the 
available output of H's ownership interest in the facility.
    Example 2. Wholesale requirements contract. (i) City J issues 20-
year bonds to acquire an electric generating facility having a 
reasonably expected economic life substantially greater than 20 years 
and a nameplate capacity of 100 MW. The available output of the facility 
under paragraph (b)(1) of this section is approximately 17,520,000 MWh 
(100 MW x 24 hours x 365 days x 20 years). On the issue date, J enters 
into a contract with T, an investor-owned utility, to provide T with all 
of its power requirements for a period of 10 years, commencing on the 
issue date. J reasonably expects that T will actually purchase an 
average of 30 MW over the 10-year period. The contract is taken into 
account under the private business tests pursuant to paragraph (c)(3) of 
this section because the term of the contract is substantial relative to 
the term of the issue and the amount of output to be purchased is a 
substantial portion of the available output.
    (ii) Under paragraph (d) of this section, the amount of reasonably 
expected private business use under this contract is approximately 15 
percent (30 MW x 24 hours x 365 days x 10 years, or 2,628,000 MWh) of 
the available output. Accordingly, the issue meets the private business 
use test. J reasonably expects that the amount to be paid for an average 
of 30 MW of power (less the operation and maintenance costs directly 
attributable to generating that 30 MW of power), will be more than 10 
percent of debt service on the issue on a present-value basis. 
Accordingly, the issue meets the private security or payment test 
because J reasonably expects that payment of more than 10 percent of the 
debt service will be indirectly derived from payments by T. The bonds 
are private activity bonds under paragraph (c) of this section. Further, 
if 15 percent of the sale proceeds of the issue is greater than $15 
million and the issue meets the private security or payment test with 
respect to the $15 million output limitation, the bonds are also private 
activity bonds under section 141(b)(4). See Sec. 1.141-8.
    Example 3. Retail contracts. (i) State Agency M, a political 
subdivision, issues bonds in 2003 to finance the construction of a 
generating facility that will be used to furnish electricity to M's 
retail customers. In 2007, M enters into a 10-year contract with 
industrial corporation I. Under the contract, M agrees to supply I with 
all of its power requirements during the contract term, and I agrees to 
pay for that power at a negotiated price as it is delivered. The 
contract does not require I to pay for any power except to the extent I 
has requirements. In addition, the contract requires I to pay reasonable 
and customary liquidated damages in the event of a default by I, and 
permits I to terminate the contract while it has requirements by paying 
M a specified amount that is a reasonable and customary amount for 
terminating the contract. Any damages or termination payment by I will 
be reasonably related to I's obligation to buy requirements that is 
discharged by the payment. Under paragraph (c)(3) of this section, the 
contract does not meet the benefits and burdens test. Thus, it is not 
taken into account under the private business tests.
    (ii) The facts are the same as in paragraph (i) of this Example 3, 
except that the contract requires I to make guaranteed minimum payments, 
regardless of I's requirements, in an amount such that the contract does 
not meet the exception for small purchases in

[[Page 657]]

paragraph (f)(1) of this section. Under paragraph (c)(3)(ii) of this 
section, the contract meets the benefits and burdens test because it 
obligates I to make payments that are not contingent on its output 
requirements. Thus, it is taken into account under the private business 
tests.
    Example 4. Allocation of existing contracts to new facilities. Power 
Authority K, a political subdivision created by the legislature in State 
X to own and operate certain power generating facilities, sells all of 
the power from its existing facilities to four private utility systems 
under contracts executed in 1999, under which the four systems are 
required to take or pay for specified portions of the total power output 
until the year 2029. Existing facilities supply all of the present needs 
of the four utility systems, but their future power requirements are 
expected to increase substantially beyond the capacity of K's current 
generating system. K issues 20-year bonds in 2004 to construct a large 
generating facility. As part of the financing plan for the bonds, a 
fifth private utility system contracts with K to take or pay for 15 
percent of the available output of the new facility. The balance of the 
output of the new facility will be available for sale as required, but 
initially it is not anticipated that there will be any need for that 
power. The revenues from the contract with the fifth private utility 
system will be sufficient to pay less than 10 percent of the debt 
service on the bonds (determined on a present value basis). The balance, 
which will exceed 10 percent of the debt service on the bonds, will be 
paid from revenues derived from the contracts with the four systems 
initially from sale of power produced by the old facilities. The output 
contracts with all the private utilities are allocated to K's entire 
generating system. See paragraphs (h)(1) and (2) of this section. Thus, 
the bonds meet the private business use test because more than 10 
percent of the proceeds will be used in the trade or business of a 
nongovernmental person. In addition, the bonds meet the private security 
or payment test because payment of more than 10 percent of the debt 
service, pursuant to underlying arrangements, will be derived from 
payments in respect of property used for a private business use.
    Example 5. Allocation to displaced resource. Municipal utility MU, a 
political subdivision, purchases all of the electricity required to meet 
the needs of its customers (1,000 MW) from B, an investor-owned utility 
that operates its own electric generating facilities, under a 50-year 
take or pay contract. MU does not anticipate that it will require 
additional electric resources, and any new resources would produce 
electricity at a higher cost to MU than its cost under its contract with 
B. Nevertheless, B encourages MU to construct a new generating plant 
sufficient to meet MU's requirements. MU issues obligations to construct 
facilities that will produce 1,000 MW of electricity. MU, B, and I, 
another investor-owned utility, enter into an agreement under which MU 
assigns to I its rights under MU's take or pay contract with B. Under 
this arrangement, I will pay MU, and MU will continue to pay B, for the 
1,000 MW. I's payments to MU will at least equal the amounts required to 
pay debt service on MU's bonds. In addition, under paragraph (h)(1)(iii) 
of this section, the contract among MU, B, and I is entered into as part 
of a common plan of financing of the MU facilities. Under all the facts 
and circumstances, MU's assignment to I of its rights under the original 
take or pay contract is allocable to MU's new facilities under paragraph 
(h) of this section. Because I is a nongovernmental person, MU's bonds 
are private activity bonds.
    Example 6. Operation of transmission facilities by regional 
transmission organization. (i) Public Power Agency D is a political 
subdivision that owns and operates electric generation, transmission and 
distribution facilities. In 2003, D transfers operating control of its 
transmission system to a regional transmission organization (RTO), a 
nongovernmental person, pursuant to an operating agreement that is 
approved by the FERC under sections 205 and 206 of the Federal Power 
Act. D retains ownership of its facilities. No portion of the RTO's 
compensation is based on a share of net profits from the operation of 
D's facilities, and the RTO does not bear any risk of loss of those 
facilities. Under paragraph (g)(1)(ii) of this section, the RTO's use of 
D's facilities does not constitute a private business use.
    (ii) Company A is located in D's service territory. In 2004, Power 
Supplier E, a nongovernmental person, enters into a 10-year contract 
with A to supply A's electricity requirements. The electricity supplied 
by E to A will be transmitted over D's transmission and distribution 
facilities. D's distribution facilities are available for use on a 
nondiscriminatory, open access basis by buyers and sellers of 
electricity in accordance with rates that are generally applicable and 
uniformly applied within the meaning of Sec. 1.141-3(c)(2). D's 
facilities are not financed for a principal purpose of providing the 
facilities for use by E. Under paragraph (g)(2) of this section, the 
contract between A and E does not result in private business use of D's 
facilities.
    Example 7. Certain actions not treated as deliberate actions. The 
facts are the same as in Example 6 of this paragraph (i), except that 
the RTO's compensation is based on a share of net profits from operating 
D's facilities. In addition, D had issued bonds in 1994 to finance 
improvements to its transmission system. At the time D transfers 
operating control of its transmission system to the RTO, D chooses to 
apply the private activity bond

[[Page 658]]

regulations of Sec. Sec. 1.141-1 through 1.141-15 to the 1994 bonds. 
The operation of D's facilities by the RTO results in private business 
use under Sec. 1.141-3 and paragraph (g)(1)(i) of this section. Under 
the special exception in paragraph (g)(4)(ii) of this section, however, 
the transfer of control is not treated as a deliberate action. 
Accordingly, the transfer of control does not cause the 1994 bonds to 
meet the private activity bond tests.
    Example 8. Current refunding. The facts are the same as in Example 7 
of this paragraph (i), and in addition D issues bonds in 2004 to 
currently refund the 1994 bonds. The weighted average maturity of the 
2004 bonds is not greater than the remaining weighted average maturity 
of the 1994 bonds. D chooses to apply the private activity bond 
regulations of Sec. Sec. 1.141-1 through 1.141-15 to the refunding 
bonds. In general, reasonable expectations must be separately tested on 
the date that refunding bonds are issued under Sec. 1.141-2(d). Under 
the special exception in paragraph (g)(4)(iii) of this section, however, 
the transfer of the financed facilities to the RTO need not be taken 
into account in applying the reasonable expectations test to the 
refunding bonds.

[T.D. 9016, 67 FR 59759, Sept. 23, 2002; 67 FR 70845, Nov. 27, 2002]



Sec. 1.141-8  $15 million limitation for output facilities.

    (a) In general--(1) General rule. Section 141(b)(4) provides a 
special private activity bond limitation (the $15 million output 
limitation) for issues 5 percent or more of the proceeds of which are to 
be used to finance output facilities (other than a facility for the 
furnishing of water). Under this rule, an issue consists of private 
activity bonds under the private business tests of section 141(b)(1) and 
(2) if the nonqualified amount with respect to output facilities 
financed by the proceeds of the issue exceeds $15 million. The $15 
million output limitation applies in addition to the private business 
tests of section 141(b)(1) and (2). Under section 141(b)(4) and 
paragraph (a)(2) of this section, the $15 million output limitation is 
reduced in certain cases. Specifically, an issue meets the test in 
section 141(b)(4) if both of the following tests are met:
    (i) More than $15 million of the proceeds of the issue to be used 
with respect to an output facility are to be used for a private business 
use. Investment proceeds are disregarded for this purpose if they are 
not allocated disproportionately to the private business use portion of 
the issue.
    (ii) The payment of the principal of, or the interest on, more than 
$15 million of the sale proceeds of the portion of the issue used with 
respect to an output facility is (under the terms of the issue or any 
underlying arrangement) directly or indirectly--
    (A) Secured by any interest in an output facility used or to be used 
for a private business use (or payments in respect of such an output 
facility); or
    (B) To be derived from payments (whether or not to the issuer) in 
respect of an output facility used or to be used for a private business 
use.
    (2) Reduction in $15 million output limitation for outstanding 
issues--(i) General rule. In determining whether an issue 5 percent or 
more of the proceeds of which are to be used with respect to an output 
facility consists of private activity bonds under the $15 million output 
limitation, the $15 million limitation on private business use and 
private security or payments is applied by taking into account the 
aggregate nonqualified amounts of any outstanding bonds of other issues 
5 percent or more of the proceeds of which are or will be used with 
respect to that output facility or any other output facility that is 
part of the same project.
    (ii) Bonds taken into account. For purposes of this paragraph 
(a)(2), in applying the $15 million output limitation to an issue (the 
later issue), a tax-exempt bond of another issue (the earlier issue) is 
taken into account if--
    (A) That bond is outstanding on the issue date of the later issue;
    (B) That bond will not be redeemed within 90 days of the issue date 
of the later issue in connection with the refunding of that bond by the 
later issue; and
    (C) 5 percent or more of the sale proceeds of the earlier issue 
financed an output facility that is part of the same project as the 
output facility that is financed by 5 percent or more of the sale 
proceeds of the later issue.
    (3) Benefits and burdens test applicable--(i) In general. In 
applying the $15 million output limitation, the benefits and burdens 
test of Sec. 1.141-7 applies, except that ``$15 million'' is applied in

[[Page 659]]

place of ``10 percent'', or ``5 percent'' as appropriate.
    (ii) Earlier issues for the project. If bonds of an earlier issue 
are outstanding and must be taken into account under paragraph (a)(2) of 
this section, the nonqualified amount for that earlier issue is 
multiplied by a fraction, the numerator of which is the adjusted issue 
price of the earlier issue as of the issue date of the later issue, and 
the denominator of which is the issue price of the earlier issue. Pre-
issuance accrued interest as defined in Sec. 1.148-1(b) is disregarded 
for this purpose.
    (b) Definition of project--(1) General rule. For purposes of 
paragraph (a)(2) of this section, project has the meaning provided in 
this paragraph. Facilities that are functionally related and subordinate 
to a project are treated as part of that same project. Facilities having 
different purposes or serving different customer bases are not 
ordinarily part of the same project. For example, the following are 
generally not part of the same project--
    (i) Generation, transmission and distribution facilities;
    (ii) Separate facilities designed to serve wholesale customers and 
retail customers; and
    (iii) A peaking unit and a baseload unit (regardless of the location 
of the units).
    (2) Separate ownership. Except as otherwise provided in this 
paragraph (b)(2), facilities that are not owned by the same person are 
not part of the same project. If different governmental persons act in 
concert to finance a project, however (for example as participants in a 
joint powers authority), their interests are aggregated with respect to 
that project to determine whether the $15 million output limitation is 
met. In the case of undivided ownership interests in a single output 
facility, property that is not owned by different persons is treated as 
separate projects only if the separate interests are financed--
    (i) With bonds of different issuers; and
    (ii) Without a principal purpose of avoiding the limitation in this 
section.
    (3) Generating property--(i) Property on same site. In the case of 
generation and related facilities, project means property located at the 
same site.
    (ii) Special rule for generating units. Separate generating units 
are not part of the same project if one unit is reasonably expected, on 
the issue date of each issue that finances the units, to be placed in 
service more than 3 years before the other. Common facilities or 
property that will be functionally related to more than one generating 
unit must be allocated on a reasonable basis. If a generating unit 
already is constructed or is under construction (the first unit) and 
bonds are to be issued to finance an additional generating unit (the 
second unit), all costs for any common facilities paid or incurred 
before the earlier of the issue date of bonds to finance the second unit 
or the commencement of construction of the second unit are allocated to 
the first unit. At the time that bonds are issued to finance the second 
unit (or, if earlier, upon commencement of construction of that unit), 
any remaining costs of the common facilities may be allocated between 
the first and second units so that in the aggregate the allocation is 
reasonable.
    (4) Transmission and distribution. In the case of transmission or 
distribution facilities, project means functionally related or 
contiguous property. Separate transmission or distribution facilities 
are not part of the same project if one facility is reasonably expected, 
on the issue date of each issue that finances the facilities, to be 
placed in service more than 2 years before the other.
    (5) Subsequent improvements--(i) In general. An improvement to 
generation, transmission or distribution facilities that is not part of 
the original design of those facilities (the original project) is not 
part of the same project as the original project if the construction, 
reconstruction, or acquisition of that improvement commences more than 3 
years after the original project was placed in service and the bonds 
issued to finance that improvement are issued more than 3 years after 
the original project was placed in service.
    (ii) Special rule for transmission and distribution facilities. An 
improvement

[[Page 660]]

to transmission or distribution facilities that is not part of the 
original design of that property is not part of the same project as the 
original project if the issuer did not reasonably expect the need to 
make that improvement when it commenced construction of the original 
project and the construction, reconstruction, or acquisition of that 
improvement is mandated by the federal government or a state regulatory 
authority to accommodate requests for wheeling.
    (6) Replacement property. For purposes of this section, property 
that replaces existing property of an output facility is treated as part 
of the same project as the replaced property unless--
    (i) The need to replace the property was not reasonably expected on 
the issue date or the need to replace the property occurred more than 3 
years before the issuer reasonably expected (determined on the issue 
date of the bonds financing the property) that it would need to replace 
the property; and
    (ii) The bonds that finance (and refinance) the output facility have 
a weighted average maturity that is not greater than 120 percent of the 
reasonably expected economic life of the facility.
    (c) Example. The application of the provisions of this section is 
illustrated by the following example:

    Example. (i) Power Authority K, a political subdivision, intends to 
issue a single issue of tax-exempt bonds at par with a stated principal 
amount and sale proceeds of $500 million to finance the acquisition of 
an electric generating facility. No portion of the facility will be used 
for a private business use, except that L, an investor-owned utility, 
will purchase 10 percent of the output of the facility under a take 
contract and will pay 10 percent of the debt service on the bonds. The 
nonqualified amount with respect to the bonds is $50 million.
    (ii) The maximum amount of tax-exempt bonds that may be issued for 
the acquisition of an interest in the facility in paragraph (i) of this 
Example is $465 million (that is, $450 million for the 90 percent of the 
facility that is governmentally owned and used plus a nonqualified 
amount of $15 million).

[T.D. 9016, 67 FR 59763, Sept. 23, 2002]



Sec. 1.141-9  Unrelated or disproportionate use test.

    (a) General rules--(1) Description of test. Under section 141(b)(3) 
(the unrelated or disproportionate use test), an issue meets the private 
business tests if the amount of private business use and private 
security or payments attributable to unrelated or disproportionate 
private business use exceeds 5 percent of the proceeds of the issue. For 
this purpose, the private business use test is applied by taking into 
account only use that is not related to any government use of proceeds 
of the issue (unrelated use) and use that is related but 
disproportionate to any government use of those proceeds 
(disproportionate use).
    (2) Application of unrelated or disproportionate use test--(i) Order 
of application. The unrelated or disproportionate use test is applied by 
first determining whether a private business use is related to a 
government use. Next, private business use that relates to a government 
use is examined to determine whether it is disproportionate to that 
government use.
    (ii) Aggregation of unrelated and disproportionate use. All the 
unrelated use and disproportionate use financed with the proceeds of an 
issue are aggregated to determine compliance with the unrelated or 
disproportionate use test. The amount of permissible unrelated and 
disproportionate private business use is not reduced by the amount of 
private business use financed with the proceeds of an issue that is 
neither unrelated use nor disproportionate use.
    (iii) Deliberate actions. A deliberate action that occurs after the 
issue date does not result in unrelated or disproportionate use if the 
issue meets the conditions of Sec. 1.141-12(a).
    (b) Unrelated use--(1) In general. Whether a private business use is 
related to a government use financed with the proceeds of an issue is 
determined on a case-by-case basis, emphasizing the operational 
relationship between the government use and the private business use. In 
general, a facility that is used for a related private business use must 
be located within, or adjacent to, the governmentally used facility.
    (2) Use for the same purpose as government use. Use of a facility by 
a nongovernmental person for the same purpose as use by a governmental 
person is not treated as unrelated use if the

[[Page 661]]

government use is not insignificant. Similarly, a use of a facility in 
the same manner both for private business use that is related use and 
private business use that is unrelated use does not result in unrelated 
use if the related use is not insignificant. For example, a privately 
owned pharmacy in a governmentally owned hospital does not ordinarily 
result in unrelated use solely because the pharmacy also serves 
individuals not using the hospital. In addition, use of parking spaces 
in a garage by a nongovernmental person is not treated as unrelated use 
if more than an insignificant portion of the parking spaces are used for 
a government use (or a private business use that is related to a 
government use), even though the use by the nongovernmental person is 
not directly related to that other use.
    (c) Disproportionate use--(1) Definition of disproportionate use. A 
private business use is disproportionate to a related government use 
only to the extent that the amount of proceeds used for that private 
business use exceeds the amount of proceeds used for the related 
government use. For example, a private use of $100 of proceeds that is 
related to a government use of $70 of proceeds results in $30 of 
disproportionate use.
    (2) Aggregation of related uses. If two or more private business 
uses of the proceeds of an issue relate to a single government use of 
those proceeds, those private business uses are aggregated to apply the 
disproportionate use test.
    (3) Allocation rule. If a private business use relates to more than 
a single use of the proceeds of the issue (for example, two or more 
government uses of the proceeds of the issue or a government use and a 
private use), the amount of any disproportionate use may be determined 
by--
    (i) Reasonably allocating the proceeds used for the private business 
use among the related uses;
    (ii) Aggregating government uses that are directly related to each 
other; or
    (iii) Allocating the private business use to the government use to 
which it is primarily related.
    (d) Maximum use taken into account. The determination of the amount 
of unrelated use or disproportionate use of a facility is based on the 
maximum amount of reasonably expected government use of a facility 
during the measurement period. Thus, no unrelated use or 
disproportionate use arises solely because a facility initially has 
excess capacity that is to be used by a nongovernmental person if the 
facility will be completely used by the issuer during the term of the 
issue for more than an insignificant period.
    (e) Examples. The following examples illustrate the application of 
this section:
    Example 1. School and remote cafeteria. County X issues bonds with 
proceeds of $20 million and uses $18.1 million of the proceeds for 
construction of a new school building and $1.9 million of the proceeds 
for construction of a privately operated cafeteria in its administrative 
office building, which is located at a remote site. The bonds are 
secured, in part, by the cafeteria. The $1.9 million of proceeds is 
unrelated to the government use (that is, school construction) financed 
with the bonds and exceeds 5 percent of $20 million. Thus, the issue 
meets the private business tests.
    Example 2. Public safety building and courthouse. City Y issues 
bonds with proceeds of $50 million for construction of a new public 
safety building ($32 million) and for improvements to an existing 
courthouse ($15 million). Y uses $3 million of the bond proceeds for 
renovations to an existing privately operated cafeteria located in the 
courthouse. The bonds are secured, in part, by the cafeteria. Y's use of 
the $3 million for the privately operated cafeteria does not meet the 
unrelated or disproportionate use test because these expenditures are 
neither unrelated use nor disproportionate use.
    Example 3. Unrelated garage. City Y issues bonds with proceeds of 
$50 million for construction of a new public safety building ($30.5 
million) and for improvements to an existing courthouse ($15 million). Y 
uses $3 million of the bond proceeds for renovations to an existing 
privately operated cafeteria located in the courthouse. The bonds are 
secured, in part, by the cafeteria. Y also uses $1.5 million of the 
proceeds to construct a privately operated parking garage adjacent to a 
private office building. The private business use of the parking garage 
is unrelated to any government use of proceeds of the issue. Since the 
proceeds used for unrelated uses and disproportionate uses do not exceed 
5 percent of the proceeds, the unrelated or disproportionate use test is 
not met.

[[Page 662]]

    Example 4. Disproportionate use of garage. County Z issues bonds 
with proceeds of $20 million for construction of a hospital with no 
private business use ($17 million); renovation of an office building 
with no private business use ($1 million); and construction of a garage 
that is entirely used for a private business use ($2 million). The use 
of the garage is related to the use of the office building but not to 
the use of the hospital. The private business use of the garage results 
in $1 million of disproportionate use because the proceeds used for the 
garage ($2 million) exceed the proceeds used for the related government 
use ($1 million). The bonds are not private activity bonds, however, 
because the disproportionate use does not exceed 5 percent of the 
proceeds of the issue.
    Example 5. Bonds for multiple projects. (i) County W issues bonds 
with proceeds of $80 million for the following purposes: (1) $72 million 
to construct a County-owned and operated waste incinerator; (2) $1 
million for a County-owned and operated facility for the temporary 
storage of hazardous waste prior to final disposal; (3) $1 million to 
construct a privately owned recycling facility located at a remote site; 
and (4) $6 million to build a garage adjacent to the County-owned 
incinerator that will be leased to Company T to store and repair trucks 
that it owns and uses to haul County W refuse. Company T uses 75 percent 
of its trucks to haul materials to the incinerator and the remaining 25 
percent of its trucks to haul materials to the temporary storage 
facility.
    (ii) The $1 million of proceeds used for the recycling facility is 
used for an unrelated use. The garage is related use. In addition, 75 
percent of the use of the $6 million of proceeds used for the garage is 
allocable to the government use of proceeds at the incinerator. The 
remaining 25 percent of the proceeds used for the garage ($1.5 million) 
relates to the government use of proceeds at the temporary storage 
facility. Thus, this portion of the proceeds used for the garage exceeds 
the proceeds used for the temporary storage facility by $0.5 million and 
this excess is disproportionate use (but not unrelated use). Thus, the 
aggregate amount of unrelated use and disproportionate use financed with 
the proceeds of the issue is $1.5 million. Alternatively, under 
paragraph (c)(3)(iii) of this section, the entire garage may be treated 
as related to the government use of the incinerator and, under that 
allocation, the garage is not disproportionate use. In either event, 
section 141(b)(3) limits the aggregate unrelated use and 
disproportionate use to $4 million. Therefore, the bonds are not private 
activity bonds under this section.

[T.D. 8712, 62 FR 2297, Jan. 16, 1997]



Sec. 1.141-10  Coordination with volume cap. [Reserved]



Sec. 1.141-11  Acquisition of nongovernmental output property. [Reserved]



Sec. 1.141-12  Remedial actions.

    (a) Conditions to taking remedial action. An action that causes an 
issue to meet the private business tests or the private loan financing 
test is not treated as a deliberate action if the issuer takes a 
remedial action described in paragraph (d), (e), or (f) of this section 
with respect to the nonqualified bonds and if all of the requirements in 
paragraphs (a) (1) through (5) of this section are met.
    (1) Reasonable expectations test met. The issuer reasonably expected 
on the issue date that the issue would meet neither the private business 
tests nor the private loan financing test for the entire term of the 
bonds. For this purpose, if the issuer reasonably expected on the issue 
date to take a deliberate action prior to the final maturity date of the 
issue that would cause either the private business tests or the private 
loan financing test to be met, the term of the bonds for this purpose 
may be determined by taking into account a redemption provision if the 
provisions of Sec. 1.141-2(d)(2)(ii) (A) through (C) are met.
    (2) Maturity not unreasonably long. The term of the issue must not 
be longer than is reasonably necessary for the governmental purposes of 
the issue (within the meaning of Sec. 1.148-1(c)(4)). Thus, this 
requirement is met if the weighted average maturity of the bonds of the 
issue is not greater than 120 percent of the average reasonably expected 
economic life of the property financed with the proceeds of the issue as 
of the issue date.
    (3) Fair market value consideration. Except as provided in paragraph 
(f) of this section, the terms of any arrangement that results in 
satisfaction of either the private business tests or the private loan 
financing test are bona fide and arm's-length, and the new user pays 
fair market value for the use of

[[Page 663]]

the financed property. Thus, for example, fair market value may be 
determined in a manner that takes into account restrictions on the use 
of the financed property that serve a bona fide governmental purpose.
    (4) Disposition proceeds treated as gross proceeds for arbitrage 
purposes. The issuer must treat any disposition proceeds as gross 
proceeds for purposes of section 148. For purposes of eligibility for 
temporary periods under section 148(c) and exemptions from the 
requirement of section 148(f) the issuer may treat the date of receipt 
of the disposition proceeds as the issue date of the bonds and disregard 
the receipt of disposition proceeds for exemptions based on expenditure 
of proceeds under Sec. 1.148-7 that were met before the receipt of the 
disposition proceeds.
    (5) Proceeds expended on a governmental purpose. Except for a 
remedial action under paragraph (d) of this section, the proceeds of the 
issue that are affected by the deliberate action must have been expended 
on a governmental purpose before the date of the deliberate action.
    (b) Effect of a remedial action--(1) In general. The effect of a 
remedial action is to cure use of proceeds that causes the private 
business use test or the private loan financing test to be met. A 
remedial action does not affect application of the private security or 
payment test.
    (2) Effect on bonds that have been advance refunded. If proceeds of 
an issue were used to advance refund another bond, a remedial action 
taken with respect to the refunding bond proportionately reduces the 
amount of proceeds of the advance refunded bond that is taken into 
account under the private business use test or the private loan 
financing test.
    (c) Disposition proceeds--(1) Definition. Disposition proceeds are 
any amounts (including property, such as an agreement to provide 
services) derived from the sale, exchange, or other disposition 
(disposition) of property (other than investments) financed with the 
proceeds of an issue.
    (2) Allocating disposition proceeds to an issue. In general, if the 
requirements of paragraph (a) of this section are met, after the date of 
the disposition, the proceeds of the issue allocable to the transferred 
property are treated as financing the disposition proceeds rather than 
the transferred property. If a disposition is made pursuant to an 
installment sale, the proceeds of the issue continue to be allocated to 
the transferred property. If an issue does not meet the requirements for 
remedial action in paragraph (a) of this section or the issuer does not 
take an appropriate remedial action, the proceeds of the issue are 
allocable to either the transferred property or the disposition 
proceeds, whichever allocation produces the greater amount of private 
business use and private security or payments.
    (3) Allocating disposition proceeds to different sources of funding. 
If property has been financed by different sources of funding, for 
purposes of this section, the disposition proceeds from that property 
are first allocated to the outstanding bonds that financed that property 
in proportion to the principal amounts of those outstanding bonds. In no 
event may disposition proceeds be allocated to bonds that are no longer 
outstanding or to a source of funding not derived from a borrowing (such 
as revenues of the issuer) if the disposition proceeds are not greater 
than the total principal amounts of the outstanding bonds that are 
allocable to that property. For purposes of this paragraph (c)(3), 
principal amount has the same meaning as in Sec. 1.148-9(b)(2) and 
outstanding bonds do not include advance refunded bonds.
    (d) Redemption or defeasance of nonqualified bonds--(1) In general. 
The requirements of this paragraph (d) are met if all of the 
nonqualified bonds of the issue are redeemed. Proceeds of tax-exempt 
bonds must not be used for this purpose, unless the tax-exempt bonds are 
qualified bonds, taking into account the purchaser's use of the 
facility. If the bonds are not redeemed within 90 days of the date of 
the deliberate action, a defeasance escrow must be established for those 
bonds within 90 days of the deliberate action.
    (2) Special rule for dispositions for cash. If the consideration for 
the disposition of financed property is exclusively cash, the 
requirements of this paragraph (d) are met if the disposition proceeds 
are used to redeem a pro rata

[[Page 664]]

portion of the nonqualified bonds at the earliest call date after the 
deliberate action. If the bonds are not redeemed within 90 days of the 
date of the deliberate action, the disposition proceeds must be used to 
establish a defeasance escrow for those bonds within 90 days of the 
deliberate action.
    (3) Notice of defeasance. The issuer must provide written notice to 
the Commissioner of the establishment of the defeasance escrow within 90 
days of the date the defeasance escrow is established.
    (4) Special limitation. The establishment of a defeasance escrow 
does not satisfy the requirements of this paragraph (d) if the period 
between the issue date and the first call date of the bonds is more than 
10 1/2 years.
    (5) Defeasance escrow defined. A defeasance escrow is an irrevocable 
escrow established to redeem bonds on their earliest call date in an 
amount that, together with investment earnings, is sufficient to pay all 
the principal of, and interest and call premium on, bonds from the date 
the escrow is established to the earliest call date. The escrow may not 
be invested in higher yielding investments or in any investment under 
which the obligor is a user of the proceeds of the bonds.
    (e) Alternative use of disposition proceeds--(1) In general. The 
requirements of this paragraph (e) are met if--
    (i) The deliberate action is a disposition for which the 
consideration is exclusively cash;
    (ii) The issuer reasonably expects to expend the disposition 
proceeds within two years of the date of the deliberate action;
    (iii) The disposition proceeds are treated as proceeds for purposes 
of section 141 and are used in a manner that does not cause the issue to 
meet either the private business tests or the private loan financing 
test, and the issuer does not take any action subsequent to the date of 
the deliberate action to cause either of these tests to be met; and
    (iv) If the issuer does not use all of the disposition proceeds for 
an alternative use described in paragraph (e)(1)(iii) of this section, 
the issuer uses those remaining disposition proceeds for a remedial 
action that meets paragraph (d) of this section.
    (2) Special rule for use by 501(c)(3) organizations. If the 
disposition proceeds are to be used by a 501(c)(3) organization, the 
nonqualified bonds must in addition be treated as reissued for purposes 
of sections 141, 145, 147, 149, and 150 and, under this treatment, 
satisfy all of the applicable requirements for qualified 501(c)(3) 
bonds. Thus, beginning on the date of the deliberate action, 
nonqualified bonds that satisfy these requirements must be treated as 
qualified 501(c)(3) bonds for all purposes, including sections 145(b) 
and 150(b).
    (f) Alternative use of facility. The requirements of this paragraph 
(f) are met if--
    (1) The facility with respect to which the deliberate action occurs 
is used in an alternative manner (for example, used for a qualifying 
purpose by a nongovernmental person or used by a 501(c)(3) organization 
rather than a governmental person);
    (2) The nonqualified bonds are treated as reissued, as of the date 
of the deliberate action, for purposes of sections 55 through 59 and 
141, 142, 144, 145, 146, 147, 149 and 150, and under this treatment, the 
nonqualified bonds satisfy all the applicable requirements for qualified 
bonds throughout the remaining term of the nonqualified bonds;
    (3) The deliberate action does not involve a disposition to a 
purchaser that finances the acquisition with proceeds of another issue 
of tax-exempt bonds; and
    (4) Any disposition proceeds other than those arising from an 
agreement to provide services (including disposition proceeds from an 
installment sale) resulting from the deliberate action are used to pay 
the debt service on the bonds on the next available payment date or, 
within 90 days of receipt, are deposited into an escrow that is 
restricted to the yield on the bonds to pay the debt service on the 
bonds on the next available payment date.
    (g) Rules for deemed reissuance. For purposes of determining whether 
bonds that are treated as reissued under paragraphs (e) and (f) of this 
section are qualified bonds--

[[Page 665]]

    (1) The provisions of the Code and regulations thereunder in effect 
as of the date of the deliberate action apply; and
    (2) For purposes of paragraph (f) of this section, section 147(d) 
(relating to the acquisition of existing property) does not apply.
    (h) Authority of Commissioner to provide for additional remedial 
actions. The Commissioner may, by publication in the Federal Register or 
the Internal Revenue Bulletin, provide additional remedial actions, 
including making a remedial payment to the United States, under which a 
subsequent action will not be treated as a deliberate action for 
purposes of Sec. 1.141-2.
    (i) Effect of remedial action on continuing compliance. Solely for 
purposes of determining whether deliberate actions that are taken after 
a remedial action cause an issue to meet the private business tests or 
the private loan financing test--
    (1) If a remedial action is taken under paragraph (d), (e), or (f) 
of this section, the private business use or private loans resulting 
from the deliberate action are not taken into account for purposes of 
determining whether the bonds are private activity bonds; and
    (2) After a remedial action is taken, the amount of disposition 
proceeds is treated as equal to the proceeds of the issue that had been 
allocable to the transferred property immediately prior to the 
disposition. See paragraph (k) of this section, Example 5.
    (j) Nonqualified bonds--(1) Amount of nonqualified bonds. The 
percentage of outstanding bonds that are nonqualified bonds equals the 
highest percentage of private business use in any 1-year period 
commencing with the deliberate action.
    (2) Allocation of nonqualified bonds. Allocations to nonqualified 
bonds must be made on a pro rata basis, except that, for purposes of 
paragraph (d) of this section (relating to redemption or defeasance), an 
issuer may treat bonds with longer maturities (determined on a bond-by-
bond basis) as the nonqualified bonds.
    (k) Examples. The following examples illustrate the application of 
this section:
    Example 1. Disposition proceeds less than outstanding bonds used to 
retire bonds. On June 1, 1997, City C issues 30-year bonds with an issue 
price of $10 million to finance the construction of a hospital building. 
The bonds have a weighted average maturity that does not exceed 120 
percent of the reasonably expected economic life of the building. On the 
issue date, C reasonably expects that it will be the only user of the 
building for the entire term of the bonds. Six years after the issue 
date, C sells the building to Corporation P for $5 million. The sale 
price is the fair market value of the building, as verified by an 
independent appraiser. C uses all of the $5 million disposition proceeds 
to immediately retire a pro rata portion of the bonds. The sale does not 
cause the bonds to be private activity bonds because C has taken a 
remedial action described in paragraph (d) of this section so that P is 
not treated as a private business user of bond proceeds.
    Example 2. Lease to nongovernmental person. The facts are the same 
as in Example 1, except that instead of selling the building, C, 6 years 
after the issue date, leases the building to P for 7 years and uses 
other funds to redeem all of the $10 million outstanding bonds within 90 
days of the deliberate act. The bonds are not treated as private 
activity bonds because C has taken the remedial action described in 
paragraph (d) of this section.
    Example 3. Sale for less than fair market value. The facts are the 
same as in Example 1, except that the fair market value of the building 
at the time of the sale to P is $6 million. Because the transfer was for 
less than fair market value, the bonds are ineligible for the remedial 
actions under this section. The bonds are private activity bonds because 
P is treated as a user of all of the proceeds and P makes a payment ($6 
million) for this use that is greater than 10 percent of the debt 
service on the bonds, on a present value basis.
    Example 4. Fair market value determined taking into account 
governmental restrictions. The facts are the same as in Example 1, 
except that the building was used by C only for hospital purposes and C 
determines to sell the building subject to a restriction that it be used 
only for hospital purposes. After conducting a public bidding procedure 
as required by state law, the best price that C is able to obtain for 
the building subject to this restriction is $4.5 million from P. C uses 
all of the $4.5 million disposition proceeds to immediately retire a pro 
rata portion of the bonds. The sale does not cause the bonds to be 
private activity bonds because C has taken a remedial action described 
in paragraph (d) of this section so that P is not treated as a private 
business user of bond proceeds.
    Example 5. Alternative use of disposition proceeds. The facts are 
the same as in Example 1,

[[Page 666]]

except that C reasonably expects on the date of the deliberate action to 
use the $5 million disposition proceeds for another governmental purpose 
(construction of governmentally owned roads) within two years of 
receipt, rather than using the $5 million to redeem outstanding bonds. C 
treats these disposition proceeds as gross proceeds for purposes of 
section 148. The bonds are not private activity bonds because C has 
taken a remedial action described in paragraph (e) of this section. 
After the date of the deliberate action, the proceeds of all of the 
outstanding bonds are treated as used for the construction of the roads, 
even though only $5 million of disposition proceeds was actually used 
for the roads.
    Example 6. Alternative use of financed property. The facts are the 
same as in Example 1, except that C determines to lease the hospital 
building to Q, an organization described in section 501(c)(3), for a 
term of 10 years rather than to sell the building to P. In order to 
induce Q to provide hospital services, C agrees to lease payments that 
are less than fair market value. Before entering into the lease, an 
applicable elected representative of C approves the lease after a 
noticed public hearing. As of the date of the deliberate action, the 
issue meets all the requirements for qualified 501(c)(3) bonds, treating 
the bonds as reissued on that date. For example, the issue meets the two 
percent restriction on use of proceeds of finance issuance costs of 
section 147(g) because the issue pays no costs of issuance from 
disposition proceeds in connection with the deemed reissuance. C and Q 
treat the bonds as qualified 501(c)(3) bonds for all purposes commencing 
with the date of the deliberate action. The bonds are treated as 
qualified 501(c)(3) bonds commencing with the date of the deliberate 
action.
    Example 7. Deliberate action before proceeds are expended on a 
governmental purpose. County J issues bonds with proceeds of $10 million 
that can be used only to finance a correctional facility. On the issue 
date of the bonds, J reasonably expects that it will be the sole user of 
the bonds for the useful life of the facility. The bonds have a weighted 
average maturity that does not exceed 120 percent of the reasonably 
expected economic life of the facility. After the issue date of the 
bonds, but before the facility is placed in service, J enters into a 
contract with the federal government pursuant to which the federal 
government will make a fair market value, lump sum payment equal to 25 
percent of the cost of the facility. In exchange for this payment, J 
provides the federal government with priority rights to use of 25 
percent of the facility. J uses the payment received from the federal 
government to defease the nonqualified bonds. The agreement does not 
cause the bonds to be private activity bonds because J has taken a 
remedial action described in paragraph (d) of this section. See 
paragraph (a)(5) of this section.
    Example 8. Compliance after remedial action. In 1997, City G issues 
bonds with proceeds of $10 million to finance a courthouse. The bonds 
have a weighted average maturity that does not exceed 120 percent of the 
reasonably expected economic life of the courthouse. G uses $1 million 
of the proceeds for a private business use and more than 10 percent of 
the debt service on the issue is secured by private security or 
payments. G later sells one-half of the courthouse property to a 
nongovernmental person for cash. G immediately redeems 60 percent of the 
outstanding bonds. This percentage of outstanding bonds is based on the 
highest private business use of the courthouse in any 1-year period 
commencing with the deliberate action. For purposes of subsequently 
applying section 141 to the issue, G may continue to use all of the 
proceeds of the outstanding bonds in the same manner (that is, for both 
the courthouse and the existing private business use) without causing 
the issue to meet the private business use test. The issue, however, 
continues to meet the private security or payment test. The result would 
be the same if D, instead of redeeming the bonds, established a 
defeasance escrow for those bonds, provided that the requirement of 
paragraph (d)(4) of this section was met.

[T.D. 8712, 62 FR 2298, Jan. 16, 1997]



Sec. 1.141-13  Refunding issues.

    (a) In general. Except as provided in this section, a refunding 
issue and a prior issue are tested separately under section 141. Thus, 
the determination of whether a refunding issue consists of private 
activity bonds generally does not depend on whether the prior issue 
consists of private activity bonds.
    (b) Application of private business use test and private loan 
financing test--(1) Allocation of proceeds. In applying the private 
business use test and the private loan financing test to a refunding 
issue, the proceeds of the refunding issue are allocated to the same 
expenditures and purpose investments as the proceeds of the prior issue.
    (2) Determination of amount of private business use--(i) In general. 
Except as provided in paragraph (b)(2)(ii) of this section, the amount 
of private business use of a refunding issue is determined under Sec. 
1.141-3(g), based on the measurement period for that issue (for example, 
without regard to any private business use that occurred prior to the 
issue date of the refunding issue).

[[Page 667]]

    (ii) Refundings of governmental bonds. In applying the private 
business use test to a refunding issue that refunds a prior issue of 
governmental bonds, the amount of private business use of the refunding 
issue is the amount of private business use--
    (A) During the combined measurement period; or
    (B) At the option of the issuer, during the period described in 
paragraph (b)(2)(i) of this section, but only if, without regard to the 
reasonable expectations test of Sec. 1.141-2(d), the prior issue does 
not satisfy the private business use test, based on a measurement period 
that begins on the first day of the combined measurement period and ends 
on the issue date of the refunding issue.
    (iii) Combined measurement period--(A) In general. Except as 
provided in paragraph (b)(2)(iii)(B) of this section, the combined 
measurement period is the period that begins on the first day of the 
measurement period (as defined in Sec. 1.141-3(g)) for the prior issue 
(or, in the case of a series of refundings of governmental bonds, the 
first issue of governmental bonds in the series) and ends on the last 
day of the measurement period for the refunding issue.
    (B) Transition rule for refundings of bonds originally issued before 
May 16, 1997. If the prior issue (or, in the case of a series of 
refundings of governmental bonds, the first issue of governmental bonds 
in the series) was issued before May 16, 1997, then the issuer, at its 
option, may treat the combined measurement period as beginning on the 
date (the transition date) that is the earlier of December 19, 2005 or 
the first date on which the prior issue (or an earlier issue in the case 
of a series of refundings of governmental bonds) became subject to the 
1997 regulations (as defined in Sec. 1.141-15(b)). If the issuer treats 
the combined measurement period as beginning on the transition date in 
accordance with this paragraph (b)(2)(iii)(B), then paragraph (c)(2) of 
this section shall be applied by treating the transition date as the 
issue date of the earliest issue, by treating the bonds as reissued on 
the transition date at an issue price equal to the value of the bonds 
(as determined under Sec. 1.148-4(e)) on that date, and by disregarding 
any private security or private payments before the transition date.
    (iv) Governmental bond. For purposes of this section, the term 
governmental bond means any bond that, when issued, purported to be a 
governmental bond, as defined in Sec. 1.150-1(b), or a qualified 
501(c)(3) bond, as defined in section 145(a).
    (v) Special rule for refundings of qualified 501(c)(3) bonds with 
governmental bonds. For purposes of applying this paragraph (b)(2) to a 
refunding issue that refunds a qualified 501(c)(3) bond, any use of the 
property refinanced by the refunding issue before the issue date of the 
refunding issue by a 501(c)(3) organization with respect to its 
activities that do not constitute an unrelated trade or business under 
section 513(a) is treated as government use.
    (c) Application of private security or payment test--(1) Separate 
issue treatment. If the amount of private business use of a refunding 
issue is determined based on the measurement period for that issue in 
accordance with paragraph (b)(2)(i) or (b)(2)(ii)(B) of this section, 
then the amount of private security and private payments allocable to 
the refunding issue is determined under Sec. 1.141-4 by treating the 
refunding issue as a separate issue.
    (2) Combined issue treatment. If the amount of private business use 
of a refunding issue is determined based on the combined measurement 
period for that issue in accordance with paragraph (b)(2)(ii)(A) of this 
section, then the amount of private security and private payments 
allocable to the refunding issue is determined under Sec. 1.141-4 by 
treating the refunding issue and all earlier issues taken into account 
in determining the combined measurement period as a combined issue. For 
this purpose, the present value of the private security and private 
payments is compared to the present value of the debt service on the 
combined issue (other than debt service paid with proceeds of any 
refunding bond). Present values are computed as of the issue date of the 
earliest issue taken into account in determining the combined 
measurement period (the earliest issue). Except as provided in paragraph

[[Page 668]]

(c)(3) of this section, present values are determined by using the yield 
on the combined issue as the discount rate. The yield on the combined 
issue is determined by taking into account payments on the refunding 
issue and all earlier issues taken into account in determining the 
combined measurement period (other than payments made with proceeds of 
any refunding bond), and based on the issue price of the earliest issue. 
In the case of a refunding of only a portion of the original principal 
amount of a prior issue, the refunded portion of the prior issue is 
treated as a separate issue and any private security or private payments 
with respect to the prior issue are allocated ratably between the 
combined issue and the unrefunded portion of the prior issue in a 
consistent manner based on relative debt service. See paragraph 
(b)(2)(iii)(B) of this section for special rules relating to certain 
refundings of governmental bonds originally issued before May 16, 1997.
    (3) Special rule for arrangements not entered into in contemplation 
of the refunding issue. In applying the private security or payment test 
to a refunding issue that refunds a prior issue of governmental bonds, 
the issuer may use the yield on the prior issue to determine the present 
value of private security and private payments under arrangements that 
were not entered into in contemplation of the refunding issue. For this 
purpose, any arrangement that was entered into more than 1 year before 
the issue date of the refunding issue is treated as not entered into in 
contemplation of the refunding issue.
    (d) Multipurpose issue allocations--(1) In general. For purposes of 
section 141, unless the context clearly requires otherwise, Sec. 1.148-
9(h) applies to allocations of multipurpose issues (as defined in Sec. 
1.148-1(b)), including allocations involving the refunding purposes of 
the issue. An allocation under this paragraph (d) may be made at any 
time, but once made may not be changed. An allocation is not reasonable 
under this paragraph (d) if it achieves more favorable results under 
section 141 than could be achieved with actual separate issues. The 
issue to be allocated and each of the separate issues under the 
allocation must consist of one or more tax-exempt bonds. Allocations 
made under this paragraph (d) and Sec. 1.148-9(h) must be consistent 
for purposes of section 141 and section 148.
    (2) Exceptions. This paragraph (d) does not apply for purposes of 
sections 141(c)(1) and 141(d)(1).
    (e) Application of reasonable expectations test to certain refunding 
bonds. An action that would otherwise cause a refunding issue to satisfy 
the private business tests or the private loan financing test is not 
taken into account under the reasonable expectations test of Sec. 
1.141-2(d) if--
    (1) The action is not a deliberate action within the meaning of 
Sec. 1.141-2(d)(3); and
    (2) The weighted average maturity of the refunding bonds is not 
greater than the weighted average reasonably expected economic life of 
the property financed by the prior bonds.
    (f) Special rule for refundings of certain general obligation bonds. 
Notwithstanding any other provision of this section, a refunding issue 
does not consist of private activity bonds if--
    (1) The prior issue meets the requirements of Sec. 1.141-2(d)(5) 
(relating to certain general obligation bond programs that finance a 
large number of separate purposes); or
    (2) The refunded portion of the prior issue is part of a series of 
refundings of all or a portion of an issue that meets the requirements 
of Sec. 1.141-2(d)(5).
    (g) Examples. The following examples illustrate the application of 
this section:

    Example 1. Measuring private business use. In 2002, Authority A 
issues tax-exempt bonds that mature in 2032 to acquire an office 
building. The measurement period for the 2002 bonds under Sec. 1.141-
3(g) is 30 years. At the time A acquires the building, it enters into a 
10-year lease with a nongovernmental person under which the 
nongovernmental person will use 5 percent of the building in its trade 
or business during each year of the lease term. In 2007, A issues bonds 
to refund the 2002 bonds. The 2007 bonds mature on the same date as the 
2002 bonds and have a measurement period of 25 years under Sec. 1.141-
3(g). Under paragraph (b)(2)(ii)(A) of this section, the amount of 
private business use of the proceeds of the 2007 bonds is 1.67 percent, 
which equals the amount of private business use during the combined 
measurement period (5 percent of \1/3\ of the 30-year combined

[[Page 669]]

measurement period). In addition, the 2002 bonds do not satisfy the 
private business use test, based on a measurement period beginning on 
the first day of the measurement period for the 2002 bonds and ending on 
the issue date of the 2007 bonds, because only 5 percent of the proceeds 
of the 2002 bonds are used for a private business use during that 
period. Thus, under paragraph (b)(2)(ii)(B) of this section, A may treat 
the amount of private business use of the 2007 bonds as 1 percent (5 
percent of \1/5\ of the 25-year measurement period for the 2007 bonds). 
The 2007 bonds do not satisfy the private business use test.
    Example 2. Combined issue yield computation. (i) On January 1, 2000, 
County B issues 20-year bonds to finance the acquisition of a municipal 
auditorium. The 2000 bonds have a yield of 7.7500 percent, compounded 
annually, and an issue price and par amount of $100 million. The debt 
service payments on the 2000 bonds are as follows:

------------------------------------------------------------------------
                         Date                             Debt service
------------------------------------------------------------------------
1/1/01...............................................         $9,996,470
1/1/02...............................................          9,996,470
1/1/03...............................................          9,996,470
1/1/04...............................................          9,996,470
1/1/05...............................................          9,996,470
1/1/06...............................................          9,996,470
1/1/07...............................................          9,996,470
1/1/08...............................................          9,996,470
1/1/09...............................................          9,996,470
1/1/10...............................................          9,996,470
1/1/11...............................................          9,996,470
1/1/12...............................................          9,996,470
1/1/13...............................................          9,996,470
1/1/14...............................................          9,996,470
1/1/15...............................................          9,996,470
1/1/16...............................................          9,996,470
1/1/17...............................................          9,996,470
1/1/18...............................................          9,996,470
1/1/19...............................................          9,996,470
1/1/20...............................................          9,996,470
                                                      ------------------
                                                             199,929,400
------------------------------------------------------------------------

    (ii) On January 1, 2005, B issues 15-year bonds to refund all of the 
outstanding 2000 bonds maturing after January 1, 2005 (in the aggregate 
principal amount of $86,500,000). The 2005 bonds have a yield of 6.0000 
percent, compounded annually, and an issue price and par amount of 
$89,500,000. The debt service payments on the 2005 bonds are as follows:

------------------------------------------------------------------------
                         Date                             Debt service
------------------------------------------------------------------------
1/1/06...............................................         $9,215,167
1/1/07...............................................          9,215,167
1/1/08...............................................          9,215,167
1/1/09...............................................          9,215,167
1/1/10...............................................          9,215,167
1/1/11...............................................          9,215,167
1/1/12...............................................          9,215,167
1/1/13...............................................          9,215,167
1/1/14...............................................          9,215,167
1/1/15...............................................          9,215,167
1/1/16...............................................          9,215,167
1/1/17...............................................          9,215,167
1/1/18...............................................          9,215,167
1/1/19...............................................          9,215,167
1/1/20...............................................          9,215,167
                                                      ------------------
                                                             138,227,511
------------------------------------------------------------------------

    (iii) In accordance with Sec. 1.141-15(h), B chooses to apply Sec. 
1.141-13 (together with the other provisions set forth in Sec. 1.141-
15(h)), to the 2005 bonds. For purposes of determining the amount of 
private security and private payments with respect to the 2005 bonds, 
the 2005 bonds and the refunded portion of the 2000 bonds are treated as 
a combined issue under paragraph (c)(2) of this section. The yield on 
the combined issue is determined in accordance with Sec. Sec. 1.148-4, 
1.141-4(b)(2)(iii) and 1.141-13(c)(2). Under this methodology, the yield 
on the combined issue is 7.1062 percent per year compounded annually, 
illustrated as follows:

----------------------------------------------------------------------------------------------------------------
                                             Previous debt
                                              service on
                   Date                        refunded     Refunding debt      Total debt      Present value on
                                              portion of        service          service             1/1/00
                                              prior issue
----------------------------------------------------------------------------------------------------------------
1/1/00....................................  ..............  ..............  .................   ($86,500,000.00)
1/1/01....................................       6,689,793  ..............          6,689,793       6,245,945.33
1/1/02....................................       6,689,793  ..............          6,689,793       5,831,545.62
1/1/03....................................       6,689,793  ..............          6,689,793       5,444,640.09
1/1/04....................................       6,689,793  ..............          6,689,793       5,083,404.58
1/1/05....................................       6,689,793  ..............          6,689,793       4,746,135.95
1/1/06....................................  ..............       9,215,167          9,215,167       6,104,023.84
1/1/07....................................  ..............       9,215,167          9,215,167       5,699,040.20
1/1/08....................................  ..............       9,215,167          9,215,167       5,320,926.00
1/1/09....................................  ..............       9,215,167          9,215,167       4,967,898.55
1/1/10....................................  ..............       9,215,167          9,215,167       4,638,293.40
1/1/11....................................  ..............       9,215,167          9,215,167       4,330,556.57
1/1/12....................................  ..............       9,215,167          9,215,167       4,043,237.15
1/1/13....................................  ..............       9,215,167          9,215,167       3,774,980.51
1/1/14....................................  ..............       9,215,167          9,215,167       3,524,521.90
1/1/15....................................  ..............       9,215,167          9,215,167       3,290,680.46
1/1/16....................................  ..............       9,215,167          9,215,167       3,072,353.70
1/1/17....................................  ..............       9,215,167          9,215,167       2,868,512.26
1/1/18....................................  ..............       9,215,167          9,215,167       2,678,195.09

[[Page 670]]

 
1/1/19....................................  ..............       9,215,167          9,215,167       2,500,504.89
1/1/20....................................  ..............       9,215,167          9,215,167       2,334,603.90
                                           ---------------------------------------------------------------------
                                                33,448,965     138,227,511    171,676,4760.00               0.00
----------------------------------------------------------------------------------------------------------------

    Example 3. Determination of private payments allocable to combined 
issue. The facts are the same as in Example 2. In addition, on January 
1, 2001, B enters into a contract with a nongovernmental person for the 
use of the auditorium. The contract results in a private payment in the 
amount of $500,000 on each January 1 beginning on January 1, 2001, and 
ending on January 1, 2020. Under paragraph (c)(2) of this section, the 
amount of the private payments allocable to the combined issue is 
determined by treating the refunded portion of the 2000 bonds 
($86,500,000 principal amount) as a separate issue, and by allocating 
the total private payments ratably between the combined issue and the 
unrefunded portion of the 2000 bonds ($13,500,000 principal amount) 
based on relative debt service, as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                         Percentage   Amount of
                                                            Debt                         of private    private
                                             Private     service on   Debt service on     payments     payments
                   Date                      payments    unrefunded    combined issue    allocable    allocable
                                                         portion of                     to combined  to combined
                                                        prior issue                        issue        issue
----------------------------------------------------------------------------------------------------------------
1/1/01...................................     $500,000   $3,306,677         $6,689,793        66.92     $334,608
1/1/02...................................      500,000    3,306,677          6,689,793        66.92      334,608
1/1/03...................................      500,000    3,306,677          6,689,793        66.92      334,608
1/1/04...................................      500,000    3,306,677          6,689,793        66.92      334,608
1/1/05...................................      500,000    3,306,677          6,689,793        66.92      334,608
1/1/06...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/07...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/08...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/09...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/10...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/11...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/12...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/13...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/14...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/15...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/16...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/17...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/18...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/19...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/20...................................      500,000  ...........          9,215,167       100.00      500,000
                                          ----------------------------------------------------------------------
                                           $10,000,000  $16,533,385       $171,676,476  ...........   $9,173,039
----------------------------------------------------------------------------------------------------------------

    Example 4. Refunding taxable bonds and qualified bonds. (i) In 1999, 
City C issues taxable bonds to finance the construction of a facility 
for the furnishing of water. The bonds are secured by revenues from the 
facility. The facility is managed pursuant to a management contract with 
a nongovernmental person that gives rise to private business use. In 
2007, C terminates the management contract and takes over the operation 
of the facility. In 2009, C issues bonds to refund the 1999 bonds. On 
the issue date of the 2009 bonds, C reasonably expects that the facility 
will not be used for a private business use during the term of the 2009 
bonds. In addition, during the term of the 2009 bonds, the facility is 
not used for a private business use. Under paragraph (b)(2)(i) of this 
section, the 2009 bonds do not satisfy the private business use test 
because the amount of private business use is based on the measurement 
period for those bonds and therefore does not take into account any 
private business use that occurred pursuant to the management contract.
    (ii) The facts are the same as in paragraph (i) of this Example 4, 
except that the 1999 bonds are issued as exempt facility bonds under 
section 142(a)(4). The 2009 bonds do not satisfy the private business 
use test.
    Example 5. Multipurpose issue. In 2001, State D issues bonds to 
finance the construction of two office buildings, Building 1 and 
Building 2. D expends an equal amount of the proceeds on each building. 
D enters into arrangements that result in 8 percent of Building 1 and 12

[[Page 671]]

percent of Building 2 being used for a private business use during the 
measurement period under Sec. 1.141-3(g). These arrangements result in 
a total of 10 percent of the proceeds of the 2001 bonds being used for a 
private business use. In 2006, D purports to allocate, under paragraph 
(d) of this section, an equal amount of the outstanding 2001 bonds to 
Building 1 and Building 2. D also enters into another private business 
use arrangement with respect to Building 1 that results in an additional 
2 percent (and a total of 10 percent) of Building 1 being used for a 
private business use during the measurement period. An allocation is not 
reasonable under paragraph (d) of this section if it achieves more 
favorable results under section 141 than could be achieved with actual 
separate issues. D's allocation is unreasonable because, if permitted, 
it would result in more than 10 percent of the proceeds of the 2001 
bonds being used for a private business use.

    Example 6. Non-deliberate action. In 1998, City E issues bonds to 
finance the purchase of land and construction of a building (the prior 
bonds). On the issue date of the prior bonds, E reasonably expects that 
it will be the sole user of the financed property for the entire term of 
the bonds. In 2003, the federal government acquires the financed 
property in a condemnation action. In 2006, E issues bonds to refund the 
prior bonds (the refunding bonds). The weighted average maturity of the 
refunding bonds is not greater than the reasonably expected economic 
life of the financed property. In general, under Sec. 1.141-2(d) and 
this section, reasonable expectations must be separately tested on the 
issue date of a refunding issue. Under paragraph (e) of this section, 
however, the condemnation action is not taken into account in applying 
the reasonable expectations test to the refunding bonds because the 
condemnation action is not a deliberate action within the meaning of 
Sec. 1.141-2(d)(3) and the weighted average maturity of the refunding 
bonds is not greater than the weighted average reasonably expected 
economic life of the property financed by the prior bonds. Thus, the 
condemnation action does not cause the refunding bonds to be private 
activity bonds.

    Example 7. Non-transitioned refunding of bonds subject to 1954 Code. 
In 1985, County F issues bonds to finance a court house. The 1985 bonds 
are subject to the provisions of the Internal Revenue Code of 1954. In 
2006, F issues bonds to refund all of the outstanding 1985 bonds. The 
weighted average maturity of the 2006 bonds is longer than the remaining 
weighted average maturity of the 1985 bonds. In addition, the 2006 bonds 
do not satisfy any transitional rule for refundings in the Tax Reform 
Act of 1986, 100 Stat. 2085 (1986). Section 141 and this section apply 
to determine whether the 2006 bonds are private activity bonds including 
whether, for purposes of Sec. 1.141-13(b)(2)(ii)(B), the 1985 bonds 
satisfy the private business use test based on a measurement period that 
begins on the first day of the combined measurement period for the 2006 
bonds and ends on the issue date of the 2006 bonds.

[T.D. 9234, 70 FR 75032, Dec. 19, 2006]



Sec. 1.141-14  Anti-abuse rules.

    (a) Authority of Commissioner to reflect substance of transactions. 
If an issuer enters into a transaction or series of transactions with 
respect to one or more issues with a principal purpose of transferring 
to nongovernmental persons (other than as members of the general public) 
significant benefits of tax-exempt financing in a manner that is 
inconsistent with the purposes of section 141, the Commissioner may take 
any action to reflect the substance of the transaction or series of 
transactions, including--
    (1) Treating separate issues as a single issue for purposes of the 
private activity bond tests;
    (2) Reallocating proceeds to expenditures, property, use, or bonds;
    (3) Reallocating payments to use or proceeds;
    (4) Measuring private business use on a basis that reasonably 
reflects the economic benefit in a manner different than as provided in 
Sec. 1.141-3(g); and
    (5) Measuring private payments or security on a basis that 
reasonably reflects the economic substance in a manner different than as 
provided in Sec. 1.141-4.
    (b) Examples. The following examples illustrate the application of 
this section:
    Example 1. Reallocating proceeds to indirect use. City C issues 
bonds with proceeds of $20 million for the stated purpose of financing 
improvements to roads that it owns. As a part of the same plan of 
financing, however, C also agrees to make a loan of $7 million to 
Corporation M from its general revenues that it otherwise would have 
used for the road improvements. The interest rate of the loan 
corresponds to the interest rate on a portion of the issue. A principal 
purpose of the financing arrangement is to transfer to M significant 
benefits of the tax-exempt financing. Although C actually allocates all 
of the proceeds of the bonds to the road improvements, the Commissioner 
may reallocate a portion of the proceeds of the bonds to the loan to M 
because a principal purpose of the financing arrangement is to transfer 
to

[[Page 672]]

M significant benefits of tax-exempt financing in a manner that is 
inconsistent with the purposes of section 141. The bonds are private 
activity bonds because the issue meets the private loan financing test. 
The bonds also meet the private business tests. See also Sec. Sec. 
1.141-3(a)(2), 1.141-4(a)(1), and 1.141-5(a), under which indirect use 
of proceeds and payments are taken into account.
    Example 2. Taking into account use of amounts derived from proceeds 
that would be otherwise disregarded. County B issues bonds with proceeds 
of $10 million to finance the purchase of land. On the issue date, B 
reasonably expects that it will be the sole user of the land. 
Subsequently, the federal government acquires the land for $3 million in 
a condemnation action. B uses this amount to make a loan to Corporation 
M. In addition, the interest rate on the loan reflects the tax-exempt 
interest rate on the bonds and thus is substantially less than a current 
market rate. A principal purpose of the arrangement is to transfer to M 
significant benefits of the tax-exempt financing. Although the 
condemnation action is not a deliberate action, the Commissioner may 
treat the condemnation proceeds as proceeds of the issue because a 
principal purpose of the arrangement is to transfer to M significant 
benefits of tax-exempt financing in a manner inconsistent with the 
purposes of section 141. The bonds are private activity bonds.
    Example 3. Measuring private business use on an alternative basis. 
City F issues bonds with a 30-year term to finance the acquisition of an 
industrial building having a remaining reasonably expected useful 
economic life of more than 30 years. On the issue date, F leases the 
building to Corporation G for 3 years. F reasonably expects that it will 
be the sole user of the building for the remaining term of the bonds. 
Because of the local market conditions, it is reasonably expected that 
the fair rental value of the industrial building will be significantly 
greater during the early years of the term of the bonds than in the 
later years. The annual rental payments are significantly less than fair 
market value, reflecting the interest rate on the bonds. The present 
value of these rental payments (net of operation and maintenance 
expenses) as of the issue date, however, is approximately 25 percent of 
the present value of debt service on the issue. Under Sec. 1.141-3, the 
issue does not meet the private business tests, because only 10 percent 
of the proceeds are used in a trade or business by a nongovernmental 
person. A principal purpose of the issue is to transfer to G significant 
benefits of tax-exempt financing in a manner inconsistent with the 
purposes of section 141. The method of measuring private business use 
over the reasonably expected useful economic life of financed property 
is for the administrative convenience of issuers of state and local 
bonds. In cases where this method is used in a manner inconsistent with 
the purposes of section 141, the Commissioner may measure private 
business use on another basis that reasonably reflects economic benefit, 
such as in this case on an annual basis. If the Commissioner measures 
private business use on an annual basis, the bonds are private activity 
bonds because the private payment test is met and more than 10 percent 
of the proceeds are used in a trade or business by a nongovernmental 
person.
    Example 4. Treating separate issues as a single issue. City D enters 
into a development agreement with Corporation T to induce T to locate 
its headquarters within D's city limits. Pursuant to the development 
agreement, in 1997 D will issue $20 million of its general obligation 
bonds (the 1997 bonds) to purchase land that it will grant to T. The 
development agreement also provides that, in 1998, D will issue $20 
million of its tax increment bonds (the 1998 bonds), secured solely by 
the increase in property taxes in a special taxing district. 
Substantially all of the property within the special taxing district is 
owned by T or D. T will separately enter into an agreement to guarantee 
the payment of tax increment to D in an amount sufficient to retire the 
1998 bonds. The proceeds of the 1998 bonds will be used to finance 
improvements owned and operated by D that will not give rise to private 
business use. Treated separately, the 1997 issue meets the private 
business use test, but not the private security or payment test; the 
1998 issue meets the private security or payment test, but not the 
private business use test. A principal purpose of the financing plan, 
including the two issues, is to transfer significant benefits of tax-
exempt financing to T for its headquarters. Thus, the 1997 issue and the 
1998 issue may be treated by the Commissioner as a single issue for 
purposes of applying the private activity bond tests. Accordingly, the 
bonds of both the 1997 issue and the 1998 issue may be treated as 
private activity bonds.
    Example 5. Reallocating proceeds. City E acquires an electric 
generating facility with a useful economic life of more than 40 years 
and enters into a 30-year take or pay contract to sell 30 percent of the 
available output to investor-owned utility M. E plans to use the 
remaining 70 percent of available output for its own governmental 
purposes. To finance the entire cost of the facility, E issues $30 
million of its series A taxable bonds at taxable interest rates and $70 
million series B bonds, which purport to be tax-exempt bonds, at tax-
exempt interest rates. E allocates all of M's private business use to 
the proceeds of the series A bonds and all of its own government use to 
the proceeds of the series B bonds. The series A bonds have a weighted 
average maturity of 15 years, while the series B bonds have a weighted 
average maturity of 26 years. M's payments under the take or pay 
contract are expressly

[[Page 673]]

determined by reference to 30 percent of M's total costs (that is, the 
sum of the debt service required to be paid on both the series A and the 
series B bonds and all other operating costs). The allocation of all of 
M's private business use to the series A bonds does not reflect economic 
substance because the series of transactions transfers to M significant 
benefits of the tax-exempt interest rates paid on the series B bonds. A 
principal purpose of the financing arrangement is to transfer to M 
significant benefits of the tax-exempt financing. Accordingly, the 
Commissioner may allocate M's private business use on a pro rata basis 
to both the series B bonds as well as the series A bonds, in which case 
the series B bonds are private activity bonds.
    Example 6. Allocations respected. The facts are the same as in 
Example 5, except that the debt service component of M's payments under 
the take or pay contract is based exclusively on the amounts necessary 
to pay the debt service on the taxable series A bonds. E's allocation of 
all of M's private business use to the series A bonds is respected 
because the series of transactions does not actually transfer benefits 
of tax-exempt interest rates to M. Accordingly, the series B bonds are 
not private activity bonds. The result would be the same if M's payments 
under the take or pay contract were based exclusively on fair market 
value pricing, rather than the tax-exempt interest rates on E's bonds. 
The result also would be the same if the series A bonds and the series B 
bonds had substantially equivalent weighted average maturities and E and 
M had entered into a customary contract providing for payments based on 
a ratable share of total debt service. E would not be treated by the 
Commissioner in any of these cases as entering into the contract with a 
principal purpose of transferring the benefits of tax-exempt financing 
to M in a manner inconsistent with the purposes of section 141.

[T.D. 8712, 62 FR 2301, Jan. 16, 1997]



Sec. 1.141-15  Effective dates.

    (a) Scope. The effective dates of this section apply for purposes of 
Sec. Sec. 1.141-1 through 1.141-6(a), 1.141-7 through 1.141-14, 1.145-1 
through 1.145-2, 1.150-1(a)(3) and the definition of bond documents 
contained in Sec. 1.150-1(b).
    (b) Effective dates--(1) In general. Except as otherwise provided in 
this section, Sec. Sec. 1.141-0 through 1.141-6(a), 1.141-9 through 
1.141-12, 1.141-14, 1.145-1 through 1.145-2(c), and the definition of 
bond documents contained in Sec. 1.150-1(b) (the 1997 regulations) 
apply to bonds issued on or after May 16, 1997, that are subject to 
section 1301 of the Tax Reform Act of 1986 (100 Stat. 2602).
    (2) Certain short-term arrangements. The provisions of Sec. 1.141-3 
that refer to arrangements for 200 days, 100 days, or 50 days apply to 
any bond sold on or after November 20, 2001 and may be applied to any 
bond outstanding on November 20, 2001 to which Sec. 1.141-3 applies.
    (3) Certain prepayments. Except as provided in paragraph (c) of this 
section, paragraphs (c)(2)(ii), (c)(2)(iii) and (c)(2)(iv) of Sec. 
1.141-5 apply to bonds sold on or after October 3, 2003. Issuers may 
apply paragraphs (c)(2)(ii), (c)(2)(iii) and (c)(2)(iv) of Sec. 1.141-
5, in whole but not in part, to bonds sold before October 3, 2003 that 
are subject to Sec. 1.141-5.
    (c) Refunding bonds. Except as otherwise provided in this section, 
the 1997 regulations (defined in paragraph (b)(1) of this section) do 
not apply to any bonds issued on or after May 16, 1997, to refund a bond 
to which those regulations do not apply unless--
    (1) The refunding bonds are subject to section 1301 of the Tax 
Reform Act of 1986 (100 Stat. 2602); and
    (2)(i) The weighted average maturity of the refunding bonds is 
longer than--
    (A) The weighted average maturity of the refunded bonds; or
    (B) In the case of a short-term obligation that the issuer 
reasonably expects to refund with a long-term financing (such as a bond 
anticipation note), 120 percent of the weighted average reasonably 
expected economic life of the facilities financed; or
    (ii) A principal purpose for the issuance of the refunding bonds is 
to make one or more new conduit loans.
    (d) Permissive application of regulations. Except as provided in 
paragraph (e) of this section, the 1997 regulations (defined in 
paragraph (b)(1) of this section) may be applied in whole, but not in 
part, to actions taken before February 23, 1998, with respect to--
    (1) Bonds that are outstanding on May 16, 1997, and subject to 
section 141; or
    (2) Refunding bonds issued on or after May 16, 1997, that are 
subject to 141.
    (e) Permissive application of certain sections. The following 
sections may each be applied to any bonds--
    (1) Section 1.141-3(b)(4);
    (2) Section 1.141-3(b)(6); and
    (3) Section 1.141-12.

[[Page 674]]

    (f) Effective dates for certain regulations relating to output 
facilities--(1) General rule. Except as otherwise provided in this 
section, Sec. Sec. 1.141-7 and 1.141-8 apply to bonds sold on or after 
November 22, 2002, that are subject to section 1301 of the Tax Reform 
Act of 1986 (100 Stat. 2602).
    (2) Transition rule for requirements contracts. For bonds otherwise 
subject to Sec. Sec. 1.141-7 and 1.141-8, Sec. 1.141-7(c)(3) applies 
to output contracts entered into on or after September 19, 2002. An 
output contract is treated as entered into on or after that date if it 
is amended on or after that date, but only if the amendment results in a 
change in the parties to the contract or increases the amount of 
requirements covered by the contract by reason of an extension of the 
contract term or a change in the method for determining such 
requirements. For purposes of this paragraph (f)(2)--
    (i) The extension of the term of a contract causes the contract to 
be treated as entered into on the first day of the additional term;
    (ii) The exercise by a party of a legally enforceable right that was 
provided under a contract before September 19, 2002, on terms that were 
fixed and determinable before such date, is not treated as an amendment 
of the contract. For example, the exercise by a purchaser after 
September 19, 2002 of a renewal option that was provided under a 
contract before that date, on terms identical to the original contract, 
is not treated as an amendment of the contract; and
    (iii) An amendment that increases the amount of requirements covered 
by the contract by reason of a change in the method for determining such 
requirements is treated as a separate contract that is entered into as 
of the effective date of the amendment, but only with respect to the 
increased output to be provided under the contract.
    (g) Refunding bonds for output facilities. Except as otherwise 
provided in paragraph (h) or (i) of this section, Sec. Sec. 1.141-7 and 
1.141-8 do not apply to any bonds sold on or after November 22, 2002, to 
refund a bond to which Sec. Sec. 1.141-7 and 1.141-8 do not apply 
unless--
    (1) The refunding bonds are subject to section 1301 of the Tax 
Reform Act of 1986 (100 Stat. 2602); and
    (2)(i) The weighted average maturity of the refunding bonds is 
longer than--
    (A) The weighted average maturity of the refunded bonds; or
    (B) In the case of a short-term obligation that the issuer 
reasonably expects to refund with a long-term financing (such as a bond 
anticipation note), 120 percent of the weighted average reasonably 
expected economic life of the facilities financed; or
    (ii) A principal purpose for the issuance of the refunding bonds is 
to make one or more new conduit loans.
    (h) Permissive retroactive application. Except as provided in 
paragraphs (d), (e) or (i) of this section, Sec. Sec. 1.141-1 through 
1.141-6(a), 1.141-7 through 1.141-14, 1.145-1 through 1.145-2, 1.149(d)-
1(g), 1.150-1(a)(3), the definition of bond documents contained in Sec. 
1.150-1(b) and Sec. 1.150-1(c)(3)(ii) may be applied by issuers in 
whole, but not in part, to--
    (1) Outstanding bonds that are sold before February 17, 2006, and 
subject to section 141; or
    (2) Refunding bonds that are sold on or after February 17, 2006, and 
subject to section 141.
    (i) Permissive application of certain regulations relating to output 
facilities. Issuers may apply Sec. Sec. 1.141-7(f)(3) and 1.141-7(g) to 
any bonds.
    (j) Effective dates for certain regulations relating to refundings. 
Except as otherwise provided in this section, Sec. Sec. 1.141-13, 
1.145-2(d), 1.149(d)-1(g), 1.150-1(a)(3) and 1.150-1(c)(3)(ii) apply to 
bonds that are sold on or after February 17, 2006, and that are subject 
to the 1997 regulations (defined in paragraph (b)(1) of this section).

[T.D. 8757, 63 FR 3265, Jan. 22, 1998, as amended by T.D. 8941, 66 FR 
4670, Jan. 18, 2001; T.D. 8967, 66 FR 58062, Nov. 20, 2001; T.D. 9016, 
67 FR 59765, Sept. 23, 2002; T.D. 9085, 68 FR 45775, Aug. 4, 2003; T.D. 
9234, 70 FR 75035, Dec. 19, 2005; 71 FR 1971, Jan. 12, 2006]



Sec. 1.141-16  Effective dates for qualified private activity bond 
provisions.

    (a) Scope. The effective dates of this section apply for purposes of 
Sec. Sec. 1.142-0 through 1.142-2, 1.144-0 through 1.144-2, 1.147-0 
through 1.147-2, and 1.150-4.

[[Page 675]]

    (b) Effective dates. Except as otherwise provided in this section, 
the regulations designated in paragraph (a) of this section apply to 
bonds issued on or after May 16, 1997 (the effective date).
    (c) Permissive application. The regulations designated in paragraph 
(a) of this section may be applied by issuers in whole, but not in part, 
to bonds outstanding on the effective date. For this purpose, issuers 
may apply Sec. 1.142-2 without regard to paragraph (c)(3) thereof to 
failures to properly use proceeds that occur on or after April 21, 2003.
    (d) Certain remedial actions--(1) General rule. The provisions of 
Sec. 1.142-2(e) apply to failures to properly use proceeds that occur 
on or after August 13, 2004 and may be applied by issuers to failures to 
properly use proceeds that occur on or after May 14, 2004, provided that 
the bonds are subject to Sec. 1.142-2.
    (2) Special rule for allocations of nonqualified bonds. For purposes 
of Sec. 1.142-2(e)(2), in addition to the allocation methods permitted 
in Sec. 1.142-2(e)(2), an issuer may treat bonds with the longest 
maturities (determined on a bond-by-bond basis) as the nonqualified 
bonds, but only with respect to failures to properly use proceeds that 
occur on or after May 14, 2004, with respect to bonds sold before August 
13, 2004.

[T.D. 8712, 62 FR 2302, Jan. 16, 1997, as amended by T.D. 9150, 69 FR 
50066, Aug. 13, 2004]



Sec. 1.142-0  Table of contents.

    This section lists the captioned paragraphs contained in Sec. Sec. 
1.142-1 through 1.142-3.

    Sec. 1.142-1 Exempt facility bonds.
    (a) Overview.
    (b) Scope.
    (c) Effective dates.
    Sec. 1.142-2 Remedial actions.
    (a) General rule.
    (b) Reasonable expectations requirement.
    (c) Redemption or defeasance.
    (1) In general.
    (2) Notice of defeasance.
    (3) Special limitation.
    (4) Special rule for dispositions of personal property.
    (5) Definitions.
    (d) When a failure to properly use proceeds occurs.
    (1) Proceeds not spent.
    (2) Proceeds spent.
    (e) Nonqualified bonds.
    (1) Amount of nonqualified bonds.
    (2) Allocation of nonqualified bonds.
    Sec. 1.142-3 Refunding issues. [Reserved]

[T.D. 8712, 62 FR 2302, Jan. 16, 1997, as amended by T.D. 9150, 69 FR 
50066, Aug. 13, 2004]



Sec. 1.142-1  Exempt facility bonds.

    (a) Overview. Interest on a private activity bond is not excludable 
from gross income under section 103(a) unless the bond is a qualified 
bond. Under section 141(e)(1)(A), an exempt facility bond issued under 
section 142 may be a qualified bond.
    Under section 142(a), an exempt facility bond is any bond issued as 
a part of an issue using 95 percent or more of the proceeds for certain 
exempt facilities.
    (b) Scope. Sections 1.142-0 through 1.142-3 apply for purposes of 
the rules for exempt facility bonds under section 142, except that, with 
respect to net proceeds that have been spent, Sec. 1.142-2 does not 
apply to bonds issued under section 142(d) (relating to bonds issued to 
provide qualified residential rental projects) and section 142(f) (2) 
and (4) (relating to bonds issued to provide local furnishing of 
electric energy or gas).
    (c) Effective dates. For effective dates of Sec. Sec. 1.142-0 
through 1.142-2, see Sec. 1.141-16.

[T.D. 8712, 62 FR 2302, Jan. 16, 1997]



Sec. 1.142-2  Remedial actions.

    (a) General rule. If less than 95 percent of the net proceeds of an 
exempt facility bond are actually used to provide an exempt facility, 
and for no other purpose, the issue will be treated as meeting the use 
of proceeds requirement of section 142(a) if the issue meets the 
condition of paragraph (b) of this section and the issuer takes the 
remedial action described in paragraph (c) of this section.
    (b) Reasonable expectations requirement. The issuer must have 
reasonably expected on the issue date that 95 percent of the net 
proceeds of the issue would be used to provide an exempt facility and 
for no other purpose for the entire term of the bonds (disregarding any 
redemption provisions). To meet this condition the amount of the issue 
must have been based on reasonable estimates about the cost of the 
facility.

[[Page 676]]

    (c) Redemption or defeasance--(1) In general. The requirements of 
this paragraph (c) are met if all of the nonqualified bonds of the issue 
are redeemed on the earliest call date after the date on which the 
failure to properly use the proceeds occurs under paragraph (d) of this 
section. Proceeds of tax-exempt bonds (other than those described in 
paragraph (d)(1) of this section) must not be used for this purpose. If 
the bonds are not redeemed within 90 days of the date on which the 
failure to properly use proceeds occurs, a defeasance escrow must be 
established for those bonds within 90 days of that date.
    (2) Notice of defeasance. The issuer must provide written notice to 
the Commissioner of the establishment of the defeasance escrow within 90 
days of the date the escrow is established.
    (3) Special limitation. The establishment of a defeasance escrow 
does not satisfy the requirements of this paragraph (c) if the period 
between the issue date and the first call date is more than 10\1/2\ 
years.
    (4) Special rule for dispositions of personal property. For 
dispositions of personal property exclusively for cash, the requirements 
of this paragraph (c) are met if the issuer expends the disposition 
proceeds within 6 months of the date of the disposition to acquire 
replacement property for the same qualifying purpose of the issue under 
section 142.
    (5) Definitions. For purposes of paragraph (c)(4) of this section, 
disposition proceeds means disposition proceeds as defined in Sec. 
1.141-12(c).
    (d) When a failure to properly use proceeds occurs--(1) Proceeds not 
spent. For net proceeds that are not spent, a failure to properly use 
proceeds occurs on the earlier of the date on which the issuer 
reasonably determines that the financed facility will not be completed 
or the date on which the financed facility is placed in service.
    (2) Proceeds spent. For net proceeds that are spent, a failure to 
properly use proceeds occurs on the date on which an action is taken 
that causes the bonds not to be used for the qualifying purpose for 
which the bonds were issued.
    (e) Nonqualified bonds--(1) Amount of nonqualified bonds. For 
purposes of this section, the nonqualified bonds are a portion of the 
outstanding bonds in an amount that, if the remaining bonds were issued 
on the date on which the failure to properly use the proceeds occurs, at 
least 95 percent of the net proceeds of the remaining bonds would be 
used to provide an exempt facility. If no proceeds have been spent to 
provide an exempt facility, all of the outstanding bonds are 
nonqualified bonds.
    (2) Allocation of nonqualified bonds. Allocations of nonqualified 
bonds must be made on a pro rata basis, except that an issuer may treat 
any bonds of an issue as the nonqualified bonds so long as--
    (i) The remaining weighted average maturity of the issue, determined 
as of the date on which the nonqualified bonds are redeemed or defeased 
(determination date), and excluding from the determination the 
nonqualified bonds redeemed or defeased by the issuer to meet the 
requirements of paragraph (c) of this section, is not greater than
    (ii) The remaining weighted average maturity of the issue, 
determined as of the determination date, but without regard to the 
redemption or defeasance of any bonds (including the nonqualified bonds) 
occurring on the determination date.

[T.D. 8712, 62 FR 2302, Jan. 16, 1997, as amended by T.D. 9150, 69 FR 
50067, Aug. 13, 2004]



Sec. 1.142-3  Refunding Issues. [Reserved]



Sec. 1.142-4  Use of proceeds to provide a facility.

    (a) In general. [Reserved]
    (b) Reimbursement allocations. If an expenditure for a facility is 
paid before the issue date of the bonds to provide that facility, the 
facility is described in section 142(a) only if the expenditure meets 
the requirements of Sec. 1.150-2 (relating to reimbursement 
allocations). For purposes of this paragraph (b), if the proceeds of an 
issue are used to pay principal of or interest on an obligation other 
than a State or local bond (for example, temporary construction 
financing of the conduit borrower), that issue is not a refunding issue, 
and, thus, Sec. 1.150-2(g) does not apply.

[[Page 677]]

    (c) Limitation on use of facilities by substantial users--(1) In 
general. If the original use of a facility begins before the issue date 
of the bonds to provide the facility, the facility is not described in 
section 142(a) if any person that was a substantial user of the facility 
at any time during the 5-year period before the issue date or any 
related person to that user receives (directly or indirectly) 5 percent 
or more of the proceeds of the issue for the user's interest in the 
facility and is a substantial user of the facility at any time during 
the 5-year period after the issue date, unless--
    (i) An official intent for the facility is adopted under Sec. 
1.150-2 within 60 days after the date on which acquisition, 
construction, or reconstruction of that facility commenced; and
    (ii) For an acquisition, no person that is a substantial user or 
related person after the acquisition date was also a substantial user 
more than 60 days before the date on which the official intent was 
adopted.
    (2) Definitions. For purposes of paragraph (c)(1) of this section, 
substantial user has the meaning used in section 147(a)(1), related 
person has the meaning used in section 144(a)(3), and a user that is a 
governmental unit within the meaning of Sec. 1.103-1 is disregarded.
    (d) Effective date--(1) In general. This section applies to bonds 
sold on or after July 8, 1997. See Sec. 1.103-8(a)(5) for rules 
applicable to bonds sold before that date.
    (2) Elective retroactive application. An issuer may apply this 
section to any bond sold before July 8, 1997.

[T.D. 8718, 62 FR 25506, May 9, 1997]



Sec. 1.142(a)(5)-1  Exempt facility bonds: Sewage facilities.

    (a) In general. Under section 103(a), a private activity bond is a 
tax-exempt bond only if it is a qualified bond. A qualified bond 
includes an exempt facility bond, defined as any bond issued as part of 
an issue 95 percent or more of the net proceeds of which are used to 
provide a facility specified in section 142. One type of facility 
specified in section 142(a) is a sewage facility. This section defines 
the term sewage facility for purposes of section 142(a).
    (b) Definitions--(1) Sewage facility defined. A sewage facility is 
property--
    (i) Except as provided in paragraphs (b)(2) and (d) of this section, 
used for the secondary treatment of wastewater; however, for property 
treating wastewater reasonably expected to have an average daily raw 
wasteload concentration of biochemical oxygen demand (BOD) that exceeds 
350 milligrams per liter as oxygen (measured at the time the influent 
enters the facility) (the BOD limit), this paragraph (b)(1)(i) applies 
only to the extent the treatment is for wastewater having an average 
daily raw wasteload concentration of BOD that does not exceed the BOD 
limit;
    (ii) Used for the preliminary and/or primary treatment of wastewater 
but only to the extent used in connection with secondary treatment 
(without regard to the BOD limit described in paragraph (b)(1)(i) of 
this section);
    (iii) Used for the advanced or tertiary treatment of wastewater but 
only to the extent used in connection with and after secondary 
treatment;
    (iv) Used for the collection, storage, use, processing, or final 
disposal of--
    (A) Wastewater, which property is necessary for such preliminary, 
primary, secondary, advanced, or tertiary treatment; or
    (B) Sewage sludge removed during such preliminary, primary, 
secondary, advanced, or tertiary treatment (without regard to the BOD 
limit described in paragraph (b)(1)(i) of this section);
    (v) Used for the treatment, collection, storage, use, processing, or 
final disposal of septage (without regard to the BOD limit described in 
paragraph (b)(1)(i) of this section); and
    (vi) Functionally related and subordinate to property described in 
this paragraph (b)(1), such as sewage disinfection property.
    (2) Special rules and exceptions--(i) Exception to BOD limit. A 
facility treating wastewater with an average daily raw wasteload 
concentration of BOD exceeding the BOD limit will not fail to qualify as 
a sewage facility described in paragraph (b)(1) of this section to the 
extent that the failure to satisfy the BOD limit results from the 
implementation of a federal, state, or local

[[Page 678]]

water conservation program (for example, a program designed to promote 
water use efficiency that results in BOD concentrations beyond the BOD 
limit).
    (ii) Anti-abuse rule for BOD limit. A facility does not satisfy the 
BOD limit if there is any intentional manipulation of the BOD level to 
circumvent the BOD limit (for example, increasing the volume of water in 
the wastewater before the influent enters the facility with the 
intention of reducing the BOD level).
    (iii) Authority of Commissioner. In appropriate cases upon 
application to the Commissioner, the Commissioner may determine that 
facilities employing technologically advanced or innovative treatment 
processes qualify as sewage facilities if it is demonstrated that these 
facilities perform functions that are consistent with the definition of 
sewage facilities described in paragraph (b)(1) of this section.
    (3) Other applicable definitions--(i) Advanced or tertiary treatment 
means the treatment of wastewater after secondary treatment. Advanced or 
tertiary treatment ranges from biological treatment extensions to 
physical-chemical separation techniques such as denitrification, ammonia 
stripping, carbon adsorption, and chemical precipitation.
    (ii) Nonconventional pollutants are any pollutants that are not 
listed in 40 CFR 401.15, 401.16, or appendix A to part 423.
    (iii) Preliminary treatment means treatment that removes large 
extraneous matter from incoming wastewater and renders the incoming 
wastewater more amenable to subsequent treatment and handling.
    (iv) Pretreatment means a process that preconditions wastewater to 
neutralize or remove toxic, priority, or nonconventional pollutants that 
could adversely affect sewers or inhibit a preliminary, primary, 
secondary, advanced, or tertiary treatment operation.
    (v) Primary treatment means treatment that removes material that 
floats or will settle, usually by screens or settling tanks.
    (vi) Priority pollutants are those pollutants listed in appendix A 
to 40 CFR part 423.
    (vii) Secondary treatment means the stage in sewage treatment in 
which a bacterial process (or an equivalent process) consumes the 
organic parts of wastes, usually by trickling filters or an activated 
sludge process.
    (viii) Sewage sludge is defined in 40 CFR 122.2 and includes 
septage.
    (ix) Toxic pollutants are those pollutants listed in 40 CFR 401.15.
    (c) Other property not included in the definition of a sewage 
facility. Property other than property described in paragraph (b)(1) of 
this section is not a sewage facility. Thus, for example, property is 
not a sewage facility, or functionally related and subordinate property, 
if the property is used for pretreatment of wastewater (whether or not 
this treatment is necessary to perform preliminary, primary, secondary, 
advanced, or tertiary treatment), or the related collection, storage, 
use, processing, or final disposal of the wastewater. In addition, 
property used to treat, process, or use wastewater subsequent to the 
time the wastewater can be discharged into navigable waters, as defined 
in 33 U.S.C. 1362, is not a sewage facility.
    (d) Allocation of costs. In the case of property that has both a use 
described in paragraph (b)(1) of this section (a sewage treatment 
function) and a use other than sewage treatment, only the portion of the 
cost of the property allocable to the sewage treatment function is taken 
into account as an expenditure to provide sewage facilities. The portion 
of the cost of property allocable to the sewage treatment function is 
determined by allocating the cost of that property between the 
property's sewage treatment function and any other uses by any method 
which, based on all the facts and circumstances, reasonably reflects a 
separation of costs for each use of the property.
    (e) Effective date--(1) In general. This section applies to issues 
of bonds issued after February 21, 1995.
    (2) Refundings. In the case of a refunding bond issued to refund a 
bond to which this section does not apply, the issuer need not apply 
this section to that refunding bond. This paragraph (e)(2) applies only 
if the weighted average maturity of the refunding bonds, as

[[Page 679]]

described in section 147(b), is not greater than the remaining weighted 
average maturity of the refunded bonds.

[T.D. 8576, 59 FR 66163, Dec. 23, 1994]



Sec. 1.142(f)(4)-1  Manner of making election to terminate tax-exempt 
bond financing.

    (a) Overview. Section 142(f)(4) permits a person engaged in the 
local furnishing of electric energy or gas (a local furnisher) that uses 
facilities financed with exempt facility bonds under section 142(a)(8) 
and that expands its service area in a manner inconsistent with the 
requirements of sections 142(a)(8) and (f) to make an election to ensure 
that those bonds will continue to be treated as exempt facility bonds. 
The election must meet the requirements of paragraphs (b) and (c) of 
this section.
    (b) Time for making election--(1) In general. An election under 
section 142(f)(4)(B) must be filed with the Internal Revenue Service on 
or before 90 days after the date of the service area expansion that 
causes bonds to cease to meet the requirements of sections 142(a)(8) and 
(f).
    (2) Date of service area expansion. For the purposes of this 
section, the date of the service area expansion is the first date on 
which the local furnisher is authorized to collect revenue for the 
provision of service in the expanded area.
    (c) Manner of making election. An election under section 
142(f)(4)(B) must be captioned ``ELECTION TO TERMINATE TAX-EXEMPT BOND 
FINANCING'', must be signed under penalties of perjury by a person who 
has authority to sign on behalf of the local furnisher, and must contain 
the following information--
    (1) The name of the local furnisher;
    (2) The tax identification number of the local furnisher;
    (3) The complete address of the local furnisher;
    (4) The date of the service area expansion;
    (5) Identification of each bond issue subject to the election, 
including the complete name of each issue, the tax identification number 
of each issuer, the report number of the information return filed under 
section 149(e) for each issue, the issue date of each issue, the CUSIP 
number (if any) of the bond with the latest maturity of each issue, the 
issue price of each issue, the adjusted issue price of each issue as of 
the date of the election, the earliest date on which the bonds of each 
issue may be redeemed, and the principal amount of bonds of each issue 
to be redeemed on the earliest redemption date;
    (6) A statement that the local furnisher making the election agrees 
to the conditions stated in section 142(f)(4)(B); and
    (7) A statement that each issuer of the bonds subject to the 
election has received written notice of the election.
    (d) Effect on section 150(b). Except as provided in paragraph (e) of 
this section, if a local furnisher files an election within the period 
specified in paragraph (b) of this section, section 150(b) does not 
apply to bonds identified in the election during and after that period.
    (e) Effect of failure to meet agreements. If a local furnisher fails 
to meet any of the conditions stated in an election pursuant to 
paragraph (c)(6) of this section, the election is invalid.
    (f) Corresponding provisions of the Internal Revenue Code of 1954. 
Section 103(b)(4)(E) of the Internal Revenue Code of 1954 set forth 
corresponding requirements for the exclusion from gross income of the 
interest on bonds issued for facilities for the local furnishing of 
electric energy or gas. For the purposes of this section any reference 
to sections 142(a)(8) and (f) of the Internal Revenue Code of 1986 
includes a reference to the corresponding portion of section 
103(b)(4)(E) of the Internal Revenue Code of 1954.
    (g) Effective dates. This section applies to elections made on or 
after January 19, 2001.

[T.D. 8941, 66 FR 4671, Jan. 18, 2001]



Sec. 1.143(g)-1  Requirements related to arbitrage.

    (a) In general. Under section 143, for an issue to be an issue of 
qualified mortgage bonds or qualified veterans' mortgage bonds 
(together, mortgage revenue bonds), the requirements of section 143(g) 
must be satisfied. An issue satisfies the requirements of section 143(g) 
only if such issue meets the

[[Page 680]]

requirements of paragraph (b) of this section and, in the case of an 
issue 95 percent or more of the net proceeds of which are to be used to 
provide residences for veterans, such issue also meets the requirements 
of paragraph (c) of this section. The requirements of section 143(g) and 
this section are applicable in addition to the requirements of section 
148 and Sec. Sec. 1.148-0 through 1.148-11.
    (b) Effective rate of mortgage interest not to exceed bond yield by 
more than 1.125 percentage points--(1) Maximum yield. An issue shall be 
treated as meeting the requirements of this paragraph (b) only if the 
excess of the effective rate of interest on the mortgages financed by 
the issue, over the yield on the issue, is not greater over the term of 
the issue than 1.125 percentage points.
    (2) Effective rate of interest. (i) In determining the effective 
rate of interest on any mortgage for purposes of this paragraph (b), 
there shall be taken into account all fees, charges, and other amounts 
borne by the mortgagor that are attributable to the mortgage or to the 
bond issue. Such amounts include points, commitment fees, origination 
fees, servicing fees, and prepayment penalties paid by the mortgagor.
    (ii) Items that shall be treated as borne by the mortgagor and shall 
be taken into account in calculating the effective rate of interest also 
include--
    (A) All points, commitment fees, origination fees, or similar 
charges borne by the seller of the property; and
    (B) The excess of any amounts received from any person other than 
the mortgagor by any person in connection with the acquisition of the 
mortgagor's interest in the property over the usual and reasonable 
acquisition costs of a person acquiring like property when owner-
financing is not provided through the use of mortgage revenue bonds.
    (iii) The following items shall not be treated as borne by the 
mortgagor and shall not be taken into account in calculating the 
effective rate of interest--
    (A) Any expected rebate of arbitrage profit under paragraph (c) of 
this section; and
    (B) Any application fee, survey fee, credit report fee, insurance 
charge or similar settlement or financing cost to the extent such amount 
does not exceed amounts charged in the area in cases when owner-
financing is not provided through the use of mortgage revenue bonds. For 
example, amounts paid for Federal Housing Administration, Veterans' 
Administration, or similar private mortgage insurance on an individual's 
mortgage, or amounts paid for pool mortgage insurance on a pool of 
mortgages, are not taken into account so long as such amounts do not 
exceed the amounts charged in the area with respect to a similar 
mortgage, or pool of mortgages, that is not financed with mortgage 
revenue bonds. For this purpose, amounts paid for pool mortgage 
insurance include amounts paid to an entity (for example, the Government 
National Mortgage Association, the Federal National Mortgage Association 
(FNMA), the Federal Home Loan Mortgage Corporation, or other mortgage 
insurer) to directly guarantee the pool of mortgages financed with the 
bonds, or to guarantee a pass-through security backed by the pool of 
mortgages financed with the bonds.
    (C) The following example illustrates the provisions of this 
paragraph (b)(2)(iii):

    Example. Housing Authority X issues bonds intended to be qualified 
mortgage bonds under section 143(a). At the time the bonds are issued, X 
enters into an agreement with a group of mortgage lending institutions 
(lenders) under which the lenders agree to originate and service 
mortgages that meet certain specified requirements. After originating a 
specified amount of mortgages, each lender issues a ``pass-though 
security'' (each, a PTS) backed by the mortgages and sells the PTS to X. 
Under the terms of the PTS, the lender pays X an amount equal to the 
regular monthly payments on the mortgages (less certain fees), whether 
or not received by the lender (plus any prepayments and liquidation 
proceeds in the event of a foreclosure or other disposition of any 
mortgages). FNMA guarantees the timely payment of principal and interest 
on each PTS. From the payments received from each mortgagor, the lender 
pays a fee to FNMA for its guarantee of the PTS. The amounts paid to 
FNMA do not exceed the amounts charged in the area with respect to a 
similar pool of mortgages that is not financed with mortgage revenue 
bonds. Under this paragraph (b)(2)(iii), the fees for the guarantee 
provided by FNMA are an insurance charge

[[Page 681]]

because the guarantee is pool mortgage insurance. Because the amounts 
charged for the guarantee do not exceed the amounts charged in the area 
with respect to a similar pool of mortgages that is not financed with 
mortgage revenue bonds, the amounts charged for the guarantee are not 
taken into account in computing the effective rate of interest on the 
mortgages financed with X's bonds.

    (3) Additional rules. To the extent not inconsistent with the Tax 
Reform Act of 1986, Public Law 99-514 (the 1986 Act), or subsequent law, 
Sec. 6a.103A-2(i)(2) (other than paragraphs (i)(2)(i) and (i)(2)(ii)(A) 
through (C)) of this chapter applies to provide additional rules 
relating to compliance with the requirement that the effective rate of 
mortgage interest not exceed the bond yield by more than 1.125 
percentage points.
    (c) Arbitrage and investment gains to be used to reduce costs of 
owner-financing. As provided in section 143(g)(3), certain earnings on 
nonpurpose investments must either be paid or credited to mortgagors, or 
paid to the United States, in certain circumstances. To the extent not 
inconsistent with the 1986 Act or subsequent law, Sec. 6a.103A-2(i)(4) 
of this chapter applies to provide guidance relating to compliance with 
this requirement.
    (d) Effective dates--(1) In general. Except as otherwise provided in 
this section, Sec. 1.143(g)-1 applies to bonds sold on or after May 23, 
2005, that are subject to section 143.
    (2) Permissive retroactive application in whole. Except as provided 
in paragraph (d)(4) of this section, issuers may apply Sec. 1.143(g)-1, 
in whole, but not in part, to bonds sold before May 23, 2005, that are 
subject to section 143.
    (3) Bonds subject to the Internal Revenue Code of 1954. Except as 
provided in paragraph (d)(4) of this section and subject to the 
applicable effective dates for the corresponding statutory provisions, 
an issuer may apply Sec. 1.143(g)-1, in whole, but not in part, to 
bonds that are subject to section 103A(i) of the Internal Revenue Code 
of 1954.
    (4) Special rule for pre-July 1, 1993 bonds. To the extent that an 
issuer applies this section to bonds issued before July 1, 1993, Sec. 
6a.103A-2(i)(3) of this chapter also applies to the bonds.

[T.D. 9204, 70 FR 29449, May 23, 2005]



Sec. 1.144-0  Table of contents.

    This section lists the captioned paragraphs contained in 
Sec. Sec. 1.144-1 and 1.144-2.

Sec. 1.144-1 Qualified small issue bonds, qualified student loan bonds, 
          and qualified redevelopment bonds.
    (a) Overview.
    (b) Scope.
    (c) Effective dates.
Sec. 1.144-2 Remedial actions.

[T.D. 8712, 62 FR 2303, Jan. 16, 1997]



Sec. 1.144-1  Qualified small issue bonds, qualified student loan bonds, 
and qualified redevelopment bonds.

    (a) Overview. Interest on a private activity bond is not excludable 
from gross income under section 103(a) unless the bond is a qualified 
bond. Under section 141(e)(1)(D), a qualified small issue bond issued 
under section 144(a) may be a qualified bond. Under section 144(a), any 
qualified small issue bond is any bond issued as a part of an issue 95 
percent or more of the proceeds of which are to be used to provide 
certain manufacturing facilities or certain depreciable farm property 
and which meets other requirements. Under section 141(e)(1)(F) a 
qualified redevelopment bond issued under section 144(c) is a qualified 
bond. Under section 144(c), a qualified redevelopment bond is any bond 
issued as a part of an issue 95 percent or more of the net proceeds of 
which are to be used for one or more redevelopment purposes and which 
meets certain other requirements.
    (b) Scope. Sections 1.144-0 through 1.144-2 apply for purposes of 
the rules for small issue bonds under section 144(a) and qualified 
redevelopment bonds under section 144(c), except that Sec. 1.144-2 does 
not apply to the requirements for qualified small issue bonds under 
section 144(a)(4) (relating to the limitation on capital expenditures) 
or under section 144(a)(10) (relating to the aggregate limit of tax-
exempt bonds per taxpayer).
    (c) Effective dates. For effective dates of Sec. Sec. 1.144-0 
through 1.144-2, see Sec. 1.141-16.

[T.D. 8712, 62 FR 2303, Jan. 16, 1997]

[[Page 682]]



Sec. 1.144-2  Remedial actions.

    The remedial action rules of Sec. 1.142-2 apply to qualified small 
issue bonds issued under section 144(a) and to qualified redevelopment 
bonds issued under section 144(c), for this purpose treating those bonds 
as exempt facility bonds and the qualifying purposes for those bonds as 
exempt facilities.

[T.D. 8712, 62 FR 2303, Jan. 16, 1997]



Sec. 1.145-0  Table of contents.

    This section lists the captioned paragraphs contained in 
Sec. Sec. 1.145-1 and 1.145-2.

Sec. 1.145-1 Qualified 501(c)(3) bonds.
    (a) Overview.
    (b) Scope.
    (c) Effective dates.
Sec. 1.145-2 Application of private activity bond regulations.
    (a) In general.
    (b) Modification of private business tests.
    (c) Exceptions.
    (1) Certain provisions relating to governmental programs.
    (2) Costs of issuance.
    (d) Issuance costs financed by prior issue.

[T.D. 8712, 62 FR 2303, Jan. 16, 1997, as amended by T.D. 9234, 70 FR 
75035, Dec. 19, 2005]



Sec. 1.145-1  Qualified 501(c)(3) bonds.

    (a) Overview. Interest on a private activity bond is not excludable 
from gross income under section 103(a) unless the bond is a qualified 
bond. Under section 141(e)(1)(G), a qualified 501(c)(3) bond issued 
under section 145 is a qualified bond. Under section 145, a qualified 
501(c)(3) bond is any bond issued as a part of an issue that satisfies 
the requirements of sections 145(a) through (d).
    (b) Scope. Sections 1.145-0 through 1.145-2 apply for purposes of 
section 145(a).
    (c) Effective dates. For effective dates of Sec. Sec. 1.145-0 
through 1.145-2, see Sec. 1.141-15.

[T.D. 8712, 62 FR 2303, Jan. 16, 1997]



Sec. 1.145-2  Application of private activity bond regulations.

    (a) In general. Except as provided in this section, Sec. Sec. 1.141-
0 through 1.141-15 apply to section 145(a). For example, under this 
section, Sec. 1.141-1, and Sec. 1.141-2, an issue ceases to be an issue 
of qualified 501(c)(3) bonds if the issuer or a conduit borrower 
501(c)(3) organization takes a deliberate action, subsequent to the 
issue date, that causes the issue to fail to comply with the 
requirements of sections 141(e) and 145 (such as an action that results 
in revocation of exempt status of the 501(c)(3) organization).
    (b) Modification of private business tests. In applying 
Sec. Sec. 1.141-0 through 1.141-15 to section 145(a)--
    (1) References to governmental persons include 501(c)(3) 
organizations with respect to their activities that do not constitute 
unrelated trades or businesses under section 513(a);
    (2) References to ``10 percent'' and ``proceeds'' in the context of 
the private business use test and the private security or payment test 
mean ``5 percent'' and ``net proceeds''; and
    (3) References to the private business use test in Sec. Sec. 1.141-2 
and 1.141-12 include the ownership test of section 145(a)(1).
    (c) Exceptions--(1) Certain provisions relating to governmental 
programs. The following provisions do not apply to section 145: 
Sec. 1.141-2(d)(4) (relating to the special rule for dispositions of 
personal property in the ordinary course of an established governmental 
program) and Sec. 1.141-2(d)(5) (relating to the special rule for 
general obligation bond programs that finance a large number of separate 
purposes).
    (2) Costs of issuance. Section 1.141-3(g)(6) does not apply to 
section 145(a)(2) to the extent that it provides that costs of issuance 
are allocated ratably among the other purposes for which the proceeds 
are used. For purposes of section 145(a)(2), costs of issuance are 
treated as private business use.
    (d) Issuance costs financed by prior issue. Solely for purposes of 
applying the private business use test to a refunding issue under Sec. 
1.141-13, the use of proceeds of the prior issue (or any earlier issue 
in a series of refundings) to pay issuance costs of the prior issue (or 
the earlier issue) is treated as a government use.

[T.D. 8712, 62 FR 2303, Jan. 16, 1997, as amended by T.D. 9234, 70 FR 
75035, Dec. 19, 2005]

[[Page 683]]



Sec. 1.147-0  Table of contents.

    This section lists the captioned paragraphs contained in 
Sec. Sec. 1.147-1 and 1.147-2.

Sec. 1.147-1 Other requirements applicable to certain private activity 
          bonds.
    (a) Overview.
    (b) Scope.
    (c) Effective dates.
Sec. 1.147-2 Remedial actions.

[T.D. 8712, 62 FR 2304, Jan. 16, 1997]



Sec. 1.147-1  Other requirements applicable to certain private activity 
bonds.

    (a) Overview. Interest on a private activity bond is not excludable 
from gross income under section 103(a) unless the bond is a qualified 
bond. Under section 147, certain requirements must be met for a private 
activity bond to qualify as a qualified bond.
    (b) Scope. Sections 1.147-0 through 1.147-2 apply for purposes of 
the rules in section 147 for qualified private activity bonds that 
permit use of proceeds to acquire land for environmental purposes 
(section 147(c)(3)), permit use of proceeds for certain rehabilitations 
(section 147(d) (2) and (3)), prohibit use of proceeds to finance 
skyboxes, airplanes, gambling establishments and similar facilities 
(section 147(e)), and require public approval (section 147(f)), but not 
for the rules limiting use of proceeds to acquire land or existing 
property under sections 147(c) (1) and (2), and (d)(1).
    (c) Effective dates. For effective dates of Sec. Sec. 1.147-0 
through 1.147-2, see Sec. 1.141-16.

[T.D. 8712, 62 FR 2304, Jan. 16, 1997]



Sec. 1.147-2  Remedial actions.

    The remedial action rules of Sec. 1.142-2 apply to the rules in 
section 147 for qualified private activity bonds that permit use of 
proceeds to acquire land for environmental purposes (section 147(c)(3)), 
permit use of proceeds for certain rehabilitations (section 147(d) (2) 
and (3)), prohibit use of proceeds to finance skyboxes, airplanes, 
gambling establishments and similar facilities (section 147(e)), and 
require public approval (section 147(f)), for this purpose treating 
those private activity bonds subject to the rules under section 147 as 
exempt facility bonds and the qualifying purposes for those bonds as 
exempt facilities.

[T.D. 8712, 62 FR 2304, Jan. 16, 1997]



Sec. 1.147(b)-1  Bond maturity limitation-treatment of working capital.

    Section 147(b) does not apply to proceeds of a private activity bond 
issue used to finance working capital expenditures.

[T.D. 8476, 58 FR 33515, June 18, 1993]



Sec. 1.148-0  Scope and table of contents.

    (a) Overview. Under section 103(a), interest on certain obligations 
issued by States and local governments is excludable from the gross 
income of the owners. Section 148 was enacted to minimize the arbitrage 
benefits from investing gross proceeds of tax-exempt bonds in higher 
yielding investments and to remove the arbitrage incentives to issue 
more bonds, to issue bonds earlier, or to leave bonds outstanding longer 
than is otherwise reasonably necessary to accomplish the governmental 
purposes for which the bonds were issued. To accomplish these purposes, 
section 148 restricts the direct and indirect investment of bond 
proceeds in higher yielding investments and requires that certain 
earnings on higher yielding investments be rebated to the United States. 
Violation of these provisions causes the bonds in the issue to become 
arbitrage bonds, the interest on which is not excludable from the gross 
income of the owners under section 103(a). The regulations in Sec. Sec. 
1.148-1 through 1.148-11 apply in a manner consistent with these 
purposes.
    (b) Scope. Sections 1.148-1 through 1.148-11 apply generally for 
purposes of the arbitrage restrictions on State and local bonds under 
section 148.
    (c) Table of contents. This paragraph (c) lists the table of 
contents for Sec. Sec. 1.148-1, 1.148-2, 1.148-3, 1.148-4, 1.148-5, 
1.148-6, 1.148-7, 1.148-8, 1.148-9, 1.148-10 and 1.148-11.

Sec. 1.148-1 Definitions and elections.
    (a) In general.
    (b) Certain definitions.
    (c) Definition of replacement proceeds.
    (1) In general.
    (2) Sinking fund.
    (3) Pledged fund.
    (4) Other replacement proceeds.

[[Page 684]]

    (d) Elections.
    (e) Investment-type property.
    (1) In general.
    (2) Prepayments.
    (3) Certain hedges.
Sec. 1.148-2 General arbitrage yield restriction rules.
    (a) In general.
    (b) Reasonable expectations.
    (1) In general.
    (2) Certification of expectations.
    (c) Intentional acts.
    (d) Materially higher yielding investments.
    (1) In general.
    (2) Definitions of materially higher yield.
    (3) Mortgage loans.
    (e) Temporary periods.
    (1) In general.
    (2) General 3-year temporary period for capital projects and 
qualified mortgage loans.
    (3) Temporary period for restricted working capital expenditures.
    (4) Temporary period for pooled financings.
    (5) Temporary period for replacement proceeds.
    (6) Temporary period for investment proceeds.
    (7) Other amounts.
    (f) Reserve or replacement funds.
    (1) General 10 percent limitation on funding with sale proceeds.
    (2) Exception from yield restriction for reasonably required reserve 
or replacement funds.
    (3) Certain parity reserve funds.
    (g) Minor portion.
    (h) Certain waivers permitted.
Sec. 1.148-3 General arbitrage rebate rules.
    (a) In general.
    (b) Definition of rebate amount.
    (c) Computation of future value of a payment or receipt.
    (d) Payments and receipts.
    (1) Definition of payments.
    (2) Definition of receipts.
    (3) Special rules for commingled funds.
    (e) Computation dates.
    (1) In general.
    (2) Final computation date.
    (f) Amount of required rebate installment payment.
    (1) Amount of interim rebate payments.
    (2) Amount of final rebate payment.
    (3) Future value of rebate payments.
    (g) Time and manner of payment.
    (h) Penalty in lieu of loss of tax exemption.
    (1) In general.
    (2) Interest on underpayments.
    (3) Waivers of the penalty.
    (4) Application to alternative penalty under Sec. 1.148-7.
    (i) Recovery of overpayment of rebate.
    (1) In general.
    (2) Limitations on recovery.
    (j) Examples.
    (k) Bona fide debt service fund exception.
Sec. 1.148-4 Yield on an issue of bonds.
    (a) In general.
    (b) Computing yield on a fixed yield issue.
    (1) In general.
    (2) Yield on certain fixed yield bonds subject to mandatory or 
contingent early redemption.
    (3) Yield on certain fixed yield bonds subject to optional early 
redemption.
    (4) Yield recomputed upon transfer of certain rights associated with 
the bond.
    (5) Special aggregation rule treating certain bonds as a single 
fixed yield bond.
    (6) Examples.
    (c) Computing yield on a variable yield issue.
    (1) In general.
    (2) Payments on bonds included in yield for a computation period.
    (3) Example.
    (d) Conversion from variable yield issue to fixed yield issue.
    (e) Value of bonds.
    (1) Plain par bonds.
    (2) Other bonds.
    (f) Qualified guarantees.
    (1) In general.
    (2) Interest savings.
    (3) Guarantee in substance.
    (4) Reasonable charge.
    (5) Guarantee of purpose investments.
    (6) Allocation of qualified guarantee payments.
    (7) Refund or reduction of guarantee payments.
    (g) Yield on certain mortgage revenue and student loan bonds.
    (h) Qualified hedging transactions.
    (1) In general.
    (2) Qualified hedge defined.
    (3) Accounting for qualified hedges.
    (4) Certain variable yield bonds treated as fixed yield bonds.
    (5) Contracts entered into before issue date of hedged bond.
    (6) Authority of the Commissioner.
Sec. 1.148-5 Yield and valuation of investments.
    (a) In general.
    (b) Yield on an investment.
    (1) In general.
    (2) Yield on a separate class of investments.
    (3) Investments to be held beyond issue's maturity or beyond 
temporary period.
    (4) Consistent redemption assumptions on purpose investments.
    (5) Student loan special allowance payments included in yield.
    (c) Yield reduction payments to the United States.
    (1) In general.
    (2) Manner of payment.
    (3) Applicability of special yield reduction rule.
    (d) Value of investments.
    (1) In general.

[[Page 685]]

    (2) Mandatory valuation of yield restricted investments at present 
value.
    (3) Mandatory valuation of certain investments at fair market value.
    (4) Special transition rule for transferred proceeds.
    (5) Definition of present value of an investment.
    (6) Definition of fair market value.
    (e) Administrative costs of investments.
    (1) In general.
    (2) Qualified administrative costs on nonpurpose investments.
    (3) Qualified administrative costs on purpose investments.
Sec. 1.148-6 General allocation and accounting rules.
    (a) In general.
    (1) Reasonable accounting methods required.
    (2) Bona fide deviations from accounting method.
    (b) Allocation of gross proceeds to an issue.
    (1) One-issue rule and general ordering rules.
    (2) Universal cap on value of nonpurpose investments allocated to an 
issue.
    (c) Fair market value limit on allocations to nonpurpose 
investments.
    (d) Allocation of gross proceeds to expenditures.
    (1) Expenditures in general.
    (2) Treatment of gross proceeds invested in purpose investments.
    (3) Expenditures for working capital purposes.
    (4) Expenditures for grants.
    (5) Expenditures for reimbursement purposes.
    (6) Expenditures of certain commingled investment proceeds of 
governmental issues.
    (7) Payments to related parties.
    (e) Special rules for commingled funds.
    (1) In general.
    (2) Investments held by a commingled fund.
    (3) Certain expenditures involving a commingled fund.
    (4) Fiscal periods.
    (5) Unrealized gains and losses on investments of a commingled fund.
    (6) Allocations of commingled funds serving as common reserve funds 
or sinking funds.
Sec. 1.148-7 Spending exceptions to the rebate requirement.
    (a) Scope of section.
    (1) In general.
    (2) Relationship of spending exceptions.
    (3) Spending exceptions not mandatory.
    (b) Rules applicable for all spending exceptions.
    (1) Special transferred proceeds rules.
    (2) Application of multipurpose issue rules.
    (3) Expenditures for governmental purposes of the issue.
    (4) De minimis rule.
    (5) Special definition of reasonably required reserve or replacement 
fund.
    (6) Pooled financing issue.
    (c) 6-month exception.
    (1) General rule.
    (2) Additional period for certain bonds.
    (3) Amounts not included in gross proceeds.
    (4) Series of refundings.
    (d) 18-month exception.
    (1) General rule.
    (2) Extension for reasonable retainage.
    (3) Gross proceeds.
    (4) Application to multipurpose issues.
    (e) 2-year exception.
    (1) General rule.
    (2) Extension for reasonable retainage.
    (3) Definitions.
    (f) Construction issue.
    (1) Definition.
    (2) Use of actual facts.
    (3) Ownership requirement.
    (g) Construction expenditures.
    (1) Definition.
    (2) Certain acquisitions under turnkey contracts treated as 
construction expenditures.
    (3) Constructed personal property.
    (4) Specially developed computer software.
    (5) Examples.
    (h) Reasonable retainage definition.
    (i) Available construction proceeds.
    (1) Definition in general.
    (2) Earnings on a reasonably required reserve or replacement fund.
    (3) Reasonable expectations test for future earnings.
    (4) Issuance costs.
    (5) One and one-half percent penalty in lieu of arbitrage rebate.
    (6) Payments on purpose investments and repayments of grants.
    (7) Examples.
    (j) Election to treat portion of issue used for construction as 
separate issue.
    (1) In general.
    (2) Example.
    (k) One and one-half percent penalty in lieu of arbitrage rebate.
    (1) In general.
    (2) Application to reasonable retainage.
    (3) Coordination with rebate requirement.
    (l) Termination of 1\1/2\ percent penalty.
    (1) Termination after initial temporary period.
    (2) Termination before end of initial temporary period.
    (3) Application to reasonable retainage.
    (4) Example.
    (m) Payment of penalties.
Sec. 1.148-8 Small issuer exception to rebate requirement.
    (a) Scope.
    (b) General taxing powers.
    (c) Size limitation.
    (1) In general.
    (2) Aggregation rules.

[[Page 686]]

    (3) Certain refunding bonds not taken into account.
    (d) Pooled financings.
    (1) Treatment of pool issuer.
    (2) Treatment of conduit borrowers.
    (e) Refunding issues.
    (1) In general.
    (2) Multipurpose issues.
Sec. 1.148-9 Arbitrage rules for refunding issues.
    (a) Scope of application.
    (b) Transferred proceeds allocation rule.
    (1) In general.
    (2) Special definition of principal amount.
    (3) Relation of transferred proceeds rule to universal cap rule.
    (4) Limitation on multi-generational transfers.
    (c) Special allocation rules for refunding issues.
    (1) Allocations of investments.
    (2) Allocations of mixed escrows to expenditures for principal, 
interest, and redemption prices on a prior issue.
    (d) Temporary periods in refundings.
    (1) In general.
    (2) Types of temporary periods in refundings.
    (e) Reasonably required reserve or replacement funds in refundings.
    (f) Minor portions in refundings.
    (g) Certain waivers permitted.
    (h) Multipurpose issue allocations.
    (1) Application of multipurpose issue allocation rules.
    (2) Rules on allocations of multipurpose issues.
    (3) Separate purposes of a multipurpose issue.
    (4) Allocations of bonds of a multipurpose issue.
    (5) Limitation on multi-generation allocations.
    (i) Operating rules for separation of prior issues into refunded and 
unrefunded portions.
    (1) In general.
    (2) Allocations of proceeds and investments in a partial refunding.
    (3) References to prior issue.
Sec. 1.148-10 Anti-abuse rules and authority of Commissioner.
    (a) Abusive arbitrage device.
    (1) In general.
    (2) Abusive arbitrage device defined.
    (3) Exploitation of tax-exempt interest rates.
    (4) Overburdening the tax-exempt market.
    (b) Consequences of overburdening the tax-exempt bond market.
    (1) In general.
    (2) Application.
    (c) Anti-abuse rules on excess gross proceeds of advance refunding 
issues.
    (1) In general.
    (2) Definition of excess gross proceeds.
    (3) Special treatment of transferred proceeds.
    (4) Special rule for crossover refundings.
    (5) Special rule for gross refundings.
    (d) Examples.
    (e) Authority of the Commissioner to clearly reflect the economic 
substance of a transaction.
    (f) Authority of the Commissioner to require an earlier date for 
payment of rebate.
    (g) Authority of the Commissioner to waive regulatory limitations.
Sec. 1.148-11 Effective dates.
    (a) In general.
    (b) Elective retroactive application in whole.
    (1) In general.
    (2) No elective retroactive application for 18-month spending 
exception.
    (3) No elective retroactive application for hedges of fixed rate 
issues.
    (4) No elective retroactive application for safe harbor for 
establishing fair market value for guaranteed investment contracts and 
investments purchased for a yield restricted defeasance escrow.
    (c) Elective retroactive application of certain provisions.
    (1) Retroactive application of overpayment recovery provisions.
    (2) Certain allocations of multipurpose issues.
    (3) Special limitation.
    (d) Transition rule excepting certain state guarantee funds from the 
definition of replacement proceeds.
    (1) Certain perpetual trust funds.
    (2) Permanent University Fund.
    (e) Transition rule regarding special allowance payments.
    (f) Transition rule regarding applicability of yield reduction rule.
    (g) Provisions applicable to certain bonds sold before effective 
date.
    (h) Safe harbor for establishing fair market value for guaranteed 
investment contracts and investments purchased for a yield restricted 
defeasance escrow.
    (i) Special rule for certain broker's commissions and similar fees.
    (j) Certain prepayments.

[T.D. 8476, 58 FR 33515, June 18, 1993, as amended by T.D. 8538, 59 FR 
24041, May 10, 1994; T.D. 8718, 62 FR 25506, May 9, 1997; T.D. 9085, 68 
FR 45775, Aug. 4, 2003; T.D. 9097, 68 FR 69022, Dec. 11, 2003]



Sec. 1.148-1  Definitions and elections.

    (a) In general. The definitions in this section and the definitions 
under section 150 apply for purposes of section 148 and Sec. Sec. 
1.148-1 through 1.148-11.
    (b) Certain definitions. The following definitions apply:
    Accounting method means both the overall method used to account for

[[Page 687]]

gross proceeds of an issue (e.g., the cash method or a modified accrual 
method) and the method used to account for or allocate any particular 
item within that overall accounting method (e.g., accounting for 
investments, expenditures, allocations to and from different sources, 
and particular items of the foregoing).
    Annuity contract means annuity contract as defined in section 72.
    Available amount means available amount as defined in Sec. 1.148-
6(d)(3)(iii).
    Bona fide debt service fund means a fund, which may include proceeds 
of an issue, that--
    (1) Is used primarily to achieve a proper matching of revenues with 
principal and interest payments within each bond year; and
    (2) Is depleted at least once each bond year, except for a 
reasonable carryover amount not to exceed the greater of:
    (i) the earnings on the fund for the immediately preceding bond 
year; or
    (ii) one-twelfth of the principal and interest payments on the issue 
for the immediately preceding bond year.
    Bond year means, in reference to an issue, each 1-year period that 
ends on the day selected by the issuer. The first and last bond years 
may be short periods. If no day is selected by the issuer before the 
earlier of the final maturity date of the issue or the date that is 5 
years after the issue date, bond years end on each anniversary of the 
issue date and on the final maturity date.
    Capital project or capital projects means all capital expenditures, 
plus related working capital expenditures to which the de minimis rule 
under Sec. 1.148-6(d)(3)(ii)(A) applies, that carry out the 
governmental purposes of an issue. For example, a capital project may 
include capital expenditures for one or more buildings, plus related 
start-up operating costs.
    Commingled fund means any fund or account containing both gross 
proceeds of an issue and amounts in excess of $25,000 that are not gross 
proceeds of that issue if the amounts in the fund or account are 
invested and accounted for collectively, without regard to the source of 
funds deposited in the fund or account. An open-end regulated investment 
company under section 851, however, is not a commingled fund.
    Computation date means each date on which the rebate amount for an 
issue is computed under Sec. 1.148-3(e).
    Computation period means the period between computation dates. The 
first computation period begins on the issue date and ends on the first 
computation date. Each succeeding computation period begins on the date 
immediately following the computation date and ends on the next 
computation date.
    Consistently applied means applied uniformly within a fiscal period 
and between fiscal periods to account for gross proceeds of an issue and 
any amounts that are in a commingled fund.
    De minimis amount means--
    (1) In reference to original issue discount (as defined in section 
1273(a)(1)) or premium on an obligation--
    (i) An amount that does not exceed 2 percent multiplied by the 
stated redemption price at maturity; plus
    (ii) Any original issue premium that is attributable exclusively to 
reasonable underwriters' compensation; and
    (2) In reference to market discount (as defined in section 
1278(a)(2)(A)) or premium on an obligation, an amount that does not 
exceed 2 percent multiplied by the stated redemption price at maturity.
    Economic accrual method (also known as the constant interest method 
or actuarial method) means the method of computing yield that is based 
on the compounding of interest at the end of each compounding period.
    Fair market value means fair market value as defined in Sec. 1.148-
5(d)(6).
    Fixed rate investment means any investment whose yield is fixed and 
determinable on the issue date.
    Fixed yield bond means any bond whose yield is fixed and 
determinable on the issue date using the assumptions and rules provided 
in Sec. 1.148-4(b).
    Fixed yield issue means any issue if each bond that is part of the 
issue is a fixed yield bond.
    Gross proceeds means any proceeds and replacement proceeds of an 
issue.
    Guaranteed investment contract includes any nonpurpose investment 
that has specifically negotiated withdrawal or reinvestment provisions 
and a specifically negotiated interest rate, and also includes any 
agreement to supply

[[Page 688]]

investments on two or more future dates (e.g., a forward supply 
contract).
    Higher yielding investments means higher yielding investments as 
defined in section 148(b)(1).
    Investment means any investment property as defined in sections 
148(b)(2) and 148(b)(3), and any other tax-exempt bond.
    Investment proceeds means any amounts actually or constructively 
received from investing proceeds of an issue.
    Investment-type property is defined in paragraph (e) of this 
section.
    Issue price means, except as otherwise provided, issue price as 
defined in sections 1273 and 1274. Generally, the issue price of bonds 
that are publicly offered is the first price at which a substantial 
amount of the bonds is sold to the public. Ten percent is a substantial 
amount. The public does not include bond houses, brokers, or similar 
persons or organizations acting in the capacity of underwriters or 
wholesalers. The issue price does not change if part of the issue is 
later sold at a different price. The issue price of bonds that are not 
substantially identical is determined separately. The issue price of 
bonds for which a bona fide public offering is made is determined as of 
the sale date based on reasonable expectations regarding the initial 
public offering price. If a bond is issued for property, the applicable 
Federal tax-exempt rate is used in lieu of the Federal rate in 
determining the issue price under section 1274. The issue price of bonds 
may not exceed their fair market value as of the sale date.
    Issuer generally means the entity that actually issues the issue, 
and, unless the context or a provision clearly requires otherwise, each 
conduit borrower of the issue. For example, rules imposed on issuers to 
account for gross proceeds of an issue apply to a conduit borrower to 
account for any gross proceeds received under a purpose investment. 
Provisions regarding elections, filings, liability for the rebate 
amount, and certifications of reasonable expectations apply only to the 
actual issuer.
    Multipurpose issue means an issue the proceeds of which are used for 
two or more separate purposes determined in accordance with Sec. 1.148-
9(h).
    Net sale proceeds means sale proceeds, less the portion of those 
sale proceeds invested in a reasonably required reserve or replacement 
fund under section 148(d) and as part of a minor portion under section 
148(e).
    Nonpurpose investment means any investment property, as defined in 
section 148(b), that is not a purpose investment.
    Payment means a payment as defined in Sec. 1.148-3(d) for purposes 
of computing the rebate amount, and a payment as defined in Sec. 1.148-
5(b) for purposes of computing the yield on an investment.
    Plain par bond means a qualified tender bond or a bond--
    (1) Issued with not more than a de minimis amount of original issue 
discount or premium;
    (2) Issued for a price that does not include accrued interest other 
than pre-issuance accrued interest;
    (3) That bears interest from the issue date at a single, stated, 
fixed rate or that is a variable rate debt instrument under section 
1275, in each case with interest unconditionally payable at least 
annually; and
    (4) That has a lowest stated redemption price that is not less than 
its outstanding stated principal amount.
    Plain par investment means an investment that is an obligation--
    (1) Issued with not more than a de minimis amount of original issue 
discount or premium, or, if acquired on a date other than the issue 
date, acquired with not more than a de minimis amount of market discount 
or premium;
    (2) Issued for a price that does not include accrued interest other 
than pre-issuance accrued interest;
    (3) That bears interest from the issue date at a single, stated, 
fixed rate or that is a variable rate debt instrument under section 
1275, in each case with interest unconditionally payable at least 
annually; and
    (4) That has a lowest stated redemption price that is not less than 
its outstanding stated principal amount.
    Pre-issuance accrued interest means amounts representing interest 
that accrued on an obligation for a period not greater than one year 
before its issue date but only if those amounts are paid within one year 
after the issue date.

[[Page 689]]

    Proceeds means any sale proceeds, investment proceeds, and 
transferred proceeds of an issue. Proceeds do not include, however, 
amounts actually or constructively received with respect to a purpose 
investment that are properly allocable to the immaterially higher yield 
under Sec. 1.148-2(d) or section 143(g) or to qualified administrative 
costs recoverable under Sec. 1.148-5(e).
    Program investment means a purpose investment that is part of a 
governmental program in which--
    (1) The program involves the origination or acquisition of purpose 
investments;
    (2) At least 95 percent (90 percent for qualified student loans 
under section 144(b)(1)(A)) of the cost of the purpose investments 
acquired under the program represents one or more loans to a substantial 
number of persons representing the general public, States or political 
subdivisions, 501(c)(3) organizations, persons who provide housing and 
related facilities, or any combination of the foregoing;
    (3) At least 95 percent of the receipts from the purpose investments 
are used to pay principal, interest, or redemption prices on issues that 
financed the program, to pay or reimburse administrative costs of those 
issues or of the program, to pay or reimburse anticipated future losses 
directly related to the program, to finance additional purpose 
investments for the same general purposes of the program, or to redeem 
and retire governmental obligations at the next earliest possible date 
of redemption;
    (4) The program documents prohibit any obligor on a purpose 
investment financed by the program or any related party to that obligor 
from purchasing bonds of an issue that finance the program in an amount 
related to the amount of the purpose investment acquired from that 
obligor; and
    (5) The issuer has not waived the right to treat the investment as a 
program investment.
    Purpose investment means an investment that is acquired to carry out 
the governmental purpose of an issue.
    Qualified administrative costs means qualified administrative costs 
as defined in Sec. 1.148-5(e).
    Qualified guarantee means a qualified guarantee as defined in Sec. 
1.148-4(f).
    Qualified hedge means a qualified hedge as defined in Sec. 1.148-
4(h)(2).
    Reasonable expectations or reasonableness. An issuer's expectations 
or actions are reasonable only if a prudent person in the same 
circumstances as the issuer would have those same expectations or take 
those same actions, based on all the objective facts and circumstances. 
Factors relevant to a determination of reasonableness include the 
issuer's history of conduct concerning stated expectations made in 
connection with the issuance of obligations, the level of inquiry by the 
issuer into factual matters, and the existence of covenants, enforceable 
by bondholders, that require implementation of specific expectations. 
For a conduit financing issue, factors relevant to a determination of 
reasonableness include the reasonable expectations of the conduit 
borrower, but only if, under the circumstances, it is reasonable and 
prudent for the issuer to rely on those expectations.
    Rebate amount means 100 percent of the amount owed to the United 
States under section 148(f)(2), as further described in Sec. 1.148-3.
    Receipt means a receipt as defined in Sec. 1.148-3(d) for purposes 
of computing the rebate amount, and a receipt as defined in Sec. 1.148-
5(b) for purposes of computing yield on an investment.
    Refunding escrow means one or more funds established as part of a 
single transaction or a series of related transactions, containing 
proceeds of a refunding issue and any other amounts to provide for 
payment of principal or interest on one or more prior issues. For this 
purpose, funds are generally not so established solely because of--
    (1) The deposit of proceeds of an issue and replacement proceeds of 
the prior issue in an escrow more than 6 months apart, or
    (2) The deposit of proceeds of completely separate issues in an 
escrow.
    Replacement proceeds is defined in paragraph (c) of this section.
    Restricted working capital expenditures means working capital 
expenditures that are subject to the proceeds-spent-last rule in Sec. 
1.148-6(d)(3)(i) and are ineligible for any exception to that rule.

[[Page 690]]

    Sale proceeds means any amounts actually or constructively received 
from the sale of the issue, including amounts used to pay underwriters' 
discount or compensation and accrued interest other than pre-issuance 
accrued interest. Sale proceeds also include, but are not limited to, 
amounts derived from the sale of a right that is associated with a bond, 
and that is described in Sec. 1.148-4(b)(4). See also Sec. 1.148-
4(h)(5) treating amounts received upon the termination of certain hedges 
as sale proceeds.
    Stated redemption price means the redemption price of an obligation 
under the terms of that obligation, including any call premium.
    Transferred proceeds means transferred proceeds as defined in Sec. 
1.148-9 (or the applicable corresponding provision of prior law).
    Unconditionally payable means payable under terms in which--
    (1) Late payment or nonpayment results in a significant penalty to 
the borrower or reasonable remedies to the lender, and
    (2) It is reasonably certain on the issue date that the payment will 
actually be made.
    Value means value determined under Sec. 1.148-4(e) for a bond, and 
value determined under Sec. 1.148-5(d) for an investment.
    Variable yield bond means any bond that is not a fixed yield bond.
    Variable yield issue means any issue that is not a fixed yield 
issue.
    Yield means yield computed under Sec. 1.148-4 for an issue, and 
yield computed under Sec. 1.148-5 for an investment.
    Yield restricted means required to be invested at a yield that is 
not materially higher than the yield on the issue under section 148(a) 
and Sec. 1.148-2.
    (c) Definition of replacement proceeds--(1) In general. Amounts are 
replacement proceeds of an issue if the amounts have a sufficiently 
direct nexus to the issue or to the governmental purpose of the issue to 
conclude that the amounts would have been used for that governmental 
purpose if the proceeds of the issue were not used or to be used for 
that governmental purpose. For this purpose, governmental purposes 
include the expected use of amounts for the payment of debt service on a 
particular date. The mere availability or preliminary earmarking of 
amounts for a governmental purpose, however, does not in itself 
establish a sufficient nexus to cause those amounts to be replacement 
proceeds. Replacement proceeds include, but are not limited to, sinking 
funds, pledged funds, and other replacement proceeds described in 
paragraph (c)(4) of this section, to the extent that those funds or 
amounts are held by or derived from a substantial beneficiary of the 
issue. A substantial beneficiary of an issue includes the issuer and any 
related party to the issuer, and, if the issuer is not a state, the 
state in which the issuer is located. A person is not a substantial 
beneficiary of an issue solely because it is a guarantor under a 
qualified guarantee.
    (2) Sinking fund. Sinking fund includes a debt service fund, 
redemption fund, reserve fund, replacement fund, or any similar fund, to 
the extent reasonably expected to be used directly or indirectly to pay 
principal or interest on the issue.
    (3) Pledged fund--(i) In general. A pledged fund is any amount that 
is directly or indirectly pledged to pay principal or interest on the 
issue. A pledge need not be cast in any particular form but, in 
substance, must provide reasonable assurance that the amount will be 
available to pay principal or interest on the issue, even if the issuer 
encounters financial difficulties. A pledge to a guarantor of an issue 
is an indirect pledge to secure payment of principal or interest on the 
issue. A pledge of more than 50 percent of the outstanding stock of a 
corporation that is a conduit borrower of the issue is not treated as a 
pledge for this purpose, unless the corporation is formed or availed of 
to avoid the creation of replacement proceeds.
    (ii) Negative pledges. An amount is treated as pledged to pay 
principal or interest on an issue if it is held under an agreement to 
maintain the amount at a particular level for the direct or indirect 
benefit of the bondholders or a guarantor of the bonds. An amount is not 
treated as pledged under this paragraph (c)(3)(ii), however, if--
    (A) The issuer or a substantial beneficiary may grant rights in the 
amount

[[Page 691]]

that are superior to the rights of the bondholders or the guarantor; or
    (B) The amount does not exceed reasonable needs for which it is 
maintained, the required level is tested no more frequently than every 6 
months, and the amount may be spent without any substantial restriction 
other than a requirement to replenish the amount by the next testing 
date.
    (4) Other replacement proceeds--(i) Bonds outstanding longer than 
necessary--(A) In general. Replacement proceeds arise to the extent that 
the issuer reasonably expects as of the issue date that--
    (1) The term of an issue will be longer than is reasonably necessary 
for the governmental purposes of the issue, and
    (2) There will be available amounts during the period that the issue 
remains outstanding longer than necessary. Whether an issue is 
outstanding longer than necessary is determined under Sec. 1.148-10. 
Replacement proceeds are created under this paragraph (c)(4)(i)(A) at 
the beginning of each fiscal year during which an issue remains 
outstanding longer than necessary in an amount equal to available 
amounts of the issuer as of that date.
    (B) Safe harbor against creation of replacement proceeds. As a safe 
harbor, replacement proceeds do not arise under paragraph (c)(4)(i)(A) 
of this section--
    (1) For the portion of an issue that is to be used to finance 
restricted working capital expenditures, if that portion is not 
outstanding longer than 2 years;
    (2) For the portion of an issue (including a refunding issue) that 
is to be used to finance or refinance capital projects, if that portion 
has a weighted average maturity that does not exceed 120 percent of the 
average reasonably expected economic life of the financed capital 
projects, determined in the same manner as under section 147(b); or
    (3) For the portion of an issue that is a refunding issue, if that 
portion has a weighted average maturity that does not exceed the 
remaining weighted average maturity of the prior issue, and the issue of 
which the prior issue is a part satisfies paragraph (c)(4)(i)(B) (1) or 
(2) of this section.
    (ii) Bonds financing a working capital reserve--(A) In general. 
Except as otherwise provided in paragraph (c)(4)(ii)(B) of this section, 
replacement proceeds arise to the extent a working capital reserve is, 
directly or indirectly, financed with the proceeds of the issue 
(regardless of the expenditure of proceeds of the issue). Thus, for 
example, if an issuer that does not maintain a working capital reserve 
borrows to fund a working capital reserve, the issuer will have 
replacement proceeds. To determine the amount of a working capital 
reserve maintained, an issuer may use the average amount maintained as a 
working capital reserve during annual periods of at least 1 year, the 
last of which ends within 1 year before the issue date. For example, the 
amount of a working capital reserve may be computed using the average of 
the beginning or ending monthly balances of the amount maintained as a 
reserve (net of unexpended gross proceeds) during the 1 year period 
preceding the issue date.
    (B) Exception to creation of replacement proceeds. Replacement 
proceeds do not arise under paragraph (c)(4)(ii)(A) of this section with 
respect to an issue--
    (1) All of the net proceeds of which are spent within 6 months of 
the issue date under section 148(f)(4)(B)(iii)(I); or
    (2) That is not subject to the rebate requirement under the 
exception provided by section 148(f)(4)(D).
    (d) Elections. Except as otherwise provided, any required elections 
must be made in writing, and, once made, may not be revoked without the 
permission of the Commissioner.
    (e) Investment-type property--(1) In general. Investment-type 
property includes any property, other than property described in section 
148(b)(2)(A), (B), (C) or (E), that is held principally as a passive 
vehicle for the production of income. For this purpose, production of 
income includes any benefit based on the time value of money.
    (2) Prepayments--(i) In general--(A) Generally. Except as otherwise 
provided in this paragraph (e)(2), a prepayment for property or 
services, including a prepayment for property or services that is made 
after the date that the contract to buy the property or services is 
entered into, also gives rise to

[[Page 692]]

investment-type property if a principal purpose for prepaying is to 
receive an investment return from the time the prepayment is made until 
the time payment otherwise would be made. A prepayment does not give 
rise to investment-type property if--
    (1) Prepayments on substantially the same terms are made by a 
substantial percentage of persons who are similarly situated to the 
issuer but who are not beneficiaries of tax-exempt financing;
    (2) The prepayment is made within 90 days of the reasonably expected 
date of delivery to the issuer of all of the property or services for 
which the prepayment is made; or
    (3) The prepayment meets the requirements of paragraph 
(e)(2)(iii)(A) or (B) of this section.
    (B) Example. The following example illustrates an application of 
this paragraph (e)(2)(i):

    Example. Prepayment after contract is executed.
    In 1998, City A enters into a ten-year contract with Company Y. 
Under the contract, Company Y is to provide services to City A over the 
term of the contract and in return City A will pay Company Y for its 
services as they are provided. In 2004, City A issues bonds to finance a 
lump sum payment to Company Y in satisfaction of City A's obligation to 
pay for Company Y's services to be provided over the remaining term of 
the contract. The use of bond proceeds to make the lump sum payment 
constitutes a prepayment for services under paragraph (e)(2)(i) of this 
section, even though the payment is made after the date that the 
contract is executed.

    (ii) Customary prepayments. The determination of whether a 
prepayment satisfies paragraph (e)(2)(i)(A)(1) of this section is 
generally made based on all the facts and circumstances. In addition, a 
prepayment is deemed to satisfy paragraph (e)(2)(i)(A)(1) of this 
section if--
    (A) The prepayment is made for--
    (1) Maintenance, repair, or an extended warranty with respect to 
personal property (for example, automobiles or electronic equipment); or
    (2) Updates or maintenance or support services with respect to 
computer software; and
    (B) The same maintenance, repair, extended warranty, updates or 
maintenance or support services, as applicable, are regularly provided 
to nongovernmental persons on the same terms.
    (iii) Certain prepayments to acquire a supply of natural gas or 
electricity--(A) Natural gas prepayments. A prepayment meets the 
requirements of this paragraph (e)(2)(iii)(A) if--
    (1) It is made by or for one or more utilities that are owned by a 
governmental person, as defined in Sec. 1.141-1(b) (each of which is 
referred to in this paragraph (e)(2)(iii)(A) as the issuing municipal 
utility), to purchase a supply of natural gas; and
    (2) At least 90 percent of the prepaid natural gas financed by the 
issue is used for a qualifying use. Natural gas is used for a qualifying 
use if it is to be--
    (i) Furnished to retail gas customers of the issuing municipal 
utility who are located in the natural gas service area of the issuing 
municipal utility, provided, however, that gas used to produce 
electricity for sale shall not be included under this paragraph 
(e)(2)(iii)(A)(2)(i);
    (ii) Used by the issuing municipal utility to produce electricity 
that will be furnished to retail electric customers of the issuing 
municipal utility who are located in the electricity service area of the 
issuing municipal utility;
    (iii) Used by the issuing municipal utility to produce electricity 
that will be sold to a utility that is owned by a governmental person 
and furnished to retail electric customers of the purchaser who are 
located in the electricity service area of the purchaser;
    (iv) Sold to a utility that is owned by a governmental person if the 
requirements of paragraph (e)(2)(iii)(A)(2)(i), (ii) or (iii) of this 
section are satisfied by the purchaser (treating the purchaser as the 
issuing municipal utility); or
    (v) Used to fuel the pipeline transportation of the prepaid gas 
supply acquired in accordance with this paragraph (e)(2)(iii)(A).
    (B) Electricity prepayments. A prepayment meets the requirements of 
this paragraph (e)(2)(iii)(B) if--

[[Page 693]]

    (1) It is made by or for one or more utilities that are owned by a 
governmental person (each of which is referred to in this paragraph 
(e)(2)(iii)(B) as the issuing municipal utility) to purchase a supply of 
electricity; and
    (2) At least 90 percent of the prepaid electricity financed by the 
issue is used for a qualifying use. Electricity is used for a qualifying 
use if it is to be--
    (i) Furnished to retail electric customers of the issuing municipal 
utility who are located in the electricity service area of the issuing 
municipal utility; or
    (ii) Sold to a utility that is owned by a governmental person and 
furnished to retail electric customers of the purchaser who are located 
in the electricity service area of the purchaser.
    (C) Service area. For purposes of this paragraph (e)(2)(iii), the 
service area of a utility owned by a governmental person consists of--
    (1) Any area throughout which the utility provided, at all times 
during the 5-year period ending on the issue date--
    (i) In the case of a natural gas utility, natural gas transmission 
or distribution service; and
    (ii) In the case of an electric utility, electricity distribution 
service; and
    (2) Any area recognized as the service area of the utility under 
state or Federal law.
    (D) Retail customer. For purposes of this paragraph (e)(2)(iii), a 
retail customer is a customer that purchases natural gas or electricity, 
as applicable, other than for resale.
    (E) Commodity swaps. A prepayment does not fail to meet the 
requirements of this paragraph (e)(2)(iii) by reason of any commodity 
swap contract that may be entered into between the issuer and an 
unrelated party (other than the gas or electricity supplier), or between 
the gas or electricity supplier and an unrelated party (other than the 
issuer), so long as each swap contract is an independent contract. A 
swap contract is an independent contract if the obligation of each party 
to perform under the swap contract is not dependent on performance by 
any person (other than the other party to the swap contract) under 
another contract (for example, a gas or electricity supply contract or 
another swap contract); provided, however, that a commodity swap 
contract will not fail to be an independent contract solely because the 
swap contract may terminate in the event of a failure of a gas or 
electricity supplier to deliver gas or electricity for which the swap 
contract is a hedge.
    (F) Remedial action. Issuers may apply principles similar to the 
rules of Sec. 1.141-12, including Sec. 1.141-12(d) (relating to 
redemption or defeasance of nonqualified bonds) and Sec. 1.141-12(e) 
(relating to alternative use of disposition proceeds), to cure a 
violation of paragraph (e)(2)(iii)(A)(2) or (e)(2)(iii)(B)(2) of this 
section. For this purpose, the amount of nonqualified bonds is 
determined in the same manner as for output contracts taken into account 
under the private business tests, including the principles of Sec. 
1.141-7(d), treating nonqualified sales of gas or electricity under this 
paragraph (e)(2)(iii) as satisfying the benefits and burdens test under 
Sec. 1.141-7(c)(1).
    (iv) Additional prepayments as permitted by the Commissioner. The 
Commissioner may, by published guidance, set forth additional 
circumstances in which a prepayment does not give rise to investment-
type property.

[T.D. 8476, 58 FR 33517, June 18, 1993; 58 FR 44452, Aug. 23, 1993, as 
amended by T.D. 8538, 59 FR 24041, May 10, 1994; T.D. 8718, 62 FR 25507, 
May 9, 1997; T.D. 9085, 68 FR 45775, Aug. 4, 2003]



Sec. 1.148-2  General arbitrage yield restriction rules.

    (a) In general. Under section 148(a), the direct or indirect 
investment of the gross proceeds of an issue in higher yielding 
investments causes the bonds of the issue to be arbitrage bonds. The 
investment of proceeds in higher yielding investments, however, during a 
temporary period described in paragraph (e) of this section, as part of 
a reasonably required reserve or replacement fund described in paragraph 
(f) of this section, or as part of a minor portion described in 
paragraph (g) of this section does not cause the bonds of the issue to 
be arbitrage bonds. Bonds are not arbitrage bonds under this section as 
a result of an inadvertent, insubstantial error.

[[Page 694]]

    (b) Reasonable expectations--(1) In general. Except as provided in 
paragraph (c) of this section, the determination of whether an issue 
consists of arbitrage bonds under section 148(a) is based on the 
issuer's reasonable expectations as of the issue date regarding the 
amount and use of the gross proceeds of the issue.
    (2) Certification of expectations--(i) In general. An officer of the 
issuer responsible for issuing the bonds must, in good faith, certify 
the issuer's expectations as of the issue date. The certification must 
state the facts and estimates that form the basis for the issuer's 
expectations. The certification is evidence of the issuer's 
expectations, but does not establish any conclusions of law or any 
presumptions regarding either the issuer's actual expectations or their 
reasonableness.
    (ii) Exceptions to certification requirement. An issuer is not 
required to make a certification for an issue under paragraph (b)(2)(i) 
of this section if--
    (A) The issuer reasonably expects as of the issue date that there 
will be no unspent gross proceeds after the issue date, other than gross 
proceeds in a bona fide debt service fund (e.g., equipment lease 
financings in which the issuer purchases equipment in exchange for an 
installment payment note); or
    (B) The issue price of the issue does not exceed $1,000,000.
    (c) Intentional acts. The taking of any deliberate, intentional 
action by the issuer or person acting on its behalf after the issue date 
in order to earn arbitrage causes the bonds of the issue to be arbitrage 
bonds if that action, had it been expected on the issue date, would have 
caused the bonds to be arbitrage bonds. An intent to violate the 
requirements of section 148 is not necessary for an action to be 
intentional.
    (d) Materially higher yielding investments--(1) In general. The 
yield on investments is materially higher than the yield on the issue to 
which the investments are allocated if the yield on the investments over 
the term of the issue exceeds the yield on the issue by an amount in 
excess of the applicable definition of materially higher set forth in 
paragraph (d)(2) of this section. If yield restricted investments in the 
same class are subject to different definitions of materially higher, 
the applicable definition of materially higher that produces the lowest 
permitted yield applies to all the investments in the class. The yield 
on the issue is determined under Sec. 1.148-4. The yield on investments 
is determined under Sec. 1.148-5.
    (2) Definitions of materially higher yield--(i) General rule for 
purpose and nonpurpose investments. For investments that are not 
otherwise described in this paragraph (d)(2), materially higher means 
one-eighth of 1 percentage point.
    (ii) Refunding escrows and replacement proceeds. For investments in 
a refunding escrow or for investments allocable to replacement proceeds, 
materially higher means one-thousandth of 1 percentage point.
    (iii) Program investments. For program investments that are not 
described in paragraph (d)(2)(iv) of this section, materially higher 
means 1 and one-half percentage points.
    (iv) Student loans. For qualified student loans that are program 
investments, materially higher means 2 percentage points.
    (v) Tax-exempt investments. For investments that are tax-exempt 
bonds and are not investment property under section 148(b)(3), no yield 
limitation applies.
    (3) Mortgage loans. Qualified mortgage loans that satisfy the 
requirements of section 143(g) are treated as meeting the requirements 
of this paragraph (d).
    (e) Temporary periods--(1) In general. During the temporary periods 
set forth in this paragraph (e), the proceeds and replacement proceeds 
of an issue may be invested in higher yielding investments without 
causing bonds in the issue to be arbitrage bonds. This paragraph (e) 
does not apply to refunding issues (see Sec. 1.148-9).
    (2) General 3-year temporary period for capital projects and 
qualified mortgage loans--(i) In general. The net sale proceeds and 
investment proceeds of an issue reasonably expected to be allocated to 
expenditures for capital projects qualify for a temporary period of 3 
years beginning on the issue date (the 3-year temporary period). The 3-
year temporary period also applies to the

[[Page 695]]

proceeds of qualified mortgage bonds and qualified veterans' mortgage 
bonds by substituting qualified mortgage loans in each place that 
capital projects appears in this paragraph (e)(2). The 3-year temporary 
period applies only if the issuer reasonably expects to satisfy the 
expenditure test, the time test, and the due diligence test. These rules 
apply separately to each conduit loan financed by an issue (other than 
qualified mortgage loans), with the expenditure and time tests measured 
from the issue date of the issue.
    (A) Expenditure test. The expenditure test is met if at least 85 
percent of the net sale proceeds of the issue are allocated to 
expenditures on the capital projects by the end of the 3-year temporary 
period.
    (B) Time test. The time test is met if the issuer incurs within 6 
months of the issue date a substantial binding obligation to a third 
party to expend at least 5 percent of the net sale proceeds of the issue 
on the capital projects. An obligation is not binding if it is subject 
to contingencies within the issuer's or a related party's control.
    (C) Due diligence test. The due diligence test is met if completion 
of the capital projects and the allocation of the net sale proceeds of 
the issue to expenditures proceed with due diligence.
    (ii) 5-year temporary period. In the case of proceeds expected to be 
allocated to a capital project involving a substantial amount of 
construction expenditures (as defined in Sec. 1.148-7), a 5-year 
temporary period applies in lieu of the 3-year temporary period if the 
issuer satisfies the requirements of paragraph (e)(2)(i) of this section 
applied by substituting ``5 years'' in each place that ``3 years'' 
appears, and both the issuer and a licensed architect or engineer 
certify that the longer period is necessary to complete the capital 
project.
    (3) Temporary period for restricted working capital expenditures--
(i) General rule. The proceeds of an issue that are reasonably expected 
to be allocated to restricted working capital expenditures within 13 
months after the issue date qualify for a temporary period of 13 months 
beginning on the issue date. Paragraph (e)(2) of this section contains 
additional temporary period rules for certain working capital 
expenditures that are treated as part of a capital project.
    (ii) Longer temporary period for certain tax anticipation issues. If 
an issuer reasonably expects to use tax revenues arising from tax levies 
for a single fiscal year to redeem or retire an issue, and the issue 
matures by the earlier of 2 years after the issue date or 60 days after 
the last date for payment of those taxes without interest or penalty, 
the temporary period under paragraph (e)(3)(i) of this section is 
extended until the maturity date of the issue.
    (4) Temporary period for pooled financings--(i) In general. Proceeds 
of a pooled financing issue reasonably expected to be used to finance 
purpose investments qualify for a temporary period of 6 months while 
held by the issuer before being loaned to a conduit borrower. Any 
otherwise available temporary period for proceeds held by a conduit 
borrower, however, is reduced by the period of time during which those 
proceeds were held by the issuer before being loaned. For example, if 
the proceeds of a pooled financing issue loaned to a conduit borrower 
would qualify for a 3-year temporary period, and the proceeds are held 
by the issuer for 5 months before being loaned to the conduit borrower, 
the proceeds qualify for only an additional 31-month temporary period 
after being loaned to the conduit borrower. Except as provided in 
paragraph (e)(4)(iv) of this section, this paragraph (e)(4) does not 
apply to any qualified mortgage bond or qualified veterans' mortgage 
bond under section 143.
    (ii) Loan repayments--(A) Amount held by the issuer. The temporary 
period under this paragraph (e)(4) for proceeds from the sale or 
repayment of any loan that are reasonably expected to be used to make or 
finance new loans is 3 months.
    (B) Amounts re-loaned to conduit borrowers. Any temporary period for 
proceeds held by a conduit borrower under a new loan from amounts 
described in paragraph (e)(4)(ii)(A) of this section is determined by 
treating the date the new loan is made as the issue date and by reducing 
the temporary period by the period the amounts were held by

[[Page 696]]

the issuer following the last repayment.
    (iii) Construction issues. If all or a portion of a pooled financing 
issue qualifies as a construction issue under Sec. 1.148-7(b)(6), 
paragraph (e)(4)(i) of this section is applied by substituting ``2 
years'' for ``6 months.''
    (iv) Amounts re-loaned for qualified mortgage loans. The temporary 
period under this paragraph (e)(4) for proceeds from the sale, 
prepayment, or repayment of any qualified mortgage loan that are 
reasonably expected to be used to make or finance new qualified mortgage 
loans is 3 years.
    (5) Temporary period for replacement proceeds--(i) In general. 
Except as otherwise provided, replacement proceeds qualify for a 
temporary period of 30 days beginning on the date that the amounts are 
first treated as replacement proceeds.
    (ii) Temporary period for bona fide debt service funds. Amounts in a 
bona fide debt service fund for an issue qualify for a temporary period 
of 13 months. If only a portion of a fund qualifies as a bona fide debt 
service fund, only that portion qualifies for this temporary period.
    (6) Temporary period for investment proceeds. Except as otherwise 
provided in this paragraph (e), investment proceeds qualify for a 
temporary period of 1 year beginning on the date of receipt.
    (7) Other amounts. Gross proceeds not otherwise eligible for a 
temporary period described in this paragraph (e) qualify for a temporary 
period of 30 days beginning on the date of receipt.
    (f) Reserve or replacement funds--(1) General 10 percent limitation 
on funding with sale proceeds. An issue consists of arbitrage bonds if 
sale proceeds of the issue in excess of 10 percent of the stated 
principal amount of the issue are used to finance any reserve or 
replacement fund, without regard to whether those sale proceeds are 
invested in higher yielding investments. If an issue has more than a de 
minimis amount of original issue discount or premium, the issue price 
(net of pre-issuance accrued interest) is used to measure the 10-percent 
limitation in lieu of stated principal amount. This rule does not limit 
the use of amounts other than sale proceeds of an issue to fund a 
reserve or replacement fund.
    (2) Exception from yield restriction for reasonably required reserve 
or replacement funds--(i) In general. The investment of amounts that are 
part of a reasonably required reserve or replacement fund in higher 
yielding investments will not cause an issue to consist of arbitrage 
bonds. A reasonably required reserve or replacement fund may consist of 
all or a portion of one or more funds, however labelled, derived from 
one or more sources. Amounts in a reserve or replacement fund in excess 
of the amount that is reasonably required are not part of a reasonably 
required reserve or replacement fund.
    (ii) Size limitation. The amount of gross proceeds of an issue that 
qualifies as a reasonably required reserve or replacement fund may not 
exceed an amount equal to the least of 10 percent of the stated 
principal amount of the issue, the maximum annual principal and interest 
requirements on the issue, or 125 percent of the average annual 
principal and interest requirements on the issue. If an issue has more 
than a de minimis amount of original issue discount or premium, the 
issue price of the issue (net of pre-issuance accrued interest) is used 
to measure the 10 percent limitation in lieu of its stated principal 
amount. For a reserve or replacement fund that secures more than one 
issue (e.g. a parity reserve fund), the size limitation may be measured 
on an aggregate basis.
    (iii) Valuation of investments. Investments in a reasonably required 
reserve or replacement fund may be valued in any reasonable, 
consistently applied manner that is permitted under Sec. 1.148-5.
    (iv) 150 percent debt service limitation on investment in nonpurpose 
investments for certain private activity bonds. Section 148(d)(3) 
contains additional limits on the amount of gross proceeds of an issue 
of private activity bonds, other than qualified 501(c)(3) bonds, that 
may be invested in higher yielding nonpurpose investments without 
causing the bonds to be arbitrage bonds. For purposes of these rules, 
initial temporary period means the temporary periods under paragraphs 
(e)(2), (e)(3), and

[[Page 697]]

(e)(4) of this section and under Sec. 1.148-9(d)(2)(i), (ii), and 
(iii).
    (3) Certain parity reserve funds. The limitation contained in 
paragraph (f)(1) of this section does not apply to an issue if the 
master legal document authorizing the issuance of the bonds (e.g., a 
master indenture) was adopted before August 16, 1986, and that 
document--
    (i) Requires a reserve or replacement fund in excess of 10 percent 
of the sale proceeds, but not more than maximum annual principal and 
interest requirements;
    (ii) Is not amended after August 31, 1986 (other than to permit the 
issuance of additional bonds as contemplated in the master legal 
document); and
    (iii) Provides that bonds having a parity of security may not be 
issued by or on behalf of the issuer for the purposes provided under the 
document without satisfying the reserve fund requirements of the 
indenture.
    (g) Minor portion. Under section 148(e), a bond of an issue is not 
an arbitrage bond solely because of the investment in higher yielding 
investments of gross proceeds of the issue in an amount not exceeding 
the lesser of--
    (1) 5 percent of the sale proceeds of the issue; or
    (2) $100,000.
    (h) Certain waivers permitted. On or before the issue date, an 
issuer may elect to waive the right to invest in higher yielding 
investments during any temporary period under paragraph (e) of this 
section or as part of a reasonably required reserve or replacement fund 
under paragraph (f) of this section. At any time, an issuer may waive 
the right to invest in higher yielding investments as part of a minor 
portion under paragraph (g) of this section.

[T.D. 8476, 58 FR 33520, June 18, 1993; 58 FR 44452, Aug. 23, 1993, as 
amended by T.D. 8538, 59 FR 24042, May 10, 1994; T.D. 8718, 62 FR 25507, 
May 9, 1997]



Sec. 1.148-3  General arbitrage rebate rules.

    (a) In general. Section 148(f) requires that certain earnings on 
nonpurpose investments allocable to the gross proceeds of an issue be 
paid to the United States to prevent the bonds in the issue from being 
arbitrage bonds. The arbitrage that must be rebated is based on the 
difference between the amount actually earned on nonpurpose investments 
and the amount that would have been earned if those investments had a 
yield equal to the yield on the issue.
    (b) Definition of rebate amount. As of any date, the rebate amount 
for an issue is the excess of the future value, as of that date, of all 
receipts on nonpurpose investments over the future value, as of that 
date, of all payments on nonpurpose investments.
    (c) Computation of future value of a payment or receipt. The future 
value of a payment or receipt at the end of any period is determined 
using the economic accrual method and equals the value of that payment 
or receipt when it is paid or received (or treated as paid or received), 
plus interest assumed to be earned and compounded over the period at a 
rate equal to the yield on the issue, using the same compounding 
interval and financial conventions used to compute that yield.
    (d) Payments and receipts--(1) Definition of payments. For purposes 
of this section, payments are--
    (i) Amounts actually or constructively paid to acquire a nonpurpose 
investment (or treated as paid to a commingled fund);
    (ii) For a nonpurpose investment that is first allocated to an issue 
on a date after it is actually acquired (e.g., an investment that 
becomes allocable to transferred proceeds or to replacement proceeds) or 
that becomes subject to the rebate requirement on a date after it is 
actually acquired (e.g., an investment allocated to a reasonably 
required reserve or replacement fund for a construction issue at the end 
of the 2-year spending period), the value of that investment on that 
date;
    (iii) For a nonpurpose investment that was allocated to an issue at 
the end of the preceding computation period, the value of that 
investment at the beginning of the computation period;
    (iv) On the last day of each bond year during which there are 
amounts allocated to gross proceeds of an issue that are subject to the 
rebate requirement, and on the final maturity date, a computation credit 
of $1,000; and

[[Page 698]]

    (v) Yield reduction payments on nonpurpose investments made pursuant 
to Sec. 1.148-5(c).
    (2) Definition of receipts. For purposes of this section, receipts 
are--
    (i) Amounts actually or constructively received from a nonpurpose 
investment (including amounts treated as received from a commingled 
fund), such as earnings and return of principal;
    (ii) For a nonpurpose investment that ceases to be allocated to an 
issue before its disposition or redemption date (e.g., an investment 
that becomes allocable to transferred proceeds of another issue or that 
ceases to be allocable to the issue pursuant to the universal cap under 
Sec. 1.148-6) or that ceases to be subject to the rebate requirement on 
a date earlier than its disposition or redemption date (e.g., an 
investment allocated to a fund initially subject to the rebate 
requirement but that subsequently qualifies as a bona fide debt service 
fund), the value of that nonpurpose investment on that date; and
    (iii) For a nonpurpose investment that is held at the end of a 
computation period, the value of that investment at the end of that 
period.
    (3) Special rules for commingled funds. Section 1.148-6(e) provides 
special rules to limit certain of the required determinations of 
payments and receipts for investments of a commingled fund.
    (e) Computation dates--(1) In general. For a fixed yield issue, an 
issuer may treat any date as a computation date. For a variable yield 
issue, an issuer:
    (i) May treat the last day of any bond year ending on or before the 
latest date on which the first rebate amount is required to be paid 
under paragraph (f) of this section (the first required payment date) as 
a computation date but may not change that treatment after the first 
payment date; and
    (ii) After the first required payment date, must consistently treat 
either the end of each bond year or the end of each fifth bond year as 
computation dates and may not change these computation dates after the 
first required payment date.
    (2) Final computation date. The date that an issue is discharged is 
the final computation date. For an issue retired within 3 years of the 
issue date, however, the final computation date need not occur before 
the end of 8 months after the issue date or during the period in which 
the issuer reasonably expects that any of the spending exceptions under 
Sec. 1.148-7 will apply to the issue.
    (f) Amount of required rebate installment payment--(1) Amount of 
interim rebate payments. The first rebate installment payment must be 
made for a computation date that is not later than 5 years after the 
issue date. Subsequent rebate installment payments must be made for a 
computation date that is not later than 5 years after the previous 
computation date for which an installment payment was made. A rebate 
installment payment must be in an amount that, when added to the future 
value, as of the computation date, of previous rebate payments made for 
the issue, equals at least 90 percent of the rebate amount as of that 
date.
    (2) Amount of final rebate payment. For the final computation date, 
a final rebate payment must be paid in an amount that, when added to the 
future value of previous rebate payments made for the issue, equals 100 
percent of the rebate amount as of that date.
    (3) Future value of rebate payments. The future value of a rebate 
payment is determined under paragraph (c) of this section. This value is 
computed by taking into account recoveries of overpayments.
    (g) Time and manner of payment. Each rebate payment must be paid no 
later than 60 days after the computation date to which the payment 
relates. Any rebate payment paid within this 60-day period may be 
treated as paid on the computation date to which it relates. A rebate 
payment is paid when it is filed with the Internal Revenue Service at 
the place or places designated by the Commissioner. A payment must be 
accompanied by the form provided by the Commissioner for this purpose.
    (h) Penalty in lieu of loss of tax exemption--(1) In general. The 
failure to pay the correct rebate amount when required will cause the 
bonds of the issue to be arbitrage bonds, unless the Commissioner 
determines that the failure was not caused by willful neglect and the 
issuer promptly pays a penalty to

[[Page 699]]

the United States. If no bond of the issue is a private activity bond 
(other than a qualified 501(c)(3) bond), the penalty equals 50 percent 
of the rebate amount not paid when required to be paid, plus interest on 
that amount. Otherwise, the penalty equals 100 percent of the rebate 
amount not paid when required to be paid, plus interest on that amount.
    (2) Interest on underpayments. Interest accrues at the underpayment 
rate under section 6621, beginning on the date the correct rebate amount 
is due and ending on the date 10 days before it is paid.
    (3) Waivers of the penalty. The penalty is automatically waived if 
the rebate amount that the issuer failed to pay plus interest is paid 
within 180 days after discovery of the failure, unless, the Commissioner 
determines that the failure was due to willful neglect, or the issue is 
under examination by the Commissioner at any time during the period 
beginning on the date the failure first occurred and ending on the date 
90 days after the receipt of the rebate amount. Generally, extensions of 
this 180-day period and waivers of the penalty in other cases will be 
granted by the Commissioner only in unusual circumstances. For purposes 
of this paragraph (h)(3), willful neglect does not include a failure 
that is attributable solely to the permissible retroactive selection of 
a short first bond year if the rebate amount that the issuer failed to 
pay is paid within 60 days of the selection of that bond year.
    (4) Application to alternative penalty under Sec. 1.148-7. 
Paragraphs (h) (1), (2), and (3) of this section apply to failures to 
pay penalty payments under Sec. 1.148-7 (alternative penalty amounts) 
by substituting alternative penalty amounts for rebate amount and the 
last day of each spending period for computation date.
    (i) Recovery of overpayment of rebate--(1) In general. An issuer may 
recover an overpayment for an issue of tax-exempt bonds by establishing 
to the satisfaction of the Commissioner that the overpayment occurred. 
An overpayment is the excess of the amount paid to the United States for 
an issue under section 148 over the sum of the rebate amount for the 
issue as of the most recent computation date and all amounts that are 
otherwise required to be paid under section 148 as of the date the 
recovery is requested.
    (2) Limitations on recovery. (i) An overpayment may be recovered 
only to the extent that a recovery on the date that it is first 
requested would not result in an additional rebate amount if that date 
were treated as a computation date.
    (ii) Except for overpayments of penalty in lieu of rebate under 
section 148(f)(4)(C)(vii) and Sec. 1.148-7(k), an overpayment of less 
than $5,000 may not be recovered before the final computation date.
    (j) Examples. The provisions of this section may be illustrated by 
the following examples.

    Example 1. Calculation and payment of rebate for a fixed yield 
issue. (i) Facts. On January 1, 1994, City A issues a fixed yield issue 
and invests all the sale proceeds of the issue ($49 million). There are 
no other gross proceeds. The issue has a yield of 7.0000 percent per 
year compounded semiannually (computed on a 30 day month/360 day year 
basis). City A receives amounts from the investment and immediately 
expends them for the governmental purpose of the issue as follows:

------------------------------------------------------------------------
                          Date                                Amount
------------------------------------------------------------------------
2/1/94..................................................      $3,000,000
5/1/94..................................................       5,000,000
1/1/95..................................................       5,000,000
9/1/95..................................................      20,000,000
3/1/96..................................................      22,000,000
------------------------------------------------------------------------

    (ii) First computation date. (A) City A chooses January 1, 1999, as 
its first computation date. This date is the latest date that may be 
used to compute the first required rebate installment payment. The 
rebate amount as of this date is computed by determining the future 
value of the receipts and the payments for the investment. The 
compounding interval is each 6-month (or shorter) period and the 30 day 
month/360 day year basis is used because these conventions were used to 
compute yield on the issue. The future value of these amounts, plus the 
computation credit, as of January 1, 1999, is:

------------------------------------------------------------------------
                                            Receipts        FV (7.0000
                 Date                      (payments)        percent)
------------------------------------------------------------------------
1/1/94................................    ($49,000,000)    ($69,119,339)
2/1/94................................       3,000,000        4,207,602
5/1/94................................       5,000,000        6,893,079
1/1/95................................       5,000,000        6,584,045
1/1/95................................          (1,000)          (1,317)
9/1/95................................      20,000,000       25,155,464
1/1/96................................          (1,000)           1,229)
3/1/96................................      22,000,000       26,735,275
1/1/97................................          (1,000)          (1,148)
                                       ---------------------------------

[[Page 700]]

 
Rebate amount (1/01/99)...............  ...............         452,432
------------------------------------------------------------------------

    (B) City A pays 90 percent of the rebate amount ($407,189) to the 
United States within 60 days of January 1, 1999.
    (iii) Second computation date. (A) On the next required computation 
date, January 1, 2004, the future value of the payments and receipts is:

------------------------------------------------------------------------
                                                  Receipts    FV (7.0000
                     Date                        (payments)    percent)
------------------------------------------------------------------------
1/1/99........................................     $452,432     $638,200
                                               -------------------------
Rebate amount (1/01/04).......................  ...........      638,200
------------------------------------------------------------------------

    (B) As of this computation date, the future value of the payment 
treated as made on January 1, 1999, is $574,380, which equals at least 
90 percent of the rebate amount as of this computation date ($638,200 x 
0.9), and thus no additional rebate payment is due as of this date.
    (iv) Final computation date. (A) On January 1, 2009, City A redeems 
all the bonds, and thus this date is the final computation date. The 
future value of the receipts and payments as of this date is:

------------------------------------------------------------------------
                                                Receipts     FV (7.0000
                    Date                       (payments)     percent)
------------------------------------------------------------------------
1/1/04......................................     $638,200      $900,244
1/1/09......................................       (1,000)       (1,000)
                                             ---------------------------
Rebate amount (1/01/09).....................  ............      899,244
------------------------------------------------------------------------

    (B) As of this computation date, the future value of the payment 
made on January 1, 1999, is $810,220 and thus an additional rebate 
payment of $89,024 is due. This payment reflects the future value of the 
10 percent unpaid portion, and thus would not be owed had the issuer 
paid the full rebate amount as of any prior computation date.
    Example 2. Calculation and payment of rebate for a variable yield 
issue. (i) Facts. On July 1, 1994, City B issues a variable yield issue 
and invests all of the sale proceeds of the issue ($30 million). There 
are no other gross proceeds. As of July 1, 1999, there are nonpurpose 
investments allocated to the issue. Prior to July 1, 1999, City B 
receives amounts from nonpurpose investments and immediately expends 
them for the governmental purpose of the issue as follows:

------------------------------------------------------------------------
                           Date                                Amount
------------------------------------------------------------------------
8/1/1994..................................................    $5,000,000
7/1/1995..................................................     8,000,000
12/1/1995.................................................    17,000,000
7/1/1999..................................................       650,000
------------------------------------------------------------------------

    (ii) First computation date. (A) City B treats the last day of the 
fifth bond year (July 1, 1999) as a computation date. The yield on the 
variable yield issue during the first computation period (the period 
beginning on the issue date and ending on the first computation date) is 
6.0000 percent per year compounded semiannually. The value of the 
nonpurpose investments allocated to the issue as of July 1, 1999, is $3 
million. The rebate amount as of July 1, 1999, is computed by 
determining the future value of the receipts and the payments for the 
nonpurpose investments. The compounding interval is each 6-month (or 
shorter) period and the 30 day month/360 day year basis is used because 
these conventions were used to compute yield on the issue. The future 
value of these amounts and of the computation date credits as of July 1, 
1999, is:

------------------------------------------------------------------------
                                          Receipts         FV (6.0000
                 Date                    (payments)         percent)
------------------------------------------------------------------------
7/1/1994.............................   ($30,000,000)      ($40,317,491)
8/1/1994.............................       5,000,000          6,686,560
7/1/1995.............................         (1,000)            (1,267)
7/1/1995.............................       8,000,000         10,134,161
12/1/1995............................      17,000,000         21,011,112
7/1/1996.............................         (1,000)            (1,194)
7/1/1997.............................         (1,000)            (1,126)
7/1/1998.............................         (1,000)            (1,061)
7/1/1999.............................       3,000,000          3,000,000
7/1/1999.............................         650,000            650,000
7/1/1999.............................         (1,000)            (1,000)
                                      ----------------------------------
Rebate amount (7/01/1999)............  ..............          1,158,694
------------------------------------------------------------------------


    (B) City B pays 90 percent of the rebate amount ($1,042,824.60) to 
the United States within 60 days of July 1, 1999.
    (iii) Next computation date. (A) On July 1, 2004, City B redeems all 
of the bonds. Thus, the next computation date is July 1, 2004. On July 
30, 1999, City B chose to compute rebate for periods following the first 
computation period by treating the end of each fifth bond year as a 
computation date. The yield during the second computation period is 
5.0000 percent per year compounded semiannually. The computation of the 
rebate amount as of this date reflects the value of the nonpurpose 
investments allocated to the issue at the end of the prior computation 
period. On July 1, 2004, City B sells those nonpurpose investments for 
$3,925,000 and expends that amount for the governmental purpose of the 
issue.
    (B) As of July 1, 2004, the future value of the rebate amount 
computed as of July 1, 1999, and of all other payments and receipts is:

------------------------------------------------------------------------
                                                 Receipts    FV (5.0000
                     Date                       (payments)    percent)
------------------------------------------------------------------------
7/1/1999.....................................   $1,158,694    $1,483,226
7/1/1999.....................................  (3,000,000)   (3,840,254)
7/1/2000.....................................      (1,000)       (1,218)
7/1/2001.....................................      (1,000)       (1,160)
7/1/2002.....................................      (1,000)       (1,104)
7/1/2003.....................................      (1,000)       (1,051)

[[Page 701]]

 
7/1/2004.....................................      (2,000)       (2,000)
7/1/2004.....................................    3,925,000     3,925,000
                                              --------------------------
                                               ...........     1,561,439
------------------------------------------------------------------------

    (C) As of this computation date, the future value of the payment 
made on July 1, 1999, is $1,334,904 and thus an additional rebate 
payment of $226,535 is due.
    (D) If the yield during the second computation period were, instead, 
7.0000 percent, the rebate amount computed as of July 1, 1999, would be 
$1,320,891. The future value of the payment made on July 1, 1999, would 
be $1,471,007, and, therefore, City B would have overpaid the rebate 
amount by $150,116.

    (k) Bona fide debt service fund exception. Under section 
148(f)(4)(A), the rebate requirement does not apply to amounts in 
certain bona fide debt service funds. An issue with an average annual 
debt service that is not in excess of $2,500,000 may be treated as 
satisfying the $100,000 limitation in section 148(f)(4)(A)(ii).

[T.D. 8476, 58 FR 33522, June 18, 1993; 58 FR 44452, Aug. 23, 1993, as 
amended by T.D. 8538, 59 FR 24042, May 10, 1994; T.D. 8476, 59 FR 24350, 
May 11, 1994; T.D. 8718, 62 FR 25507, May 9, 1997]



Sec. 1.148-4  Yield on an issue of bonds.

    (a) In general. The yield on an issue of bonds is used to apply 
investment yield restrictions under section 148(a) and to compute rebate 
liability under section 148(f). Yield is computed under the economic 
accrual method using any consistently applied compounding interval of 
not more than one year. A short first compounding interval and a short 
last compounding interval may be used. Yield is expressed as an annual 
percentage rate that is calculated to at least four decimal places 
(e.g., 5.2525 percent). Other reasonable, standard financial 
conventions, such as the 30 days per month/360 days per year convention, 
may be used in computing yield but must be consistently applied. The 
yield on an issue that would be a purpose investment (absent section 
148(b)(3)(A)) is equal to the yield on the conduit financing issue that 
financed that purpose investment. The Commissioner may permit issuers of 
qualified mortgage bonds or qualified student loan bonds to use a single 
yield for two or more issues.
    (b) Computing yield on a fixed yield issue--(1) In general--(i) 
Yield on an issue. The yield on a fixed yield issue is the discount rate 
that, when used in computing the present value as of the issue date of 
all unconditionally payable payments of principal, interest, and fees 
for qualified guarantees on the issue and amounts reasonably expected to 
be paid as fees for qualified guarantees on the issue, produces an 
amount equal to the present value, using the same discount rate, of the 
aggregate issue price of bonds of the issue as of the issue date. 
Further, payments include certain amounts properly allocable to a 
qualified hedge. Yield on a fixed yield issue is computed as of the 
issue date and is not affected by subsequent unexpected events, except 
to the extent provided in paragraphs (b)(4) and (h)(3) of this section.
    (ii) Yield on a bond. Yield on a fixed yield bond is computed in the 
same manner as yield on a fixed yield issue.
    (2) Yield on certain fixed yield bonds subject to mandatory or 
contingent early redemption--(i) In general. The yield on a fixed yield 
issue that includes a bond subject to mandatory early redemption or 
expected contingent redemption is computed by treating that bond as 
redeemed on its reasonably expected early redemption date for an amount 
equal to its value on that date. Reasonable expectations are determined 
on the issue date. A bond is subject to mandatory early redemption if it 
is unconditionally payable in full before its final maturity date. A 
bond is subject to a contingent redemption if it must be, or is 
reasonably expected to be, redeemed prior to final maturity upon the 
occurrence of a contingency. A contingent redemption is taken into 
account only if the contingency is reasonably expected to occur, in 
which case the date of occurrence of the contingency must be reasonably 
estimated. For example, if bonds are reasonably expected to be redeemed 
early using excess revenues from general or special property taxes or 
benefit assessments or similar amounts, the reasonably expected 
redemption schedule is used to determine yield. For purposes of this 
paragraph (b)(2)(i), excess

[[Page 702]]

proceeds calls for issues for which the requirements of Sec. 1.148-2(e) 
(2) or (3) are satisfied, calamity calls, and refundings do not cause a 
bond to be subject to early redemption. The value of a bond is 
determined under paragraph (e) of this section.
    (ii) Substantially identical bonds subject to mandatory early 
redemption. If substantially identical bonds of an issue are subject to 
specified mandatory redemptions prior to final maturity (e.g., a 
mandatory sinking fund redemption requirement), yield on that issue is 
computed by treating those bonds as redeemed in accordance with the 
redemption schedule for an amount equal to their value. Generally, bonds 
are substantially identical if the stated interest rate, maturity, and 
payment dates are the same. In computing the yield on an issue 
containing bonds described in this paragraph (b)(2)(ii), each of those 
bonds must be treated as redeemed at its present value, unless the 
stated redemption price at maturity of the bond does not exceed the 
issue price of the bond by more than one-fourth of one percent 
multiplied by the product of the stated redemption price at maturity and 
the number of years to the weighted average maturity date of the 
substantially identical bonds, in which case each of those bonds must be 
treated as redeemed at its outstanding stated principal amount, plus 
accrued, unpaid interest. Weighted average maturity is determined by 
taking into account the mandatory redemption schedule.
    (3) Yield on certain fixed yield bonds subject to optional early 
redemption--(i) In general. If a fixed yield bond is subject to optional 
early redemption and is described in paragraph (b)(3)(ii) of this 
section, the yield on the issue containing the bond is computed by 
treating the bond as redeemed at its stated redemption price on the 
optional redemption date that would produce the lowest yield on the 
issue.
    (ii) Fixed yield bonds subject to special yield calculation rule. A 
fixed yield bond is described in this paragraph (b)(3)(ii) only if it--
    (A) Is subject to optional redemption within five years of the issue 
date, but only if the yield on the issue computed by assuming all bonds 
in the issue subject to redemption within 5 years of the issue date are 
redeemed at maturity is more than one-eighth of one percentage point 
higher than the yield on that issue computed by assuming all bonds 
subject to optional redemption within 5 years of the issue date are 
redeemed at the earliest date for their redemption;
    (B) Is issued at an issue price that exceeds the stated redemption 
price at maturity by more than one-fourth of one percent multiplied by 
the product of the stated redemption price at maturity and the number of 
complete years to the first optional redemption date for the bond; or
    (C) Bears interest at increasing interest rates (i.e., a stepped 
coupon bond).
    (4) Yield recomputed upon transfer of certain rights associated with 
the bond. For purposes of Sec. 1.148-3, as of the date of any transfer, 
waiver, modification, or similar transaction (collectively, a transfer) 
of any right that is part of the terms of a bond or is otherwise 
associated with a bond (e.g., a redemption right), in a transaction that 
is separate and apart from the original sale of the bond, the issue is 
treated as if it were retired and a new issue issued on the date of the 
transfer (reissued). The redemption price of the retired issue and the 
issue price of the new issue equal the aggregate values of all the bonds 
of the issue on the date of the transfer. In computing yield on the new 
issue, any amounts received by the issuer as consideration for the 
transfer are taken into account.
    (5) Special aggregation rule treating certain bonds as a single 
fixed yield bond. Two variable yield bonds of an issue are treated in 
the aggregate as a single fixed yield bond if--
    (i) Aggregate treatment would result in the single bond being a 
fixed yield bond; and
    (ii) The terms of the bonds do not contain any features that could 
distort the aggregate fixed yield from what the yield would be if a 
single fixed yield bond were issued. For example, if an issue contains a 
bond bearing interest at a floating rate and a related bond bearing 
interest at a rate equal to a fixed rate minus that floating rate, those 
two bonds are treated as a single fixed yield bond only if neither bond

[[Page 703]]

may be redeemed unless the other bond is also redeemed at the same time.
    (6) Examples. The provisions of this paragraph (b) may be 
illustrated by the following examples.
    Example 1. No early call--(i) Facts. On January 1, 1994, City A 
issues an issue consisting of four identical fixed yield bonds. The 
stated final maturity date of each bond is January 1, 2004, and no bond 
is subject to redemption before this date. Interest is payable on 
January 1 of each year at a rate of 6.0000 percent per year on the 
outstanding principal amount. The total stated principal amount of the 
bonds is $20 million. The issue price of the bonds $20,060,000.
    (ii) Computation. The yield on the issue is computed by treating the 
bonds as retired at the stated maturity under the general rule of Sec. 
1.148-4(b)(1). The bonds are treated as redeemed for their stated 
redemption prices. The yield on the issue is 5.8731 percent per year 
compounded semiannually, computed as follows:

------------------------------------------------------------------------
                                                             PV (5.8731
                     Date                        Payments     percent)
------------------------------------------------------------------------
1/1/1995.....................................   $1,200,000    $1,132,510
1/1/1996.....................................    1,200,000     1,068,816
1/1/1997.....................................    1,200,000     1,008,704
1/1/1998.....................................    1,200,000       951,973
1/1/1999.....................................    1,200,000       898,433
1/1/2000.....................................    1,200,000       847,903
1/1/2001.....................................    1,200,000       800,216
1/1/2002.....................................    1,200,000       755,210
1/1/2003.....................................    1,200,000       712,736
1/1/2004.....................................   21,200,000    11,883,498
                                                           -------------
                                                              20,060,000
------------------------------------------------------------------------

    Example 2. Mandatory calls. (i) Facts. The facts are the same as in 
Example 1. In this case, however, the bonds are subject to mandatory 
sinking fund redemption on January 1 of each year, beginning January 1, 
2001. On each sinking fund redemption date, one of the bonds is chosen 
by lottery and is required to be redeemed at par plus accrued interest.
    (ii) Computation. Because the bonds are subject to specified 
redemptions, yield on the issue is computed by treating the bonds as 
redeemed in accordance with the redemption schedule under Sec. 1.148-
4(b)(2)(ii). Because the bonds are not sold at a discount, the bonds are 
treated as retired at their stated redemption prices. The yield on the 
issue is 5.8678 percent per year compounded semiannually, computed as 
follows:

------------------------------------------------------------------------
                                                             PV (5.8678
                     Date                        Payments     percent)
------------------------------------------------------------------------
1/1/1995.....................................   $1,200,000    $1,132,569
1/1/1996.....................................    1,200,000     1,068,926
1/1/1997.....................................    1,200,000     1,008,860
1/1/1998.....................................    1,200,000       952,169
1/1/1999.....................................    1,200,000       898,664
1/1/2000.....................................    1,200,000       848,166
1/1/2001.....................................    6,200,000     4,135,942
1/1/2002.....................................    5,900,000     3,714,650
1/1/2003.....................................    5,600,000     3,327,647
1/1/2004.....................................    5,300,000     2,972,407
                                                           -------------
                                               ...........   $20,060,000
------------------------------------------------------------------------

    Example 3. Optional early call. (i) Facts. On January 1, 1994, City 
C issues an issue consisting of three bonds. Each bond has a stated 
principal amount of $10 million dollars and is issued for par. Bond X 
bears interest at 5 percent per year and matures on January 1, 1999. 
BondY bears interest at 6 percent per year and matures on January 1, 
2002. Bond Z bears interest at 7 percent per year and matures on January 
1, 2004. Bonds Y and Z are callable by the issuer at par plus accrued 
interest after December 31, 1998.
    (ii) Computation. (A) The yield on the issue computed as if each 
bond is outstanding to its maturity is 6.0834 percent per year 
compounded semiannually, computed as follows:

------------------------------------------------------------------------
                                                             PV (6.0834
                     Date                        Payments     percent)
------------------------------------------------------------------------
1/1/1995.....................................   $1,800,000    $1,695,299
1/1/1996.....................................    1,800,000     1,596,689
1/1/1997.....................................    1,800,000     1,503,814
1/1/1998.....................................    1,800,000     1,416,342
1/1/1999.....................................   11,800,000     8,744,830
1/1/2000.....................................    1,300,000       907,374
1/1/2001.....................................    1,300,000       854,595
1/1/2002.....................................   11,300,000     6,996,316
1/1/2003.....................................      700,000       408,190
1/1/2004.....................................   10,700,000     5,876,551
                                                           -------------
                                                              30,000,000
------------------------------------------------------------------------

    (B) The yield on the issue computed as if all bonds are called at 
the earliest date for redemption is 5.9126 percent per year compounded 
semiannually, computed as follows:

------------------------------------------------------------------------
                                                             PV (5.9126
                     Date                        Payments     percent)
------------------------------------------------------------------------
1/1/1995.....................................   $1,800,000    $1,698,113
1/1/1996.....................................    1,800,000     1,601,994
1/1/1997.....................................    1,800,000     1,511,315
1/1/1998.....................................    1,800,000     1,425,769
1/1/1999.....................................   31,800,000    23,762,809
                                                           -------------
                                                              30,000,000
------------------------------------------------------------------------

    (C) Because the yield on the issue computed by assuming all bonds in 
the issue subject to redemption within 5 years of the issue date are 
redeemed at maturity is more than one-eighth of one percentage point 
higher than the yield on the issue computed by assuming all bonds 
subject to optional redemption within 5 years of the issue date are 
redeemed at the earliest date for their redemption, each bond is treated 
as redeemed on the date that would produce the lowest yield for the 
issue. The lowest yield on the issue would result from a redemption of 
all the

[[Page 704]]

bonds on January 1, 1999. Thus, the yield on the issue is 5.9126 percent 
per year compounded semiannually.

    (c) Computing yield on a variable yield issue--(1) In general. The 
yield on a variable yield issue is computed separately for each 
computation period. The yield for each computation period is the 
discount rate that, when used in computing the present value as of the 
first day of the computation period of all the payments of principal and 
interest and fees for qualified guarantees that are attributable to the 
computation period, produces an amount equal to the present value, using 
the same discount rate, of the aggregate issue price (or deemed issue 
price, as determined in paragraph (c)(2)(iv) of this section) of the 
bonds of the issue as of the first day of the computation period. The 
yield on a variable yield bond is computed in the same manner as the 
yield on a variable yield issue. Except as provided in paragraph (c)(2) 
of this section, yield on any fixed yield bond in a variable yield issue 
is computed in the same manner as the yield on a fixed yield issue as 
provided in paragraph (b) of this section.
    (2) Payments on bonds included in yield for a computation period--
(i) Payments in general. The payments on a bond that are attributable to 
a computation period include any amounts actually paid during the period 
for principal on the bond. Payments also include any amounts paid during 
the current period both for interest accruing on the bond during the 
current period and for interest accruing during the prior period that 
was included in the deemed issue price of the bond as accrued unpaid 
interest at the start of the current period under this paragraph (c)(2). 
Further, payments include any amounts properly allocable to fees for a 
qualified guarantee of the bond for the period and to any amounts 
properly allocable to a qualified hedge for the period.
    (ii) Payments at actual redemption. If a bond is actually redeemed 
during a computation period, an amount equal to the greater of its value 
on the redemption date or the actual redemption price is a payment on 
the actual redemption date.
    (iii) Payments for bonds outstanding at end of computation period. 
If a bond is outstanding at the end of a computation period, a payment 
equal to the bond's value is taken into account on the last day of that 
period.
    (iv) Issue price for bonds outstanding at beginning of next 
computation period. A bond outstanding at the end of a computation 
period is treated as if it were immediately reissued on the next day for 
a deemed issue price equal to the value from the day before as 
determined under paragraph (c)(2)(iii) of this section.
    (3) Example. The provisions of this paragraph (c) may be illustrated 
by the following example.

    Example. On January 1, 1994, City A issues an issue of identical 
plain par bonds in an aggregate principal amount of $1,000,000. The 
bonds pay interest at a variable rate on each June 1 throughout the term 
of the issue. The entire principal amount of the bonds plus accrued, 
unpaid interest is payable on the final maturity date of January 1, 
2000. No bond year is selected. On June 1, 1994, 1995, 1996, 1997, and 
1998, interest in the amounts of $30,000, $55,000, $57,000, $56,000, and 
$45,000 is paid on the bonds. From June 1, 1998, to January 1, 1999, 
$30,000 of interest accrues on the bonds. From January 1, 1999, to June 
1, 1999, another $35,000 of interest accrues. On June 1, 1999, the 
issuer actually pays $65,000 of interest. On January 1, 2000, $1,000,000 
of principal and $38,000 of accrued interest are paid. The payments for 
the computation period starting on the issue date and ending on January 
1, 1999, include all annual interest payments paid from the issue date 
to June 1, 1998. Because the issue is outstanding on January 1, 1999, it 
is treated as redeemed on that date for amount equal to its value 
($1,000,000 plus accrued, unpaid interest of $30,000 under paragraph 
(e)(1) of this section). Thus, $1,030,000 is treated as paid on January 
1, 1999. The issue is then treated as reissued on January 1, 1999, for 
$1,030,000. The payments for the next computation period starting on 
January 1, 1999, and ending on January 1, 2000, include the interest 
actually paid on the bonds during that period ($65,000 on June 1, 1999, 
plus $38,000 paid on January 1, 2000). Because the issue was actually 
redeemed on January 1, 2000, an amount equal to its stated redemption 
price is also treated as paid on January 1, 2000.

    (d) Conversion from variable yield issue to fixed yield issue. For 
purposes of determining yield under this section, as of the first day on 
which a variable yield issue would qualify as a fixed yield issue if it 
were newly issued on that date (a conversion date), that issue is 
treated as if it were reissued as a

[[Page 705]]

fixed yield issue on the conversion date. The redemption price of the 
variable yield issue and the issue price of the fixed yield issue equal 
the aggregate values of all the bonds on the conversion date. Thus, for 
example, for plain par bonds (e.g., tender bonds), the deemed issue 
price would be the outstanding principal amount, plus accrued unpaid 
interest. If the conversion date occurs on a date other than a 
computation date, the issuer may continue to treat the issue as a 
variable yield issue until the next computation date, at which time it 
must be treated as converted to a fixed yield issue.
    (e) Value of bonds--(1) Plain par bonds. Except as otherwise 
provided, the value of a plain par bond is its outstanding stated 
principal amount, plus accrued unpaid interest. The value of a plain par 
bond that is actually redeemed or treated as redeemed is its stated 
redemption price on the redemption date, plus accrued, unpaid interest.
    (2) Other bonds. The value of a bond other than a plain par bond on 
a date is its present value on that date. The present value of a bond is 
computed under the economic accrual method taking into account all the 
unconditionally payable payments of principal, interest, and fees for a 
qualified guarantee to be paid on or after that date and using the yield 
on the bond as the discount rate, except that for purposes of Sec. 
1.148-6(b)(2) (relating to the universal cap), these values may be 
determined by consistently using the yield on the issue of which the 
bonds are a part. To determine yield on fixed yield bonds, see paragraph 
(b)(1) of this section. The rules contained in paragraphs (b)(2) and 
(b)(3) of this section apply for this purpose. In the case of bonds 
described in paragraph (b)(2)(ii) of this section, the present value of 
those bonds on any date is computed using the yield to the final 
maturity date of those bonds as the discount rate. In determining the 
present value of a variable yield bond under this paragraph (e)(2), the 
initial interest rate on the bond established by the interest index or 
other interest rate setting mechanism is used to determine the interest 
payments on that bond.
    (f) Qualified guarantees--(1) In general. Fees properly allocable to 
payments for a qualified guarantee for an issue (as determined under 
paragraph (f)(6) of this section) are treated as additional interest on 
that issue under section 148. A guarantee is a qualified guarantee if it 
satisfies each of the requirements of paragraphs (f)(2) through (f)(4) 
of this section.
    (2) Interest savings. As of the date the guarantee is obtained, the 
issuer must reasonably expect that the present value of the fees for the 
guarantee will be less than the present value of the expected interest 
savings on the issue as a result of the guarantee. For this purpose, 
present value is computed using the yield on the issue, determined with 
regard to guarantee payments, as the discount rate.
    (3) Guarantee in substance. The arrangement must create a guarantee 
in substance. The arrangement must impose a secondary liability that 
unconditionally shifts substantially all of the credit risk for all or 
part of the payments, such as payments for principal and interest, 
redemption prices, or tender prices, on the guaranteed bonds. Reasonable 
procedural or administrative requirements of the guarantee do not cause 
the guarantee to be conditional. In the case of a guarantee against 
failure to remarket a qualified tender bond, commercially reasonable 
limitations based on credit risk, such as limitations on payment in the 
event of default by the primary obligor or the bankruptcy of a long-term 
credit guarantor, do not cause the guarantee to be conditional. The 
guarantee may be in any form. The guarantor may not be a co-obligor. 
Thus, the guarantor must not expect to make any payments other than 
under a direct-pay letter of credit or similar arrangement for which the 
guarantor will be reimbursed immediately. The guarantor and any related 
parties together must not use more than 10 percent of the proceeds of 
the portion of the issue allocable to the guaranteed bonds.
    (4) Reasonable charge--(i) In general. Fees for a guarantee must not 
exceed a reasonable, arm's-length charge for the transfer of credit 
risk. In complying with this requirement, the issuer may not rely on the 
representations of the guarantor.

[[Page 706]]

    (ii) Fees for services other than transfer of credit risk must be 
separately stated. A fee for a guarantee must not include any payment 
for any direct or indirect services other than the transfer of credit 
risk, unless the compensation for those other services is separately 
stated, reasonable, and excluded from the guarantee fee. Fees for the 
transfer of credit risk include fees for the guarantor's overhead and 
other costs relating to the transfer of credit risk. For example, a fee 
includes payment for services other than transfer of credit risk if--
    (A) It includes payment for the cost of underwriting or remarketing 
bonds or for the cost of insurance for casualty to bond-financed 
property;
    (B) It is refundable upon redemption of the guaranteed bond before 
the final maturity date and the amount of the refund would exceed the 
portion of the fee that had not been earned; or
    (C) The requirements of Sec. 1.148-2(e)(2) (relating to temporary 
periods for capital projects) are not satisfied, and the guarantor is 
not reasonably assured that the bonds will be repaid if the project to 
be financed is not completed.
    (5) Guarantee of purpose investments. Except for guarantees of 
qualified mortgage loans and qualified student loans, a guarantee of 
payments on a purpose investment is a qualified guarantee of the issue 
if all payments on the purpose investment reasonably coincide with 
payments on the related bonds and the payments on the purpose investment 
are unconditionally payable no more than 6 months before the 
corresponding interest payment and 12 months before the corresponding 
principal payments on the bonds. This paragraph (f)(5) only applies if, 
in addition to satisfying the other requirements of this paragraph (f), 
the guarantee is, in substance, a guarantee of the bonds allocable to 
that purpose investment and to no other bonds except for bonds that are 
equally and ratably secured by purpose investments of the same conduit 
borrower.
    (6) Allocation of qualified guarantee payments--(i) In general. 
Payments for a qualified guarantee must be allocated to bonds and to 
computation periods in a manner that properly reflects the proportionate 
credit risk for which the guarantor is compensated. Proportionate credit 
risk for bonds that are not substantially identical may be determined 
using any reasonable, consistently applied method. For example, this 
risk may be based on the ratio of the total principal and interest paid 
and to be paid on a guaranteed bond to the total principal and interest 
paid and to be paid on all bonds of the guaranteed issue. An allocation 
method generally is not reasonable, for example, if a substantial 
portion of the fee is allocated to the construction portion of the issue 
and a correspondingly insubstantial portion is allocated to the later 
years covered by the guarantee. Reasonable letter of credit set up fees 
may be allocated ratably during the initial term of the letter of 
credit. Upon an early redemption of a variable yield bond, fees 
otherwise allocable to the period after the redemption are allocated to 
remaining outstanding bonds of the issue or, if none remain outstanding, 
to the period before the redemption.
    (ii) Safe harbor for allocation of qualified guarantee fees for 
variable yield issues. An allocation of non-level payments for a 
qualified guarantee for variable yield bonds is treated as meeting the 
requirements of paragraph (f)(6)(i) of this section if, for each bond 
year for which the guarantee is in effect, an equal amount (or for any 
short bond year, a proportionate amount of the equal amount) is treated 
as paid as of the beginning of that bond year. The present value of the 
annual amounts must equal the fee for the guarantee allocated to that 
bond, with present value computed as of the first day the guarantee is 
in effect by using as the discount rate the yield on the variable yield 
bonds covered by the guarantee, determined without regard to any fee 
allocated under this paragraph (f)(6)(ii).
    (7) Refund or reduction of guarantee payments. If as a result of an 
investment of proceeds of a refunding issue in a refunding escrow, there 
will be a reduction in, or refund of, payments for a guarantee 
(savings), the savings must be treated as a reduction in the payments on 
the refunding issue.
    (g) Yield on certain mortgage revenue and student loan bonds. For 
purposes of

[[Page 707]]

section 148 and this section, section 143(g)(2)(C)(ii) applies to the 
computation of yield on an issue of qualified mortgage bonds or 
qualified veterans' mortgage bonds. For purposes of applying section 148 
and section 143(g) with respect to purpose investments allocable to a 
variable yield issue of qualified mortgage bonds, qualified veterans' 
mortgage bonds, or qualified student loan bonds that is reasonably 
expected as of the issue date to convert to a fixed yield issue, the 
yield may be computed over the term of the issue, and, if the yield is 
so computed, paragraph (d) of this section does not apply to the issue. 
As of any date, the yield over the term of the issue is based on--
    (1) With respect to any bond of the issue that has not converted to 
a fixed and determinable yield on or before that date, the actual 
amounts paid or received to that date and the amounts that are 
reasonably expected (as of that date) to be paid or received with 
respect to that bond over the remaining term of the issue (taking into 
account prepayment assumptions under section 143(g)(2)(B)(iv), if 
applicable); and
    (2) With respect to any bond of the issue that has converted to a 
fixed and determinable yield on or before that date, the actual amounts 
paid or received before that bond converted, if any, and the amount that 
was reasonably expected (on the date that bond converted) to be paid or 
received with respect to that bond over the remaining term of the issue 
(taking into account prepayment assumptions under section 
143(g)(2)(B)(iv), if applicable).
    (h) Qualified hedging transactions--(1) In general. Payments made or 
received by an issuer under a qualified hedge (as defined in paragraph 
(h)(2) of this section) relating to bonds of an issue are taken into 
account (as provided in paragraph (h)(3) of this section) to determine 
the yield on the issue. Except as provided in paragraphs (h)(4) and 
(h)(5)(ii)(E) of this section, the bonds to which a qualified hedge 
relates are treated as variable yield bonds from the issue date of the 
bonds. This paragraph (h) applies solely for purposes of sections 
143(g), 148, and 149(d).
    (2) Qualified hedge defined. Except as provided in paragraph (h)(5) 
of this section, the term qualified hedge means a contract that 
satisfies each of the following requirements:
    (i) Hedge--(A) In general. The contract is entered into primarily to 
modify the issuer's risk of interest rate changes with respect to a bond 
(a hedge). For example, the contract may be an interest rate swap, an 
interest rate cap, a futures contract, a forward contract, or an option.
    (B) Special rule for fixed rate issues. If the contract modifies the 
issuer's risk of interest rate changes with respect to a bond that is 
part of an issue that, absent the contract, would be a fixed rate issue, 
the contract must be entered into--
    (1) No later than 15 days after the issue date (or the deemed issue 
date under paragraph (d) of this section) of the issue; or
    (2) No later than the expiration of a qualified hedge with respect 
to bonds of that issue that satisfies paragraph (h)(2)(i)(B)(1) of this 
section; or
    (3) No later than the expiration of a qualified hedge with respect 
to bonds of that issue that satisfies either paragraph (h)(2)(i)(B)(2) 
of this section or this paragraph (h)(2)(i)(B)(3).
    (C) Contracts with certain acquisition payments. If a hedge provider 
makes a single payment to the issuer (e.g., a payment for an off-market 
swap) in connection with the acquisition of a contract, the issuer may 
treat a portion of that contract as a hedge provided--
    (1) The hedge provider's payment to the issuer and the issuer's 
payments under the contract in excess of those that it would make if the 
contract bore rates equal to the on-market rates for the contract 
(determined as of the date the parties enter into the contract) are 
separately identified in a certification of the hedge provider; and
    (2) The payments described in paragraph (h)(2)(i)(C)(1) of this 
section are not treated as payments on the hedge.
    (ii) No significant investment element--(A) In general. The contract 
does not contain a significant investment element. Except as provided in 
paragraph (h)(2)(ii)(B) of this section, a contract contains a 
significant investment element if a significant portion of any

[[Page 708]]

payment by one party relates to a conditional or unconditional 
obligation by the other party to make a payment on a different date. 
Examples of contracts that contain a significant investment element are 
a debt instrument held by the issuer; an interest rate swap requiring 
any payments other than periodic payments, within the meaning of Sec. 
1.446-3 (periodic payments) (e.g., a payment for an off-market swap or 
prepayment of part or all of one leg of a swap); and an interest rate 
cap requiring the issuer's premium for the cap to be paid in a single, 
up-front payment.
    (B) Special level payment rule for interest rate caps. An interest 
rate cap does not contain a significant investment element if--
    (1) All payments to the issuer by the hedge provider are periodic 
payments;
    (2) The issuer makes payments for the cap at the same time as 
periodic payments by the hedge provider must be made if the specified 
index (within the meaning of Sec. 1.446-3) of the cap is above the 
strike price of the cap; and
    (3) Each payment by the issuer bears the same ratio to the notional 
principal amount (within the meaning of Sec. 1.446-3) that is used to 
compute the hedge provider's payment, if any, on that date.
    (iii) Parties. The contract is entered into between the issuer or 
the political subdivision on behalf of which the issuer issues the bonds 
(collectively referred to in this paragraph (h) as the issuer) and a 
provider that is not a related party (the hedge provider).
    (iv) Hedged bonds. The contract covers, in whole or in part, all of 
one or more groups of substantially identical bonds in the issue (i.e., 
all of the bonds having the same interest rate, maturity, and terms). 
Thus, for example, a qualified hedge may include a hedge of all or a pro 
rata portion of each interest payment on the variable rate bonds in an 
issue for the first 5 years following their issuance. For purposes of 
this paragraph (h), unless the context clearly requires otherwise, 
hedged bonds means the specific bonds or portions thereof covered by a 
hedge.
    (v) Interest based contract. The contract is primarily interest 
based. A contract is not primarily interest based unless--
    (A) The hedged bond, without regard to the contract, is either a 
fixed rate bond, a variable rate debt instrument within the meaning of 
Sec. 1.1275-5 provided the rate is not based on an objective rate other 
than a qualified inverse floating rate or a qualified inflation rate, a 
tax-exempt obligation described in Sec. 1.1275-4(d)(2), or an 
inflation-indexed debt instrument within the meaning of Sec. 1.1275-7; 
and
    (B) As a result of treating all payments on (and receipts from) the 
contract as additional payments on (and receipts from) the hedged bond, 
the resulting bond would be substantially similar to either a fixed rate 
bond, a variable rate debt instrument within the meaning of Sec. 
1.1275-5 provided the rate is not based on an objective rate other than 
a qualified inverse floating rate or a qualified inflation rate, a tax-
exempt obligation described in Sec. 1.1275-4(d)(2), or an inflation-
indexed debt instrument within the meaning of Sec. 1.1275-7. For this 
purpose, differences that would not prevent the resulting bond from 
being substantially similar to another type of bond include a difference 
between the index used to compute payments on the hedged bond and the 
index used to compute payments on the hedge where one index is 
substantially the same, but not identical to, the other; the difference 
resulting from the payment of a fixed premium for a cap (e.g., payments 
for a cap that are made in other than level installments); and the 
difference resulting from the allocation of a termination payment where 
the termination was not expected as of the date the contract was entered 
into.
    (vi) Payments closely correspond. The payments received by the 
issuer from the hedge provider under the contract correspond closely in 
time to either the specific payments being hedged on the hedged bonds or 
specific payments required to be made pursuant to the bond documents, 
regardless of the hedge, to a sinking fund, debt service fund, or 
similar fund maintained for the issue of which the hedged bond is a 
part.
    (vii) Source of payments. Payments to the hedge provider are 
reasonably expected to be made from the same source of funds that, 
absent the hedge, would be reasonably expected to be

[[Page 709]]

used to pay principal and interest on the hedged bonds.
    (viii) Identification. The contract must be identified by the actual 
issuer on its books and records maintained for the hedged bonds not 
later than 3 days after the date on which the issuer and the hedge 
provider enter into the contract. The identification must specify the 
hedge provider, the terms of the contract, and the hedged bonds. The 
identification must contain sufficient detail to establish that the 
requirements of this paragraph (h)(2) and, if applicable, paragraph 
(h)(4) of this section are satisfied. In addition, the existence of the 
hedge must be noted on the first form relating to the issue of which the 
hedged bonds are a part that is filed with the Internal Revenue Service 
on or after the date on which the contract is identified pursuant to 
this paragraph (h)(2)(viii).
    (3) Accounting for qualified hedges--(i) In general. Except as 
otherwise provided in paragraph (h)(4) of this section, payments made or 
received by the issuer under a qualified hedge are treated as payments 
made or received, as appropriate, on the hedged bonds that are taken 
into account in determining the yield on those bonds. These payments are 
reasonably allocated to the hedged bonds in the period to which the 
payments relate, as determined under paragraph (h)(3)(iii) of this 
section. Payments made or received by the issuer include payments deemed 
made or received when a contract is terminated or deemed terminated 
under this paragraph (h)(3). Payments reasonably allocable to the 
modification of risk of interest rate changes and to the hedge 
provider's overhead under this paragraph (h) are included as payments 
made or received under a qualified hedge.
    (ii) Exclusions from hedge. If any payment for services or other 
items under the contract is not expressly treated by paragraph (h)(3)(i) 
of this section as a payment under the qualified hedge, the payment is 
not a payment with respect to a qualified hedge.
    (iii) Timing and allocation of payments. Except as provided in 
paragraphs (h)(3)(iv) and (h)(5) of this section, payments made or 
received by the issuer under a qualified hedge are taken into account in 
the same period in which those amounts would be treated as income or 
deductions under Sec. 1.446-4 (without regard to Sec. 1.446-
4(a)(2)(iv)) and are adjusted as necessary to reflect the end of a 
computation period and the start of a new computation period.
    (iv) Termination payments--(A) Termination defined. A termination of 
a qualified hedge includes any sale or other disposition of the hedge by 
the issuer or the acquisition by the issuer of an offsetting hedge. A 
deemed termination occurs when the hedged bonds are redeemed or when a 
hedge ceases to be a qualified hedge of the hedged bonds. In the case of 
an assignment by a hedge provider of its remaining rights and 
obligations under the hedge to a third party or a modification of the 
hedging contract, the assignment or modification is treated as a 
termination with respect to the issuer only if it results in a deemed 
exchange of the hedge and a realization event under section 1001 to the 
issuer.
    (B) General rule. A payment made or received by an issuer to 
terminate a qualified hedge, including loss or gain realized or deemed 
realized, is treated as a payment made or received on the hedged bonds, 
as appropriate. The payment is reasonably allocated to the remaining 
periods originally covered by the terminated hedge in a manner that 
reflects the economic substance of the hedge.
    (C) Special rule for terminations when bonds are redeemed. Except as 
otherwise provided in this paragraph (h)(3)(iv)(C) and in paragraph 
(h)(3)(iv)(D) of this section, when a qualified hedge is deemed 
terminated because the hedged bonds are redeemed, the fair market value 
of the qualified hedge on the redemption date is treated as a 
termination payment made or received on that date. When hedged bonds are 
redeemed, any payment received by the issuer on termination of a hedge, 
including a termination payment or a deemed termination payment, 
reduces, but not below zero, the interest payments made by the issuer on 
the hedged bonds in the computation period ending on the termination 
date. The remainder of the payment, if any, is reasonably allocated over 
the bond years in the immediately preceding

[[Page 710]]

computation period or periods to the extent necessary to eliminate the 
excess.
    (D) Special rules for refundings. To the extent that the hedged 
bonds are redeemed using the proceeds of a refunding issue, the 
termination payment is accounted for under paragraph (h)(3)(iv)(B) of 
this section by treating it as a payment on the refunding issue, rather 
than the hedged bonds. In addition, to the extent that the refunding 
issue is redeemed during the period to which the termination payment has 
been allocated to that issue, paragraph (h)(3)(iv)(C) of this section 
applies to the termination payment by treating it as a payment on the 
redeemed refunding issue.
    (E) Safe harbor for allocation of certain termination payments. A 
payment to terminate a qualified hedge does not result in that hedge 
failing to satisfy the applicable provisions of paragraph (h)(3)(iv)(B) 
of this section if the payment is allocated in accordance with this 
paragraph (h)(3)(iv)(E). For an issue that is a variable yield issue 
after termination of a qualified hedge, an amount must be allocated to 
each date on which the hedge provider's payment, if any, would have been 
made had the hedge not been terminated. The amounts allocated to each 
date must bear the same ratio to the notional principal amount (within 
the meaning of Sec. 1.446-3) that would have been used to compute the 
hedge provider's payment, if any, on that date, and the sum of the 
present values of those amounts must equal the present value of the 
termination payment. Present value is computed as of the day the 
qualified hedge is terminated, using the yield on the hedged bonds, 
determined without regard to the termination payment. The yield used for 
this purpose is computed for the period beginning on the first date the 
qualified hedge is in effect and ending on the date the qualified hedge 
is terminated. On the other hand, for an issue that is a fixed yield 
issue after termination of a qualified hedge, the termination payment is 
taken into account as a single payment on the date it is paid.
    (4) Certain variable yield bonds treated as fixed yield bonds--(i) 
In general. Except as otherwise provided in this paragraph (h)(4), if 
the issuer of variable yield bonds enters into a qualified hedge, the 
hedged bonds are treated as fixed yield bonds paying a fixed interest 
rate if:
    (A) Maturity. The term of the hedge is equal to the entire period 
during which the hedged bonds bear interest at variable interest rates, 
and the issuer does not reasonably expect that the hedge will be 
terminated before the end of that period.
    (B) Payments closely correspond. Payments to be received under the 
hedge correspond closely in time to the hedged portion of payments on 
the hedged bonds. Hedge payments received within 15 days of the related 
payments on the hedged bonds generally so correspond.
    (C) Aggregate payments fixed. Taking into account all payments made 
and received under the hedge and all payments on the hedged bonds (i.e., 
after netting all payments), the issuer's aggregate payments are fixed 
and determinable as of a date not later than 15 days after the issue 
date of the hedged bonds. Payments on bonds are treated as fixed for 
purposes of this paragraph (h)(4)(i)(C) if payments on the bonds are 
based, in whole or in part, on one interest rate, payments on the hedge 
are based, in whole or in part, on a second interest rate that is 
substantially the same as, but not identical to, the first interest rate 
and payments on the bonds would be fixed if the two rates were 
identical. Rates are treated as substantially the same if they are 
reasonably expected to be substantially the same throughout the term of 
the hedge. For example, an objective 30-day tax-exempt variable rate 
index or other objective index may be substantially the same as an 
issuer's individual 30-day interest rate.
    (ii) Accounting. Except as otherwise provided in this paragraph 
(h)(4)(ii), in determining yield on the hedged bonds, all the issuer's 
payments on the hedged bonds and all payments made and received on a 
hedge described in paragraph (h)(4)(i) of this section are taken into 
account. If payments on the bonds and payments on the hedge are based, 
in whole or in part, on variable interest rates that are substantially 
the same within the meaning of paragraph

[[Page 711]]

(h)(4)(i)(C) of this section (but not identical), yield on the issue is 
determined by treating the variable interest rates as identical. For 
example, if variable rate bonds bearing interest at a weekly rate equal 
to the rate necessary to remarket the bonds at par are hedged with an 
interest rate swap under which the issuer receives payments based on a 
short-term floating rate index that is substantially the same as, but 
not identical to, the weekly rate on the bonds, the interest payments on 
the bonds are treated as equal to the payments received by the issuer 
under the swap for purposes of computing the yield on the bonds.
    (iii) Effect of termination--(A) In general. Except as otherwise 
provided in this paragraph (h)(4)(iii) and paragraph (h)(5) of this 
section, the issue of which the hedged bonds are a part is treated as if 
it were reissued as of the termination date of the qualified hedge 
covered by paragraph (h)(4)(i) of this section in determining yield on 
the hedged bonds for purposes of Sec. 1.148-3. The redemption price of 
the retired issue and the issue price of the new issue equal the 
aggregate values of all the bonds of the issue on the termination date. 
In computing the yield on the new issue for this purpose, any 
termination payment is accounted for under paragraph (h)(3)(iv) of this 
section, applied by treating the termination payment as made or received 
on the new issue under this paragraph (h)(4)(iii).
    (B) Effect of early termination. Except as otherwise provided in 
this paragraph (h)(4)(iii), the general rules of paragraph (h)(4)(i) of 
this section do not apply in determining the yield on the hedged bonds 
for purposes of Sec. 1.148-3 if the hedge is terminated or deemed 
terminated within 5 years after the issue date of the issue of which the 
hedged bonds are a part. Thus, the hedged bonds are treated as variable 
yield bonds for purposes of Sec. 1.148-3 from the issue date.
    (C) Certain terminations disregarded. This paragraph (h)(4)(iii) 
does not apply to a termination if, based on the facts and circumstances 
(e.g., taking into account both the termination and any qualified hedge 
that immediately replaces the terminated hedge), there is no change in 
the yield.
    (5) Contracts entered into before issue date of hedged bond--(i) In 
general. A contract does not fail to be a hedge under paragraph 
(h)(2)(i) of this section solely because it is entered into before the 
issue date of the hedged bond. However, that contract must be one to 
which either paragraph (h)(5)(ii) or (h)(5)(iii) of this section 
applies.
    (ii) Contracts expected to be closed substantially contemporaneously 
with the issue date of hedged bond--(A) Application. This paragraph 
(h)(5)(ii) applies to a contract if, on the date the contract is 
identified, the issuer reasonably expects to terminate or otherwise 
close (terminate) the contract substantially contemporaneously with the 
issue date of the hedged bond.
    (B) Contract terminated. If a contract to which this paragraph 
(h)(5)(ii) applies is terminated substantially contemporaneously with 
the issue date of the hedged bond, the amount paid or received, or 
deemed to be paid or received, by the issuer in connection with the 
issuance of the hedged bond to terminate the contract is treated as an 
adjustment to the issue price of the hedged bond and as an adjustment to 
the sale proceeds of the hedged bond for purposes of section 148. 
Amounts paid or received, or deemed to be paid or received, before the 
issue date of the hedged bond are treated as paid or received on the 
issue date in an amount equal to the future value of the payment or 
receipt on that date. For this purpose, future value is computed using 
yield on the hedged bond without taking into account amounts paid or 
received (or deemed paid or received) on the contract.
    (C) Contract not terminated. If a contract to which this paragraph 
(h)(5)(ii) applies is not terminated substantially contemporaneously 
with the issue date of the hedged bond, the contract is deemed 
terminated for its fair market value as of the issue date of the hedged 
bond. Once a contract has been deemed terminated pursuant to this 
paragraph (h)(5)(ii)(C), payments on and receipts from the contract are 
no longer taken into account under this paragraph (h) for purposes of 
determining yield on the hedged bond.

[[Page 712]]

    (D) Relation to other requirements of a qualified hedge. Payments 
made in connection with the issuance of a bond to terminate a contract 
to which this paragraph (h)(5)(ii) applies do not prevent the contract 
from satisfying the requirements of paragraph (h)(2)(vi) of this 
section.
    (E) Fixed yield treatment. A bond that is hedged with a contract to 
which this paragraph (h)(5)(ii) applies does not fail to be a fixed 
yield bond if, taking into account payments on the contract and the 
payments to be made on the bond, the bond satisfies the definition of 
fixed yield bond. See also paragraph (h)(4) of this section.
    (iii) Contracts expected not to be closed substantially 
contemporaneously with the issue date of hedged bond--(A) Application. 
This paragraph (h)(5)(iii) applies to a contract if, on the date the 
contract is identified, the issuer does not reasonably expect to 
terminate the contract substantially contemporaneously with the issue 
date of the hedge bond.
    (B) Contract terminated. If a contract to which this paragraph 
(h)(5)(iii) applies is terminated in connection with the issuance of the 
hedged bond, the amount paid or received, or deemed to be paid or 
received, by the issuer to terminate the contract is treated as an 
adjustment to the issue price of the hedged bond and as an adjustment to 
the sale proceeds of the hedged bond for purposes of section 148.
    (C) Contract not terminated. If a contract to which this paragraph 
(h)(5)(iii) applies is not terminated substantially contemporaneously 
with the issue date of the hedged bond, no payments with respect to the 
hedge made by the issuer before the issue date of the hedged bond are 
taken into account under this section.
    (iv) Identification. The identification required under paragraph 
(h)(2)(viii) of this section must specify the reasonably expected 
governmental purpose, issue price, maturity, and issue date of the 
hedged bond, the manner in which interest is reasonably expected to be 
computed, and whether paragraph (h)(5)(ii) or (h)(5)(iii) of this 
section applies to the contract. If an issuer identifies a contract 
under this paragraph (h)(5)(iv) that would be a qualified hedge with 
respect to the anticipated bond, but does not issue the anticipated bond 
on the identified issue date, the contract is taken into account as a 
qualified hedge of any bond of the issuer that is issued for the 
identified governmental purpose within a reasonable interval around the 
identified issue date of the anticipated bond.
    (6) Authority of the Commissioner. The Commissioner, by publication 
of a revenue ruling or revenue procedure (see Sec. 601.601(d)(2) of 
this chapter), may specify contracts that, although they do not meet the 
requirements of paragraph (h)(2) of this section, are qualified hedges 
or, although they do not meet the requirements of paragraph (h)(4) of 
this section, cause the hedged bonds to be treated as fixed yield bonds.

[T.D. 8476, 58 FR 33524, June 18, 1993; 58 FR 44452, Aug. 23, 1993, as 
amended by T.D. 8538, 59 FR 24042, May 10, 1994; T.D. 8718, 62 FR 25507, 
May 9, 1997; T.D. 8838, 64 FR 48547, Sept. 7, 1999]



Sec. 1.148-5  Yield and valuation of investments.

    (a) In general. This section provides rules for computing the yield 
and value of investments allocated to an issue for various purposes 
under section 148.
    (b) Yield on an investment--(1) In general. Except as otherwise 
provided, the yield on an investment allocated to an issue is computed 
under the economic accrual method, using the same compounding interval 
and financial conventions used to compute the yield on the issue. The 
yield on an investment allocated to an issue is the discount rate that, 
when used in computing the present value as of the date the investment 
is first allocated to the issue of all unconditionally payable receipts 
from the investment, produces an amount equal to the present value of 
all unconditionally payable payments for the investment. For this 
purpose, payments means amounts to be actually or constructively paid to 
acquire the investment, and receipts means amounts to be actually or 
constructively received from the investment, such as earnings and return 
of principal. The yield on a variable rate investment is determined in a 
manner comparable to the determination of the

[[Page 713]]

yield on a variable rate issue. For an issue of qualified mortgage 
bonds, qualified veterans' mortgage bonds, or qualified student loan 
bonds on which interest is paid semiannually, all regular monthly loan 
payments to be received during a semiannual debt service period may be 
treated as received at the end of that period. In addition, for any 
conduit financing issue, payments made by the conduit borrower are not 
treated as paid until the conduit borrower ceases to receive the benefit 
of earnings on those amounts.
    (2) Yield on a separate class of investments--(i) In general. For 
purposes of the yield restriction rules of section 148(a) and Sec. 
1.148-2, yield is computed separately for each class of investments. For 
this purpose, in determining the yield on a separate class of 
investments, the yield on each individual investment within the class is 
blended with the yield on other individual investments within the class, 
whether or not held concurrently, by treating those investments as a 
single investment. The yields on investments that are not within the 
same class are not blended.
    (ii) Separate classes of investments. Each of the following is a 
separate class of investments--
    (A) Each category of yield restricted purpose investment and program 
investment that is subject to a different definition of materially 
higher under Sec. 1.148-2(d)(2);
    (B) Yield-restricted nonpurpose investments; and
    (C) All other nonpurpose investments;
    (iii) Permissive application of single investment rules to certain 
yield restricted investments for all purposes of section 148. For all 
purposes of section 148, if an issuer reasonably expects as of the issue 
date to establish and maintain a sinking fund solely to reduce the yield 
on the investments in a refunding escrow, then the issuer may treat all 
of the yield restricted nonpurpose investments in the refunding escrow 
and that sinking fund as a single investment having a single yield, 
determined under this paragraph (b)(2). Thus, an issuer may not treat 
the nonpurpose investments in a reasonably required reserve fund and a 
refunding escrow as a single investment having a single yield under this 
paragraph (b)(2)(iii).
    (iv) Mandatory application of single investment rules for refunding 
escrows for all purposes of section 148. For all purposes of section 
148, in computing the yield on yield restricted investments allocable to 
proceeds (i.e., sale proceeds, investment proceeds, and transferred 
proceeds) of a refunding issue that are held in one or more refunding 
escrows, the individual investments are treated as a single investment 
having a single yield, whether or not held concurrently. For example, 
this single investment includes both the individual investments 
allocable to sale and investment proceeds of a refunding issue that are 
held in one refunding escrow for a prior issue and the investments 
allocable to transferred proceeds of that refunding issue that are held 
in another refunding escrow.
    (3) Investments to be held beyond issue's maturity or beyond 
temporary period. In computing the yield on investments allocable to an 
issue that are to be held beyond the reasonably expected redemption date 
of the issue, those investments are treated as sold for an amount equal 
to their value on that date. In computing the yield on investments that 
are held beyond an applicable temporary period under Sec. 1.148-2, for 
purposes of Sec. 1.148-2 those investments may be treated as purchased 
for an amount equal to their fair market value as of the end of the 
temporary period.
    (4) Consistent redemption assumptions on purpose investments. The 
yield on purpose investments allocable to an issue is computed using the 
same redemption assumptions used to compute the yield on the issue. 
Yield on purpose investments allocable to an issue of qualified mortgage 
bonds and qualified veterans' mortgage bonds must be determined in a 
manner that is consistent with, and using the assumptions required by, 
section 143(g)(2)(B).
    (5) Student loan special allowance payments included in yield. 
Except as provided in Sec. 1.148-11(e), the yield on qualified student 
loans is computed by including as receipts any special allowance 
payments made by the Secretary of Education pursuant to section 438 of 
the Higher Education Act of 1965.

[[Page 714]]

    (c) Yield reduction payments to the United States--(1) In general. 
In determining the yield on an investment to which this paragraph (c) 
applies, any amount paid to the United States in accordance with this 
paragraph (c), including a rebate amount, is treated as a payment for 
that investment that reduces the yield on that investment.
    (2) Manner of payment--(i) In general. Except as otherwise provided 
in paragraph (c)(2)(ii) of this section, an amount is paid under this 
paragraph (c) if it is paid to the United States at the same time and in 
the same manner as rebate amounts are required to be paid or at such 
other time or in such manner as the Commissioner may prescribe. For 
example, yield reduction payments must be made on or before the date of 
required rebate installment payments as described in Sec. Sec. 1.148-
3(f), (g), and (h). The provisions of Sec. 1.148-3(i) apply to payments 
made under this paragraph (c).
    (ii) Special rule for purpose investments. For purpose investments 
allocable to an issue--
    (A) No amounts are required to be paid to satisfy this paragraph (c) 
until the earlier of the end of the tenth bond year after the issue date 
of the issue or 60 days after the date on which the issue is no longer 
outstanding; and
    (B) For payments made prior to the date on which the issue is 
retired, the issuer need not pay more than 75 percent of the amount 
otherwise required to be paid as of the date to which the payment 
relates.
    (3) Applicability of special yield reduction rule--(i) Covered 
investments. This paragraph (c) applies to--
    (A) Nonpurpose investments allocable to proceeds of an issue that 
qualified for one of the temporary periods available for capital 
projects, restricted working capital expenditures, pooled financings, or 
investment proceeds under Sec. 1.148-2(e)(2), (e)(3), (e)(4), or 
(e)(6), respectively;
    (B) Investments allocable to a variable yield issue during any 
computation period in which at least 5 percent of the value of the issue 
is represented by variable yield bonds, unless the issue is an issue of 
hedge bonds (as defined in section 149(g)(3)(A));
    (C) Nonpurpose investments allocable to transferred proceeds of--
    (1) A current refunding issue to the extent necessary to reduce the 
yield on those investments to satisfy yield restrictions under section 
148(a); or
    (2) An advance refunding issue to the extent that investment of the 
refunding escrows allocable to the proceeds, other than transferred 
proceeds, of the refunding issue in zero-yielding nonpurpose investments 
is insufficient to satisfy yield restrictions under section 148(a);
    (D) Purpose investments allocable to qualified student loans under a 
program described in section 144(b)(1)(A);
    (E) Nonpurpose investments allocable to gross proceeds of an issue 
in a reasonably required reserve or replacement fund or in a fund that, 
except for its failure to satisfy the size limitation in Sec. 1.148-
2(f)(2)(ii), would qualify as a reasonably required reserve or 
replacement fund, but only to the extent that--
    (1) The value of the nonpurpose investments in the fund is not 
greater than 15 percent of the stated principal amount of the issue, as 
computed under Sec. 1.148-2(f)(2)(ii), or
    (2) The amounts in the fund (other than investment earnings) are not 
reasonably expected to be used to pay debt service on the issue other 
than in connection with reductions in the amount required to be in that 
fund (e.g. a reserve fund for a revolving fund loan program);
    (F) Nonpurpose investments allocated to replacement proceeds of a 
refunded issue as a result of the application of the universal cap to 
amounts in a refunding escrow (see Sec. 1.148-11(c)(1)(ii)); and
    (G) Investments described in Sec. 1.148-11(f).
    (ii) Exception to yield reduction payments rule for advance 
refunding issues. Paragraph (c)(1) of this section does not apply to 
investments allocable to gross proceeds of an advance refunding issue, 
other than--
    (A) Transferred proceeds to which paragraph (c)(3)(i)(C) of this 
section applies;
    (B) Replacement proceeds to which paragraph (c)(3)(i)(F) of this 
section applies; and

[[Page 715]]

    (C) Transferred proceeds to which paragraph (c)(3)(i)(E) of this 
section applies, but only to the extent necessary to satisfy yield 
restriction under section 148(a) on those proceeds treating all 
investments allocable to those proceeds as a separate class.
    (d) Value of investments--(1) In general. Except as otherwise 
provided, the value of an investment (including a payment or receipt on 
the investment) on a date must be determined using one of the following 
valuation methods consistently for all purposes of section 148 to that 
investment on that date:
    (i) Plain par investment--outstanding principal amount. A plain par 
investment may be valued at its outstanding stated principal amount, 
plus any accrued unpaid interest on that date.
    (ii) Fixed rate investment--present value. A fixed rate investment 
may be valued at its present value on that date.
    (iii) Any investment--fair market value. An investment may be valued 
at its fair market value on that date.
    (2) Mandatory valuation of yield restricted investments at present 
value. Any yield restricted investment must be valued at present value. 
For example, a purpose investment or an investment allocable to gross 
proceeds in a refunding escrow after the expiration of the initial 
temporary period must be valued at present value. See, however, 
paragraph (b)(3) of this section.
    (3) Mandatory valuation of certain investments at fair market 
value--(i) In general. Except as provided in paragraphs (d)(2), 
(d)(3)(ii), and (d)(4) of this section, an investment must be valued at 
fair market value on the date that it is first allocated to an issue or 
first ceases to be allocated to an issue as a consequence of a deemed 
acquisition or deemed disposition. For example, if an issuer deposits 
existing investments into a sinking fund for an issue, those investments 
must be valued at fair market value as of the date first deposited into 
the fund.
    (ii) Exception to fair market value requirement for transferred 
proceeds allocations, universal cap allocations, and commingled funds. 
Paragraph (d)(3)(i) of this section does not apply if the investment is 
allocated from one issue to another issue as a result of the transferred 
proceeds allocation rule under Sec. 1.148-9(b) or the universal cap 
rule under Sec. 1.148-6(b)(2), provided that both issues consist 
exclusively of tax-exempt bonds. In addition, paragraph (d)(3)(i) of 
this section does not apply to investments in a commingled fund (other 
than a bona fide debt service fund) unless it is an investment being 
initially deposited in or withdrawn from a commingled fund described in 
Sec. 1.148-6(e)(5)(iii).
    (4) Special transition rule for transferred proceeds. The value of a 
nonpurpose investment that is allocated to transferred proceeds of a 
refunding issue on a transfer date may not exceed the value of that 
investment on the transfer date used for purposes of applying the 
arbitrage restrictions to the refunded issue.
    (5) Definition of present value of an investment. Except as 
otherwise provided, present value of an investment is computed under the 
economic accrual method, using the same compounding interval and 
financial conventions used to compute the yield on the issue. The 
present value of an investment on a date is equal to the present value 
of all unconditionally payable receipts to be received from and payments 
to be paid for the investment after that date, using the yield on the 
investment as the discount rate.
    (6) Definition of fair market value--(i) In general. The fair market 
value of an investment is the price at which a willing buyer would 
purchase the investment from a willing seller in a bona fide, arm's-
length transaction. Fair market value generally is determined on the 
date on which a contract to purchase or sell the nonpurpose investment 
becomes binding (i.e., the trade date rather than the settlement date). 
Except as otherwise provided in this paragraph (d)(6), an investment 
that is not of a type traded on an established securities market, within 
the meaning of section 1273, is rebuttably presumed to be acquired or 
disposed of for a price that is not equal to its fair market value. The 
fair market value of a United States Treasury obligation that is 
purchased directly from the United States Treasury is its purchase 
price.
    (ii) Safe harbor for establishing fair market value for certificates 
of deposit.

[[Page 716]]

This paragraph (d)(6)(ii) applies to a certificate of deposit that has a 
fixed interest rate, a fixed payment schedule, and a substantial penalty 
for early withdrawal. The purchase price of such a certificate of 
deposit is treated as its fair market value on the purchase date if the 
yield on the certificate of deposit is not less than--
    (A) The yield on reasonably comparable direct obligations of the 
United States; and
    (B) The highest yield that is published or posted by the provider to 
be currently available from the provider on reasonably comparable 
certificates of deposit offered to the public.
    (iii) Safe harbor for establishing fair market value for guaranteed 
investment contracts and investments purchased for a yield restricted 
defeasance escrow. The purchase price of a guaranteed investment 
contract and the purchase price of an investment purchased for a yield 
restricted defeasance escrow will be treated as the fair market value of 
the investment on the purchase date if all of the following requirements 
are satisfied:
    (A) The issuer makes a bona fide solicitation for the purchase of 
the investment. A bona fide solicitation is a solicitation that 
satisfies all of the following requirements:
    (1) The bid specifications are in writing and are timely forwarded 
to potential providers.
    (2) The bid specifications include all material terms of the bid. A 
term is material if it may directly or indirectly affect the yield or 
the cost of the investment.
    (3) The bid specifications include a statement notifying potential 
providers that submission of a bid is a representation that the 
potential provider did not consult with any other potential provider 
about its bid, that the bid was determined without regard to any other 
formal or informal agreement that the potential provider has with the 
issuer or any other person (whether or not in connection with the bond 
issue), and that the bid is not being submitted solely as a courtesy to 
the issuer or any other person for purposes of satisfying the 
requirements of paragraph (d)(6)(iii)(B)(1) or (2) of this section.
    (4) The terms of the bid specifications are commercially reasonable. 
A term is commercially reasonable if there is a legitimate business 
purpose for the term other than to increase the purchase price or reduce 
the yield of the investment. For example, for solicitations of 
investments for a yield restricted defeasance escrow, the hold firm 
period must be no longer than the issuer reasonably requires.
    (5) For purchases of guaranteed investment contracts only, the terms 
of the solicitation take into account the issuer's reasonably expected 
deposit and drawdown schedule for the amounts to be invested.
    (6) All potential providers have an equal opportunity to bid. For 
example, no potential provider is given the opportunity to review other 
bids (i.e., a last look) before providing a bid.
    (7) At least three reasonably competitive providers are solicited 
for bids. A reasonably competitive provider is a provider that has an 
established industry reputation as a competitive provider of the type of 
investments being purchased.
    (B) The bids received by the issuer meet all of the following 
requirements:
    (1) The issuer receives at least three bids from providers that the 
issuer solicited under a bona fide solicitation meeting the requirements 
of paragraph (d)(6)(iii)(A) of this section and that do not have a 
material financial interest in the issue. A lead underwriter in a 
negotiated underwriting transaction is deemed to have a material 
financial interest in the issue until 15 days after the issue date of 
the issue. In addition, any entity acting as a financial advisor with 
respect to the purchase of the investment at the time the bid 
specifications are forwarded to potential providers has a material 
financial interest in the issue. A provider that is a related party to a 
provider that has a material financial interest in the issue is deemed 
to have a material financial interest in the issue.
    (2) At least one of the three bids described in paragraph 
(d)(6)(iii)(B)(1) of this section is from a reasonably competitive 
provider, within the meaning of paragraph (d)(6)(iii)(A)(7) of this 
section.

[[Page 717]]

    (3) If the issuer uses an agent to conduct the bidding process, the 
agent did not bid to provide the investment.
    (C) The winning bid meets the following requirements:
    (1) Guaranteed investment contracts. If the investment is a 
guaranteed investment contract, the winning bid is the highest yielding 
bona fide bid (determined net of any broker's fees).
    (2) Other investments. If the investment is not a guaranteed 
investment contract, the following requirements are met:
    (i) The winning bid is the lowest cost bona fide bid (including any 
broker's fees). The lowest cost bid is either the lowest cost bid for 
the portfolio or, if the issuer compares the bids on an investment-by-
investment basis, the aggregate cost of a portfolio comprised of the 
lowest cost bid for each investment. Any payment received by the issuer 
from a provider at the time a guaranteed investment contract is 
purchased (e.g., an escrow float contract) for a yield restricted 
defeasance escrow under a bidding procedure meeting the requirements of 
this paragraph (d)(6)(iii) is taken into account in determining the 
lowest cost bid.
    (ii) The lowest cost bona fide bid (including any broker's fees) is 
not greater than the cost of the most efficient portfolio comprised 
exclusively of State and Local Government Series Securities from the 
United States Department of the Treasury, Bureau of Public Debt. The 
cost of the most efficient portfolio of State and Local Government 
Series Securities is to be determined at the time that bids are required 
to be submitted pursuant to the terms of the bid specifications.
    (iii) If State and Local Government Series Securities from the 
United States Department of the Treasury, Bureau of Public Debt are not 
available for purchase on the day that bids are required to be submitted 
pursuant to terms of the bid specifications because sales of those 
securities have been suspended, the cost comparison of paragraph 
(d)(6)(iii) (C)(2)(ii) of this section is not required.
    (D) The provider of the investments or the obligor on the guaranteed 
investment contract certifies the administrative costs that it pays (or 
expects to pay, if any) to third parties in connection with supplying 
the investment.
    (E) The issuer retains the following records with the bond documents 
until three years after the last outstanding bond is redeemed:
    (1) For purchases of guaranteed investment contracts, a copy of the 
contract, and for purchases of investments other than guaranteed 
investment contracts, the purchase agreement or confirmation.
    (2) The receipt or other record of the amount actually paid by the 
issuer for the investments, including a record of any administrative 
costs paid by the issuer, and the certification under paragraph 
(d)(6)(iii)(D) of this section.
    (3) For each bid that is submitted, the name of the person and 
entity submitting the bid, the time and date of the bid, and the bid 
results.
    (4) The bid solicitation form and, if the terms of the purchase 
agreement or the guaranteed investment contract deviated from the bid 
solicitation form or a submitted bid is modified, a brief statement 
explaining the deviation and stating the purpose for the deviation. For 
example, if the issuer purchases a portfolio of investments for a yield 
restricted defeasance escrow and, in order to satisfy the yield 
restriction requirements of section 148, an investment in the winning 
bid is replaced with an investment with a lower yield, the issuer must 
retain a record of the substitution and how the price of the substitute 
investment was determined. If the issuer replaces an investment in the 
winning bid portfolio with another investment, the purchase price of the 
new investment is not covered by the safe harbor unless the investment 
is bid under a bidding procedure meeting the requirements of this 
paragraph (d)(6)(iii).
    (5) For purchases of investments other than guaranteed investment 
contracts, the cost of the most efficient portfolio of State and Local 
Government Series Securities, determined at the time that the bids were 
required to be submitted pursuant to the terms of the bid 
specifications.
    (e) Administrative costs of investments--(1) In general. Except as 
otherwise provided in this paragraph (e), an allocation of gross 
proceeds of an issue to a

[[Page 718]]

payment or a receipt on an investment is not adjusted to take into 
account any costs or expenses paid, directly or indirectly, to purchase, 
carry, sell, or retire the investment (administrative costs). Thus, 
these administrative costs generally do not increase the payments for, 
or reduce the receipts from, investments.
    (2) Qualified administrative costs on nonpurpose investments--(i) In 
general. In determining payments and receipts on nonpurpose investments, 
qualified administrative costs are taken into account. Thus, qualified 
administrative costs increase the payments for, or decrease the receipts 
from, the investments. Qualified administrative costs are reasonable, 
direct administrative costs, other than carrying costs, such as 
separately stated brokerage or selling commissions, but not legal and 
accounting fees, recordkeeping, custody, and similar costs. General 
overhead costs and similar indirect costs of the issuer such as employee 
salaries and office expenses and costs associated with computing the 
rebate amount under section 148(f) are not qualified administrative 
costs. In general, administrative costs are not reasonable unless they 
are comparable to administrative costs that would be charged for the 
same investment or a reasonably comparable investment if acquired with a 
source of funds other than gross proceeds of tax-exempt bonds.
    (ii) Special rule for administrative costs of nonpurpose investments 
in certain regulated investment companies and commingled funds. 
Qualified administrative costs include all reasonable administrative 
costs, without regard to the limitation on indirect costs under 
paragraph (e)(2)(i) of this section, incurred by:
    (A) Regulated investment companies. A publicly offered regulated 
investment company (as defined in section 67(c)(2)(B)); and
    (B) External commingled funds. A widely held commingled fund in 
which no investor in the fund owns more than 10 percent of the 
beneficial interest in the fund. For purposes of this paragraph 
(e)(2)(ii)(B), a fund is treated as widely held only if, during the 
immediately preceding fixed, semiannual period chosen by the fund (e.g., 
semiannual periods ending June 30 and December 31), the fund had a daily 
average of more than 15 investors that were not related parties, and the 
daily average amount each investor had invested in the fund was not less 
than the lesser of $500,000 and 1 percent of the daily average of the 
total amount invested in the fund. For purposes of this paragraph 
(e)(2)(ii)(B), an investor will be treated as owning not more than 10 
percent of the beneficial interest in the fund if, on the date of each 
deposit by the investor into the fund, the total amount the investor and 
any related parties have on deposit in the fund is not more than 10 
percent of the total amount that all investors have on deposit in the 
fund. For purposes of the preceding sentence, the total amount that all 
investors have on deposit in the fund is equal to the sum of all 
deposits made by the investor and any related parties on the date of 
those deposits and the closing balance in the fund on the day before 
those deposits. If any investor in the fund owns more than 10 percent of 
the beneficial interest in the fund, the fund does not qualify under 
this paragraph (e)(2)(ii)(B) until that investor makes sufficient 
withdrawals from the fund to reduce its beneficial interest in the fund 
to 10 percent or less.
    (iii) Special rule for guaranteed investment contracts and 
investments purchased for a yield restricted defeasance escrow--(A) In 
general. An amount paid for a broker's commission or similar fee with 
respect to a guaranteed investment contract or investments purchased for 
a yield restricted defeasance escrow is a qualified administrative cost 
if the fee is reasonable within the meaning of paragraph (e)(2)(i) of 
this section.
    (B) Safe harbor--(1) In general. A broker's commission or similar 
fee with respect to the acquisition of a guaranteed investment contract 
or investments purchased for a yield restricted defeasance escrow is 
reasonable within the meaning of paragraph (e)(2)(i) of this section to 
the extent that--
    (i) The amount of the fee that the issuer treats as a qualified 
administrative cost does not exceed the lesser of:
    (A) $30,000 and
    (B) 0.2% of the computational base or, if more, $3,000; and

[[Page 719]]

    (ii) For any issue, the issuer does not treat as qualified 
administrative costs more than $85,000 in brokers' commissions or 
similar fees with respect to all guaranteed investment contracts and 
investments for yield restricted defeasance escrows purchased with gross 
proceeds of the issue.
    (2) Computational base. For purposes of paragraph (e)(2)(iii)(B)(1) 
of this section, computational base shall mean--
    (i) For a guaranteed investment contract, the amount of gross 
proceeds the issuer reasonably expects, as of the date the contract is 
acquired, to be deposited in the guaranteed investment contract over the 
term of the contract, and
    (ii) For investments (other than guaranteed investment contracts) to 
be deposited in a yield restricted defeasance escrow, the amount of 
gross proceeds initially invested in those investments.
    (3) Cost-of-living adjustment. In the case of a calendar year after 
2004, each of the dollar amounts in paragraph (e)(2)(iii)(B)(1) of this 
section shall be increased by an amount equal to--
    (i) Such dollar amount; multiplied by
    (ii) The cost-of-living adjustment determined under section 1(f)(3) 
for such calendar year by using the language ``calendar year 2003'' 
instead of ``calendar year 1992'' in section 1(f)(3)(B).
    (4) Rounding. If any increase determined under paragraph 
(e)(2)(iii)(B)(3) of this section is not a multiple of $1,000, such 
increase shall be rounded to the nearest multiple thereof.
    (5) Applicable year for cost-of-living adjustment. The cost-of-
living adjustments under paragraph (e)(2)(iii)(B)(3) of this section 
shall apply to the safe harbor amounts under paragraph (e)(2)(iii)(B)(1) 
of this section based on the year the guaranteed investment contract or 
the investments for the yield restricted defeasance escrow, as 
applicable, are acquired.
    (6) Cost-of-living adjustment to determine remaining amount of per-
issue safe harbor--(i) In general. This paragraph (e)(2)(iii)(B)(6) 
applies to determine the portion of the safe harbor amount under 
paragraph (e)(2)(iii)(B)(1)(ii) of this section, as modified by 
paragraph (e)(2)(iii)(B)(3) of this section (the per-issue safe harbor), 
that is available (the remaining amount) for any year (the determination 
year) if the per-issue safe harbor was partially used in one or more 
prior years.
    (ii) Remaining amount of per-issue safe harbor. The remaining amount 
of the per-issue safe harbor for any determination year is equal to the 
per-issue safe harbor for that year, reduced by the portion of the per-
issue safe harbor used in one or more prior years.
    (iii) Portion of per-issue safe harbor used in prior years. The 
portion of the per-issue safe harbor used in any prior year (the prior 
year) is equal to the total amount of broker's commissions or similar 
fees paid in connection with guaranteed investment contracts or 
investments for a yield restricted defeasance escrow acquired in the 
prior year that the issuer treated as qualified administrative costs for 
the issue, multiplied by a fraction the numerator of which is the per-
issue safe harbor for the determination year and the denominator of 
which is the per-issue safe harbor for the prior year. See paragraph 
(e)(2)(iii)(C) Example 2 of this section.
    (C) Examples. The following examples illustrate the application of 
the safe harbor in paragraph (e)(2)(iii)(B) of this section:

    Example 1. Multipurpose issue. In 2003, the issuer of a multipurpose 
issue uses brokers to acquire the following investments with gross 
proceeds of the issue: a guaranteed investment contract for amounts to 
be deposited in a construction fund (construction GIC), Treasury 
securities to be deposited in a yield restricted defeasance escrow 
(Treasury investments) and a guaranteed investment contract that will be 
used to earn a return on what otherwise would be idle cash balances from 
maturing investments in the yield restricted defeasance escrow (the 
float GIC). The issuer deposits $22,000,000 into the construction GIC 
and reasonably expects that no further deposits will be made over its 
term. The issuer uses $8,040,000 of the proceeds to purchase the 
Treasury investments. The issuer reasonably expects that it will make 
aggregate deposits of $600,000 to the float GIC over its term. The 
brokers' fees are $30,000 for the construction GIC, $16,080 for the 
Treasury investments and $3,000 for the float GIC. The issuer has not 
previously treated any brokers' commissions or similar fees as qualified 
administrative costs. The issuer may claim all $49,080 in brokers' fees 
for these investments as qualified administrative costs because the fees 
do not exceed the safe harbors in paragraph (e)(2)(iii)(B) of

[[Page 720]]

this section. Specifically, each of the brokers' fees equals the lesser 
of $30,000 and 0.2% of the computational base (or, if more, $3,000) 
(i.e., lesser of $30,000 and 0.2% x $22,000,000 for the construction 
GIC; lesser of $30,000 and 0.2% x $8,040,000 for the Treasury 
investments; and lesser of $30,000 and $3,000 for the float GIC). In 
addition, the total amount of brokers' fees claimed by the issuer as 
qualified administrative costs ($49,080) does not exceed the per-issue 
safe harbor of $85,000.
    Example 2. Cost-of-living adjustment. In 2003, an issuer issues 
bonds and uses gross proceeds of the issue to acquire two guaranteed 
investment contracts. The issuer pays a total of $50,000 in brokers' 
fees for the two guaranteed investment contracts and treats these fees 
as qualified administrative costs. In a year subsequent to 2003 (Year 
Y), the issuer uses gross proceeds of the issue to acquire two 
additional guaranteed investment contracts, paying a total of $20,000 in 
broker's fees for the two guaranteed investment contracts, and treats 
those fees as qualified administrative costs. For Year Y, applying the 
cost-of-living adjustment under paragraph (e)(2)(iii)(B)(3) of this 
section, the safe harbor dollar limits under paragraph (e)(2)(iii)(B)(1) 
of this section are $3,000, $32,000 and $90,000. The remaining amount of 
the per-issue safe harbor for Year Y is $37,059 ($90,000-[$50,000 x 
$90,000/$85,000]). The broker's fees in Year Y do not exceed the per-
issue safe harbor under paragraph (e)(2)(iii)(B)(1)(ii) (as modified by 
paragraph (e)(2)(iii)(B)(3)) of this section because the broker's fees 
do not exceed the remaining amount of the per-issue safe harbor 
determined under paragraph (e)(2)(iii)(B)(6) of this section for Year Y. 
In a year subsequent to Year Y (Year Z), the issuer uses gross proceeds 
of the issue to acquire an additional guaranteed investment contract, 
pays a broker's fee of $15,000 for the guaranteed investment contract, 
and treats the broker's fee as a qualified administrative cost. For Year 
Z, applying the cost-of-living adjustment under paragraph 
(e)(2)(iii)(B)(3) of this section, the safe harbor dollar limits under 
paragraph (e)(2)(iii)(B)(1) of this section are $3,000, $33,000 and 
$93,000. The remaining amount of the per-issue safe harbor for Year Z is 
$17,627 ($93,000--[($50,000 x $93,000/$85,000) + ($20,000 x $93,000/
$90,000)]). The broker's fee incurred in Year Z does not exceed the per-
issue safe harbor under paragraph (e)(2)(iii)(B)(1)(ii) (as modified by 
paragraph (e)(2)(iii)(B)(3)) of this section because the broker's fee 
does not exceed the remaining amount of the per-issue safe harbor 
determined under paragraph (e)(2)(iii)(B)(6) of this section for Year Z. 
See paragraph (e)(2)(iii)(B)(6) of this section.
    (3) Qualified administrative costs on purpose investments--(i) In 
general. In determining payments and receipts on purpose investments, 
qualified administrative costs described in this paragraph (e)(3) paid 
by the conduit borrower are taken into account. Thus, these costs 
increase the payments for, or decrease the receipts from, the purpose 
investments. This rule applies even if those payments merely reimburse 
the issuer. Although the actual payments by the conduit borrower may be 
made at any time, for this purpose, a pro rata portion of each payment 
made by a conduit borrower is treated as a reimbursement of reasonable 
administrative costs, if the present value of those payments does not 
exceed the present value of the reasonable administrative costs paid by 
the issuer, using the yield on the issue as the discount rate.
    (ii) Definition of qualified administrative costs of purpose 
investments--(A) In general. Except as otherwise provided in this 
paragraph (e)(3)(ii), qualified administrative costs of a purpose 
investment means--
    (1) Costs or expenses paid, directly or indirectly, to purchase, 
carry, sell, or retire the investment; and
    (2) Costs of issuing, carrying, or repaying the issue, and any 
underwriters' discount.
    (B) Limitation on program investments. For a program investment, 
qualified administrative costs include only those costs described in 
paragraph (e)(3)(ii)(A)(2) of this section.

[T.D. 8476, 58 FR 33529, June 18, 1993; 58 FR 44452, Aug. 23, 1993, as 
amended by T.D. 8538, 59 FR 24044, May 10, 1994; T.D. 8718, 62 FR 25511, 
May 9, 1997; T.D. 8801, 63 FR 71751, Dec. 30, 1998; T.D. 9097, 68 FR 
69022, Dec. 11, 2003]



Sec. 1.148-6  General allocation and accounting rules.

    (a) In general--(1) Reasonable accounting methods required. An 
issuer may use any reasonable, consistently applied accounting method to 
account for gross proceeds, investments, and expenditures of an issue.
    (2) Bona fide deviations from accounting method. An accounting 
method does not fail to be reasonable and consistently applied solely 
because a different accounting method is used for a bona fide 
governmental purpose to consistently account for a particular item. Bona 
fide governmental purposes may include special State law restrictions

[[Page 721]]

imposed on specific funds or actions to avoid grant forfeitures.
    (3) Absence of allocation and accounting methods. If an issuer fails 
to maintain books and records sufficient to establish the accounting 
method for an issue and the allocation of the proceeds of that issue, 
the rules of this section are applied using the specific tracing method. 
This paragraph (a)(3) applies to bonds issued on or after May 16, 1997.
    (b) Allocation of gross proceeds to an issue--(1) One-issue rule and 
general ordering rules. Except as otherwise provided, amounts are 
allocable to only one issue at a time as gross proceeds, and if amounts 
simultaneously are proceeds of one issue and replacement proceeds of 
another issue, those amounts are allocable to the issue of which they 
are proceeds. Amounts cease to be allocated to an issue as proceeds only 
when those amounts are allocated to an expenditure for a governmental 
purpose, are allocated to transferred proceeds of another issue, or 
cease to be allocated to that issue at retirement of the issue or under 
the universal cap of paragraph (b)(2) of this section. Amounts cease to 
be allocated to an issue as replacement proceeds only when those amounts 
are allocated to an expenditure for a governmental purpose, are no 
longer used in a manner that causes those amounts to be replacement 
proceeds of that issue, or cease to be allocated to that issue because 
of the retirement of the issue or the application of the universal cap 
under paragraph (b)(2) of this section. Amounts that cease to be 
allocated to an issue as gross proceeds are eligible for allocation to 
another issue. Under Sec. 1.148-10(a), however, the rules in this 
paragraph (b)(1) do not apply in certain cases involving abusive 
arbitrage devices.
    (2) Universal cap on value of nonpurpose investments allocated to an 
issue--(i) Application. The rules in this paragraph (b)(2) provide an 
overall limitation on the amount of gross proceeds allocable to an 
issue. Although the universal cap generally may be applied at any time 
in the manner described in this paragraph (b)(2), it need not be applied 
on any otherwise required date of application if its application on that 
date would not result in a reduction or reallocation of gross proceeds 
of an issue. For this purpose, if an issuer reasonably expects as of the 
issue date that the universal cap will not reduce the amount of gross 
proceeds allocable to the issue during the term of the issue, the 
universal cap need not be applied on any date on which an issue actually 
has all of the following characteristics--
    (A) No replacement proceeds are allocable to the issue, other than 
replacement proceeds in a bona fide debt service fund or a reasonably 
required reserve or replacement fund;
    (B) The net sale proceeds of the issue--
    (1) Qualified for one of the temporary periods available for capital 
projects, restricted working capital expenditures, or pooled financings 
under Sec. 1.148-2 (e)(2), (e)(3), or (e)(4), and those net sales 
proceeds were in fact allocated to expenditures prior to the expiration 
of the longest applicable temporary period; or
    (2) were deposited in a refunding escrow and expended as originally 
expected;
    (C) The issue does not refund a prior issue that, on any transfer 
date, has unspent proceeds allocable to it;
    (D) None of the bonds are retired prior to the date on which those 
bonds are treated as retired in computing the yield on the issue; and
    (E) No proceeds of the issue are invested in qualified student loans 
or qualified mortgage loans.
    (ii) General rule. Except as otherwise provided below, amounts that 
would otherwise be gross proceeds allocable to an issue are allocated 
(and remain allocated) to the issue only to the extent that the value of 
the nonpurpose investments allocable to those gross proceeds does not 
exceed the value of all outstanding bonds of the issue. For this 
purpose, gross proceeds allocable to cash, tax-exempt bonds that would 
be nonpurpose investments (absent section 148(b)(3)(A)), qualified 
student loans, and qualified mortgage loans are treated as nonpurpose 
investments. The values of bonds and investments are determined under 
Sec. 1.148-4(e) and Sec. 1.148-5(d), respectively. The value of all 
outstanding bonds of the issue is referred to as the universal cap. 
Thus, for example, the universal cap for an issue

[[Page 722]]

of plain par bonds is equal to the outstanding stated principal amount 
of those bonds plus accrued interest.
    (iii) Determination and application of the universal cap. Except as 
otherwise provided, beginning with the first bond year that commences 
after the second anniversary of the issue date, the amount of the 
universal cap and the value of the nonpurpose investments must be 
determined as of the first day of each bond year. For refunding and 
refunded issues, the cap and values must be determined as of each date 
that, but for this paragraph (b)(2), proceeds of the refunded issue 
would become transferred proceeds of the refunding issue, and need not 
otherwise be determined in the bond year in which that date occurs. All 
values are determined as of the close of business on each determination 
date, after giving effect to all payments on bonds and payments for and 
receipts on investments on that date.
    (iv) General ordering rule for allocations of amounts in excess of 
the universal cap--(A) In general. If the value of all nonpurpose 
investments allocated to the gross proceeds of an issue exceeds the 
universal cap for that issue on a date as of which the cap is determined 
under paragraph (b)(2)(iii) of this section, nonpurpose investments 
allocable to gross proceeds necessary to eliminate that excess cease to 
be allocated to the issue, in the following order of priority--
    (1) First, nonpurpose investments allocable to replacement proceeds;
    (2) Second, nonpurpose investments allocable to transferred 
proceeds; and
    (3) Third, nonpurpose investments allocable to sale proceeds and 
investment proceeds.
    (B) Re-allocation of certain amounts. Except as provided in Sec. 
1.148-9(b)(3), amounts that cease to be allocated to an issue as a 
result of the application of the universal cap may only be allocated to 
another issue as replacement proceeds.
    (C) Allocations of portions of investments. Portions of investments 
to which this paragraph (b)(2)(iv) applies are allocated under either 
the ratable method or the representative method in the same manner as 
allocations of portions of investments to transferred proceeds under 
Sec. 1.148-9(c).
    (v) Nonpurpose investments in a bona fide debt service fund not 
counted. For purposes of this paragraph (b)(2), nonpurpose investments 
allocated to gross proceeds in a bona fide debt service fund for an 
issue are not taken into account in determining the value of the 
nonpurpose investments, and those nonpurpose investments remain 
allocated to the issue.
    (c) Fair market value limit on allocations to nonpurpose 
investments. Upon a purchase or sale of a nonpurpose investment, gross 
proceeds of an issue are not allocated to a payment for that nonpurpose 
investment in an amount greater than, or to a receipt from that 
nonpurpose investment in an amount less than, the fair market value of 
the nonpurpose investment as of the purchase or sale date. For purposes 
of this paragraph (c) only, the fair market value of a nonpurpose 
investment is adjusted to take into account qualified administrative 
costs allocable to the investment.
    (d) Allocation of gross proceeds to expenditures--(1) Expenditures 
in general--(i) General rule. Reasonable accounting methods for 
allocating funds from different sources to expenditures for the same 
governmental purpose include any of the following methods if 
consistently applied: a specific tracing method; a gross proceeds spent 
first method; a first-in, first-out method; or a ratable allocation 
method.
    (ii) General limitation. An allocation of gross proceeds of an issue 
to an expenditure must involve a current outlay of cash for a 
governmental purpose of the issue. A current outlay of cash means an 
outlay reasonably expected to occur not later than 5 banking days after 
the date as of which the allocation of gross proceeds to the expenditure 
is made.
    (iii) Timing. An issuer must account for the allocation of proceeds 
to expenditures not later than 18 months after the later of the date the 
expenditure is paid or the date the project, if any, that is financed by 
the issue is placed in service. This allocation must be made in any 
event by the date 60 days after the fifth anniversary of the issue date 
or the date 60 days after the

[[Page 723]]

retirement of the issue, if earlier. This paragraph (d)(1)(iii) applies 
to bonds issued on or after May 16, 1997.
    (2) Treatment of gross proceeds invested in purpose investments--(i) 
In general. Gross proceeds of an issue invested in a purpose investment 
are allocated to an expenditure on the date on which the conduit 
borrower under the purpose investment allocates the gross proceeds to an 
expenditure in accordance with this paragraph (d).
    (ii) Exception for qualified mortgage loans and qualified student 
loans. If gross proceeds of an issue are allocated to a purpose 
investment that is a qualified mortgage loan or a qualified student 
loan, those gross proceeds are allocated to an expenditure for the 
governmental purpose of the issue on the date on which the issuer 
allocates gross proceeds to that purpose investment.
    (iii) Continuing allocation of gross proceeds to purpose 
investments. Regardless of whether gross proceeds of a conduit financing 
issue invested in a purpose investment have been allocated to an 
expenditure under paragraph (d)(2) (i) or (ii) of this section, with 
respect to the actual issuer those gross proceeds continue to be 
allocated to the purpose investment until the sale, discharge, or other 
disposition of the purpose investment.
    (3) Expenditures for working capital purposes--(i) In general. 
Except as otherwise provided in this paragraph (d)(3) or paragraph 
(d)(4) of this section, proceeds of an issue may only be allocated to 
working capital expenditures as of any date to the extent that those 
working capital expenditures exceed available amounts (as defined in 
paragraph (d)(3)(iii) of this section) as of that date (i.e., a 
``proceeds-spent-last'' method). For this purpose, proceeds include 
replacement proceeds described in Sec. 1.148-1(c)(4).
    (ii) Exceptions--(A) General de minimis exception. Paragraph 
(d)(3)(i) of this section does not apply to expenditures to pay--
    (1) Any issuance costs of the issue or any qualified administrative 
costs within the meaning of Sec. Sec. 1.148-5(e)(2) (i) or (ii), or 
Sec. 1.148-5(e)(3)(ii)(A);
    (2) Fees for qualified guarantees of the issue or payments for a 
qualified hedge for the issue;
    (3) Interest on the issue for a period commencing on the issue date 
and ending on the date that is the later of three years from the issue 
date or one year after the date on which the project is placed in 
service;
    (4) Amounts paid to the United States under Sec. Sec. 1.148-3, 
1.148-5(c), or 1.148-7 for the issue;
    (5) Costs, other than those described in paragraphs (d)(3)(ii)(A) 
(1) through (4) of this section, that do not exceed 5 percent of the 
sale proceeds of an issue and that are directly related to capital 
expenditures financed by the issue (e.g., initial operating expenses for 
a new capital project);
    (6) Principal or interest on an issue paid from unexpected excess 
sale or investment proceeds; and
    (7) Principal or interest on an issue paid from investment earnings 
on a reserve or replacement fund that are deposited in a bona fide debt 
service fund.
    (B) Exception for extraordinary items. Paragraph (d)(3)(i) of this 
section does not apply to expenditures for extraordinary, nonrecurring 
items that are not customarily payable from current revenues, such as 
casualty losses or extraordinary legal judgments in amounts in excess of 
reasonable insurance coverage. If, however, an issuer or a related party 
maintains a reserve for such items (e.g., a self-insurance fund) or has 
set aside other available amounts for such expenses, gross proceeds 
within that reserve must be allocated to expenditures only after all 
other available amounts in that reserve are expended.
    (C) Exception for payment of principal and interest on prior issues. 
Paragraph (d)(3)(i) of this section does not apply to expenditures for 
payment of principal, interest, or redemption prices on a prior issue 
and, for a crossover refunding issue, interest on that issue.
    (D) No exceptions if replacement proceeds created. The exceptions 
provided in this paragraph (d)(3)(ii) do not apply if the allocation 
merely substitutes gross proceeds for other amounts that would have been 
used to make those expenditures in a manner that gives

[[Page 724]]

rise to replacement proceeds. For example, if a purported reimbursement 
allocation of proceeds of a reimbursement bond does not result in an 
expenditure under Sec. 1.150-2, those proceeds may not be allocated to 
pay interest on an issue that, absent this allocation, would have been 
paid from the issuer's current revenues.
    (iii) Definition of available amount--(A) In general. For purposes 
of this paragraph (d)(3), available amount means any amount that is 
available to an issuer for working capital expenditure purposes of the 
type financed by an issue. Except as otherwise provided, available 
amount excludes proceeds of the issue but includes cash, investments, 
and other amounts held in accounts or otherwise by the issuer or a 
related party if those amounts may be used by the issuer for working 
capital expenditures of the type being financed by an issue without 
legislative or judicial action and without a legislative, judicial, or 
contractual requirement that those amounts be reimbursed.
    (B) Reasonable working capital reserve treated as unavailable. A 
reasonable working capital reserve is treated as unavailable. Any 
working capital reserve is reasonable if it does not exceed 5 percent of 
the actual working capital expenditures of the issuer in the fiscal year 
before the year in which the determination of available amounts is made. 
For this purpose only, in determining the working capital expenditures 
of an issuer for a prior fiscal year, any expenditures (whether capital 
or working capital expenditures) that are paid out of current revenues 
may be treated as working capital expenditures.
    (C) Qualified endowment funds treated as unavailable. For a 
501(c)(3) organization, a qualified endowment fund is treated as 
unavailable. A fund is a qualified endowment fund if--
    (1) The fund is derived from gifts or bequests, or the income 
thereon, that were neither made nor reasonably expected to be used to 
pay working capital expenditures;
    (2) Pursuant to reasonable, established practices of the 
organization, the governing body of the 501(c)(3) organization 
designates and consistently operates the fund as a permanent endowment 
fund or quasi-endowment fund restricted as to use; and
    (3) There is an independent verification that the fund is reasonably 
necessary as part of the organization's permanent capital.
    (D) Application to statutory safe harbor for tax and revenue 
anticipation bonds. For purposes of section 148(f)(4)(B)(iii)(II), 
available amount has the same meaning as in paragraph (d)(3)(iii) of 
this section, except that the otherwise-permitted reasonable working 
capital reserve is treated as part of the available amount.
    (4) Expenditures for grants--(i) In general. Gross proceeds of an 
issue that are used to make a grant are allocated to an expenditure on 
the date on which the grant is made.
    (ii) Characterization of repayments of grants. If any amount of a 
grant financed by gross proceeds of an issue is repaid to the grantor, 
the repaid amount is treated as unspent proceeds of the issue as of the 
repayment date unless expended within 60 days of repayment.
    (iii) Definition of grant. Grant means a transfer for a governmental 
purpose of money or property to a transferee that is not a related party 
to or an agent of the transferor. The transfer must not impose any 
obligation or condition to directly or indirectly repay any amount to 
the transferor. Obligations or conditions intended solely to assure 
expenditure of the transferred moneys in accordance with the 
governmental purpose of the transfer do not prevent a transfer from 
being a grant.
    (5) Expenditures for reimbursement purposes. In allocating gross 
proceeds of issues of reimbursement bonds (as defined in Sec. 1.150-2)) 
to certain expenditures, Sec. 1.150-2 applies. In allocating gross 
proceeds to an expenditure to reimburse a previously paid working 
capital expenditure, paragraph (d)(3) of this section applies. Thus, if 
the expenditure is described in paragraph (d)(3)(ii) of this section or 
there are no available amounts on the date a working capital expenditure 
is made and there are no other available amounts on the date of the 
reimbursement of

[[Page 725]]

that expenditure, gross proceeds are allocated to the working capital 
expenditure as of the date of the reimbursement.
    (6) Expenditures of certain commingled investment proceeds of 
governmental issues. This paragraph (d)(6) applies to any issue of 
governmental bonds, any issue of private activity bonds issued to 
finance a facility that is required by section 142 to be owned by a 
governmental unit, and any portion of an issue that is not treated as 
consisting of private activity bonds under section 141(b)(9). Investment 
proceeds of the issue (other than investment proceeds held in a 
refunding escrow) are treated as allocated to expenditures for a 
governmental purpose when the amounts are deposited in a commingled fund 
with substantial tax or other revenues from governmental operations of 
the issuer and the amounts are reasonably expected to be spent for 
governmental purposes within 6 months from the date of the commingling. 
In establishing these reasonable expectations, an issuer may use any 
reasonable accounting assumption and is not bound by the proceeds-spent-
last assumption generally required for working capital expenditures 
under paragraph (d)(3) of this section.
    (7) Payments to related parties. Any payment of gross proceeds of 
the issue to a related party of the payor is not an expenditure of those 
gross proceeds.
    (e) Special rules for commingled funds--(1) In general. An 
accounting method for gross proceeds of an issue in a commingled fund, 
other than a bona fide debt service fund, is reasonable only if it 
satisfies the requirements of paragraphs (e)(2) through (6) of this 
section in addition to the other requirements of this section.
    (2) Investments held by a commingled fund--(i) Required ratable 
allocations. Not less frequently than as of the close of each fiscal 
period, all payments and receipts (including deemed payments and 
receipts) on investments held by a commingled fund must be allocated 
(but not necessarily distributed) among the different investors in the 
fund. This allocation must be based on a consistently applied, 
reasonable ratable allocation method.
    (ii) Safe harbors for ratable allocation methods. Reasonable ratable 
allocation methods include, without limitation, methods that allocate 
these items in proportion to either--
    (A) The average daily balances of the amounts in the commingled fund 
from different investors during a fiscal period (as described in 
paragraph (e)(4) of this section); or
    (B) The average of the beginning and ending balances of the amounts 
in the commingled fund from different investors for a fiscal period that 
does not exceed one month.
    (iii) Definition of investor. For purposes of this paragraph (e), 
the term investor means each different source of funds invested in a 
commingled fund. For example, if a city invests gross proceeds of an 
issue and tax revenues in a commingled fund, it is treated as two 
different investors.
    (3) Certain expenditures involving a commingled fund. If a ratable 
allocation method is used under paragraph (d) of this section to 
allocate expenditures from the commingled fund, the same ratable 
allocation method must be used to allocate payments and receipts on 
investments in the commingled fund under paragraph (e)(2) of this 
section.
    (4) Fiscal periods. The fiscal year of a commingled fund is the 
calendar year unless the fund adopts another fiscal year. A commingled 
fund may use any consistent fiscal period that does not exceed three 
months (e.g., a daily, weekly, monthly, or quarterly fiscal period).
    (5) Unrealized gains and losses on investments of a commingled 
fund--(i) Mark-to-market requirement for internal commingled funds with 
longer-term investment portfolios. Except as otherwise provided in this 
paragraph (e), in the case of a commingled fund in which the issuer and 
any related party own more than 25 percent of the beneficial interests 
in the fund (an internal commingled fund), the fund must treat all its 
investments as if sold at fair market value either on the last day of 
the fiscal year or the last day of each fiscal period. The net gains or 
losses from these deemed sales of investments must be allocated to all 
investors of the commingled fund during the period since the last 
allocation.

[[Page 726]]

    (ii) Exception for internal commingled funds with shorter-term 
investment portfolios. If the remaining weighted average maturity of all 
investments held by a commingled fund during a particular fiscal year 
does not exceed 18 months, and the investments held by the commingled 
fund during that fiscal year consist exclusively of obligations, the 
mark-to-market requirement of paragraph (e)(5)(i) of this section does 
not apply.
    (iii) Exception for commingled reserve funds and sinking funds. The 
mark-to-market requirement of paragraph (e)(5)(i) of this section does 
not apply to a commingled fund that operates exclusively as a reserve 
fund, sinking fund, or replacement fund for two or more issues of the 
same issuer.
    (6) Allocations of commingled funds serving as common reserve funds 
or sinking funds--(i) Permitted ratable allocation methods. If a 
commingled fund serves as a common reserve fund, replacement fund, or 
sinking fund for two or more issues (a commingled reserve), after making 
reasonable adjustments to account for proceeds allocated under paragraph 
(b)(1) or (b)(2) of this section, investments held by that commingled 
fund must be allocated ratably among the issues served by the commingled 
fund in accordance with one of the following methods--
    (A) The relative values of the bonds of those issues under Sec. 
1.148-4(e);
    (B) The relative amounts of the remaining maximum annual debt 
service requirements on the outstanding principal amounts of those 
issues; or
    (C) The relative original stated principal amounts of the 
outstanding issues.
    (ii) Frequency of allocations. An issuer must make any allocations 
required by this paragraph (e)(6) as of a date at least every 3 years 
and as of each date that an issue first becomes secured by the 
commingled reserve. If relative original principal amounts are used to 
allocate, allocations must also be made on the retirement of any issue 
secured by the commingled reserve.

[T.D. 8476, 58 FR 33532, June 18, 1993; 58 FR 44452, Aug. 23, 1993, as 
amended by T.D. 8538, 59 FR 24045, May 10, 1994; T.D. 8712, 62 FR 2304, 
Jan. 16, 1997; T.D. 8718, 62 FR 25512, May 9, 1997]



Sec. 1.148-7  Spending exceptions to the rebate requirement.

    (a) Scope of section--(1) In general. This section provides guidance 
on the spending exceptions to the arbitrage rebate requirement of 
section 148(f)(2). These exceptions are the 6-month exception in section 
148(f)(4)(B) (the 6-month exception), the 18-month exception under 
paragraph (d) of this section (the 18-month exception), and the 2-year 
construction exception under section 148(f)(4)(C) (the 2-year exception) 
(collectively, the spending exceptions).
    (2) Relationship of spending exceptions. Each of the spending 
exceptions is an independent exception to arbitrage rebate. For example, 
a construction issue may qualify for the 6-month exception or the 18-
month exception even though the issuer makes one or more elections under 
the 2-year exception with respect to the issue.
    (3) Spending exceptions not mandatory. Use of the spending 
exceptions is not mandatory. An issuer may apply the arbitrage rebate 
requirement to an issue that otherwise satisfies a spending exception. 
If an issuer elects to pay penalty in lieu of rebate under the 2-year 
exception, however, the issuer must apply those penalty provisions.
    (b) Rules applicable for all spending exceptions. The provisions of 
this paragraph (b) apply for purposes of applying each of the spending 
exceptions.
    (1) Special transferred proceeds rules--(i) Application to prior 
issues. For purposes of applying the spending exceptions to a prior 
issue only, proceeds of the prior issue that become transferred proceeds 
of the refunding issue continue to be treated as unspent proceeds of the 
prior issue. If the prior issue satisfies one of the spending 
exceptions, the proceeds of the prior issue that are excepted from 
rebate under that spending exception are not subject to rebate either as 
proceeds of the prior issue or as transferred proceeds of the refunding 
issue.
    (ii) Application to refunding issues--(A) In general. The only 
spending exception applicable to refunding issues is the 6-month 
exception. For purposes of applying the 6-month exception to a refunding 
issue only, proceeds of the prior issue that become transferred

[[Page 727]]

proceeds of the refunding issue generally are not treated as proceeds of 
the refunding issue and need not be spent for the refunding issue to 
satisfy that spending exception. Even if the refunding issue qualifies 
for that spending exception, those transferred proceeds are subject to 
rebate as proceeds of the refunding issue unless an exception to rebate 
applied to those proceeds as proceeds of the prior issue.
    (B) Exception. For purposes of applying the 6-month exception to 
refunding issues, those transferred proceeds of the refunding issue 
excluded from the gross proceeds of the prior issue under the special 
definition of gross proceeds in paragraph (c)(3) of this section, and 
those that transferred from a prior taxable issue, are generally treated 
as gross proceeds of the refunding issue. Thus, for the refunding issue 
to qualify for the 6-month exception, those proceeds must be spent 
within 6 months of the issue date of the refunding issue, unless those 
amounts continue to be used in a manner that does not cause those 
amounts to be gross proceeds under paragraph (c)(3) of this section.
    (2) Application of multipurpose issue rules. Except as otherwise 
provided, if any portion of an issue is treated as a separate issue 
allocable to refunding purposes under Sec. 1.148-9(h) (relating to 
multipurpose issues), for purposes of this section, that portion is 
treated as a separate issue.
    (3) Expenditures for governmental purposes of the issue. For 
purposes of this section, expenditures for the governmental purpose of 
an issue include payments for interest, but not principal, on the issue, 
and for principal or interest on another issue of obligations. The 
preceding sentence does not apply for purposes of the 18-month and 2-
year exceptions if those payments cause the issue to be a refunding 
issue.
    (4) De minimis rule. Any failure to satisfy the final spending 
requirement of the 18-month exception or the 2-year exception is 
disregarded if the issuer exercises due diligence to complete the 
project financed and the amount of the failure does not exceed the 
lesser of 3 percent of the issue price of the issue or $250,000.
    (5) Special definition of reasonably required reserve or replacement 
fund. For purposes of this section only, a reasonably required reserve 
or replacement fund also includes any fund to the extent described in 
Sec. 1.148-5(c)(3)(i)(E) or (G).
    (6) Pooled financing issue--(i) In general. Except as otherwise 
provided in this paragraph (b)(6), the spending exceptions apply to a 
pooled financing issue as a whole, rather than to each loan separately.
    (ii) Election to apply spending exceptions separately to each loan--
(A) In general. At the election (made on or before the issue date) of 
the issuer of a pooled financing issue, the spending exceptions are 
applied separately to each conduit loan, and the applicable spending 
requirements for a loan begin on the earlier of the date the loan is 
made, or the first day following the 1-year period beginning on the 
issue date of the pooled financing issue. If this election is made, the 
rebate requirement applies to, and none of the spending exceptions are 
available for, gross proceeds of the pooled financing bonds before the 
date on which the spending requirements for those proceeds begin.
    (B) Application of spending exceptions. If the issuer makes the 
election under this paragraph (b)(6)(ii), the rebate requirement is 
satisfied for proceeds used to finance a particular conduit loan to the 
extent that the loan satisfies a spending exception or the small issuer 
exception under Sec. 1.148-8, regardless of whether any other conduit 
loans allocable to the issue satisfy such an exception. A pooled 
financing issue is an issue of arbitrage bonds, however, unless the 
entire issue satisfies the requirements of section 148. An issuer may 
pay rebate for some conduit loans and 1\1/2\ percent penalty for other 
conduit loans from the same pooled financing issue. The 1\1/2\ percent 
penalty is computed separately for each conduit loan.
    (C) Elections under 2-year exception. If the issuer makes the 
election under this paragraph (b)(6)(ii), the issuer may make all 
elections under the 2-year exception separately for each loan. Elections 
regarding a loan that otherwise must be made by the issuer on or before 
the issue date instead may be made on or before the date the loan is

[[Page 728]]

made (but not later than 1 year after the issue date).
    (D) Example. The operation of this paragraph (b)(6) is illustrated 
by the following example:

    Example. Pooled financing issue. On January 1, 1994, Authority J 
issues bonds. As of the issue date, J reasonably expects to use the 
proceeds of the issue to make loans to City K, County L, and City M. J 
does not reasonably expect to use more than 75 percent of the available 
construction proceeds of the issue for construction expenditures. On or 
before the issue date, J elects to apply the spending exceptions 
separately for each loan, with spending requirements beginning on the 
earlier of the date the loan is made or the first day following the 1-
year period beginning on the issue date. On February 1, 1994, J loans a 
portion of the proceeds to K, and K reasonably expects that 45 percent 
of those amounts will be used for construction expenditures. On the date 
this loan is made, J elects under paragraph (j) of this section to treat 
60 percent of the amount loaned to K as a separate construction issue, 
and also elects the 1\1/2\ percent penalty under paragraph (k) of this 
section for the separate construction issue. On March 1, 1994, J loans a 
portion of the proceeds to L, and L reasonably expects that more than 75 
percent of those amounts will be used for construction expenditures. On 
March 1, 1995, J loans the remainder of the proceeds to M, and none of 
those amounts will be used for construction expenditures. J must satisfy 
the rebate requirement for all gross proceeds before those amounts are 
loaned. For the loan to K, the spending periods begin on February 1, 
1994, and the 1\1/2\ percent penalty must be paid for any failure to 
meet a spending requirement for the portion of the loan to K that is 
treated as a separate construction issue. Rebate must be paid on the 
remaining portion of the loan to K, unless that portion qualifies for 
the 6-month exception. For the loan to L, the spending periods begin on 
March 1, 1994, and the rebate requirement must be satisfied unless the 
6-month, 18-month, or the 2-year exception is satisfied with respect to 
those amounts. For the loan to M, the spending periods begin on January 
2, 1995, and the rebate requirement must be satisfied for those amounts 
unless the 6-month or 18-month exception is satisfied.

    (c) 6-month exception--(1)General rule. An issue is treated as 
meeting the rebate requirement if--
    (i) The gross proceeds (as modified by paragraph (c)(3) of this 
section) of the issue are allocated to expenditures for the governmental 
purposes of the issue within the 6-month period beginning on the issue 
date (the 6-month spending period); and
    (ii) The rebate requirement is met for amounts not required to be 
spent within the 6-month spending period (excluding earnings on a bona 
fide debt service fund).
    (2) Additional period for certain bonds. The 6-month spending period 
is extended for an additional 6 months in certain circumstances 
specified under section 148(f)(4)(B)(ii).
    (3) Amounts not included in gross proceeds. For purposes of 
paragraph (c)(1)(i) of this section only, gross proceeds has the meaning 
used in Sec. 1.148-1, except it does not include amounts--
    (i) In a bona fide debt service fund;
    (ii) In a reasonably required reserve or replacement fund (see Sec. 
1.148-7(b)(5));
    (iii) That, as of the issue date, are not reasonably expected to be 
gross proceeds but that become gross proceeds after the end of the 6-
month spending period;
    (iv) Representing sale or investment proceeds derived from payments 
under any purpose investment of the issue; and
    (v) Representing repayments of grants (as defined in Sec. 1.148-
6(d)(4)) financed by the issue.
    (4) Series of refundings. If a principal purpose of a series of 
refunding issues is to exploit the difference between taxable and tax-
exempt interest rates by investing proceeds during the temporary periods 
provided in Sec. 1.148-9(d), the 6-month spending period for all issues 
in the series begins on the issue date of the first issue in the series.
    (d) 18-month exception--(1) General rule. An issue is treated as 
meeting the rebate requirement if all of the following requirements are 
satisfied--
    (i) 18-month expenditure schedule met. The gross proceeds (as 
defined in paragraph (d)(3) of this section) are allocated to 
expenditures for a governmental purpose of the issue in accordance with 
the following schedule (the 18-month expenditure schedule) measured from 
the issue date--
    (A) At least 15 percent within 6 months (the first spending period);
    (B) At least 60 percent within 12 months (the second spending 
period); and

[[Page 729]]

    (C) 100 percent within 18 months (the third spending period).
    (ii) Rebate requirement met for amounts not required to be spent. 
The rebate requirement is met for all amounts not required to be spent 
in accordance with the 18-month expenditure schedule (other than 
earnings on a bona fide debt service fund).
    (iii) Issue qualifies for initial temporary period. All of the gross 
proceeds (as defined in paragraph (d)(3)(i) of this section) of the 
issue qualify for the initial temporary period under Sec. 1.148-
2(e)(2).
    (2) Extension for reasonable retainage. An issue does not fail to 
satisfy the spending requirement for the third spending period as a 
result of a reasonable retainage if the reasonable retainage is 
allocated to expenditures within 30 months of the issue date. Reasonable 
retainage has the meaning under paragraph (h) of this section, as 
modified to refer to net sale proceeds on the date 18 months after the 
issue date.
    (3) Gross proceeds--(i) Definition of gross proceeds. For purposes 
of paragraph (d)(1) of this section only, gross proceeds means gross 
proceeds as defined in paragraph (c)(3) of this section, as modified to 
refer to ``18 months'' in paragraph (c)(3)(iii) of this section in lieu 
of ``6 months.''
    (ii) Estimated earnings. For purposes of determining compliance with 
the first two spending periods under paragraph (d)(1)(i) of this 
section, the amount of investment proceeds included in gross proceeds of 
the issue is determined based on the issuer's reasonable expectations on 
the issue date.
    (4) Application to multipurpose issues. This paragraph (d) does not 
apply to an issue any portion of which is treated as meeting the rebate 
requirement under paragraph (e) of this section (relating to the 2-year 
exception).
    (e) 2-year exception--(1) General rule. A construction issue is 
treated as meeting the rebate requirement for available construction 
proceeds if those proceeds are allocated to expenditures for 
governmental purposes of the issue in accordance with the following 
schedule (the 2-year expenditure schedule), measured from the issue 
date--
    (i) At least 10 percent within 6 months (the first spending period);
    (ii) At least 45 percent within 1 year (the second spending period);
    (iii) At least 75 percent within 18 months (the third spending 
period); and
    (iv) 100 percent within 2 years (the fourth spending period).
    (2) Extension for reasonable retainage. An issue does not fail to 
satisfy the spending requirement for the fourth spending period as a 
result of unspent amounts for reasonable retainage (as defined in 
paragraph (h) of this section) if those amounts are allocated to 
expenditures within 3 years of the issue date.
    (3) Definitions. For purposes of the 2-year exception, the following 
definitions apply:
    (i) Real property means land and improvements to land, such as 
buildings or other inherently permanent structures, including interests 
in real property. For example, real property includes wiring in a 
building, plumbing systems, central heating or air-conditioning systems, 
pipes or ducts, elevators, escalators installed in a building, paved 
parking areas, roads, wharves and docks, bridges, and sewage lines.
    (ii) Tangible personal property means any tangible property other 
than real property, including interests in tangible personal property. 
For example, tangible personal property includes machinery that is not a 
structural component of a building, subway cars, fire trucks, 
automobiles, office equipment, testing equipment, and furnishings.
    (iii) Substantially completed. Construction may be treated as 
substantially completed when the issuer abandons construction or when at 
least 90 percent of the total costs of the construction reasonably 
expected, as of that date, to be financed with the available 
construction proceeds have been allocated to expenditures.
    (f) Construction issue--(1) Definition. Construction issue means any 
issue that is not a refunding issue if--
    (i) The issuer reasonably expects, as of the issue date, that at 
least 75 percent of the available construction proceeds of the issue 
will be allocated to construction expenditures (as defined in paragraph 
(g) of this section) for

[[Page 730]]

property owned by a governmental unit or a 501(c)(3) organization; and
    (ii) Any private activity bonds that are part of the issue are 
qualified 501(c)(3) bonds or private activity bonds issued to finance 
property to be owned by a governmental unit or a 501(c)(3) organization.
    (2) Use of actual facts. For the provisions of paragraphs (e) 
through (m) of this section that apply based on the issuer's reasonable 
expectations, an issuer may elect on or before the issue date to apply 
all of those provisions based on actual facts, except that this election 
does not apply for purposes of determining whether an issue is a 
construction issue under paragraph (f)(1) of this section if the 1\1/2\ 
percent penalty election is made under paragraph (k) of this section.
    (3) Ownership requirement--(i) In general. A governmental unit or 
501(c)(3) organization is treated as the owner of property if it would 
be treated as the owner for Federal income tax purposes. For obligations 
issued on behalf of a State or local governmental unit, the entity that 
actually issues the bonds is treated as a governmental unit.
    (ii) Safe harbor for leases and management contracts. Property 
leased by a governmental unit or a 501(c)(3) organization is treated as 
owned by the governmental unit or 501(c)(3) organization if the lessee 
complies with the requirements of section 142(b)(1)(B). For a bond 
described in section 142(a)(6), the requirements of section 142(b)(1)(B) 
apply as modified by section 146(h)(2).
    (g) Construction expenditures--(1) Definition. Except as otherwise 
provided, construction expenditures means capital expenditures (as 
defined in Sec. 1.150-1) that are allocable to the cost of real 
property or constructed personal property (as defined in paragraph 
(g)(3) of this section). Except as provided in paragraph (g)(2) of this 
section, construction expenditures do not include expenditures for 
acquisitions of interests in land or other existing real property.
    (2) Certain acquisitions under turnkey contracts treated as 
construction expenditures. Expenditures are not for the acquisition of 
an interest in existing real property other than land if the contract 
between the seller and the issuer requires the seller to build or 
install the property (e.g., a turnkey contract), but only to the extent 
that the property has not been built or installed at the time the 
parties enter into the contract.
    (3) Constructed personal property. Constructed personal property 
means tangible personal property (or, if acquired pursuant to a single 
acquisition contract, properties) or specially developed computer 
software if--
    (i) A substantial portion of the property or properties is completed 
more than 6 months after the earlier of the date construction or 
rehabilitation commenced and the date the issuer entered into an 
acquisition contract;
    (ii) Based on the reasonable expectations of the issuer, if any, or 
representations of the person constructing the property, with the 
exercise of due diligence, completion of construction or rehabilitation 
(and delivery to the issuer) could not have occurred within that 6-month 
period; and
    (iii) If the issuer itself builds or rehabilitates the property, not 
more than 75 percent of the capitalizable cost is attributable to 
property acquired by the issuer (e.g., components, raw materials, and 
other supplies).
    (4) Specially developed computer software. Specially developed 
computer software means any programs or routines used to cause a 
computer to perform a desired task or set of tasks, and the 
documentation required to describe and maintain those programs, provided 
that the software is specially developed and is functionally related and 
subordinate to real property or other constructed personal property.
    (5) Examples. The operation of this paragraph (g) is illustrated by 
the following examples:

    Example 1. Purchase of construction materials. City A issues bonds 
to finance a new office building. A uses proceeds of the bonds to 
purchase materials to be used in constructing the building, such as 
bricks, pipes, wires, lighting, carpeting, heating equipment, and 
similar materials. Expenditures by A for the construction materials are 
construction expenditures because those expenditures will be 
capitalizable to the cost of the building upon completion, even though 
they are not initially capitalizable to the cost of existing real 
property. This result would be the same if A hires a third-party to 
perform

[[Page 731]]

the construction, unless the office building is partially constructed at 
the time that A contracts to purchase the building.
    Example 2. Turnkey contract. City B issues bonds to finance a new 
office building. B enters into a turnkey contract with developer D under 
which D agrees to provide B with a completed building on a specified 
completion date on land currently owned by D. Under the agreement, D 
holds title to the land and building and assumes any risk of loss until 
the completion date, at which time title to the land and the building 
will be transferred to B. No construction has been performed by the date 
that B and D enter into the agreement. All payments by B to D for 
construction of the building are construction expenditures because all 
the payments are properly capitalized to the cost of the building, but 
payments by B to D allocable to the acquisition of the land are not 
construction expenditures.
    Example 3. Right-of-way. P, a public agency, issues bonds to finance 
the acquisition of a right-of-way and the construction of sewage lines 
through numerous parcels of land. The right-of-way is acquired primarily 
through P' s exercise of its powers of eminent domain. As of the issue 
date, P reasonably expects that it will take approximately 2 years to 
acquire the entire right-of-way because of the time normally required 
for condemnation proceedings. No expenditures for the acquisition of the 
right-of-way are construction expenditures because they are costs 
incurred to acquire an interest in existing real property.
    Example 4. Subway cars. City C issues bonds to finance new subway 
cars. C reasonably expects that it will take more than 6 months for the 
subway cars to be constructed to C's specifications. The subway cars are 
constructed personal property. Alternatively, if the builder of the 
subway cars informs C that it will only take 3 months to build the 
subway cars to C's specifications, no payments for the subway cars are 
construction expenditures.
    Example 5. Fractional interest in property. U, a public agency, 
issues bonds to finance an undivided fractional interest in a newly 
constructed power-generating facility. U contributes its ratable share 
of the cost of building the new facility to the project manager for the 
facility. U's contributions are construction expenditures in the same 
proportion that the total expenditures for the facility qualify as 
construction expenditures.
    Example 6. Park land. City D issues bonds to finance the purchase of 
unimproved land and the cost of subsequent improvements to the land, 
such as grading and landscaping, necessary to transform it into a park. 
The costs of the improvements are properly capitalizable to the cost of 
the land, and therefore, are construction expenditures, but expenditures 
for the acquisition of the land are not.

    (h) Reasonable retainage definition. Reasonable retainage means an 
amount, not to exceed 5 percent of available construction proceeds as of 
the end of the fourth spending period, that is retained for reasonable 
business purposes relating to the property financed with the proceeds of 
the issue. For example, a reasonable retainage may include a retention 
to ensure or promote compliance with a construction contract in 
circumstances in which the retained amount is not yet payable, or in 
which the issuer reasonably determines that a dispute exists regarding 
completion or payment.
    (i) Available construction proceeds--(1) Definition in general. 
Available construction proceeds has the meaning used in section 
148(f)(4)(C)(vi). For purposes of this definition, earnings include 
earnings on any tax-exempt bond. Pre-issuance accrued interest and 
earnings thereon may be disregarded. Amounts that are not gross proceeds 
as a result of the application of the universal cap under Sec. 1.148-
6(b)(2) are not available construction proceeds.
    (2) Earnings on a reasonably required reserve or replacement fund. 
Earnings on any reasonably required reserve or replacement fund are 
available construction proceeds only to the extent that those earnings 
accrue before the earlier of the date construction is substantially 
completed or the date that is 2 years after the issue date. An issuer 
may elect on or before the issue date to exclude from available 
construction proceeds the earnings on such a fund. If the election is 
made, the rebate requirement applies to the excluded amounts from the 
issue date.
    (3) Reasonable expectations test for future earnings. For purposes 
of determining compliance with the spending requirements as of the end 
of each of the first three spending periods, available construction 
proceeds include the amount of future earnings that the issuer 
reasonably expected as of the issue date.
    (4) Issuance costs. Available construction proceeds do not include 
gross proceeds used to pay issuance costs financed by an issue, but do 
include

[[Page 732]]

earnings on such proceeds. Thus, an expenditure of gross proceeds of an 
issue for issuance costs does not count toward meeting the spending 
requirements. The expenditure of earnings on gross proceeds used to pay 
issuance costs does count toward meeting those requirements. If the 
spending requirements are met and the proceeds used to pay issuance 
costs are expended by the end of the fourth spending period, those 
proceeds and the earnings thereon are treated as having satisfied the 
rebate requirement.
    (5) One and one-half percent penalty in lieu of arbitrage rebate. 
For purposes of the spending requirements of paragraph (e) of this 
section, available construction proceeds as of the end of any spending 
period are reduced by the amount of penalty in lieu of arbitrage rebate 
(under paragraph (k) of this section) that the issuer has paid from 
available construction proceeds before the last day of the spending 
period.
    (6) Payments on purpose investments and repayments of grants. 
Available construction proceeds do not include--
    (i) Sale or investment proceeds derived from payments under any 
purpose investment of the issue; or
    (ii) Repayments of grants (as defined in Sec. 1.148-6(d)(4)) 
financed by the issue.
    (7) Examples. The operation of this paragraph (i) is illustrated by 
the following examples:

    Example 1. Treatment of investment earnings. City F issues bonds 
having an issue price of $10,000,000. F deposits all of the proceeds of 
the issue into a construction fund to be used for expenditures other 
than costs of issuance. F estimates on the issue date that, based on 
reasonably expected expenditures and rates of investment, earnings on 
the construction fund will be $800,000. As of the issue date and the end 
of each of the first three spending periods, the amount of available 
construction proceeds is $10,800,000. To qualify as a construction 
issue, F must reasonably expect on the issue date that at least 
$8,100,000 (75 percent of $10,800,000) will be used for construction 
expenditures. In order to meet the 10 percent spending requirement at 
the end of the first spending period, F must spend at least $1,080,000. 
As of the end of the fourth spending period, F has received $1,100,000 
in earnings. In order to meet the spending requirement at the end of the 
fourth spending period, however, F must spend all of the $11,100,000 of 
actual available construction proceeds (except for reasonable retainage 
not exceeding $555,000).
    Example 2. Treatment of investment earnings without a reserve fund. 
City G issues bonds having an issue price of $11,200,000. G does not 
elect to exclude earnings on the reserve fund from available 
construction proceeds. G uses $200,000 of proceeds to pay issuance costs 
and deposits $1,000,000 of proceeds into a reasonably required reserve 
fund. G deposits the remaining $10,000,000 of proceeds into a 
construction fund to be used for construction expenditures. On the issue 
date, G reasonably expects that, based on the reasonably expected date 
of substantial completion and rates of investment, total earnings on the 
construction fund will be $800,000, and total earnings on the reserve 
fund to the date of substantial completion will be $150,000. G 
reasonably expects that substantial completion will occur during the 
fourth spending period. As of the issue date, the amount of available 
construction proceeds is $10,950,000 ($10,000,000 originally deposited 
into the construction fund plus $800,000 expected earnings on the 
construction fund and $150,000 expected earnings on the reserve fund). 
To qualify as a construction issue, G must reasonably expect on the 
issue date that at least $8,212,500 will be used for construction 
expenditures.
    Example 3. Election to exclude earnings on a reserve fund. The facts 
are the same as Example 2, except that G elects on the issue date to 
exclude earnings on the reserve fund from available construction 
proceeds. The amount of available construction proceeds as of the issue 
date is $10,800,000.

    (j) Election to treat portion of issue used for construction as 
separate issue--(1) In general. For purposes of paragraph (e) of this 
section, if any proceeds of an issue are to be used for construction 
expenditures, the issuer may elect on or before the issue date to treat 
the portion of the issue that is not a refunding issue as two, and only 
two, separate issues, if--
    (i) One of the separate issues is a construction issue as defined in 
paragraph (f) of this section;
    (ii) The issuer reasonably expects, as of the issue date, that this 
construction issue will finance all of the construction expenditures to 
be financed by the issue; and
    (iii) The issuer makes an election to apportion the issue under this 
paragraph (j)(1) in which it identifies the amount of the issue price of 
the issue allocable to the construction issue.
    (2) Example. The operation of this paragraph (j) is illustrated by 
the following example.


[[Page 733]]


    Example. City D issues bonds having an issue price of $19,000,000. 
On the issue date, D reasonably expects to use $10,800,000 of bond 
proceeds (including investment earnings) for construction expenditures 
for the project being financed. D deposits $10,000,000 in a construction 
fund to be used for construction expenditures and $9,000,000 in an 
acquisition fund to be used for acquisition of equipment not qualifying 
as construction expenditures. D estimates on the issue date, based on 
reasonably expected expenditures and rates of investment, that total 
earnings on the construction fund will be $800,000 and total earnings on 
the acquisition fund will be $200,000. Because the total construction 
expenditures to be financed by the issue are expected to be $10,800,000, 
the maximum available construction proceeds for a construction issue is 
$14,400,000 ($10,800,000 divided by 0.75). To determine the maximum 
amount of the issue price allocable to a construction issue, the 
estimated investment earnings allocable to the construction issue are 
subtracted. The entire $800,000 of earnings on the construction fund are 
allocable to the construction issue. Only a portion of the $200,000 of 
earnings on the acquisition fund, however, are allocable to the 
construction issue. The total amount of the available construction 
proceeds that is expected to be used for acquisition is $3,600,000 
($14,400,000-$10,800,000). The portion of earnings on the acquisition 
fund that is allocable to the construction issue is $78,261 
($200,000x$3,600,000/$9,200,000). Accordingly, D may elect on or before 
the issue date to treat up to $13,521,739 of the issue price as a 
construction issue ($14,400,000-$800,000-$78,261). D's election must 
specify the amount of the issue price treated as a construction issue. 
The balance of the issue price is treated as a separate nonconstruction 
issue that is subject to the rebate requirement unless it meets another 
exception to arbitrage rebate. Because the financing of a construction 
issue is a separate governmental purpose under Sec. 1.148-9(h), the 
election causes the issue to be a multipurpose issue under that section.

    (k) One and one-half percent penalty in lieu of arbitrage rebate--
(1) In general. Under section 148(f)(4)(C)(vii), an issuer of a 
construction issue may elect on or before the issue date to pay a 
penalty (the 1\1/2\ percent penalty) to the United States in lieu of the 
obligation to pay the rebate amount on available construction proceeds 
upon failure to satisfy the spending requirements of paragraph (e) of 
this section. The 1\1/2\ percent penalty is calculated separately for 
each spending period, including each semiannual period after the end of 
the fourth spending period, and is equal to 1.5 percent times the 
underexpended proceeds as of the end of the spending period. For each 
spending period, underexpended proceeds equal the amount of available 
construction proceeds required to be spent by the end of the spending 
period, less the amount actually allocated to expenditures for the 
governmental purposes of the issue by that date. The 1\1/2\ percent 
penalty must be paid to the United States no later than 90 days after 
the end of the spending period to which it relates. The 1\1/2\ percent 
penalty continues to apply at the end of each spending period and each 
semiannual period thereafter until the earliest of the following--
    (i) The termination of the penalty under paragraph (l) of this 
section;
    (ii) The expenditure of all of the available construction proceeds; 
or
    (iii) The last stated final maturity date of bonds that are part of 
the issue and any bonds that refund those bonds.
    (2) Application to reasonable retainage. If an issue meets the 
exception for reasonable retainage except that all retainage is not 
spent within 3 years of the issue date, the issuer must pay the 1\1/2\ 
percent penalty to the United States for any reasonable retainage that 
was not so spent as of the close of the 3-year period and each later 
spending period.
    (3) Coordination with rebate requirement. The rebate requirement is 
treated as met with respect to available construction proceeds for a 
period if the 1\1/2\ percent penalty is paid in accordance with this 
section.
    (l) Termination of 1\1/2\ percent penalty--(1)Termination after 
initial temporary period. The issuer may terminate the 1\1/2\ percent 
penalty after the initial temporary period (a section 148(f)(4)(C)(viii) 
penalty termination) if--
    (i) Not later than 90 days after the earlier of the end of the 
initial temporary period or the date construction is substantially 
completed, the issuer elects to terminate the 1\1/2\ percent penalty; 
provided that solely for this purpose, the initial temporary period may 
be extended by the issuer to a date ending 5 years after the issue date;
    (ii) Within 90 days after the end of the initial temporary period, 
the issuer pays a penalty equal to 3 percent of the

[[Page 734]]

unexpended available construction proceeds determined as of the end of 
the initial temporary period, multiplied by the number of years 
(including fractions of years computed to 2 decimal places) in the 
initial temporary period;
    (iii) For the period beginning as of the close of the initial 
temporary period, the unexpended available construction proceeds are not 
invested in higher yielding investments; and
    (iv) On the earliest date on which the bonds may be called or 
otherwise redeemed, with or without a call premium, the unexpended 
available construction proceeds as of that date (not including any 
amount earned after the date on which notice of the redemption was 
required to be given) must be used to redeem the bonds. Amounts used to 
pay any call premium are treated as used to redeem bonds. This 
redemption requirement may be met by purchases of bonds by the issuer on 
the open market at prices not exceeding fair market value. A portion of 
the annual principal payment due on serial bonds of a construction issue 
may be paid from the unexpended amount, but only in an amount no greater 
than the amount that bears the same ratio to the annual principal due 
that the total unexpended amount bears to the issue price of the 
construction issue.
    (2) Termination before end of initial temporary period. If the 
construction to be financed by the construction issue is substantially 
completed before the end of the initial temporary period, the issuer may 
elect to terminate the 1\1/2\ percent penalty before the end of the 
initial temporary period (a section 148(f)(4)(C)(ix) penalty 
termination) if--
    (i) Before the close of the initial temporary period and not later 
than 90 days after the date the construction is substantially completed, 
the issuer elects to terminate the 1\1/2\ percent penalty;
    (ii) The election identifies the amount of available construction 
proceeds that will not be spent for the governmental purposes of the 
issue; and
    (iii) The issuer has met all of the conditions for a section 
148(f)(4)(C)(viii) penalty termination, applied as if the initial 
temporary period ended as of the date the required election for a 
section 148(f)(4)(C)(ix) penalty termination is made. That penalty 
termination election satisfies the required election for a section 
148(f)(4)(C)(viii) termination.
    (3) Application to reasonable retainage. Solely for purposes of 
determining whether the conditions for terminating the 1\1/2\ percent 
penalty are met, reasonable retainage may be treated as spent for a 
governmental purpose of the construction issue. Reasonable retainage 
that is so treated continues to be subject to the 1\1/2\ percent 
penalty.
    (4) Example. The operation of this paragraph (l) is illustrated by 
the following example.

    Example. City I issues a construction issue having a 20-year 
maturity and qualifying for a 3-year initial temporary period. The bonds 
are first subject to optional redemption 10 years after the issue date 
at a premium of 3 percent. I elects, on or before the issue date, to pay 
the 1\1/2\ percent penalty in lieu of arbitrage rebate. At the end of 
the 3-year temporary period, the project is not substantially completed, 
and $1,500,000 of available construction proceeds of the issue are 
unspent. At that time, I reasonably expects to need $500,000 to complete 
the project. I may terminate the 1\1/2\ percent penalty in lieu of 
arbitrage rebate with respect to the excess $1,500,000 by electing to 
terminate within 90 days of the end of the initial temporary period; 
paying a penalty to the United States of $135,000 (3 percent of 
$1,500,000 multiplied by 3 years); restricting the yield on the 
investment of unspent available construction proceeds for 7 years until 
the first call date, although any portion of these proceeds may still be 
spent on the project prior to that call date; and using the available 
construction proceeds that, as of the first call date, have not been 
allocated to expenditures for the governmental purposes of the issue to 
redeem bonds on that call date. If I fails to make the termination 
election, I is required to pay the 1\1/2\ percent penalty on unspent 
available construction proceeds every 6 months until the latest maturity 
date of bonds of the issue (or any bonds of another issue that refund 
such bonds).

    (m) Payment of penalties. Each penalty payment under this section 
must be paid in the manner provided in Sec. 1.148-3(g). See Sec. 
1.148-3(h) for rules on failures to pay penalties under this section.

[T.D. 8476, 58 FR 33535, June 18, 1993; 58 FR 44452, Aug. 23, 1993]

[[Page 735]]



Sec. 1.148-8  Small issuer exception to rebate requirement.

    (a) Scope. Under section 148(f)(4)(D), bonds issued to finance 
governmental activities of certain small issuers are treated as meeting 
the arbitrage rebate requirement of section 148(f)(2) (the ``small 
issuer exception''). This section provides guidance on the small issuer 
exception.
    (b) General taxing powers. The small issuer exception generally 
applies only to bonds issued by governmental units with general taxing 
powers. A governmental unit has general taxing powers if it has the 
power to impose taxes (or to cause another entity to impose taxes) of 
general applicability which, when collected, may be used for the general 
purposes of the issuer. The taxing power may be limited to a specific 
type of tax, provided that the applicability of the tax is not limited 
to a small number of persons. The governmental unit's exercise of its 
taxing power may be subject to procedural limitations, such as voter 
approval requirements, but may not be contingent on approval by another 
governmental unit. See, also, section 148(f)(4)(D)(iv).
    (c) Size limitation--(1) In general. An issue (other than a 
refunding issue) qualifies for the small issuer exception only if the 
issuer reasonably expects, as of the issue date, that the aggregate face 
amount of all tax-exempt bonds (other than private activity bonds) 
issued by it during that calendar year will not exceed $5,000,000; or 
the aggregate face amount of all tax-exempt bonds of the issuer (other 
than private activity bonds) actually issued during that calendar year 
does not exceed $5,000,000. For this purpose, if an issue has more than 
a de minimis amount of original issue discount or premium, aggregate 
face amount means the aggregate issue price of that issue (determined 
without regard to pre-issuance accrued interest).
    (2) Aggregation rules. The following aggregation rules apply for 
purposes of applying the $5,000,000 size limitation under paragraph 
(c)(1) of this section.
    (i) On-behalf-of issuers. An issuer and all entities (other than 
political subdivisions) that issue bonds on behalf of that issuer are 
treated as one issuer.
    (ii) Subordinate entities--(A) In general. Except as otherwise 
provided in paragraph (d) of this section and section 148(f)(4)(D)(iv), 
all bonds issued by a subordinate entity are also treated as issued by 
each entity to which it is subordinate. An issuer is subordinate to 
another governmental entity if it is directly or indirectly controlled 
by the other entity within the meaning of Sec. 1.150-1(e).
    (B) Exception for allocations of size limitation. If an entity 
properly makes an allocation of a portion of its $5,000,000 size 
limitation to a subordinate entity (including an on behalf of issuer) 
under section 148(f)(4)(D)(iv), the portion of bonds issued by the 
subordinate entity under the allocation is treated as issued only by the 
allocating entity and not by any other entity to which the issuing 
entity is subordinate. These allocations are irrevocable and must bear a 
reasonable relationship to the benefits received by the allocating unit 
from issues issued by the subordinate entity. The benefits to be 
considered include the manner in which--
    (1) Proceeds are to be distributed;
    (2) The debt service is to be paid;
    (3) The facility financed is to be owned;
    (4) The use or output of the facility is to be shared; and
    (5) Costs of operation and maintenance are to be shared.
    (iii) Avoidance of size limitation. An entity formed or availed of 
to avoid the purposes of the $5,000,000 size limitation and all entities 
that would benefit from the avoidance are treated as one issuer. 
Situations in which an entity is formed or availed of to avoid the 
purposes of the $5,000,000 size limitation include those in which the 
issuer--
    (A) Issues bonds which, but for the $5,000,000 size limitation, 
would have been issued by another entity; and
    (B) Does not receive a substantial benefit from the project financed 
by the bonds.
    (3) Certain refunding bonds not taken into account. In applying the 
$5,000,000 size limitation, there is not taken into account the portion 
of an issue that is a current refunding issue to the extent that the 
stated principal amount of the refunding bond does not exceed the 
portion of the outstanding stated principal

[[Page 736]]

amount of the refunded bond paid with proceeds of the refunding bond. 
For this purpose, principal amount means, in reference to a plain par 
bond, its stated principal amount plus accrued unpaid interest, and in 
reference to any other bond, its present value.
    (d) Pooled financings--(1) Treatment of pool issuer. To the extent 
that an issuer of a pooled financing is not an ultimate borrower in the 
financing and the conduit borrowers are governmental units with general 
taxing powers and not subordinate to the issuer, the pooled financing is 
not counted towards the $5,000,000 size limitation of the issuer for 
purposes of applying the small issuer exception to its other issues. The 
issuer of the pooled financing issue is, however, subject to the rebate 
requirement for any unloaned gross proceeds.
    (2) Treatment of conduit borrowers. A loan to a conduit borrower in 
a pooled financing qualifies for the small issuer exception, regardless 
of the size of either the pooled financing or of any loan to other 
conduit borrowers, only if--
    (i) The bonds of the pooled financing are not private activity 
bonds;
    (ii) None of the loans to conduit borrowers are private activity 
bonds; and
    (iii) The loan to the conduit borrower meets all the requirements of 
the small issuer exception.
    (e) Refunding issues--(1) In general. Sections 148(f)(4)(D) (v) and 
(vi) provide restrictions on application of the small issuer exception 
to refunding issues.
    (2) Multipurpose issues. The multipurpose issue allocation rules of 
Sec. 1.148-9(h) apply for purposes of determining whether refunding 
bonds meet the requirements of section 148(f)(4)(D)(v).

[T.D. 8476, 58 FR 33540, June 18, 1993]



Sec. 1.148-9  Arbitrage rules for refunding issues.

    (a) Scope of application. This section contains special arbitrage 
rules for refunding issues. These rules apply for all purposes of 
section 148 and govern allocations of proceeds, bonds, and investments 
to determine transferred proceeds, temporary periods, reasonably 
required reserve or replacement funds, minor portions, and separate 
issue treatment of certain multipurpose issues.
    (b) Transferred proceeds allocation rule--(1) In general. When 
proceeds of the refunding issue discharge any of the outstanding 
principal amount of the prior issue, proceeds of the prior issue become 
transferred proceeds of the refunding issue and cease to be proceeds of 
the prior issue. The amount of proceeds of the prior issue that becomes 
transferred proceeds of the refunding issue is an amount equal to the 
proceeds of the prior issue on the date of that discharge multiplied by 
a fraction--
    (i) The numerator of which is the principal amount of the prior 
issue discharged with proceeds of the refunding issue on the date of 
that discharge; and
    (ii) The denominator of which is the total outstanding principal 
amount of the prior issue on the date immediately before the date of 
that discharge.
    (2) Special definition of principal amount. For purposes of this 
section, principal amount means, in reference to a plain par bond, its 
stated principal amount, and in reference to any other bond, its present 
value.
    (3) Relation of transferred proceeds rule to universal cap rule--(i) 
In general. Paragraphs (b)(1) and (c) of this section apply to allocate 
transferred proceeds and corresponding investments to a refunding issue 
on any date required by those paragraphs before the application of the 
universal cap rule of Sec. 1.148-6(b)(2) to reallocate any of those 
amounts. To the extent nonpurpose investments allocable to proceeds of a 
refunding issue exceed the universal cap for the issue on the date that 
amounts become transferred proceeds of the refunding issue, those 
transferred proceeds and corresponding investments are reallocated back 
to the issue from which they transferred on that same date to the extent 
of the unused universal cap on that prior issue.
    (ii) Example. The following example illustrates the application of 
this paragraph of (b)(3):

    Example. On January 1, 1995, $100,000 of nonpurpose investments 
allocable to proceeds of issue A become transferred proceeds of issue B 
under Sec. 1.148-9, but the unused portion of issue B' s universal cap 
is $75,000 as of

[[Page 737]]

that date. On January 1, 1995, issue A has unused universal cap in 
excess of $25,000. Thus, $25,000 of nonpurpose investments representing 
the transferred proceeds are immediately reallocated back to issue A on 
January 1, 1995, and are proceeds of issue A. On the next transfer date 
under Sec. 1.148-9, the $25,000 receives no priority in determining 
transferred proceeds as of that date but is treated the same as all 
other proceeds of issue A subject to transfer.

    (4) Limitation on multi-generational transfers. This paragraph 
(b)(4) contains limitations on the manner in which proceeds of a first 
generation issue that is refunded by a refunding issue (a second 
generation issue) become transferred proceeds of a refunding issue (a 
third generation issue) that refunds the second generation issue. 
Proceeds of the first generation issue that become transferred proceeds 
of the third generation issue are treated as having a yield equal to the 
yield on the refunding escrow allocated to the second generation issue 
(i.e., as determined under Sec. 1.148-5(b)(2)(iv)). The determination 
of the transferred proceeds of the third generation issue does not 
affect compliance with the requirements of section 148, including the 
determination of the amount of arbitrage rebate with respect to or the 
yield on the refunding escrow, of the second generation issue.
    (c) Special allocation rules for refunding issues--(1) Allocations 
of investments--(i) In general. Except as otherwise provided in this 
paragraph (c), investments purchased with sale proceeds or investment 
proceeds of a refunding issue must be allocated to those proceeds, and 
investments not purchased with those proceeds may not be allocated to 
those proceeds (i.e., a specific tracing method).
    (ii) Allocations to transferred proceeds. When proceeds of a prior 
issue become transferred proceeds of a refunding issue, investments (and 
the related payments and receipts) of proceeds of the prior issue that 
are held in a refunding escrow for another issue are allocated to the 
transferred proceeds under the ratable allocation method described in 
paragraph (c)(1)(iii) of this section. Investments of proceeds of the 
prior issue that are not held in a refunding escrow for another issue 
are allocated to the transferred proceeds by application of the 
allocation methods described in paragraph (c)(1) (iii) or (iv) of this 
section, consistently applied to all investments on a transfer date.
    (iii) Ratable allocation method. Under the ratable allocation 
method, a ratable portion of each nonpurpose and purpose investment of 
proceeds of the prior issue is allocated to transferred proceeds of the 
refunding issue.
    (iv) Representative allocation method--(A) In general. Under the 
representative allocation method, representative portions of the 
portfolio of nonpurpose investments and the portfolio of purpose 
investments of proceeds of the prior issue are allocated to transferred 
proceeds of the refunding issue. Unlike the ratable allocation method, 
this representative allocation method permits an allocation of 
particular whole investments. Whether a portion is representative is 
based on all the facts and circumstances, including, without limitation, 
whether the current yields, maturities, and current unrealized gains or 
losses on the particular allocated investments are reasonably comparable 
to those of the unallocated investments in the aggregate. In addition, 
if a portion of nonpurpose investments is otherwise representative, it 
is within the issuer's discretion to allocate the portion from whichever 
source of funds it deems appropriate, such as a reserve fund or a 
construction fund for a prior issue.
    (B) Mark-to-market safe harbor for representative allocation method. 
In addition to other representative allocations, a specific allocation 
of a particular nonpurpose investment to transferred proceeds (e.g., of 
lower yielding investments) is treated as satisfying the representative 
allocation method if that investment is valued at fair market value on 
the transfer date in determining the payments and receipts on that date, 
but only if the portion of the nonpurpose investments that transfers is 
based on the relative fair market value of all nonpurpose investments.
    (2) Allocations of mixed escrows to expenditures for principal, 
interest, and redemption prices on a prior issue--(i) In general. Except 
for amounts required or permitted to be accounted for under paragraph 
(c)(2)(ii) of this section, proceeds of a refunding issue and other

[[Page 738]]

amounts that are not proceeds of a refunding issue that are deposited in 
a refunding escrow (a mixed escrow) must be accounted for under this 
paragraph (c)(2)(i). Those proceeds and other amounts must be allocated 
to expenditures for principal, interest, or stated redemption prices on 
the prior issue so that the expenditures of those proceeds do not occur 
faster than ratably with expenditures of the other amounts in the mixed 
escrow. During the period that the prior issue has unspent proceeds, 
however, these allocations must be ratable (with reasonable adjustments 
for rounding) both between sources for expenditures (i.e., proceeds and 
other amounts) and between uses (i.e., principal, interest, and stated 
redemption prices on the prior issue).
    (ii) Exceptions--(A) Mandatory allocation of certain non-proceeds to 
earliest expenditures. If amounts other than proceeds of the refunding 
issue are deposited in a mixed escrow, but before the issue date of the 
refunding issue those amounts had been held in a bona fide debt service 
fund or a fund to carry out the governmental purpose of the prior issue 
(e.g., a construction fund), those amounts must be allocated to the 
earliest maturing investments in the mixed escrow.
    (B) Permissive allocation of non-proceeds to earliest expenditures. 
Excluding amounts covered by paragraph (c)(2)(ii)(A) of this section and 
subject to any required earlier expenditure of those amounts, any 
amounts in a mixed escrow that are not proceeds of a refunding issue may 
be allocated to the earliest maturing investments in the mixed escrow, 
provided that those investments mature and the proceeds thereof are 
expended before the date of any expenditure from the mixed escrow to pay 
any principal of the prior issue.
    (d) Temporary periods in refundings--(1) In general. Proceeds of a 
refunding issue may be invested in higher yielding investments under 
section 148(c) only during the temporary periods described in paragraph 
(d)(2) of this section.
    (2) Types of temporary periods in refundings. The available 
temporary periods for proceeds of a refunding issue are as follows:
    (i) General temporary period for refunding issues. Except as 
otherwise provided in this paragraph (d)(2), the temporary period for 
proceeds (other than transferred proceeds) of a refunding issue is the 
period ending 30 days after the issue date of the refunding issue.
    (ii) Temporary periods for current refunding issues--(A) In general. 
Except as otherwise provided in paragraph (d)(2)(ii)(B) of this section, 
the temporary period for proceeds (other than transferred proceeds) of a 
current refunding issue is 90 days.
    (B) Temporary period for short-term current refunding issues. The 
temporary period for proceeds (other than transferred proceeds) of a 
current refunding issue that has an original term to maturity of 270 
days or less may not exceed 30 days. The aggregate temporary periods for 
proceeds (other than transferred proceeds) of all current refunding 
issues described in the preceding sentence that are part of the same 
series of refundings is 90 days. An issue is part of a series of 
refundings if it finances or refinances the same expenditures for a 
particular governmental purpose as another issue.
    (iii) Temporary periods for transferred proceeds--(A) In general. 
Except as otherwise provided in paragraph (d)(2)(iii)(B) of this 
section, each available temporary period for transferred proceeds of a 
refunding issue begins on the date those amounts become transferred 
proceeds of the refunding issue and ends on the date that, without 
regard to the discharge of the prior issue, the available temporary 
period for those proceeds would have ended had those proceeds remained 
proceeds of the prior issue.
    (B) Termination of initial temporary period for prior issue in an 
advance refunding. The initial temporary period under Sec. 1.148-2(e) 
(2) and (3) for the proceeds of a prior issue that is refunded by an 
advance refunding issue (including transferred proceeds) terminates on 
the issue date of the advance refunding issue.
    (iv) Certain short-term gross proceeds. Except for proceeds of a 
refunding issue held in a refunding escrow, proceeds otherwise 
reasonably expected to be used to pay principal or interest on the prior 
issue, replacement proceeds not

[[Page 739]]

held in a bona fide debt service fund, and transferred proceeds, the 
temporary period for gross proceeds of a refunding issue is the 13-month 
period beginning on the date of receipt.
    (e) Reasonably required reserve or replacement funds in refundings. 
In addition to the requirements of Sec. 1.148-2(f), beginning on the 
issue date of a refunding issue, a reserve or replacement fund for a 
refunding issue or a prior issue is a reasonably required reserve or 
replacement fund under section 148(d) that may be invested in higher 
yielding investments only if the aggregate amount invested in higher 
yielding investments under this paragraph (e) for both the refunding 
issue and the prior issue does not exceed the size limitations under 
Sec. 1.148-2 (f)(2) and (f)(3), measured by reference to the refunding 
issue only (regardless of whether proceeds of the prior issue have 
become transferred proceeds of the refunding issue).
    (f) Minor portions in refundings. Beginning on the issue date of the 
refunding issue, gross proceeds not in excess of a minor portion of the 
refunding issue qualify for investment in higher yielding investments 
under section 148(e), and gross proceeds not in excess of a minor 
portion of the prior issue qualify for investment in higher yielding 
investments under either section 148(e) or section 149(d)(3)(A)(v), 
whichever is applicable. Minor portion is defined in Sec. 1.148-2(g).
    (g) Certain waivers permitted. On or before the issue date, an 
issuer may waive the right to invest in higher yielding investments 
during any temporary period or as part of a reasonably required reserve 
or replacement fund. At any time, an issuer may waive the right to 
invest in higher yielding investments as part of a minor portion.
    (h) Multipurpose issue allocations--(1) Application of multipurpose 
issue allocation rules. The portion of the bonds of a multipurpose issue 
reasonably allocated to any separate purpose under this paragraph (h) is 
treated as a separate issue for all purposes of section 148 except the 
following--
    (i) Arbitrage yield. Except to the extent that the proceeds of an 
issue are allocable to two or more conduit loans that are tax-exempt 
bonds, determining the yield on a multipurpose issue and the yield on 
investments for purposes of the arbitrage yield restrictions of section 
148 and the arbitrage rebate requirement of section 148(f);
    (ii) Rebate amount. Except as provided in paragraph (h)(1)(i) of 
this section, determining the rebate amount for a multipurpose issue, 
including subsidiary matters with respect to that determination, such as 
the computation date credit under Sec. 1.148-3(d)(1), the due date for 
payments, and the $100,000 bona fide debt service fund exception under 
section 148(f)(4)(A)(ii);
    (iii) Minor portion. Determining the minor portion of an issue under 
section 148(e);
    (iv) Reasonably required reserve or replacement fund. Determining 
the portion of an issue eligible for investment in higher yielding 
investments as part of a reasonably required reserve or replacement fund 
under section 148(d); and
    (v) Effective date. Applying the provisions of Sec. 1.148-11(b) 
(relating to elective retroactive application of Sec. Sec. 1.148-1 
through 1.148-10 to certain issues).
    (2) Rules on allocations of multipurpose issues--(i) In general. 
This paragraph (h) applies to allocations of multipurpose issues, 
including allocations involving the refunding purposes of the issue. 
Except as otherwise provided in this paragraph (h), proceeds, 
investments, and bonds of a multipurpose issue may be allocated among 
the various separate purposes of the issue using any reasonable, 
consistently applied allocation method. An allocation is not reasonable 
if it achieves more favorable results under section 148 or 149(d) than 
could be achieved with actual separate issues. An allocation under this 
paragraph (h) may be made at any time, but once made may not be changed.
    (ii) Allocations involving certain common costs. A ratable 
allocation of common costs (as described in paragraph (h)(3)(ii) of this 
section) among the separate purposes of the multipurpose issue is 
generally reasonable. If another allocation method more accurately 
reflects the extent to which any separate purpose of a multipurpose 
issue enjoys the economic benefit or bears the economic burden of 
certain

[[Page 740]]

common costs, that allocation method may be used.
    (3) Separate purposes of a multipurpose issue--(i) In general. 
Separate purposes of a multipurpose issue include refunding a separate 
prior issue, financing a separate purpose investment, financing a 
construction issue (as defined in Sec. 1.148-7(f)), and any clearly 
discrete governmental purpose reasonably expected to be financed by that 
issue. In general, all integrated or functionally related capital 
projects that qualify for the same initial temporary period under Sec. 
1.148-2(e)(2) are treated as having a single governmental purpose. The 
separate purposes of a refunding issue include the separate purposes of 
the prior issue, if any. Separate purposes may be treated as a single 
purpose if the proceeds used to finance those purposes are eligible for 
the same initial temporary period under section 148(c). For example, the 
use of proceeds of a multipurpose issue to finance separate qualified 
mortgage loans may be treated as a single purpose.
    (ii) Financing common costs. Common costs of a multipurpose issue 
are not separate purposes. Common costs include issuance costs, accrued 
interest, capitalized interest on the issue, a reserve or replacement 
fund, qualified guarantee fees, and similar costs properly allocable to 
the separate purposes of the issue.
    (iii) Example. The following example illustrates the application of 
this paragraph (h)(3).

    Example. On January 1, 1994, Housing Authority of State A issues a 
$10 million issue (the 1994 issue) at an interest rate of 10 percent to 
finance qualified mortgage loans for owner-occupied residences under 
section 143. During 1994, A originates $5 million in qualified mortgage 
loans at an interest rate of 10 percent. In 1995, the market interest 
rates for housing loans falls to 8 percent and A is unable to originate 
further loans from the 1994 issue. On January 1, 1996, A issues a $5 
million issue (the 1996 issue) at an interest rate of 8 percent to 
refund partially the 1994 issue. Under paragraph (h) of this section, A 
treats the portion of the 1994 issue used to originate $5 million in 
loans as a separate issue comprised of that group of purpose 
investments. A allocates those purpose investments representing those 
loans to that separate unrefunded portion of the issue. In addition, A 
treats the unoriginated portion of the 1994 issue as a separate issue 
and allocates the nonpurpose investments representing the unoriginated 
proceeds of the 1994 issue to the refunded portion of the issue. Thus, 
when proceeds of the 1996 issue are used to pay principal on the 
refunded portion of the 1994 issue that is treated as a separate issue 
under paragraph (h) of this section, only the portion of the 1994 issue 
representing unoriginated loan funds invested in nonpurpose investments 
transfer to become transferred proceeds of the 1996 issue.

    (4) Allocations of bonds of a multipurpose issue--(i) Reasonable 
allocation of bonds to portions of issue. After reasonable adjustment of 
the issue price of a multipurpose issue to account for common costs, the 
portion of the bonds of a multipurpose issue allocated to a separate 
purpose must have an issue price that bears the same ratio to the 
aggregate issue price of the multipurpose issue as the portion of the 
sale proceeds of the multipurpose issue used for that separate purpose 
bears to the aggregate sale proceeds of the multipurpose issue. For a 
refunding issue used to refund two or more prior issues, the portion of 
the sales proceeds allocated to the refunding of a separate prior issue 
is based on the present value of the refunded debt service on that prior 
issue, using the yield on investments in the refunding escrow allocable 
to the entire refunding issue as the discount rate.
    (ii) Safe harbor for pro rata allocation method for bonds. The use 
of the relative amount of sales proceeds used for each separate purpose 
to ratably allocate each bond or a ratable number of substantially 
identical whole bonds is a reasonable method for allocating bonds of a 
multipurpose issue.
    (iii) Safe harbor for allocations of bonds used to finance separate 
purpose investments. An allocation of a portion of the bonds of a 
multipurpose issue to a particular purpose investment is generally 
reasonable if that purpose investment has principal and interest 
payments that reasonably coincide in time and amount to principal and 
interest payments on the bonds allocated to that purpose investment.
    (iv) Rounding of bond allocations to next whole bond denomination 
permitted. An allocation that rounds each resulting fractional bond up 
or down to the next integral multiple of a permitted denomination of 
bonds of that issue

[[Page 741]]

not in excess of $100,000 does not prevent the allocation from 
satisfying this paragraph (h)(4).
    (v) Restrictions on allocations of bonds to refunding purposes. For 
each portion of a multipurpose issue that is used to refund a separate 
prior issue, a method of allocating bonds of that issue is reasonable 
under this paragraph (h) only if, in addition to the requirements of 
paragraphs (h)(1) and (h)(2) of this section, the portion of the bonds 
allocated to the refunding of that prior issue--
    (A) Results from a pro rata allocation under paragraph (h)(4)(ii) of 
this section;
    (B) Reflects aggregate principal and interest payable in each bond 
year that is less than, equal to, or proportionate to, the aggregate 
principal and interest payable on the prior issue in each bond year;
    (C) Results from an allocation of all the bonds of the entire 
multipurpose issue in proportion to the remaining weighted average 
economic life of the capital projects financed or refinanced by the 
issue, determined in the same manner as under section 147(b); or
    (D) Results from another reasonable allocation method, but only to 
the extent that the application of the allocation methods provided in 
this paragraph (h)(4)(v) is not permitted under state law restrictions 
applicable to the bonds, reasonable terms of bonds issued before, or 
subject to a master indenture that became effective prior to, July 1, 
1993, or other similar restrictions or circumstances. This paragraph 
(h)(4)(v)(D) shall be strictly construed and is available only if it 
does not result in a greater burden on the market for tax-exempt bonds 
than would occur using one of the other allocation methods provided in 
this paragraph (h)(4)(v). (See also Sec. 1.148-11(c)(2).)
    (vi) Exception for refundings of interim notes. Paragraph (h)(4)(v) 
of this section need not be applied to refunding bonds issued to provide 
permanent financing for one or more projects if the prior issue had a 
term of less than 3 years and was sold in anticipation of permanent 
financing, but only if the aggregate term of all prior issues sold in 
anticipation of permanent financing was less than 3 years.
    (5) Limitation on multi-generation allocations. This paragraph (h) 
does not apply to allocations of a multipurpose refunded issue unless 
that refunded issue is refunded directly by an issue to which this 
paragraph (h) applies. For example, if a 1994 issue refunds a 1984 
multipurpose issue, which in turn refunded a 1980 multipurpose issue, 
this paragraph (h) applies to allocations of the 1984 issue for purposes 
of allocating the refunding purposes of the 1994 issue, but does not 
permit allocations of the 1980 issue.
    (i) Operating rules for separation of prior issue into refunded and 
unrefunded portions--(1) In general. For purposes of paragraph (h)(3)(i) 
of this section, the separate purposes of a prior issue include the 
refunded and unrefunded portions of the prior issue. Thus, the refunded 
and unrefunded portions are treated as separate issues under paragraph 
(h)(1) of this section. Those separate issues must satisfy the 
requirements of paragraphs (h) and (i) of this section. The refunded 
portion of the bonds of a prior issue is based on a fraction the 
numerator of which is the principal amount of the prior issue to be paid 
with proceeds of the refunding issue and the denominator of which is the 
outstanding principal amount of the bonds of the prior issue, each 
determined as of the issue date of the refunding issue. (See also 
paragraph (b)(2) of this section.)
    (2) Allocations of proceeds and investments in a partial refunding. 
As of the issue date of a partial refunding issue under this paragraph 
(i), unspent proceeds of the prior issue are allocated ratably between 
the refunded and unrefunded portions of the prior issue and the 
investments allocable to those unspent proceeds are allocated in the 
manner required for the allocation of investments to transferred 
proceeds under paragraph (c)(1)(ii) of this section.
    (3) References to prior issue. If the refunded and unrefunded 
portions of a prior issue are treated as separate issues under this 
paragraph (i), then, except to the extent that the context clearly 
requires otherwise (e.g., references to the aggregate prior issue in the 
mixed escrow rule in paragraph (c)(2) of this section), all references 
in

[[Page 742]]

this section to a prior issue refer only to the refunded portion of that 
prior issue.

[T.D. 8476, 58 FR 33541, June 18, 1993; 58 FR 44453, Aug. 23, 1993, as 
amended by T.D. 8538, 59 FR 24045, May 10, 1994; T.D. 8718, 62 FR 25512, 
May 9, 1997]



Sec. 1.148-10  Anti-abuse rules and authority of Commissioner.

    (a) Abusive arbitrage device--(1) In general. Bonds of an issue are 
arbitrage bonds under section 148 if an abusive arbitrage device under 
paragraph (a)(2) of this section is used in connection with the issue. 
This paragraph (a) is to be applied and interpreted broadly to carry out 
the purposes of section 148, as further described in Sec. 1.148-0. 
Except as otherwise provided in paragraph (c) of this section, any 
action that is expressly permitted by section 148 or Sec. Sec. 1.148-1 
through 1.148-11 is not an abusive arbitrage device (e.g., investment in 
higher yielding investments during a permitted temporary period under 
section 148(c)).
    (2) Abusive arbitrage device defined. Any action is an abusive 
arbitrage device if the action has the effect of--
    (i) Enabling the issuer to exploit the difference between tax-exempt 
and taxable interest rates to obtain a material financial advantage; and
    (ii) Overburdening the tax-exempt bond market.
    (3) Exploitation of tax-exempt interest rates. An action may exploit 
tax-exempt interest rates under paragraph (a)(2) of this section as a 
result of an investment of any portion of the gross proceeds of an issue 
over any period of time, notwithstanding that, in the aggregate, the 
gross proceeds of the issue are not invested in higher yielding 
investments over the term of the issue.
    (4) Overburdening the tax-exempt market. An action overburdens the 
tax-exempt bond market under paragraph (a)(2)(ii) of this section if it 
results in issuing more bonds, issuing bonds earlier, or allowing bonds 
to remain outstanding longer than is otherwise reasonably necessary to 
accomplish the governmental purposes of the bonds, based on all the 
facts and circumstances. Whether an action is reasonably necessary to 
accomplish the governmental purposes of the bonds depends on whether the 
primary purpose of the transaction is a bona fide governmental purpose 
(e.g., an issue of refunding bonds to achieve a debt service 
restructuring that would be issued independent of any arbitrage 
benefit). An important factor bearing on this determination is whether 
the action would reasonably be taken to accomplish the governmental 
purpose of the issue if the interest on the issue were not excludable 
from gross income under section 103(a) (assuming that the hypothetical 
taxable interest rate would be the same as the actual tax-exempt 
interest rate). Factors evidencing an overissuance include the issuance 
of an issue the proceeds of which are reasonably expected to exceed by 
more than a minor portion the amount necessary to accomplish the 
governmental purposes of the issue, or an issue the proceeds of which 
are, in fact, substantially in excess of the amount of sale proceeds 
allocated to expenditures for the governmental purposes of the issue. 
One factor evidencing an early issuance is the issuance of bonds that do 
not qualify for a temporary period under Sec. 1.148-2(e)(2), (e)(3), or 
(e)(4). One factor evidencing that bonds may remain outstanding longer 
than necessary is a term that exceeds the safe harbors against the 
creation of replacement proceeds under Sec. 1.148-1(c)(4)(i)(B). These 
factors may be outweighed by other factors, however, such as bona fide 
cost underruns or long-term financial distress.
    (b) Consequences of overburdening the tax-exempt bond market--(1) In 
general. An issue that overburdens the tax-exempt bond market (within 
the meaning of paragraph (a)(4) of this section) is subject to the 
following special limitations--
    (i) Special yield restriction. Investments are subject to the 
definition of materially higher yield under Sec. 1.148-2(d) that is 
equal to one-thousandth of 1 percent. In addition, each investment is 
treated as a separate class of investments under Sec. 1.148-
5(b)(2)(ii), the yield on which may not be blended with that of other 
investments.
    (ii) Certain regulatory provisions inapplicable. The provisions of 
Sec. 1.148-5(c) (relating to yield reduction payments) and Sec. 1.148-
5(e) (2) and (3) (relating to

[[Page 743]]

recovery of qualified administrative costs) do not apply.
    (iii) Restrictive expenditure rule. Proceeds are not allocated to 
expenditures unless the proceeds-spent-last rule under Sec. 1.148-
6(d)(3)(i) is satisfied, applied by treating those proceeds as proceeds 
to be used for restricted working capital expenditures. For this 
purpose, available amount includes a reasonable working capital reserve 
as defined in Sec. 1.148-6(d)(3)(iii)(B).
    (2) Application. The provisions of this paragraph (b) only apply to 
the portion of an issue that, as a result of actions taken (or actions 
not taken) after the issue date, overburdens the market for tax-exempt 
bonds, except that for an issue that is reasonably expected as of the 
issue date to overburden the market, those provisions apply to all of 
the gross proceeds of the issue.
    (c) Anti-abuse rules on excess gross proceeds of advance refunding 
issues--(1) In general. Except as otherwise provided in this paragraph 
(c), an abusive arbitrage device is used and bonds of an advance 
refunding issue are arbitrage bonds if the issue has excess gross 
proceeds.
    (2) Definition of excess gross proceeds. Excess gross proceeds means 
all gross proceeds of an advance refunding issue that exceed an amount 
equal to 1 percent of sale proceeds of the issue, other than gross 
proceeds allocable to--
    (i) Payment of principal, interest, or call premium on the prior 
issue;
    (ii) Payment of pre-issuance accrued interest on the refunding 
issue, and interest on the refunding issue that accrues for a period up 
to the completion date of any capital project for which the prior issue 
was issued, plus one year;
    (iii) A reasonably required reserve or replacement fund for the 
refunding issue or investment proceeds of such a fund;
    (iv) Payment of costs of issuance of the refunding issue;
    (v) Payment of administrative costs allocable to repaying the prior 
issue, carrying and repaying the refunding issue, or investments of the 
refunding issue;
    (vi) Transferred proceeds that will be used or maintained for the 
governmental purpose of the prior issue;
    (vii) Interest on purpose investments;
    (viii) Replacement proceeds in a sinking fund for the refunding 
issue;
    (ix) Qualified guarantee fees for the refunding issue or the prior 
issue; and
    (x) Fees for a qualified hedge for the refunding issue.
    (3) Special treatment of transferred proceeds. For purposes of this 
paragraph (c), all unspent proceeds of the prior issue as of the issue 
date of the refunding issue are treated as transferred proceeds of the 
advance refunding issue.
    (4) Special rule for crossover refundings. An advance refunding 
issue is not an issue of arbitrage bonds under this paragraph (c) if all 
excess gross proceeds of the refunding issue are used to pay interest 
that accrues on the refunding issue before the prior issue is 
discharged, and no gross proceeds of any refunding issue are used to pay 
interest on the prior issue or to replace funds used directly or 
indirectly to pay such interest (other than transferred proceeds used to 
pay interest on the prior issue that accrues for a period up to the 
completion date of the project for which the prior issue was issued, 
plus one year, or proceeds used to pay principal that is attributable to 
accrued original issue discount).
    (5) Special rule for gross refundings. This paragraph (c)(5) applies 
if an advance refunding issue (the series B issue) is used together with 
one or more other advance refunding issues (the series A issues) in a 
gross refunding of a prior issue, but only if the use of a gross 
refunding method is required under bond documents that were effective 
prior to November 6, 1992. These advance refunding issues are not 
arbitrage bonds under this paragraph (c) if--
    (i) All excess gross proceeds of the series B issue and each series 
A issue are investment proceeds used to pay principal and interest on 
the series B issue;
    (ii) At least 99 percent of all principal and interest on the series 
B issue is paid with proceeds of the series B and series A issues or 
with the earnings on other amounts in the refunding escrow for the prior 
issue;
    (iii) The series B issue is discharged not later than the prior 
issue; and

[[Page 744]]

    (iv) As of any date, the amount of gross proceeds of the series B 
issue allocated to expenditures does not exceed the aggregate amount of 
expenditures before that date for principal and interest on the series B 
issue, and administrative costs of carrying and repaying the series B 
issue, or of investments of the series B issue.
    (d) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1. Mortgage sale. In 1982, City issued its revenue issue 
(the 1982 issue) and lent the proceeds to Developer to finance a low-
income housing project under former section 103(b)(4)(A) of the 1954 
Code. In 1994, Developer encounters financial difficulties and 
negotiates with City to refund the 1982 issue. City issues $10 million 
in principal amount of its 8 percent bonds (the 1994 issue). City lends 
the proceeds of the 1994 issue to Developer. To evidence Developer's 
obligation to repay that loan, Developer, as obligor, issues a note to 
City (the City note). Bank agrees to provide Developer with a direct-pay 
letter of credit pursuant to which Bank will make all payments to the 
trustee for the 1994 issue necessary to meet Developer's obligations 
under the City note. Developer pays Bank a fee for the issuance of the 
letter of credit and issues a note to Bank (the Bank note). The Bank 
note is secured by a mortgage on the housing project and is guaranteed 
by FHA. The Bank note and the 1994 issue have different prepayment 
terms. The City does not reasonably expect to treat prepayments of the 
Bank note as gross proceeds of the 1994 issue. At the same time or 
pursuant to a series of related transactions, Bank sells the Bank note 
to Investor for $9.5 million. Bank invests these monies together with 
its other funds. In substance, the transaction is a loan by City to 
Bank, under which Bank enters into a series of transactions that, in 
effect, result in Bank retaining $9.5 million in amounts treated as 
proceeds of the 1994 issue. Those amounts are invested in materially 
higher yielding investments that provide funds sufficient to equal or 
exceed the Bank's liability under the letter of credit. Alternatively, 
the letter of credit is investment property in a sinking fund for the 
1994 issue provided by Developer, a substantial beneficiary of the 
financing. Because, in substance, Developer acquires the $10 million 
principal amount letter of credit for a fair market value purchase price 
of $9.5 million, the letter of credit is a materially higher yielding 
investment. Neither result would change if Developer's obligation under 
the Bank note is contingent on Bank performing its obligation under the 
letter of credit. Each characterization causes the bonds to be arbitrage 
bonds.
    Example 2. Bonds outstanding longer than necessary for yield-
blending device. (i) Longer bond maturity to create sinking fund. In 
1994, Authority issues an advance refunding issue (the refunding issue) 
to refund a 1982 prior issue (the prior issue). Under current market 
conditions, Authority will have to invest the refunding escrow at a 
yield significantly below the yield on the refunding issue. Authority 
issues its refunding issue with a longer weighted average maturity than 
otherwise necessary primarily for the purpose of creating a sinking fund 
for the refunding issue that will be invested in a guaranteed investment 
contract. The weighted average maturity of the refunding issue is less 
than 120 percent of the remaining average economic life of the 
facilities financed with the proceeds of the prior issue. The guaranteed 
investment contract has a yield that is higher than the yield on the 
refunding issue. The yield on the refunding escrow blended with the 
yield on the guaranteed investment contract does not exceed the yield on 
the issue. The refunding issue uses an abusive arbitrage device and the 
bonds of the issue are arbitrage bonds under section 148(a).
    (ii) Refunding of noncallable bonds. The facts are the same as in 
paragraph (i) of this Example 2 except that instead of structuring the 
refunding issue to enable it to take advantage of sinking fund 
investments, Authority will also refund other long-term, non-callable 
bonds in the same refunding issue. There are no savings attributable to 
the refunding of the non-callable bonds (e.g., a low-to-high refunding). 
The Authority invests the portion of the proceeds of the refunding issue 
allocable to the refunding of the non-callable bonds in the refunding 
escrow at a yield that is higher than the yield on the refunding issue, 
based on the relatively long escrow period for this portion of the 
refunding. The Authority invests the other portion of the proceeds of 
the refunding issue in the refunding escrow at a yield lower than the 
yield on the refunding issue. The blended yield on all the investments 
in the refunding escrow for the prior issues does not exceed the yield 
on the refunding issue. The portion of the refunding issue used to 
refund the noncallable bonds, however, was not otherwise necessary and 
was issued primarily to exploit the difference between taxable and tax-
exempt rates for that long portion of the refunding escrow to minimize 
the effect of lower yielding investments in the other portion of the 
escrow. The refunding issue uses an abusive arbitrage device and the 
bonds of the issue are arbitrage bonds.
    (iii) Governmental purpose. In paragraphs (i) and (ii) of this 
Example 2, the existence of a governmental purpose for the described 
financing structures would not change the conclusions unless Authority 
clearly established that the primary purpose for the use of the 
particular structure was a bona fide

[[Page 745]]

governmental purpose. The fact that each financing structure had the 
effect of eliminating significant amounts of negative arbitrage is 
strong evidence of a primary purpose that is not a bona fide 
governmental purpose. Moreover, in paragraph (i) of this Example 2, the 
structure of the refunding issue coupled with the acquisition of the 
guaranteed investment contract to lock in the investment yield 
associated with the structure is strong evidence of a primary purpose 
that is not a bona fide governmental purpose.
    Example 3. Window refunding. (i) Authority issues its 1994 refunding 
issue to refund a portion of the principal and interest on its 
outstanding 1985 issue. The 1994 refunding issue is structured using 
zero-coupon bonds that pay no interest or principal for the 5-year 
period following the issue date. The proceeds of the 1994 refunding 
issue are deposited in a refunding escrow to be used to pay only the 
interest requirements of the refunded portion of the 1985 issue. 
Authority enters into a guaranteed investment contract with a financial 
institution, G, under which G agrees to provide a guaranteed yield on 
revenues invested by Authority during the 5-year period following the 
issue date. The guaranteed investment contract has a yield that is no 
higher than the yield on the refunding issue. The revenues to be 
invested under this guaranteed investment contract consist of the 
amounts that Authority otherwise would have used to pay principal and 
interest on the 1994 refunding issue. The guaranteed investment contract 
is structured to generate receipts at times and in amounts sufficient to 
pay the principal and redemption requirements of the refunded portion of 
the 1985 issue. A principal purpose of these transactions is to avoid 
transferred proceeds. Authority will continue to invest the unspent 
proceeds of the 1985 issue that are on deposit in a refunding escrow for 
its 1982 issue at a yield equal to the yield on the 1985 issue and will 
not otherwise treat those unspent proceeds as transferred proceeds of 
the 1994 refunding issue. The 1994 refunding issue is an issue of 
arbitrage bonds since those bonds involve a transaction or series of 
transactions that overburdens the market by leaving bonds outstanding 
longer than is necessary to obtain a material financial advantage based 
on arbitrage. Specifically, Authority has structured the 1994 refunding 
issue to make available for the refunding of the 1985 issue replacement 
proceeds rather than proceeds so that the unspent proceeds of the 1985 
issue will not become transferred proceeds of the 1994 refunding issue.
    (ii) The result would be the same in each of the following 
circumstances:
    (A) The facts are the same as in paragraph (i) of this Example 3 
except that Authority does not enter into the guaranteed investment 
contract but instead, as of the issue date of the 1994 refunding issue, 
reasonably expects that the released revenues will be available for 
investment until used to pay principal and interest on the 1985 issue.
    (B) The facts are the same as in paragraph (i) of this Example 3 
except that there are no unspent proceeds of the 1985 issue and 
Authority invests the released revenues at a yield materially higher 
than the yield on the 1994 issue.
    (C) The facts are the same as in paragraph (i) of this Example 3 
except that Authority uses the proceeds of the 1994 issue for capital 
projects instead of to refund a portion of the 1985 issue.
    Example 4. Sale of conduit loan. On January 1, 1994, Authority 
issues a conduit financing issue (the 1994 conduit financing issue) and 
uses the proceeds to purchase from City, an unrelated party, a tax-
exempt bond of City (the City note). The proceeds of the 1994 conduit 
financing issue are to be used to advance refund a prior conduit 
financing issue that was issued in 1988 and used to make a loan to City. 
The 1994 conduit financing issue and the City note each have a yield of 
8 percent on January 1, 1994. On June 30, 1996, interest rates have 
decreased and Authority sells the City note to D, a person unrelated to 
either City or Authority. Based on the sale price of the City note and 
treating June 30, 1996 as the issue date of the City note, the City note 
has a 6 percent yield. Authority deposits the proceeds of the sale of 
the City note into an escrow to redeem the bonds of the 1994 conduit 
financing issue on January 1, 2001. The escrow is invested in nonpurpose 
investments having a yield of 8 percent. For purposes of section 149(d), 
City and Authority are related parties and, therefore, the issue date of 
the City note is treated as being June 30, 1996. Thus, the City note is 
an advance refunding of Authority's 1994 conduit financing issue. 
Interest on the City note is not exempt from Federal income tax from the 
date it is sold to D under section 149(d), because, by investing the 
escrow investments at a yield of 8 percent instead of a yield not 
materially higher than 6 percent, the sale of the City note employs a 
device to obtain a material financial advantage, based on arbitrage, 
apart from the savings attributable to lower interest rates. In 
addition, the City note is not a tax-exempt bond because the note is the 
second advance refunding of the original bond under section 149(d)(3). 
The City note also employs an abusive arbitrage device and is an 
arbitrage bond under section 148.
    Example 5. Re-refunding. (i) On January 1, 1984, City issues a tax-
exempt issue (the 1984 issue) to finance the cost of constructing a 
prison. The 1984 issue has a 7 percent yield and a 30-year maturity. The 
1984 issue is callable at any time on or after January 1, 1994. On 
January 1, 1990, City issues a refunding issue (the 1990 issue) to 
advance refund the 1984 issue. The 1990 issue has an 8 percent

[[Page 746]]

yield and a 30-year maturity. The 1990 issue is callable at any time on 
or after January 1, 2000. The proceeds of the 1990 issue are invested at 
an 8 percent yield in a refunding escrow for the 1984 issue (the 
original 1984 escrow) in a manner sufficient to pay debt service on the 
1984 issue until maturity (i.e., an escrow to maturity). On January 1, 
1994, City issues a refunding issue (the 1994 issue). The 1994 issue has 
a 6 percent yield and a 30-year maturity. City does not invest the 
proceeds of the 1994 issue in a refunding escrow for the 1990 issue in a 
manner sufficient to pay a portion of the debt service until, and redeem 
a portion of that issue on, January 1, 2000. Instead, City invests those 
proceeds at a 6 percent yield in a new refunding escrow for a portion of 
the 1984 issue (the new 1984 escrow) in a manner sufficient to pay debt 
service on a portion of the 1984 issue until maturity. City also 
liquidates the investments allocable to the proceeds of the 1990 issue 
held in the original 1984 escrow and reinvests those proceeds in an 
escrow to pay a portion of the debt service on the 1990 issue itself 
until, and redeem a portion of that issue on, January 1, 2000 (the 1990 
escrow). The 1994 bonds are arbitrage bonds and employ an abusive device 
under section 149(d)(4). Although, in form, the proceeds of the 1994 
issue are used to pay principal on the 1984 issue, this accounting for 
the use of the proceeds of the 1994 issue is an unreasonable, 
inconsistent accounting method under Sec. 1.148-6(a). Moreover, since 
the proceeds of the 1990 issue were set aside in an escrow to be used to 
retire the 1984 issue, the use of proceeds of the 1994 issue for that 
same purpose involves a replacement of funds invested in higher yielding 
investments under section 148(a)(2). Thus, using a reasonable, 
consistent accounting method and giving effect to the substance of the 
transaction, the proceeds of the 1994 issue are treated as used to 
refund the 1990 issue and are allocable to the 1990 escrow. The proceeds 
of the 1990 issue are treated as used to refund the 1984 issue and are 
allocable to the investments in the new 1984 escrow. The proceeds of the 
1990 issue allocable to the nonpurpose investments in the new 1984 
escrow become transferred proceeds of the 1994 issue as principal is 
paid on the 1990 issue from amounts on deposit in the 1990 escrow. As a 
result, the yield on nonpurpose investments allocable to the 1994 issue 
is materially higher than the yield on the 1994 issue, causing the bonds 
of the 1994 issue to be arbitrage bonds. In addition, the transaction 
employs a device under section 149(d)(4) to obtain a material financial 
advantage based on arbitrage, other than savings attributable to lower 
interest rates.
    (ii) The following changes in the facts do not affect the conclusion 
that the 1994 issue consists of arbitrage bonds--
    (1) The 1990 issue is a taxable issue;
    (2) The original 1984 escrow is used to pay the 1994 issue (rather 
than the 1990 issue); or
    (3) The 1994 issue is used to retire the 1984 issue within 90 days 
of January 1, 1994.

    (e) Authority of the Commissioner to clearly reflect the economic 
substance of a transaction. If an issuer enters into a transaction for a 
principal purpose of obtaining a material financial advantage based on 
the difference between tax-exempt and taxable interest rates in a manner 
that is inconsistent with the purposes of section 148, the Commissioner 
may exercise the Commissioner's discretion to depart from the rules of 
Sec. 1.148-1 through Sec. 1.148-11 as necessary to clearly reflect the 
economic substance of the transaction. For this purpose, the 
Commissioner may recompute yield on an issue or on investments, 
reallocate payments and receipts on investments, recompute the rebate 
amount on an issue, treat a hedge as either a qualified hedge or not a 
qualified hedge, or otherwise adjust any item whatsoever bearing upon 
the investments and expenditures of gross proceeds of an issue. For 
example, if the amount paid for a hedge is specifically based on the 
amount of arbitrage earned or expected to be earned on the hedged bonds, 
a principal purpose of entering into the contract is to obtain a 
material financial advantage based on the difference between tax-exempt 
and taxable interest rates in a manner that is inconsistent with the 
purposes of section 148.
    (f) Authority of the Commissioner to require an earlier date for 
payment of rebate. If the Commissioner determines that an issue is 
likely to fail to meet the requirements of Sec. 1.148-3 and that a 
failure to serve a notice of demand for payment on the issuer will 
jeopardize the assessment or collection of tax on interest paid or to be 
paid on the issue, the date that the Commissioner serves notice on the 
issuer is treated as a required computation date for payment of rebate 
for that issue.
    (g) Authority of the Commissioner to waive regulatory limitations. 
Notwithstanding any specific provision in Sec. Sec. 1.148-1 through 
1.148-11, the Commissioner may prescribe extensions of temporary 
periods, larger reasonably required reserve or replacement funds, or 
consequences of failures or remedial

[[Page 747]]

action under section 148 in lieu of or in addition to other consequences 
of those failures, or take other action, if the Commissioner finds that 
good faith or other similar circumstances so warrant, consistent with 
the purposes of section 148.

[T.D. 8476, 58 FR 33544, June 18, 1993; 58 FR 44453, Aug. 23, 1993, as 
amended by T.D. 8538, 59 FR 24046, May 10, 1994; T.D. 8476, 59 FR 24351, 
May 11, 1994; T.D. 8718, 62 FR 25512, May 9, 1997]



Sec. 1.148-11  Effective dates.

    (a) In general. Except as otherwise provided in this section, 
Sec. Sec. 1.148-1 through 1.148-11 apply to bonds sold on or after July 
8, 1997.
    (b) Elective retroactive application in whole--(1) In general. 
Except as otherwise provided in this section, and subject to the 
applicable effective dates for the corresponding statutory provisions, 
an issuer may apply the provisions of Sec. Sec. 1.148-1 through 1.148-
11 in whole, but not in part, to any issue that is outstanding on July 
8, 1997, and is subject to section 148(f) or to sections 103(c)(6) or 
103A(i) of the Internal Revenue Code of 1954, in lieu of otherwise 
applicable regulations under those sections.
    (2) No elective retroactive application for 18-month spending 
exception. The provisions of Sec. 1.148-7(d) (relating to the 18-month 
spending exception) may not be applied to any issue issued on or before 
June 30, 1993.
    (3) No elective retroactive application for hedges of fixed rate 
issues. The provisions of Sec. 1.148-4(h)(2)(i)(B) (relating to hedges 
of fixed rate issues) may not be applied to any bond sold on or before 
July 8, 1997.
    (4) No elective retroactive application for safe harbor for 
establishing fair market value for guaranteed investment contracts and 
investments purchased for a yield restricted defeasance escrow. The 
provisions of Sec. Sec. 1.148-5(d)(6)(iii) (relating to the safe harbor 
for establishing fair market value of guaranteed investment contracts 
and yield restricted defeasance escrow investments) and 1.148-
5(e)(2)(iv) (relating to a special rule for yield restricted defeasance 
escrow investments) may not be applied to any bond sold before December 
30, 1998.
    (c) Elective retroactive application of certain provisions and 
special rules--(1) Retroactive application of overpayment recovery 
provisions. An issuer may apply the provisions of Sec. 1.148-3(i) to 
any issue that is subject to section 148(f) or to sections 103(c)(6) or 
103A(i) of the Internal Revenue Code of 1954.
    (2) Certain allocations of multipurpose issues. An allocation of 
bonds to a refunding purpose under Sec. 1.148-9(h) may be adjusted as 
necessary to reflect allocations made between May 18, 1992, and August 
15, 1993, if the allocations satisfied the corresponding prior provision 
of Sec. 1.148-11(j)(4) under applicable prior regulations.
    (3) Special limitation. The provisions of Sec. 1.148-9 apply to 
issues issued before August 15, 1993, only if the issuer in good faith 
estimates the present value savings, if any, associated with the effect 
of the application of that section on refunding escrows, using any 
reasonable accounting method, and applies those savings, if any, to 
redeem outstanding tax-exempt bonds of the applicable issue at the 
earliest possible date on which those bonds may be redeemed or otherwise 
retired. These savings are not reduced to take into account any 
administrative costs associated with applying these provisions 
retroactively.
    (d) Transition rule excepting certain state guarantee funds from the 
definition of replacement proceeds--(1) Certain perpetual trust funds. A 
guarantee by a fund created and controlled by a State and established 
pursuant to its constitution does not cause the amounts in the fund to 
be pledged funds treated as replacement proceeds if--
    (i) Substantially all of the corpus of the fund consists of 
nonfinancial assets, revenues derived from these assets, gifts, and 
bequests;
    (ii) The corpus of the guarantee fund may be invaded only to support 
specifically designated essential governmental functions (designated 
functions) carried on by political subdivisions with general taxing 
powers;
    (iii) Substantially all of the available income of the fund is 
required to be applied annually to support designated functions;

[[Page 748]]

    (iv) The issue guaranteed consists of general obligations that are 
not private activity bonds substantially all of the proceeds of which 
are to be used for designated functions;
    (v) The fund satisfied each of the requirements of paragraphs 
(d)(1)(i) through (d)(1)(iii) of this section on August 16, 1986; and
    (vi) The guarantee is not attributable to a deposit to the fund made 
after May 14, 1989, unless--
    (A) The deposit is attributable to the sale or other disposition of 
fund assets; or
    (B) Prior to the deposit, the outstanding amount of the bonds 
guaranteed by the fund did not exceed 250 percent of the lower of the 
cost or fair market value of the fund.
    (2) Permanent University Fund. Replacement proceeds do not include 
amounts allocable to investments of the fund described in section 648 of 
Public Law 98-369.
    (e) Transition rule regarding special allowance payments. Section 
1.148-5(b)(5) applies to any bond issued after January 5, 1990, except a 
bond issued exclusively to refund a bond issued before January 6, 1990, 
if the amount of the refunding bond does not exceed 101 percent of the 
amount of the refunded bond, and the maturity date of the refunding bond 
is not later than the date that is 17 years after the date on which the 
refunded bond was issued (or, in the case of a series of refundings, the 
date on which the original bond was issued), but only if Sec. 1.148-
2(d)(2)(iv) is applied by substituting 1 and one-half percentage points 
for 2 percentage points.
    (f) Transition rule regarding applicability of yield reduction rule. 
Section 1.148-5(c) applies to nonpurpose investments allocable to 
replacement proceeds of an issue that are held in a reserve or 
replacement fund to the extent that--
    (1) Amounts must be paid into the fund under a constitutional 
provision, statute, or ordinance adopted before May 3, 1978;
    (2) Under that provision, amounts paid into the fund (and investment 
earnings thereon) can be used only to pay debt service on the issues; 
and
    (3) The size of the payments made into the fund is independent of 
the size of the outstanding issues or the debt service thereon.
    (g) Provisions applicable to certain bonds sold before effective 
date. Except for bonds to which paragraph (b)(1) of this section 
applies--
    (1) Section 1.148-11A provides rules applicable to bonds sold after 
June 6, 1994, and before July 8, 1997; and
    (2) Sections 1.148-1 through 1.148-11 as in effect on July 1, 1993 
(see 26 CFR part 1 as revised April 1, 1994), and Sec. 1.148-11A(i) 
(relating to elective retroactive application of certain provisions) 
provide rules applicable to certain issues issued before June 7, 1994.
    (h) Safe harbor for establishing fair market value for guaranteed 
investment contracts and investments purchased for a yield restricted 
defeasance escrow. The provisions of Sec. 1.148-5(d)(6)(iii) are 
applicable to bonds sold on or after March 1, 1999. Issuers may apply 
these provisions to bonds sold on or after December 30, 1998, and before 
March 1, 1999.
    (i) Special rule for certain broker's commissions and similar fees. 
Section 1.148-5(e)(2)(iii) applies to bonds sold on or after February 9, 
2004. In the case of bonds sold before February 9, 2004, that are 
subject to Sec. 1.148-5 (pre-effective date bonds), issuers may apply 
Sec. 1.148-5(e)(2)(iii), in whole but not in part, with respect to 
transactions entered into on or after December 11, 2003. If an issuer 
applies Sec. 1.148-5(e)(2)(iii) to pre-effective date bonds, the per-
issue safe harbor in Sec. 1.148-5(e)(2)(iii)(B)(1)(ii) is applied by 
taking into account all brokers' commissions or similar fees with 
respect to guaranteed investment contracts and investments for yield 
restricted defeasance escrows that the issuer treats as qualified 
administrative costs for the issue, including all such commissions or 
fees paid before February 9, 2004. For purposes of Sec. Sec. 1.148-
5(e)(2)(iii)(B)(3) and 1.148-5(e)(2)(iii)(B)(6) (relating to cost-of-
living adjustments), transactions entered into before 2003 are treated 
as entered into in 2003.
    (j) Certain prepayments. Section 1.148-1(e)(1) and (2) apply to 
bonds sold on or after October 3, 2003. Issuers may apply Sec. 1.148-
1(e)(1) and (2), in whole but not

[[Page 749]]

in part, to bonds sold before October 3, 2003, that are subject to Sec. 
1.148-1.

[T.D. 8476, 58 FR 33547, June 18, 1993; 58 FR 44453, Aug. 23, 1993, as 
amended by T.D. 8538, 59 FR 24046, May 10, 1994; T.D. 8718, 62 FR 25512, 
May 9, 1997; T.D. 8476, 64 FR 37037, July 9, 1999; T.D. 9085, 68 FR 
45777, Aug. 4, 2003; T.D. 9097, 68 FR 69023, Dec. 11, 2003]



Sec. 1.149(b)-1  Federally guaranteed bonds.

    (a) General rule. Under section 149(b) and this section, nothing in 
section 103(a) or in any other provision of law shall be construed to 
provide an exemption from Federal income tax for interest on any bond 
issued as part of an issue that is federally guaranteed.
    (b) Exceptions. Pursuant to section 149(b)(3)(B), section 149(b)(1) 
and paragraph (a) of this section do not apply to--
    (1) Investments in obligations issued pursuant to Sec. 21B(d)(3) of 
the Federal Home Loan Bank Act, as amended by Sec. 511 of the Financial 
Institutions Reform, Recovery, and Enforcement Act of 1989, or any 
successor provision; or
    (2) Any investments that are held in a refunding escrow (as defined 
in Sec. 1.148-1).
    (c) Effective date. This section applies to investments made after 
June 30, 1993.

[T.D. 8476, 58 FR 33548, June 18, 1993]



Sec. 1.149(d)-1  Limitations on advance refundings.

    (a) General rule. Under section 149(d) and this section, nothing in 
section 103(a) or in any other provision of law shall be construed to 
provide an exemption from Federal income tax for interest on any bond 
issued as part of an issue described in paragraphs (2), (3), or (4) of 
section 149(d).
    (b) Advance refunding issues that employ abusive devices--(1) In 
general. An advance refunding issue employs an abusive device and is 
described in section 149(d)(4) if the issue violates any of the anti-
abuse rules under Sec. 1.148-10.
    (2) Failure to pay required rebate. An advance refunding issue is 
described in section 149(d)(4) if the issue fails to meet the 
requirements of Sec. 1.148-3. This paragraph (b)(2) applies to any 
advance refunding issue issued after August 31, 1986.
    (3) Mixed escrows invested in tax-exempt bonds. An advance refunding 
issue is described in section 149(d)(4) if--
    (i) Any of the proceeds of the issue are invested in a refunding 
escrow in which a portion of the proceeds are invested in tax-exempt 
bonds and a portion of the proceeds are invested in nonpurpose 
investments;
    (ii) The yield on the tax-exempt bonds in the refunding escrow 
exceeds the yield on the issue;
    (iii) The yield on all the investments (including investment 
property and tax-exempt bonds) in the refunding escrow exceeds the yield 
on the issue; and
    (iv) The weighted average maturity of the tax-exempt bonds in the 
refunding escrow is more than 25 percent greater or less than the 
weighted average maturity of the nonpurpose investments in the refunding 
escrow, and the weighted average maturity of nonpurpose investments in 
the refunding escrow is greater than 60 days.
    (4) Tax-exempt conduit loans. For purposes of applying section 
149(d) to a conduit financing issue that finances any conduit loan that 
is a tax-exempt bond, the actual issuer of a conduit financing issue and 
the conduit borrower of that conduit financing issue are treated as 
related parties. Thus, the issue date of the conduit loan does not occur 
prior to the date on which the actual issuer of the conduit financing 
issue sells, exchanges, or otherwise disposes of that conduit loan, and 
the use of the proceeds of the disposition to pay debt service on the 
conduit financing issue causes the conduit loan to be a refunding issue. 
See Sec. 1.148-10(d), Example 4.
    (c) Unrefunded debt service remains eligible for future advance 
refunding. For purposes of section 149(d)(3)(A)(i), any principal or 
interest on a prior issue that has not been paid or provided for by any 
advance refunding issue is treated as not having been advance refunded.
    (d) Application of arbitrage regulations--(1) Application of 
multipurpose issue rules. For purposes of sections 149(d)(2) and 
(3)(A)(i), (ii), and (iii), the provisions of the multipurpose issue 
rule in Sec. 1.148-9(h) apply, except that

[[Page 750]]

the limitation in Sec. 1.148-9(h)(5) is disregarded.
    (2) General mixed escrow rules. For purposes of section 149(d), the 
provisions of Sec. 1.148-9(c) (relating to mixed escrows) apply, except 
that those provisions do not apply for purposes of section 149(d)(2) and 
(d)(3)(A) (i) and (ii) to amounts that were not gross proceeds of the 
prior issue before the issue date of the refunding issue.
    (3) Temporary periods and minor portions. Section 1.148-9(d) and (f) 
contains rules applicable to temporary periods and minor portions for 
advance refunding issues.
    (4) Definitions. Section 1.148-1 applies for purposes of section 
149(d).
    (e) Taxable refundings--(1) In general. Except as provided in 
paragraph (e)(2) of this section, for purposes of section 
149(d)(3)(A)(i), an advance refunding issue the interest on which is not 
excludable from gross income under section 103(a) (i.e., a taxable 
advance refunding issue) is not taken into account. In addition, for 
this purpose, an advance refunding of a taxable issue is not taken into 
account unless the taxable issue is a conduit loan of a tax-exempt 
conduit financing issue.
    (2) Use to avoid section 149(d)(3)(A)(i). A taxable issue is taken 
into account under section 149(d)(3)(A)(i) if it is issued to avoid the 
limitations of that section. For example, in the case of a refunding of 
a tax-exempt issue with a taxable advance refunding issue that is, in 
turn, currently refunded with a tax-exempt issue, the taxable advance 
refunding issue is taken into account under section 149(d)(3)(A)(i) if 
the two tax-exempt issues are outstanding concurrently for more than 90 
days.
    (f) Redemption at first call date--(1) General rule. Under sections 
149(d)(3)(A) (ii) and (iii) (the first call requirement), bonds refunded 
by an advance refunding must be redeemed on their first call date if the 
savings test under section 149(d)(3)(B)(i) (the savings test) is 
satisfied. The savings test is satisfied if the issuer may realize 
present value debt service savings (determined without regard to 
administrative expenses) in connection with the issue of which the 
refunding bond is a part.
    (2) First call date. First call date means the earliest date on 
which a bond may be redeemed (or, if issued before 1986, on the earliest 
date on which that bond may be redeemed at a redemption price not in 
excess of 103 percent of par). If, however, the savings test is not met 
with respect to the date described in the preceding sentence (i.e., 
there are no present value savings if the refunded bonds are retired on 
that date), the first call date is the first date thereafter on which 
the bonds can be redeemed and on which the savings test is met.
    (3) Application of savings test to multipurpose issues. Except as 
otherwise provided in this paragraph (f)(3), the multipurpose issue 
rules in Sec. 1.148-9(h) apply for purposes of the savings test. If any 
separate issue in a multipurpose issue increases the aggregate present 
value debt service savings on the entire multipurpose issue or reduces 
the present value debt service losses on that entire multipurpose issue, 
that separate issue satisfies the savings test.
    (g) Limitation on advance refundings of private activity bonds. 
Under section 149(d)(2) and this section, interest on a bond is not 
excluded from gross income if any portion of the issue of which the bond 
is a part is issued to advance refund a private activity bond (other 
than a qualified 501(c)(3) bond). For this purpose, the term private 
activity bond--
    (1) Includes a qualified bond described in section 141(e) (other 
than a qualified 501(c)(3) bond), regardless of whether the refunding 
issue consists of private activity bonds under Sec. 1.141-13; and
    (2) Does not include a taxable bond.
    (h) Effective dates--(1) In general. Except as provided in this 
paragraph (h), this section applies to bonds issued after June 30, 1993, 
to which Sec. Sec. 1.148-1 through 1.148-11 apply, including conduit 
loans that are treated as issued after June 30, 1993, under paragraph 
(b)(4) of this section. In addition, this section applies to any issue 
to which the election described in Sec. 1.148-11(b)(1) is made.
    (2) Special effective date for paragraph (b)(3). Paragraph (b)(3) of 
this section applies to any advance refunding issue issued after May 28, 
1991.

[[Page 751]]

    (3) Special effective date for paragraph (f)(3). Paragraph (f)(3) of 
this section applies to bonds sold on or after July 8, 1997 and to any 
issue to which the election described in Sec. 1.148-11(b)(1) is made. 
See Sec. 1.148-11A(i) for rules relating to certain bonds sold before 
July 8, 1997.
    (4) Special effective date for paragraph (g). See Sec. 1.141-15 for 
the applicability date of paragraph (g) of this section.

[T.D. 8476, 58 FR 33548, June 18, 1993; 58 FR 44453, Aug. 23, 1993, as 
amended by T.D. 8538, 59 FR 24046, May 10, 1994; T.D. 8718, 62 FR 25513, 
May 9, 1997; T.D. 9234, 70 FR 75035, Dec. 19, 2005]



Sec. 1.149(e)-1  Information reporting requirements for tax-exempt bonds.

    (a) General rule. Interest on a bond is included in gross income 
unless certain information with respect to the issue of which the bond 
is a part is reported to the Internal Revenue Service in accordance with 
the requirements of this section. This section applies to any bond if 
the issue of which the bond is a part is issued after December 31, 1986 
(including any bond issued to refund a bond issued on or before December 
31, 1986).
    (b) Requirements for private activity bonds--(1) In general. If the 
issue of which the bond is a part is an issue of private activity bonds, 
the issuer must comply with the following requirements--
    (i) Not later than the 15th day of the second calendar month after 
the close of the calendar quarter in which the issue is issued, the 
issuer must file with the Internal Revenue Service a completed 
information reporting form prescribed for this purpose;
    (ii) If any bond that is part of the issue is taken into account 
under section 146 (relating to volume cap on private activity bonds), 
the state certification requirement of paragraph (b)(2) of this section 
must be satisfied; and
    (iii) If any bond that is part of the issue is a qualified mortgage 
bond or qualified veterans' mortgage bond (within the meaning of section 
143 (a) or (b) or section 103A(c) (1) or (3) as in effect on the day 
before enactment of the Tax Reform Act of 1986), the issuer must submit 
the annual report containing information on the borrowers of the 
original proceeds of the issue as required under Sec. 1.103A-2 
(k)(2)(ii) and (k)(3) through (k)(6).
    (2) State certification with respect to volume cap--(i) In general. 
If an issue is subject to the volume cap under section 146, a state 
official designated by state law (if there is no such official, then the 
governor or the governor's delegate) must certify that the issue meets 
the requirements of section 146, and a copy of this certification must 
be attached to the information reporting form filed with respect to the 
issue. In the case of any constitutional home rule city (as defined in 
section 146(d)(3)(C)), the preceding sentence is applied by substituting 
``city'' for ``state'' and ``chief executive officer'' for ``governor.''
    (ii) Certification. The certifying official need not perform an 
independent investigation in order to certify that the issue meets the 
requirements of section 146. For example, if the certifying official 
receives an affidavit that was executed by an officer of the issuer who 
is responsible for issuing the bonds and that sets forth, in brief and 
summary terms, the facts necessary to determine that the issue meets the 
requirements of section 146 and if the certifying official has compared 
the information in that affidavit to other readily available information 
with respect to that issuer (e.g., previous affidavits and 
certifications for other private activity bonds issued by that issuer), 
the certifying official may rely on the affidavit.
    (c) Requirements for governmental bonds--(1) Issue price of $100,000 
or more. If the issue of which the bond is a part has an issue price of 
$100,000 or more and is not an issue of private activity bonds, then, 
not later than the 15th day of the second calendar month after the close 
of the calendar quarter in which the issue is issued, the issuer must 
file with the Internal Revenue Service a completed information reporting 
form prescribed for this purpose.
    (2) Issue price of less than $100,000--(i) In general. If the issue 
of which the bond is a part has an issue price of less than $100,000 and 
is not an issue of private activity bonds, the issuer must file with the 
Internal Revenue Service

[[Page 752]]

one of the following information reporting forms within the prescribed 
period--
    (A) Separate return. Not later than the 15th day of the second 
calendar month after the close of the calendar quarter in which the 
issue is issued, a completed information reporting form prescribed for 
this purpose with respect to that issue; or
    (B) Consolidated return. Not later than February 15 of the calendar 
year following the calendar year in which the issue is issued, a 
completed information form prescribed for this purpose with respect to 
all issues to which this paragraph (c)(2) applies that were issued by 
the issuer during the calendar year and for which information was not 
reported on a separate information return pursuant to paragraph 
(c)(2)(i)(A) of this section.
    (ii) Bond issues issued before January 1, 1992. Paragraph 
(c)(2)(i)(A) of this section does not apply if the issue of which the 
bond is a part is issued before January 1, 1992.
    (iii) Extended filing date for first and second calendar quarters of 
1992. If the issue of which the bond is a part is issued during the 
first or second calendar quarter of 1992, the prescribed period for 
filing an information reporting form with respect to that issue pursuant 
to paragraph (c)(2)(i)(A) of this section is extended until November 16, 
1992.
    (d) Filing of forms and special rules--(1) Completed form. For 
purposes of this section--
    (i) Good faith effort. An information reporting form is treated as 
completed if the issuer (or a person acting on behalf of the issuer) has 
made a good faith effort to complete the form (taking into account the 
instructions to the form).
    (ii) Information. In general, information reporting forms filed 
pursuant to this section must be completed on the basis of available 
information and reasonable expectations as of the date the issue is 
issued. Forms that are filed on a consolidated basis pursuant to 
paragraph (c)(2)(i)(B) of this section, however, may be completed on the 
basis of information readily available to the issuer at the close of the 
calendar year to which the form relates, supplemented by estimates made 
in good faith.
    (iii) Certain information not required. An issuer need not report to 
the Internal Revenue Service any information specified in the first 
sentence of section 149(e)(2) that is not required to be reported to the 
Internal Revenue Service pursuant to the information reporting forms 
prescribed under that section and the instructions to those forms.
    (2) Manner of filing--(i) Place for filing. The information 
reporting form must be filed with the Internal Revenue Service at the 
address specified on the form or in the instructions to the form.
    (ii) Extension of time. The Commissioner may grant an extension of 
time to file any form or attachment required under this section if the 
Commissioner determines that the failure to file in a timely manner was 
not due to willful neglect. The Commissioner may make this determination 
with respect to an issue or to a class of issues.
    (e) Definitions. For purposes of this section only--(1) Private 
activity bond. The term ``private activity bond'' has the meaning given 
that term in section 141(a) of the Internal Revenue Code, except that 
the term does not include any bond described in section 1312(c) of the 
Tax Reform Act of 1986 to which section 1312 or 1313 of the Tax Reform 
Act of 1986 applies.
    (2) Issue--(i) In general. Except as otherwise provided in this 
paragraph (e)(2), bonds are treated as part of the same issue only if 
the bonds are issued--
    (A) By the same issuer;
    (B) On the same date; and
    (C) Pursuant to a single transaction or to a series of related 
transactions.
    (ii) Draw-down loans, commercial paper, etc. (A) Bonds issued during 
the same calendar year may be treated as part of the same tissue if the 
bonds are issued--
    (1) Pursuant to a loan agreement under which amounts are to be 
advanced periodically (``draw-down loan''); or
    (2) With a term not exceeding 270 days.
    (B) In addition, the bonds must be equally and ratably secured under 
a single indenture or loan agreement and issued pursuant to a common 
financing arrangement (e.g., pursuant to the

[[Page 753]]

same official statement that is periodically updated to reflect changing 
factual circumstances). In the case of bonds issued pursuant to a draw-
down loan that meets the requirements of the preceding sentence, bonds 
issued during different calendar years may be treated as part of the 
same issue if all the amounts to be advanced pursuant to the draw-down 
loan are reasonably expected to be advanced within three years of the 
date of issue of the first bond.
    (iii) Leases and installment sales. Bonds other than private 
activity bonds may be treated as part of the same issue if--
    (A) The bonds are issued pursuant to a single agreement that is in 
the form of a lease or installment sales agreement; and
    (B) All of the property covered by that agreement is reasonably 
expected to be delivered within three years of the date of issue of the 
first bond.
    (iv) Qualified 501(c)(3) bonds. If an issuer elects under section 
141(b)(9) to treat a portion of an issue as a qualified 501(c)(3) bond, 
that portion is treated as a separate issue.
    (3) Date of issue--(i) Bond. The date of issue of a bond is 
determined under Sec. 1.150-1.
    (ii) Issue. The date of issue of an issue of bonds is the date of 
issue of the first bond that is part of the issue. See paragraphs (e)(2) 
(ii) and (iii) of this section for rules relating to draw-down loans, 
commercial paper, etc., and leases and installment sales.
    (iii) Bonds to which prior law applied. Notwithstanding the 
provisions of this paragraph (e)(3), an issue for which an information 
report was required to be filed under section 103(l) or section 
103A(j)(3) is treated as issued prior to January 1, 1987.
    (4) Issue price. The term ``issue price'' has the same meaning given 
the term under Sec. 1.148-1(b).

[T.D. 8425, 57 FR 36002, Aug. 12, 1992, as amended by T.D. 8425, 59 FR 
24351, May 11, 1994]



Sec. 1.149(g)-1  Hedge bonds.

    (a) Certain definitions. Except as otherwise provided, the 
definitions set forth in Sec. 1.148-1 apply for purposes of section 
149(g) and this section. In addition, the following terms have the 
following meanings:
    Reasonable expectations means reasonable expectations (as defined in 
Sec. 1.148-1), as modified to take into account the provisions of 
section 149(f)(2)(B).
    Spendable proceeds means net sale proceeds (as defined in Sec. 
1.148-1).
    (b) Applicability of arbitrage allocation and accounting rules. 
Section 1.148-6 applies for purposes of section 149(g), except that an 
expenditure that results in the creation of replacement proceeds (other 
than amounts in a bona fide debt service fund or a reasonably required 
reserve or replacement fund) is not an expenditure for purposes of 
section 149(g).
    (c) Refundings--(1) Investment in tax-exempt bonds. A bond issued to 
refund a bond that is a tax-exempt bond by virtue of the rule in section 
149(g)(3)(B) is not a tax-exempt bond unless the gross proceeds of that 
refunding bond (other than proceeds in a refunding escrow for the 
refunded bond) satisfy the requirements of section 149(g)(3)(B).
    (2) Anti-abuse rule. A refunding bond is treated as a hedge bond 
unless there is a significant governmental purpose for the issuance of 
that bond (e.g., an advance refunding bond issued to realize debt 
service savings or to relieve the issuer of significantly burdensome 
document provisions, but not to otherwise hedge against future increases 
in interest rates).
    (d) Effective date. This section applies to bonds issued after June 
30, 1993 to which Sec. Sec. 1.148-1 through 1.148-11 apply. In 
addition, this section applies to any issue to which the election 
described in Sec. 1.148-11(b)(1) is made.

[T.D. 8476, 58 FR 33549, June 18, 1993]



Sec. 1.150-1  Definitions.

    (a) Scope and effective date--(1) In general. Except as otherwise 
provided, the definitions in this section apply for all purposes of 
sections 103 and 141 through 150.
    (2) Effective date--(i) In general. Except as otherwise provided in 
this paragraph (a)(2), this section applies to issues issued after June 
30, 1993 to which Sec. Sec. 1.148-1 through 1.148-11 apply. In 
addition, this section (other than paragraph (c)(3) of this section) 
applies

[[Page 754]]

to any issue to which the election described in Sec. 1.148-11(b)(1) is 
made.
    (ii) Special effective date for paragraphs (c)(1), (c)(4)(iii), and 
(c)(6). Paragraphs (c)(1), (c)(4)(iii), and (c)(6) of this section apply 
to bonds sold on or after July 8, 1997 and to any issue to which the 
election described in Sec. 1.148-11(b)(1) is made. See Sec. 1.148-
11A(i) for rules relating to certain bonds sold before July 8, 1997.
    (3) Exceptions to general effective date. See Sec. 1.141-15 for the 
applicability date of the definition of bond documents contained in 
paragraph (b) of this section and the effective date of paragraph 
(c)(3)(ii) of this section.
    (b) Certain general definitions. The following definitions apply:
    Bond means any obligation of a State or political subdivision 
thereof under section 103(c)(1).
    Bond documents means the bond indenture or resolution, transcript of 
proceedings, and any related documents.
    Capital expenditure means any cost of a type that is properly 
chargeable to capital account (or would be so chargeable with a proper 
election or with the application of the definition of placed in service 
under Sec. 1.150-2(c)) under general Federal income tax principles. For 
example, costs incurred to acquire, construct, or improve land, 
buildings, and equipment generally are capital expenditures. Whether an 
expenditure is a capital expenditure is determined at the time the 
expenditure is paid with respect to the property. Future changes in law 
do not affect whether an expenditure is a capital expenditure.
    Conduit borrower means the obligor on a purpose investment (as 
defined in Sec. 1.148-1). For example, if an issuer invests proceeds in 
a purpose investment in the form of a loan, lease, installment sale 
obligation, or similar obligation to another entity and the obligor uses 
the proceeds to carry out the governmental purpose of the issue, the 
obligor is a conduit borrower.
    Conduit financing issue means an issue the proceeds of which are 
used or are reasonably expected to be used to finance at least one 
purpose investment representing at least one conduit loan to one conduit 
borrower.
    Conduit loan means a purpose investment (as defined in Sec. 1.148-
1).
    Governmental bond means any bond of an issue of tax-exempt bonds in 
which none of the bonds are private activity bonds.
    Issuance costs means costs to the extent incurred in connection 
with, and allocable to, the issuance of an issue within the meaning of 
section 147(g). For example, issuance costs include the following costs 
but only to the extent incurred in connection with, and allocable to, 
the borrowing: underwriters' spread; counsel fees; financial advisory 
fees; rating agency fees; trustee fees; paying agent fees; bond 
registrar, certification, and authentication fees; accounting fees; 
printing costs for bonds and offering documents; public approval process 
costs; engineering and feasibility study costs; guarantee fees, other 
than for qualified guarantees (as defined in Sec. 1.148-4(f)); and 
similar costs.
    Issue date means, in reference to an issue, the first date on which 
the issuer receives the purchase price in exchange for delivery of the 
evidence of indebtedness representing any bond included in the issue. 
Issue date means, in reference to a bond, the date on which the issuer 
receives the purchase price in exchange for that bond. In no event is 
the issue date earlier than the first day on which interest begins to 
accrue on the bond or bonds for Federal income tax purposes.
    Obligation means any valid evidence of indebtedness under general 
Federal income tax principles.
    Pooled financing issue means an issue the proceeds of which are to 
be used to finance purpose investments representing conduit loans to two 
or more conduit borrowers, unless those conduit loans are to be used to 
finance a single capital project.
    Private activity bond means a private activity bond (as defined in 
section 141).
    Qualified mortgage loan means a mortgage loan with respect to an 
owner-occupied residence acquired with the proceeds of an obligation 
described in section 143(a)(1) or 143(b) (or applicable prior law).
    Qualified student loan means a student loan acquired with the 
proceeds of

[[Page 755]]

an obligation described in section 144(b)(1).
    Related party means, in reference to a governmental unit or a 
501(c)(3) organization, any member of the same controlled group, and, in 
reference to any person that is not a governmental unit or 501(c)(3) 
organization, a related person (as defined in section 144(a)(3)).
    Taxable bond means any obligation the interest on which is not 
excludable from gross income under section 103.
    Tax-exempt bond means any bond the interest on which is excludable 
from gross income under section 103(a). For purposes of section 148, 
tax-exempt bond includes:
    (1) An interest in a regulated investment company to the extent that 
at least 95 percent of the income to the holder of the interest is 
interest that is excludable from gross income under section 103; and
    (2) A certificate of indebtedness issued by the United States 
Treasury pursuant to the Demand Deposit State and Local Government 
Series program described in 31 CFR part 344.
    Working capital expenditure means any cost that is not a capital 
expenditure. Generally, current operating expenses are working capital 
expenditures.
    (c) Definition of issue--(1) In general. Except as otherwise 
provided in this paragraph (c), the term issue means two or more bonds 
that meet all of the following requirements:
    (i) Sold at substantially the same time. The bonds are sold at 
substantially the same time. Bonds are treated as sold at substantially 
the same time if they are sold less than 15 days apart.
    (ii) Sold pursuant to the same plan of financing. The bonds are sold 
pursuant to the same plan of financing. Factors material to the plan of 
financing include the purposes for the bonds and the structure of the 
financing. For example, generally--
    (A) Bonds to finance a single facility or related facilities are 
part of the same plan of financing;
    (B) Short-term bonds to finance working capital expenditures and 
long-term bonds to finance capital projects are not part of the same 
plan of financing; and
    (C) Certificates of participation in a lease and general obligation 
bonds secured by tax revenues are not part of the same plan of 
financing.
    (iii) Payable from same source of funds. The bonds are reasonably 
expected to be paid from substantially the same source of funds, 
determined without regard to guarantees from parties unrelated to the 
obligor.
    (2) Exception for taxable bonds. Taxable bonds and tax-exempt bonds 
are not part of the same issue under this paragraph (c). The issuance of 
tax-exempt bonds in a transaction (or series of related transactions) 
that includes taxable bonds, however, may constitute an abusive 
arbitrage device under Sec. 1.148-10(a) or a device to avoid other 
limitations in sections 103 and 141 through 150 (for example, structures 
involving windows or unreasonable allocations of bonds).
    (3) Exception for certain bonds financing separate purposes--(i) In 
general. Bonds may be treated as part of separate issues if the 
requirements of this paragraph (c)(3) are satisfied. Each of these 
separate issues must finance a separate purpose (e.g., refunding a 
separate prior issue, financing a separate purpose investment, financing 
integrated or functionally related capital projects, and financing any 
clearly discrete governmental purpose). Each of these separate issues 
independently must be a tax-exempt bond (e.g., a governmental bond or a 
qualified mortgage bond). The aggregate proceeds, investments, and bonds 
in such a transaction must be allocated between each of the separate 
issues using a reasonable, consistently applied allocation method. If 
any separate issue consists of refunding bonds, the allocation rules in 
Sec. 1.148-9(h) must be satisfied. An allocation is not reasonable if 
it achieves more favorable results under sections 103 and 141 to 150 
than could be achieved with actual separate issues. All allocations 
under this paragraph (c)(3) must be made in writing on or before the 
issue date.
    (ii) Exceptions. This paragraph (c)(3) does not apply for purposes 
of sections 141, 144(a), 148, 149(d) and 149(g).
    (4) Special rules for certain financings--(i) Draw-down loans. Bonds 
issued pursuant to a draw-down loan are treated

[[Page 756]]

as part of a single issue. The issue date of that issue is the first 
date on which the aggregate draws under the loan exceed the lesser of 
$50,000 or 5 percent of the issue price.
    (ii) Commercial paper--(A) In general. Short-term bonds having a 
maturity of 270 days or less (commercial paper) issued pursuant to the 
same commercial paper program may be treated as part of a single issue, 
the issue date of which is the first date the aggregate amount of 
commercial paper issued under the program exceeds the lesser of $50,000 
or 5 percent of the aggregate issue price of the commercial paper in the 
program. A commercial paper program is a program to issue commercial 
paper to finance or refinance the same governmental purpose pursuant to 
a single master legal document. Commercial paper is not part of the same 
commercial paper program unless issued during an 18-month period, 
beginning on the deemed issue date. In addition, commercial paper issued 
after the end of this 18-month period may be treated as part of the 
program to the extent issued to refund commercial paper that is part of 
the program, but only to the extent that--
    (1) There is no increase in the principal amount outstanding; and
    (2) The program does not have a term in excess of--
    (i) 30 years; or
    (ii) The period reasonably necessary for the governmental purposes 
of the program.
    (B) Safe harbor. The requirement of paragraph (c)(4)(ii)(A)(2) of 
this section is treated as satisfied if the weighted average maturity of 
the issue does not exceed 120 percent of the weighted average expected 
economic life of the property financed by the issue.
    (iii) Certain general obligation bonds. Except as otherwise provided 
in paragraph (c)(2) of this section, bonds that are secured by a pledge 
of the issuer's full faith and credit (or a substantially similar 
pledge) and sold and issued on the same dates pursuant to a single 
offering document may be treated as part of the same issue if the issuer 
so elects on or before the issue date.
    (5) Anti-abuse rule. In order to prevent the avoidance of sections 
103 and 141 through 150 and the general purposes thereof, the 
Commissioner may treat bonds as part of the same issue or as part of 
separate issues to clearly reflect the economic substance of a 
transaction.
    (6) Sale date. The sale date of a bond is the first day on which 
there is a binding contract in writing for the sale or exchange of the 
bond.
    (d) Definition of refunding issue and related definitions--(1) 
General definition of refunding issue. Refunding issue means an issue of 
obligations the proceeds of which are used to pay principal, interest, 
or redemption price on another issue (a prior issue, as more 
particularly defined in paragraph (d)(5) of this section), including the 
issuance costs, accrued interest, capitalized interest on the refunding 
issue, a reserve or replacement fund, or similar costs, if any, properly 
allocable to that refunding issue.
    (2) Exceptions and special rules. For purposes of paragraph (d)(1) 
of this section, the following exceptions and special rules apply--
    (i) Payment of certain interest. An issue is not a refunding issue 
if the only principal and interest that is paid with proceeds of the 
issue (determined without regard to the multipurpose issue rules of 
Sec. 1.148-9(h)) is interest on another issue that--
    (A) Accrues on the other issue during a one-year period including 
the issue date of the issue that finances the interest;
    (B) Is a capital expenditure; or
    (C) Is a working capital expenditure to which the de minimis rule of 
Sec. 1.148-6(d)(3)(ii)(A) applies.
    (ii) Certain issues with different obligors--(A) In general. An 
issue is not a refunding issue to the extent that the obligor (as 
defined in paragraph (d)(2)(ii)(B) of this section) of one issue is 
neither the obligor of the other issue nor a related party with respect 
to the obligor of the other issue.
    (B) Definition of obligor. The obligor of an issue means the actual 
issuer of the issue, except that the obligor of the portion of an issue 
properly allocable to an investment in a purpose investment means the 
conduit borrower under that purpose investment. The obligor of an issue 
used to finance qualified mortgage loans, qualified student

[[Page 757]]

loans, or similar program investments (as defined in Sec. 1.148-1) does 
not include the ultimate recipient of the loan (e.g., the homeowner, the 
student).
    (iii) Certain special rules for purpose investments. For purposes of 
this paragraph (d), the following special rules apply:
    (A) Refunding of a conduit financing issue by a conduit loan 
refunding issue. Except as provided in paragraph (d)(2)(iii)(B) of this 
section, the use of the proceeds of an issue that is used to refund an 
obligation that is a purpose investment (a conduit refunding issue) by 
the actual issuer of the conduit financing issue determines whether the 
conduit refunding issue is a refunding of the conduit financing issue 
(in addition to a refunding of the obligation that is the purpose 
investment).
    (B) Recycling of certain payments under purpose investments. A 
conduit refunding issue is not a refunding of a conduit financing issue 
to the extent that the actual issuer of the conduit financing issue 
reasonably expects as of the date of receipt of the proceeds of the 
conduit refunding issue to use those amounts within 6 months (or, if 
greater, during the applicable temporary period for those amounts under 
section 148(c) or under applicable prior law) to acquire a new purpose 
investment. Any new purpose investment is treated as made from the 
proceeds of the conduit financing issue.
    (C) Application to tax-exempt loans. For purposes of this paragraph 
(d), obligations that would be purpose investments (absent section 
148(b)(3)(A)) are treated as purpose investments.
    (iv) Substance of transaction controls. In the absence of other 
applicable controlling rules under this paragraph (d), the determination 
of whether an issue is a refunding issue is based on the substance of 
the transaction in light of all the facts and circumstances.
    (v) Certain integrated transactions in connection with asset 
acquisition not treated as refunding issues. If, within six months 
before or after a person assumes (including taking subject to) 
obligations of an unrelated party in connection with an asset 
acquisition (other than a transaction to which section 381(a) applies if 
the person assuming the obligation is the acquiring corporation within 
the meaning of section 381(a)), the assumed issue is refinanced, the 
refinancing issue is not treated as a refunding issue.
    (3) Current refunding issue. Current refunding issue means:
    (i) Except as provided in paragraph (d)(3)(ii) of this section, a 
refunding issue that is issued not more than 90 days before the last 
expenditure of any proceeds of the refunding issue for the payment of 
principal or interest on the prior issue; and
    (ii) In the case of a refunding issue issued before 1986--
    (A) A refunding issue that is issued not more than 180 days before 
the last expenditure of any proceeds of the refunding issue for the 
payment of principal or interest on the prior issue; or
    (B) A refunding issue if the prior issue had a term of less than 3 
years and was sold in anticipation of permanent financing, but only if 
the aggregate term of all prior issues sold in anticipation of permanent 
financing was less than 3 years.
    (4) Advance refunding issue. Advance refunding issue means a 
refunding issue that is not a current refunding issue.
    (5) Prior issue. Prior issue means an issue of obligations all or a 
portion of the principal, interest, or call premium on which is paid or 
provided for with proceeds of a refunding issue. A prior issue may be 
issued before, at the same time as, or after a refunding issue. If the 
refunded and unrefunded portions of a prior issue are treated as 
separate issues under Sec. 1.148-9(i), for the purposes for which that 
section applies, except to the extent that the context clearly requires 
otherwise, references to a prior issue refer only to the refunded 
portion of that prior issue.
    (e) Controlled group means a group of entities controlled directly 
or indirectly by the same entity or group of entities within the meaning 
of this paragraph (e).
    (1) Direct control. The determination of direct control is made on 
the basis of all the relevant facts and circumstances. One entity or 
group of entities (the controlling entity) generally controls another 
entity or group of entities (the controlled entity) for purposes of this 
paragraph if the controlling entity possesses either of the following

[[Page 758]]

rights or powers and the rights or powers are discretionary and non-
ministerial--
    (i) The right or power both to approve and to remove without cause a 
controlling portion of the governing body of the controlled entity; or
    (ii) The right or power to require the use of funds or assets of the 
controlled entity for any purpose of the controlling entity.
    (2) Indirect control. If a controlling entity controls a controlled 
entity under the test in paragraph (e)(1) of this section, then the 
controlling entity also controls all entities controlled, directly or 
indirectly, by the controlled entity or entities.
    (3) Exception for general purpose governmental entities. An entity 
is not a controlled entity under this paragraph (e) if the entity 
possesses substantial taxing, eminent domain, and police powers. For 
example, a city possessing substantial amounts of each of these 
sovereign powers is not a controlled entity of the state.

[T.D. 8476, 58 FR 33549, June 18, 1993; 58 FR 44453, Aug. 23, 1993, as 
amended by T.D. 8538, 59 FR 24046, May 10, 1994; T.D. 8712, 62 FR 2304, 
Jan. 16, 1997; T.D. 8718, 62 FR 25513, May 9, 1997; T.D. 9234, 70 FR 
75036, Dec. 19, 2005]



Sec. 1.150-2  Proceeds of bonds used for reimbursement.

    (a) Table of contents. This table of contents contains a listing of 
the headings contained in Sec. 1.150-2.

(a) Table of contents.
(b) Scope.
(c) Definitions.
(d) General operating rules for reimbursement expenditures.
    (1) Official intent.
    (2) Reimbursement period.
    (3) Nature of expenditure.
(e) Official intent rules.
    (1) Form of official intent.
    (2) Project description in official intent.
    (3) Reasonableness of official intent.
(f) Exceptions to general operating rules.
    (1) De minimis exception.
    (2) Preliminary expenditures exception.
(g) Special rules on refundings.
    (1) In general--once financed, not reimbursed.
    (2) Certain proceeds of prior issue used for reimbursement treated 
as unspent.
(h) Anti-abuse rules.
    (1) General rule.
    (2) One-year step transaction rule.
(i) Authority of the Commissioner to prescribe rules.
(j) Effective date.
    (1) In general.
    (2) Transitional rules.

    (b) Scope. This section applies to reimbursement bonds (as defined 
in paragraph (c) of this section) for all purposes of sections 103 and 
141 to 150.
    (c) Definitions. The following definitions apply:
    Issuer means--
    (1) For any private activity bond (excluding a qualified 501(c)(3) 
bond, qualified student loan bond, qualified mortgage bond, or qualified 
veterans' mortgage bond), the entity that actually issues the 
reimbursement bond; and
    (2) For any bond not described in paragraph (1) of this definition, 
either the entity that actually issues the reimbursement bond or, to the 
extent that the reimbursement bond proceeds are to be loaned to a 
conduit borrower, that conduit borrower.
    Official intent means an issuer's declaration of intent to reimburse 
an original expenditure with proceeds of an obligation.
    Original expenditure means an expenditure for a governmental purpose 
that is originally paid from a source other than a reimbursement bond.
    Placed in service means, with respect to a facility, the date on 
which, based on all the facts and circumstances--
    (1) The facility has reached a degree of completion which would 
permit its operation at substantially its design level; and
    (2) The facility is, in fact, in operation at such level.
    Reimbursement allocation means an allocation in writing that 
evidences an issuer's use of proceeds of a reimbursement bond to 
reimburse an original expenditure. An allocation made within 30 days 
after the issue date of a reimbursement bond may be treated as made on 
the issue date.
    Reimbursement bond means the portion of an issue allocated to 
reimburse an original expenditure that was paid before the issue date.
    (d) General operating rules for reimbursement expenditures. Except 
as otherwise provided, a reimbursement allocation is treated as an 
expenditure of proceeds of a reimbursement bond for

[[Page 759]]

the governmental purpose of the original expenditure on the date of the 
reimbursement allocation only if:
    (1) Official intent. Not later than 60 days after payment of the 
original expenditure, the issuer adopts an official intent for the 
original expenditure that satisfies paragraph (e) of this section.
    (2) Reimbursement period--(i) In general. The reimbursement 
allocation is made not later than 18 months after the later of--
    (A) The date the original expenditure is paid; or
    (B) The date the project is placed in service or abandoned, but in 
no event more than 3 years after the original expenditure is paid.
    (ii) Special rule for small issuers. In applying paragraph (d)(2)(i) 
of this section to an issue that satisfies section 148(f)(4)(D)(i) (I) 
through (IV), the ``18 month'' limitation is changed to ``3 years'' and 
the ``3-year'' maximum reimbursement period is disregarded.
    (iii) Special rule for long-term construction projects. In applying 
paragraph (d)(2)(i) to a construction project for which both the issuer 
and a licensed architect or engineer certify that at least 5 years is 
necessary to complete construction of the project, the maximum 
reimbursement period is changed from ``3 years'' to ``5 years.''
    (3) Nature of expenditure. The original expenditure is a capital 
expenditure, a cost of issuance for a bond, an expenditure described in 
Sec. 1.148-6(d)(3)(ii)(B) (relating to certain extraordinary working 
capital items), a grant (as defined in Sec. 1.148-6(d)(4)), a qualified 
student loan, a qualified mortgage loan, or a qualified veterans' 
mortgage loan.
    (e) Official intent rules. An official intent satisfies this 
paragraph (e) if:
    (1) Form of official intent. The official intent is made in any 
reasonable form, including issuer resolution, action by an appropriate 
representative of the issuer (e.g., a person authorized or designated to 
declare official intent on behalf of the issuer), or specific 
legislative authorization for the issuance of obligations for a 
particular project.
    (2) Project description in official intent--(i) In general. The 
official intent generally describes the project for which the original 
expenditure is paid and states the maximum principal amount of 
obligations expected to be issued for the project. A project includes 
any property, project, or program (e.g., highway capital improvement 
program, hospital equipment acquisition, or school building renovation).
    (ii) Fund accounting. A project description is sufficient if it 
identifies, by name and functional purpose, the fund or account from 
which the original expenditure is paid (e.g., parks and recreation 
fund--recreational facility capital improvement program).
    (iii) Reasonable deviations in project description. Deviations 
between a project described in an official intent and the actual project 
financed with reimbursement bonds do not invalidate the official intent 
to the extent that the actual project is reasonably related in function 
to the described project. For example, hospital equipment is a 
reasonable deviation from hospital building improvements. In contrast, a 
city office building rehabilitation is not a reasonable deviation from 
highway improvements.
    (3) Reasonableness of official intent. On the date of the 
declaration, the issuer must have a reasonable expectation (as defined 
in Sec. 1.148-1(b)) that it will reimburse the original expenditure 
with proceeds of an obligation. Official intents declared as a matter of 
course or in amounts substantially in excess of the amounts expected to 
be necessary for the project (e.g., blanket declarations) are not 
reasonable. Similarly, a pattern of failure to reimburse actual original 
expenditures covered by official intents (other than in extraordinary 
circumstances) is evidence of unreasonableness. An official intent 
declared pursuant to a specific legislative authorization is rebuttably 
presumed to satisfy this paragraph (e)(3).
    (f) Exceptions to general operating rules--(1) De minimis exception. 
Paragraphs (d)(1) and (d)(2) of this section do not apply to costs of 
issuance of any bond or to an amount not in excess of the lesser of 
$100,000 or 5 percent of the proceeds of the issue.
    (2) Preliminary expenditures exception. Paragraphs (d)(1) and (d)(2) 
of this section do not apply to any preliminary expenditures, up to an 
amount not in excess of 20 percent of the aggregate

[[Page 760]]

issue price of the issue or issues that finance or are reasonably 
expected by the issuer to finance the project for which the preliminary 
expenditures were incurred. Preliminary expenditures include 
architectural, engineering, surveying, soil testing, reimbursement bond 
issuance, and similar costs that are incurred prior to commencement of 
acquisition, construction, or rehabilitation of a project, other than 
land acquisition, site preparation, and similar costs incident to 
commencement of construction.
    (g) Special rules on refundings--(1) In general--once financed, not 
reimbursed. Except as provided in paragraph (g)(2) of this section, 
paragraph (d) of this section does not apply to an allocation to pay 
principal or interest on an obligation or to reimburse an original 
expenditure paid by another obligation. Instead, such an allocation is 
analyzed under rules on refunding issues. See Sec. 1.148-9.
    (2) Certain proceeds of prior issue used for reimbursement treated 
as unspent. In the case of a refunding issue (or series of refunding 
issues), proceeds of a prior issue purportedly used to reimburse 
original expenditures are treated as unspent proceeds of the prior issue 
unless the purported reimbursement was a valid expenditure under 
applicable law on reimbursement expenditures on the issue date of the 
prior issue.
    (h) Anti-abuse rules--(1) General rule. A reimbursement allocation 
is not an expenditure of proceeds of an issue under this section if the 
allocation employs an abusive arbitrage device under Sec. 1.148-10 to 
avoid the arbitrage restrictions or to avoid the restrictions under 
sections 142 through 147.
    (2) One-year step transaction rule--(i) Creation of replacement 
proceeds. A purported reimbursement allocation is invalid and thus is 
not an expenditure of proceeds of an issue if, within 1 year after the 
allocation, funds corresponding to the proceeds of a reimbursement bond 
for which a reimbursement allocation was made are used in a manner that 
results in the creation of replacement proceeds (as defined in Sec. 
1.148-1) of that issue or another issue. The preceding sentence does not 
apply to amounts deposited in a bona fide debt service fund (as defined 
in Sec. 1.148-1).
    (ii) Example. The provisions of paragraph (h)(2)(i) of this section 
are illustrated by the following example.

    Example. On January 1, 1994, County A issues an issue of 7 percent 
tax-exempt bonds (the 1994 issue) and makes a purported reimbursement 
allocation to reimburse an original expenditure for specified capital 
improvements. A immediately deposits funds corresponding to the proceeds 
subject to the reimbursement allocation in an escrow fund to provide for 
payment of principal and interest on its outstanding 1991 issue of 9 
percent tax-exempt bonds (the prior issue). The use of amounts 
corresponding to the proceeds of the reimbursement bonds to create a 
sinking fund for another issue within 1 year after the purported 
reimbursement allocation invalidates the reimbursement allocation. The 
proceeds retain their character as unspent proceeds of the 7 percent 
issue upon deposit in the escrow fund. Accordingly, the proceeds are 
subject to the 7 percent yield restriction of the 1994 issue instead of 
the 9 percent yield restriction of the prior issue.

    (i) Authority of the Commissioner to prescribe rules. The 
Commissioner may by revenue ruling or revenue procedure (see Sec. 
601.601(d)(2)(ii)(b) of this chapter) prescribe rules for the 
expenditure of proceeds of reimbursement bonds in circumstances that do 
not otherwise satisfy this section.
    (j) Effective date--(1) In general. The provisions of this section 
apply to all allocations of proceeds of reimbursement bonds issued after 
June 30, 1993.
    (2) Transitional rules--(i) Official intent. An official intent is 
treated as satisfying the official intent requirement of paragraph 
(d)(1) of this section if it--
    (A) Satisfied the applicable provisions of Sec. 1.103-8(a)(5) as in 
effect prior to July 1, 1993, (as contained in 26 CFR part 1 revised as 
of April 1, 1993) and was made prior to that date, or
    (B) Satisfied the applicable provisions of Sec. 1.103-18 as in 
effect between January 27, 1992, and June 30, 1993, (as contained in 26 
CFR part 1 revised as of April 1, 1993) and was made during that period.
    (ii) Certain expenditures of private activity bonds. For any 
expenditure that was originally paid prior to August 15, 1993, and that 
would have qualified for expenditure by reimbursement from the proceeds 
of a private activity bond

[[Page 761]]

under T.D. 7199, section 1.103-8(a)(5), 1972-2 C.B. 45 (see Sec. 
601.601(d)(2)(ii)(b)) of this chapter, the requirements of that section 
may be applied in lieu of this section.

[T.D. 8476, 58 FR 33551, June 18, 1993; 58 FR 44453, Aug. 23, 1993]



Sec. 1.150-4  Change in use of facilities financed with tax-exempt 
private activity bonds.

    (a) Scope. This section applies for purposes of the rules for change 
of use of facilities financed with private activity bonds under sections 
150(b)(3) (relating to qualified 501(c)(3) bonds), 150(b)(4) (relating 
to certain exempt facility bonds and small issue bonds), 150(b)(5) 
(relating to facilities required to be owned by governmental units or 
501(c)(3) organizations), and 150(c).
    (b) Effect of remedial actions--(1) In general. Except as provided 
in this section, the change of use provisions of sections 150(b) (3) 
through (5), and 150(c) apply even if the issuer takes a remedial action 
described in Sec. Sec. 1.142-2, 1.144-2, or 1.145-2.
    (2) Exceptions--(i) Redemption. If nonqualified bonds are redeemed 
within 90 days of a deliberate action under Sec. 1.145-2(a) or within 
90 days of the date on which a failure to properly use proceeds occurs 
under Sec. 1.142-2 or Sec. 1.144-2, sections 150(b) (3) through (5) do 
not apply during the period between that date and the date on which the 
nonqualified bonds are redeemed.
    (ii) Alternative qualifying use of facility. If a bond-financed 
facility is used for an alternative qualifying use under Sec. Sec. 
1.145-2 and 1.141-12(f), sections 150(b) (3) and (5) do not apply 
because of the alternative use.
    (iii) Alternative use of disposition proceeds. If disposition 
proceeds are used for a qualifying purpose under Sec. Sec. 1.145-2 and 
1.141-12(e), 1.142-2(c)(4), or 1.144-2, sections 150(b) (3) through (5) 
do not apply because of the deliberate action that gave rise to the 
disposition proceeds after the date on which all of the disposition 
proceeds have been expended on the qualifying purpose. If all of the 
disposition proceeds are so expended within 90 days of the date of the 
deliberate action, however, sections 150(b) (3) through (5) do not apply 
because of the deliberate action.
    (c) Allocation rules--(1) In general. If a change in use of a 
portion of the property financed with an issue of qualified private 
activity bonds causes section 150 (b)(3), (b)(4), or (b)(5) to apply to 
an issue, the bonds of the issue allocable to that portion under section 
150(c)(3) are the same as the nonqualified bonds determined for purposes 
of Sec. Sec. 1.142-1, 1.144-1, and 1.145-1, except that bonds allocable 
to all common areas are also allocated to that portion.
    (2) Special rule when remedial action is taken. If an issuer takes a 
remedial action with respect to an issue of private activity bonds under 
Sec. Sec. 1.142-2, 1.144-2, or 1.145-2, the bonds of the issue 
allocable to a portion of property are the same as the nonqualified 
bonds determined for purposes of those sections.
    (d) Effective dates. For effective dates of this section, see Sec. 
1.141-16.

[T.D. 8712, 62 FR 2304, Jan. 16, 1997]



Sec. 1.150-5  Filing notices and elections.

    (a) In general. Notices and elections under the following sections 
must be filed with the Internal Revenue Service, 1111 Constitution 
Avenue, NW, Attention: T:GE:TEB:O, Washington, DC 20224 or such other 
place designated by publication of a notice in the Internal Revenue 
Bulletin--
    (1) Section 1.141-12(d)(3);
    (2) Section 1.142(f)(4)-1; and
    (3) Section 1.142-2(c)(2).
    (b) Effective dates. This section applies to notices and elections 
filed on or after January 19, 2001.

[T.D. 8941, 66 FR 4671, Jan. 18, 2001]

   Regulations Applicable to Certain Bonds Sold Prior to July 8, 1997

    Editorial Note: IRS redesignated the following sections to appear 
below the undesignated center heading ``Regulations Applicable to 
Certain Bonds Sold Prior to July 8, 1997'' and preceding the 
undesignated center heading ``Deductions for Personal Exemptions.'' See 
62 FR 25507 and 25513, May 9, 1997 for the specific sections involved in 
the redesignation.



Sec. 1.148-1A  Definitions and elections.

    (a) [Reserved]. For guidance see Sec. 1.148-1.
    (b) Certain definitions.

[[Page 762]]

    Investment-type property. See Sec. 1.148-1(b). Investment-type 
property also includes a contract that would be a hedge (within the 
meaning of Sec. 1.148-4(h)) except that it contains a significant 
investment element.
    (c) through (c)(4)(i) [Reserved]. For guidance see Sec. 1.148-1.
    (c)(4)(ii) Bonds financing a working capital reserve--(A) In 
general. Except as otherwise provided in Sec. 1.148-1(c)(4)(ii)(B), 
replacement proceeds arise to the extent a working capital reserve is, 
directly or indirectly, financed with the proceeds of the issue 
(regardless of the expenditure of proceeds of the issue). Thus, for 
example, if an issuer that does not maintain a working capital reserve 
borrows to fund such a reserve, the issuer will have replacement 
proceeds. To determine the amount of a working capital reserve 
maintained, an issuer may use the average amount maintained as a working 
capital reserve during annual periods of at least one year, the last of 
which ends within a year before the issue date. For example, the amount 
of a working capital reserve may be computed using the average of the 
beginning or ending monthly balances of the amount maintained as a 
reserve (net of unexpended gross proceeds) during the one year period 
preceding the issue date.

[T.D. 8538, 59 FR 24041, May 10, 1994. Redesignated by T.D. 8718, 62 FR 
25507, May 9, 1997]



Sec. 1.148-2A  General arbitrage yield restriction rules.

    (a) through (b)(2)(i) [Reserved]. For guidance see Sec. 1.148-2.
    (b)(2)(ii) Exceptions to certification requirement. An issuer is not 
required to make a certification for an issue under Sec. 1.148-
2(b)(2)(i) if--
    (A) The issuer reasonably expects as of the issue date that there 
will be no unspent gross proceeds after the issue date, other than gross 
proceeds in a bona fide debt service fund (e.g., equipment lease 
financings in which the issuer purchases equipment in exchange for an 
installment payment note); or
    (B) The issue price of the issue does not exceed $1,000,000.

[T.D. 8538, 59 FR 24042, May 10, 1994. Redesignated by T.D. 8718, 62 FR 
25507, May 9, 1997]



Sec. 1.148-3A  General arbitrage rebate rules.

    (a) through (h)(2) [Reserved]. For guidance see Sec. 1.148-3.
    (h)(3) Waivers of the penalty. For purposes of Sec. 1.148-3(h)(3), 
willful neglect does not include a failure that is attributable solely 
to the permissible retroactive selection of a short first bond year if 
the rebate amount that the issuer failed to pay is paid within 60 days 
of the selection of that bond year.

[T.D. 8538, 59 FR 24042, May 10, 1994. Redesignated by T.D. 8718, 62 FR 
25507, May 9, 1997]



Sec. 1.148-4A  Yield on an issue of bonds.

    (a) through (b)(4) [Reserved]. For guidance see Sec. 1.148-4.
    (b)(5) Special aggregation rule treating certain bonds as a single 
fixed yield bond. Two variable yield bonds of an issue are treated in 
the aggregate as a single fixed yield bond if--
    (i) Aggregate treatment would result in the single bond being a 
fixed yield bond; and
    (ii) The terms of the bonds do not contain any features that could 
distort the aggregate fixed yield from what the yield would be if a 
single fixed yield bond were issued. For example, if an issue contains a 
bond bearing interest at a floating rate and a related bond bearing 
interest at a rate equal to a fixed rate minus that floating rate, those 
two bonds are treated as a single fixed yield bond only if neither bond 
may be redeemed unless the other bond is also redeemed at the same time.
    (c) through (f) [Reserved]. For guidance see Sec. 1.148-4.
    (g) Yield on certain mortgage revenue and student loan bonds. For 
purposes of section 148 and Sec. 1.148-4, section 143(g)(2)(C)(ii) 
applies to the computation of yield on an issue of qualified mortgage 
bonds or qualified veterans' mortgage bonds. For purposes of applying 
sections 148 and 143(g) to a variable yield issue of qualified mortgage 
bonds, qualified veterans' mortgage bonds, or qualified student loan 
bonds, the yield on that issue is computed over the term of the issue, 
and Sec. 1.148-4(d) does not apply to the issue. As of any date before 
the final maturity date, the yield over the term of the issue is

[[Page 763]]

based on the actual amounts paid or received to that date and the 
amounts that are reasonably expected (as of that date) to be paid or 
received over the remaining term of the issue.
    (h) Qualified hedging transactions--(1) In general. Payments made or 
received by an issuer under a qualified hedge (as defined in Sec. 
1.148-4(h)(2)) relating to bonds of an issue are taken into account (as 
provided in paragraph (h)(3) of this section) to determine the yield on 
the issue. Except as provided in paragraphs (h)(4) and (h)(5)(ii)(C) of 
this section, the bonds to which a qualified hedge relates are treated 
as variable yield bonds. These hedging rules apply solely for purposes 
of sections 143(g), 148, and 149(d).
    (2) (i) through (vi) [Reserved]. For guidance see Sec. 1.148-
4(h)(2).
    (2)(vii) Timing and duration. For a contract to be a qualified hedge 
under Sec. 1.148-4(h)(2), payments must not begin to accrue under the 
contract on a date earlier than the issue date of the hedged bonds and 
must not accrue longer than the hedged interest payments on the hedged 
bonds.
    (viii) [Reserved]. For guidance see Sec. 1.148-4(h).
    (ix) Identification. For a contract to be a qualified hedge under 
Sec. 1.148-4(h)(2), the contract must be identified by the actual 
issuer on its books and records maintained for the hedged bonds not 
later than three days after the date on which the parties enter into the 
contract. The identification must specify the hedge provider, the terms 
of the contract, and the hedged bonds. The identification must contain 
sufficient detail to establish that the requirements of Sec. 1.148-
4(h)(2), and if applicable, paragraph (h)(4) of this section are 
satisfied. The existence of the hedge must be noted on all forms filed 
with the Internal Revenue Service for the issue on or after the date on 
which the hedge is entered into.
    (3) Accounting for qualified hedges--(i) In general. Except as 
otherwise provided in paragraph (h)(4) of this section, payments made or 
received by the issuer under a qualified hedge are treated as payments 
made or received, as appropriate, on the hedged bonds that are taken 
into account in determining the yield on those bonds. These payments are 
reasonably allocated to the hedged bonds in the period to which the 
payments relate, as determined under paragraph (h)(3)(iii) of this 
section. Payments made or received by the issuer include payments deemed 
made or received when a contract is terminated or deemed terminated 
under this paragraph (h)(3). Payments reasonably allocable to the 
reduction of risk of interest rate changes and to the hedge provider's 
overhead under this paragraph (h) are included as payments made or 
received under a qualified hedge.
    (ii) Exclusions from hedge. Payments for services or other items 
under the contract that are not expressly treated as payments under the 
qualified hedge under paragraph (h)(3)(i) of this section are not 
payments with respect to a qualified hedge.
    (iii) Timing and allocation of payments. The period to which a 
payment made by the issuer relates is determined under general Federal 
income tax principles, including, without limitation, Sec. 1.446-3, and 
adjusted as necessary to reflect the end of a computation period and the 
start of a new computation period. Except as provided in paragraphs 
(h)(3)(iv) and (h)(5)(ii) of this section, a payment received by the 
issuer is taken into account in the period that the interest payment 
that the payment hedges is required to be made.
    (iv) Termination payments--(A) Termination defined. A termination of 
a qualified hedge includes any sale or other disposition of the hedge by 
the issuer, or the acquisition by the issuer of an offsetting hedge. A 
deemed termination occurs when the hedged bonds are redeemed and when a 
hedge ceases to be a qualified hedge of the hedged bonds. In the case of 
an assignment by a hedge provider of its remaining rights and 
obligations on the hedge to a third party or a modification of the 
hedging contract, the assignment or modification is treated as a 
termination with respect to the issuer only if it results in a deemed 
exchange of the hedge and a realization event under section 1001.
    (B) General rule. A payment made or received by an issuer to 
terminate a qualified hedge, including loss or gain realized or deemed 
realized, is treated

[[Page 764]]

as a payment made or received on the hedged bonds, as appropriate. The 
payment is reasonably allocated to the remaining periods originally 
covered by the terminated hedge in a manner that reflects the economic 
substance of the hedge.
    (C) Special rule for terminations when bonds are redeemed. Except as 
otherwise provided in this paragraph (h)(3)(iv)(C) and in paragraph 
(h)(3)(iv)(D) of this section, when a qualified hedge is deemed 
terminated because the hedged bonds are redeemed, the fair market value 
of the contract on the redemption date is treated as a termination 
payment made or received on that date. When hedged bonds are redeemed, 
any payment received by the issuer on termination of a hedge, including 
a termination payment or a deemed termination payment, reduces, but not 
below zero, the interest payments made by the issuer on the hedged bonds 
in the computation period ending on the termination date. The remainder 
of the payment, if any, is reasonably allocated over the bond years in 
the immediately preceding computation period or periods to the extent 
necessary to eliminate the excess.
    (D) Special rules for refundings. To the extent that the hedged 
bonds are redeemed using the proceeds of a refunding issue, the 
termination payment is accounted for under paragraph (h)(3)(iv)(B) of 
this section by treating it as a payment on the refunding issue, rather 
than the hedged bonds. In addition, to the extent that the refunding 
issue, rather than the hedged bonds, has been redeemed, paragraph 
(h)(3)(iv)(C) of this section applies to the termination payment by 
treating it as a payment on the redeemed refunding issue.
    (E) Safe harbor for certain non-level payments. A non-level payment 
to terminate a hedge does not result in that hedge failing to satisfy 
the applicable provisions of paragraph (h)(3)(iv)(B) of this section if 
the payment is allocated to each bond year for which the hedge would 
have been in effect in accordance with this paragraph (h)(3)(iv)(E). For 
a variable yield issue, an equal amount (or for any short bond year, a 
proportionate amount of the equal amount) must be allocated to each bond 
year such that the sum of the present values of the annual amounts 
equals the present value of the non-level payment. Present value is 
computed as of the day the hedge is terminated, using the yield on the 
hedged bonds, determined without regard to the non-level payment. The 
yield used for this purpose is computed for the period beginning on the 
first date the hedge is in effect and ending on the date the hedge is 
terminated. On the other hand, for a fixed yield issue, the non-level 
payment is taken into account as a single payment on the date it is 
paid.
    (4) Certain variable yield bonds treated as fixed yield bonds--(i) 
In general. Except as otherwise provided in this paragraph (h)(4), if 
the issuer of variable yield bonds enters into a qualified hedge, the 
hedged bonds are treated as fixed yield bonds paying a fixed interest 
rate if:
    (A) Start date. The date on which payments begin to accrue on the 
hedge is not later than 15 days after the issue date of the hedged 
bonds.
    (B) Maturity. The term of the hedge is equal to the entire period 
during which the hedged bonds bear interest at variable interest rates.
    (C) Payments closely correspond. Payments to be received under the 
hedge correspond closely in time to the hedged portion of the payments 
on the hedged bonds. Hedge payments received within 15 days of the 
related payments on the hedged bonds generally so correspond.
    (D) Aggregate payments fixed. Taking into account all payments made 
and received under the hedge and all payments on the hedged bonds (i.e., 
after netting all payments), the issuer's aggregate payments are fixed 
and determinable as of a date not later than 15 days after the issue 
date of the hedged bonds. Payments on bonds are treated as fixed for 
purposes of this paragraph (h)(4)(i)(D) if payments on the bonds are 
based, in whole or in part, on one interest rate, payments on the hedge 
are based, in whole or in part, on a second interest rate that is 
substantially the same as, but not identical to, the first interest rate 
and payments on the bonds would be fixed if the two rates were 
identical. Rates are treated as

[[Page 765]]

substantially the same if they are reasonably expected to be 
substantially the same throughout the term of the hedge. For example, an 
objective 30-day tax-exempt variable rate index or other objective index 
(e.g., J.J. Kenny Index, PSA Municipal swap index, a percentage of 
LIBOR) may be substantially the same as an issuer's individual 30-day 
interest rate.
    (ii) Accounting. Except as otherwise provided in this paragraph 
(h)(4)(ii), in determining yield on the hedged bonds, all the issuer's 
actual interest payments on the hedged bonds and all payments made and 
received on a hedge described in paragraph (h)(4)(i) of this section are 
taken into account. If payments on the bonds and payments on the hedge 
are based, in whole or in part, on variable interest rates that are 
substantially the same within the meaning of paragraph (h)(4)(i)(D) of 
this section (but not identical), yield on the issue is determined by 
treating the variable interest rates as identical. For example, if 
variable rate bonds bearing interest at a weekly rate equal to the rate 
necessary to remarket the bonds at par are hedged with an interest rate 
swap under which the issuer receives payments based on a short-term 
floating rate index that is substantially the same as, but not identical 
to, the weekly rate on the bonds, the interest payments on the bonds are 
treated as equal to the payments received by the issuer under the swap 
for purposes of computing the yield on the bonds.
    (iii) Effect of termination--(A) In general. Except as otherwise 
provided in this paragraph (h)(4)(iii) and paragraph (h)(5) of this 
section, the issue of which the hedged bonds are a part is treated as if 
it were reissued as of the termination date of the qualified hedge 
covered by paragraph (h)(4)(i) of this section in determining yield on 
the hedged bonds for purposes of Sec. 1.148-3. The redemption price of 
the retired issue and the issue price of the new issue equal the 
aggregate values of all the bonds of the issue on the termination date. 
In computing the yield on the new issue for this purpose, any 
termination payment is accounted for under paragraph (h)(3)(iv) of this 
section, applied by treating the termination payment as made or received 
on the new issue under this paragraph (h)(4)(iii).
    (B) Effect of early termination. Except as otherwise provided in 
this paragraph (h)(4)(iii), the general rules of paragraph (h)(4)(i) of 
this section do not apply in determining the yield on the hedged bonds 
for purposes of Sec. 1.148-3 if the hedge is terminated or deemed 
terminated within 5 years after the issue date of the issue of which the 
hedged bonds are a part. Thus, the hedged bonds are treated as variable 
yield bonds for purposes of Sec. 1.148-3 from the issue date.
    (C) Certain terminations disregarded. This paragraph (h)(4)(iii) 
does not apply to a termination if, based on the facts and circumstances 
(e.g., taking into account both the termination and any qualified hedge 
that immediately replaces the terminated hedge), there is no change in 
the yield. In addition, this paragraph (h)(4)(iii) does not apply to a 
termination caused by the bankruptcy or insolvency of the hedge provider 
if the Commissioner determines that the termination occurred without any 
action by the issuer (other than to protect its rights under the hedge).
    (5) Special rules for certain hedges--(i) Certain acquisition 
payments. A payment to the issuer by the hedge provider (e.g., an up-
front payment for an off-market swap) in connection with the acquisition 
of a hedge that, but for that payment, would be a qualified hedge, does 
not cause the hedge to fail to be a qualified hedge provided the payment 
to the issuer and the issuer's payments under the hedge in excess of 
those that it would make if the hedge bore rates equal to the on-market 
rates for the hedge are separately identified in a certification of the 
hedge provider and not taken into account in determining the yield on 
the issue of which the hedged bonds are a part. The on-market rates are 
determined as of the date the parties enter into the contract.
    (ii) Anticipatory hedges--(A) In general. A contract does not fail 
to be a hedge under Sec. 1.148-4(h)(2)(i)(A) solely because it is 
entered into with respect to an anticipated issuance of tax-exempt 
bonds. The identification required under Sec. 1.148-4T(h)(2)(ix) must

[[Page 766]]

specify the reasonably expected governmental purpose, principal amount, 
and issue date of the hedged bonds, and the manner in which interest is 
reasonably expected to be computed.
    (B) Special rules. Payments made in connection with the issuance of 
a bond to terminate or otherwise close (terminate) an anticipatory hedge 
of that bond do not prevent the hedge from satisfying the requirements 
of Sec. 1.148-4(h)(2)(vi) and paragraph (h)(2)(vii) of this section. 
Amounts received or deemed to be received by the issuer in connection 
with the issuance of the hedged bonds to terminate an anticipatory hedge 
are treated as proceeds of the hedged bonds.
    (C) Fixed yield treatment. A bond that is hedged with an 
anticipatory hedge is a fixed yield bond if, taking into account 
payments on the hedge that are made or fixed on or before the issue date 
of the bond and the payments to be made on the bond, the bond satisfies 
the definition of fixed yield bond. See also paragraph (h)(4) of this 
section.
    (6) Authority of the Commissioner--(i) In general. A contract is not 
a qualified hedge if the Commissioner determines, based on all the facts 
and circumstances, that treating the contract as a qualified hedge would 
provide a material potential for arbitrage, or a principal purpose for 
entering into the contract is that arbitrage potential. For example, a 
contract that requires a substantial nonperiodic payment may constitute, 
in whole or part, an embedded loan, investment-type property, or other 
investment.
    (ii) Other qualified hedges. The Commissioner, by publication of a 
revenue ruling or revenue procedure, may specify contracts that do not 
otherwise meet the requirements of Sec. 1.148-4(h)(2) as qualified 
hedges and contracts that do not otherwise meet the requirements of 
paragraph (h)(4) of this section as causing the hedged bonds to be 
treated as fixed yield bonds.
    (iii) Recomputation of yield. If an issuer enters into a hedge that 
is not properly identified, fails to properly associate an anticipatory 
hedge with the hedged bonds, or otherwise fails to meet the requirements 
of this section, the Commissioner may recompute the yield on the issue 
taking the hedge into account if the failure to take the hedge into 
account distorts that yield or otherwise fails to clearly reflect the 
economic substance of the transaction.

[T.D. 8538, 59 FR 24042, May 10, 1994. Redesignated by T.D. 8718, 62 FR 
25507, May 9, 1997]



Sec. 1.148-5A  Yield and valuation of investments.

    (a) through (b)(2)(ii) [Reserved]. For guidance see Sec. 1.148-5.
    (b)(2)(iii) Permissive application of single investment rules to 
certain yield restricted investments for all purposes of section 148. 
For all purposes of section 148, an issuer may treat all of the yield 
restricted nonpurpose investments in a refunding escrow and a sinking 
fund that is reasonably expected as of the issue date to be maintained 
to reduce the yield on the investments in the refunding escrow as a 
single investment having a single yield, determined under Sec. 
1.148(b)(2).
    (b) (2)(iv) through (c)(1) [Reserved]. For guidance see Sec. 1.148-
5.
    (c)(2) Manner of payment--(i) In general. Except as otherwise 
provided in Sec. 1.148-5(c)(2)(ii), an amount is paid under Sec. 
1.148-5(c) if it is paid to the United States at the same time and in 
the same manner as rebate amounts are required to be paid or at such 
other time or in such manner as the Commissioner may prescribe. For 
example, yield reduction payments must be made on or before the date of 
required rebate installment payments as described in Sec. 1.148-3(f). 
The date a payment is required to be paid is determined without regard 
to Sec. 1.148-3(h). An amount that is paid untimely is not taken into 
account under this paragraph (c) unless the Commissioner determines that 
the failure to pay timely is not due to willful neglect. The provisions 
of Sec. 1.148-3(i) apply to payments made under Sec. 1.148-5(c).
    (c)(2)(ii) through (c)(3)(i) [Reserved] For guidance see Sec. 
1.148-5.
    (c)(3)(ii) Exception to yield reduction payments rule for advance 
refunding issues. Section 1.148-5(c)(1) does not apply to investments 
allocable to gross proceeds of an advance refunding issue, other than--
    (A) Transferred proceeds to which Sec. 1.148-5(c)(3)(i)(C) applies;

[[Page 767]]

    (B) Replacement proceeds to which Sec. 1.148-5(c)(3)(i)(F) applies; 
and
    (C) Transferred proceeds to which Sec. 1.148-5(c)(3)(i)(E) applies, 
but only to the extent necessary to satisfy yield restriction under 
section 148(a) on those proceeds treating all investments allocable to 
those proceeds as a separate class.
    (d)(1) through (d)(3)(i) [Reserved]. For guidance see Sec. 1.148-5.
    (d)(3)(ii) Exception to fair market value requirement for 
transferred proceeds allocations, universal cap allocations, and 
commingled funds. Section 1.148-5(d)(3)(i) does not apply if the 
investment is allocated from one issue to another issue as a result of 
the transferred proceeds allocation rule under Sec. 1.148-9(b) or the 
universal cap rule under Sec. 1.148-6(b)(2), provided that both issues 
consist exclusively of tax-exempt bonds. In addition, Sec. 1.148-
5(d)(3)(i) does not apply to investments in a commingled fund (other 
than a bona fide debt service fund) unless it is an investment being 
initially deposited in or withdrawn from a commingled fund described in 
Sec. 1.148-6(e)(5)(iii).
    (e)(1) through (e)(2)(ii)(A) [Reserved]. For guidance see Sec. 
1.148-5.
    (e)(2)(ii)(B) External commingled funds. For any semiannual period, 
a commingled fund satisfies the 10 percent requirement of Sec. 1.148-
5(e)(2)(ii)(B) if--
    (1) Based on average amounts on deposit, this requirement was 
satisfied for the prior semiannual period; and
    (2) The fund does not accept deposits that would cause it to fail to 
meet this requirement.
    (iii) Special rule for guaranteed investment contracts. For a 
guaranteed investment contract, a broker's commission or similar fee 
paid on behalf of either an issuer or the provider is treated as an 
administrative cost and, except in the case of an issue that satisfies 
section 148(f)(4)(D)(i), is not a qualified administrative cost to the 
extent that the present value of the commission, as of the date the 
contract is allocated to the issue, exceeds the present value of annual 
payments equal to .05 percent of the weighted average amount reasonably 
expected to be invested each year of the term of the contract. For this 
purpose, present value is computed using the taxable discount rate used 
by the parties to compute the commission or, if not readily 
ascertainable, a reasonable taxable discount rate.

[T.D. 8538, 59 FR 24045, May 10, 1994. Redesignated by T.D. 8718, 62 FR 
25507, May 9, 1997]



Sec. 1.148-6A  General allocation and accounting rules.

    (a) through (d)(3)(iii)(B) [Reserved]. For guidance see Sec. 1.148-
6.
    (d)(3)(iii)(C) Qualified endowment funds treated as unavailable. For 
a 501(c)(3) organization, a qualified endowment fund is treated as 
unavailable. A fund is a qualified endowment fund if--
    (1) The fund is derived from gifts or bequests, or the income 
thereon, that were neither made nor reasonably expected to be used to 
pay working capital expenditures;
    (2) Pursuant to reasonable, established practices of the 
organization, the governing body of the 501(c)(3) organization 
designates and consistently operates the fund as a permanent endowment 
fund or quasi-endowment fund restricted as to use; and
    (3) There is an independent verification (e.g., from an independent 
certified public accountant) that the fund is reasonably necessary as 
part of the organization's permanent capital.

[T. D. 8538, 59 FR 24045, May 10, 1994. Redesignated by T.D. 8718, 62 FR 
25507, May 9, 1997]



Sec. 1.148-9A  Arbitrage rules for refunding issues.

    (a) through (c)(2)(ii)(A) [Reserved]. For guidance see Sec. 1.148-
9.
    (c)(2)(ii)(B) Permissive allocation of non-proceeds to earliest 
expenditures. Excluding amounts covered by Sec. 1.148-9(c)(2)(ii)(A) 
and subject to any required earlier expenditure of those amounts, any 
amounts in a mixed escrow that are not proceeds of a refunding issue may 
be allocated to the earliest maturing investments in the mixed escrow, 
provided that those investments mature and the proceeds thereof are 
expended before the date of any expenditure from the mixed escrow to pay 
any principal of the prior issue.
    (d) through (h)(4)(v) [Reserved]. For guidance see Sec. 1.148-9.
    (h)(4)(vi) Exception for refundings of interim notes. Section 1.148-
9(h)(4)(v) need not be applied to refunding bonds

[[Page 768]]

issued to provide permanent financing for one or more projects if the 
prior issue had a term of less than 3 years and was sold in anticipation 
of permanent financing, but only if the aggregate term of all prior 
issues sold in anticipation of permanent financing was less than 3 
years.

[T.D. 8538, 59 FR 24045, May 10, 1994. Redesignated by T.D. 8718, 62 FR 
25507, May 9, 1997]



Sec. 1.148-10A  Anti-abuse rules and authority of Commissioner.

    (a) through (b)(1) [Reserved]. For guidance see Sec. 1.148-10.
    (b)(2) Application. The provisions of Sec. 1.148-10(b) only apply 
to the portion of an issue that, as a result of actions taken (or 
actions not taken) after the issue date, overburdens the market for tax-
exempt bonds, except that for an issue that is reasonably expected as of 
the issue date to overburden the market, those provisions apply to all 
of the gross proceeds of the issue.
    (c) through (c)(2)(viii) [Reserved]. For guidance see Sec. 1.148-
10.
    (c)(2)(ix) For purposes of Sec. 1.148-10(c)(2), excess gross 
proceeds do not include gross proceeds allocable to fees for a qualified 
hedge for the refunding issue.

[T.D. 8538, 59 FR 24046, May 10, 1994. Redesignated by T.D. 8718, 62 FR 
25507, May 9, 1997]



Sec. 1.148-11A  Effective dates.

    (a) through (c)(3) [Reserved]. For guidance see Sec. 1.148-11.
    (c)(4) Retroactive application of overpayment recovery provisions. 
An issuer may apply the provisions of Sec. 1.148-3(i) to any issue that 
is subject to section 148(f) or to sections 103(c)(6) or 103A(i) of the 
Internal Revenue Code of 1954.
    (d) through (h) [Reserved]. For guidance see Sec. 1.148-11.
    (i) Transition rules for certain amendments--(1) In general. Section 
1.103-8(a)(5), Sec. Sec. 1.148-1, 1.148-2, 1.148-3, 1.148-4, .148-5, 
1.148-6, 1.148-7, 1.148-8, 1.148-9, 1.148-10, 1.148-11, 1.149(d)-1, and 
1.150-1 as in effect on June 7, 1994 (see 26 CFR part 1 as revised April 
1, 1997), and Sec. Sec. 1.148-1A through 1.148-11A, 1.149(d)-1A, and 
1.150-1A apply, in whole, but not in part--
    (i) To bonds sold after June 6, 1994, and before July 8, 1997;
    (ii) To bonds issued before July 1, 1993, that are outstanding on 
June 7, 1994, if the first time the issuer applies Sec. Sec. 1.148-1 
through 1.148-11 as in effect on June 7, 1994 (see 26 CFR part 1 as 
revised April 1, 1997), to the bonds under Sec. 1.148-11 (b) or (c) is 
after June 6, 1994, and before July 8, 1997;
    (iii) At the option of the issuer, to bonds to which Sec. Sec. 
1.148-1 through 1.148-11, as in effect on July 1, 1993 (see 26 CFR part 
1 as revised April 1, 1994), apply, if the bonds are outstanding on June 
7, 1994, and the issuer applies Sec. 1.103-8(a)(5), Sec. Sec. 1.148-1, 
1.148-2, 1.148-3, 1.148-4, 1.148-5, 1.148-6, 1.148-7, 1.148-8, 1.148-9, 
1.148-10, 1.148-11, 1.149(d)-1, and 1.150-1 as in effect on June 7, 1994 
(see 26 CFR part 1 as revised April 1, 1997), and Sec. Sec. 1.148-1A 
through 1.148-11A, 1.149(d)-1A, and 1.150-1A to the bonds before July 8, 
1997.
    (2) Special rule. For purposes of paragraph (i)(1) of this section, 
any reference to a particular paragraph of Sec. Sec. 1.148-1T, 1.148-
2T, 1.148-3T, 1.148-4T, 1.148-5T, 1.148-6T, 1.148-9T, 1.148-10T, 1.148-
11T, 1.149(d)-1T, or 1.150-1T shall be applied as a reference to the 
corresponding paragraph of Sec. Sec. 1.148-1A, 1.148-2A, 1.148-3A, 
1.148-4A, 1.148-5A, 1.148-6A, 1.148-9A, 1.148-10A, 1.148-11A, 1.149(d)-
1A, or 1.150-1A, respectively.
    (3) Identification of certain hedges. For any hedge entered into 
after June 18, 1993, and on or before June 6, 1994, that would be a 
qualified hedge within the meaning of Sec. 1.148-4(h)(2), as in effect 
on June 7, 1994 (see 26 CFR part 1 as revised April 1, 1997), except 
that the hedge does not meet the requirements of Sec. 1.148-
4A(h)(2)(ix) because the issuer failed to identify the hedge not later 
than 3 days after which the issuer and the provider entered into the 
contract, the requirements of Sec. 1.148-4A(h)(2)(ix) are treated as 
met if the contract is identified by the actual issuer on its books and 
records maintained for the hedged bonds not later than July 8, 1997.

[T.D. 8538, 59 FR 24046, May 10, 1994. Redesignated and amended by T.D. 
8718, 62 FR 25507, 25513, May 9, 1997]



Sec. 1.149(d)-1A  Limitations on advance refundings.

    (a) through (f)(2) [Reserved]. For guidance see Sec. 1.149(d)-1.

[[Page 769]]

    (f)(3) Application of savings test to multipurpose issues. Except as 
otherwise provided in this paragraph (f)(3), the multipurpose issue 
rules in Sec. 1.148-9(h) apply for purposes of the savings test. If any 
separate issue in a multipurpose issue increases the aggregate present 
value debt service savings on the entire multipurpose issue or reduces 
the present value debt service losses on that entire multipurpose issue, 
that separate issue satisfies the savings test.

[T.D. 8538, 59 FR 24046, May 10, 1994. Redesignated by T.D. 8718, 62 FR 
25513, May 9, 1997]



Sec. 1.150-1A  Definitions.

    (a) through (b) [Reserved]. For guidance see Sec. 1.150-1.
    (c) Definition of issue--(1) In general. Except as otherwise 
provided, the provisions of this paragraph (c) apply for all purposes of 
sections 103 and 141 through 150. Except as otherwise provided in this 
paragraph (c), two or more bonds are treated as part of the same issue 
if all of the following factors are present:
    (i) Sold at substantially the same time. The bonds are sold at 
substantially the same time. Bonds are treated as sold at substantially 
the same time if they are sold less than 15 days apart. For this purpose 
only, a variable yield bond is treated as sold on its issue date.
    (ii) Sold pursuant to the same plan of financing. The bonds are sold 
pursuant to the same plan of financing. Factors material to the plan of 
financing include the purposes for the bonds and the structure of the 
financing. For example, generally--
    (A) Bonds to finance a single facility or related facilities are 
part of the same plan of financing;
    (B) Short-term bonds to finance working capital expenditures and 
long-term bonds to finance capital projects are not part of the same 
plan of financing; and
    (C) Certificates of participation in a lease and general obligation 
bonds secured by tax revenues are not part of the same plan of 
financing.
    (iii) Payable from same source of funds. The bonds are reasonably 
expected to be paid from substantially the same source of funds, 
determined without regard to guarantees from parties unrelated to the 
obligor.
    (2) through (4)(ii) [Reserved]. For guidance see Sec. 1.150-1 
(c)(3) through (c)(4)(ii).
    (c)(4)(iii) Certain general obligation bonds. Bonds are part of the 
same issue if secured by a pledge of the issuer's full faith and credit 
(or a substantially similar pledge) and sold and issued on the same 
dates pursuant to a single offering document.
    (5) [Reserved]. For guidance see Sec. 1.150-1(c)(5).
    (6) Sale date. The sale date of a bond is the first day on which 
there is a binding contract in writing for the sale or exchange of the 
bond.

[T.D. 8538, 59 FR 24046, May 10, 1994. Redesignated by T.D. 8718, 62 FR 
25513, May 9, 1997]

                   Deductions for Personal Exemptions



Sec. 1.151-1  Deductions for personal exemptions.

    (a) In general. (1) In computing taxable income, an individual is 
allowed a deduction for the exemptions specified in section 151. Such 
exemptions are: (i) The exemptions for an individual taxpayer and spouse 
(the so-called personal exemptions); (ii) the additional exemptions for 
a taxpayer attaining the age of 65 years and spouse attaining the age of 
65 years (the so-called old-age exemptions); (iii) the additional 
exemptions for a blind taxpayer and a blind spouse; and (iv) the 
exemptions for dependents of the taxpayer.
    (2) A nonresident alien individual who is a bona fide resident of 
Puerto Rico during the entire taxable year and subject to tax under 
section 1 or 1201(b) is allowed as deductions the exemptions specified 
in section 151, even though as to the United States such individual is a 
nonresident alien. See section 876 and the regulations thereunder, 
relating to alien residents of Puerto Rico.
    (b) Exemptions for individual taxpayer and spouse (so-called 
personal exemptions). Section 151(b) allows an exemption for the 
taxpayer and an additional exemption for the spouse of the taxpayer if a 
joint return is not made by the taxpayer and his spouse, and if the 
spouse, for the calendar year in which

[[Page 770]]

the taxable year of the taxpayer begins, has no gross income and is not 
the dependent of another taxpayer. Thus, a husband is not entitled to an 
exemption for his wife on his separate return for the taxable year 
beginning in a calendar year during which she has any gross income 
(though insufficient to require her to file a return). Since, in the 
case of a joint return, there are two taxpayers (although under section 
6013 there is only one income for the two taxpayers on such return, 
i.e., their aggregate income), two exemptions are allowed on such 
return, one for each taxpayer spouse. If in any case a joint return is 
made by the taxpayer and his spouse, no other person is allowed an 
exemption for such spouse even though such other person would have been 
entitled to claim an exemption for such spouse as a dependent if such 
joint return had not been made.
    (c) Exemptions for taxpayer attaining the age of 65 and spouse 
attaining the age of 65 (so-called old-age exemptions). (1) Section 
151(c) provides an additional exemption for the taxpayer if he has 
attained the age of 65 before the close of his taxable year. An 
additional exemption is also allowed to the taxpayer for his spouse if a 
joint return is not made by the taxpayer and his spouse and if the 
spouse has attained the age of 65 before the close of the taxable year 
of the taxpayer and, for the calendar year in which the taxable year of 
the taxpayer begins, the spouse has no gross income and is not the 
dependent of another taxpayer. If a husband and wife make a joint 
return, an old-age exemption will be allowed as to each taxpayer spouse 
who has attained the age of 65 before the close of the taxable year for 
which the joint return is made. The exemptions under section 151(c) are 
in addition to the exemptions for the taxpayer and spouse under section 
151(b).
    (2) In determining the age of an individual for the purposes of the 
exemption for old age, the last day of the taxable year of the taxpayer 
is the controlling date. Thus, in the event of a separate return by a 
husband, no additional exemption for old age may be claimed for his 
spouse unless such spouse has attained the age of 65 on or before the 
close of the taxable year of the husband. In no event shall the 
additional exemption for old age be allowed with respect to a spouse who 
dies before attaining the age of 65 even though such spouse would have 
attained the age of 65 before the close of the taxable year of the 
taxpayer. For the purposes of the old-age exemption, an individual 
attains the age of 65 on the first moment of the day preceding his 
sixty-fifth birthday. Accordingly, an individual whose sixty-fifth 
birthday falls on January 1 in a given year attains the age of 65 on the 
last day of the calendar year immediately preceding.
    (d) Exemptions for the blind. (1) Section 151(d) provides an 
additional exemption for the taxpayer if he is blind at the close of his 
taxable year. An additional exemption is also allowed to the taxpayer 
for his spouse if the spouse is blind and, for the calendar year in 
which the taxable year of the taxpayer begins, has no gross income and 
is not the dependent of another taxpayer. The determination of whether 
the spouse is blind shall be made as of the close of the taxable year of 
the taxpayer, unless the spouse dies during such taxable year, in which 
case such determination shall be made as of the time of such death.
    (2) The exemptions for the blind are in addition to the exemptions 
for the taxpayer and spouse under section 151(b) and are also in 
addition to the exemptions under section 151(c) for taxpayers and 
spouses attaining the age of 65 years. Thus, a single individual who has 
attained the age of 65 before the close of his taxable year and who is 
blind at the close of his taxable year is entitled, in addition to the 
so-called personal exemption, to two further exemptions, one by reason 
of his age and the other by reason of his blindness. If a husband and 
wife make a joint return, an exemption for the blind will be allowed as 
to each taxpayer spouse who is blind at the close of the taxable year 
for which the joint return is made.
    (3) A taxpayer claiming an exemption allowed by section 151(d) for a 
blind taxpayer and a blind spouse shall, if the individual for whom the 
exemption is claimed is not totally blind as of the last day of the 
taxable year of the taxpayer (or, in the case of a spouse who

[[Page 771]]

dies during such taxable year, as of the time of such death), attach to 
his return a certificate from a physician skilled in the diseases of the 
eye or a registered optometrist stating that as of the applicable status 
determination date in the opinion of such physician or optometrist (i) 
the central visual acuity of the individual for whom the exemption is 
claimed did not exceed 20/200 in the better eye with correcting lenses 
or (ii) such individual's visual acuity was accompanied by a limitation 
in the fields of vision such that the widest diameter of the visual 
field subtends an angle no greater than 20 degrees. If such individual 
is totally blind as of the status determination date there shall be 
attached to the return a statement by the person or persons making the 
return setting forth such fact.
    (4) Notwithstanding subparagraph (3) of this paragraph, this 
subparagraph may be applied where the individual for whom an exemption 
under section 151(d) is claimed is not totally blind, and in the 
certified opinion of an examining physician skilled in the diseases of 
the eye there is no reasonable probability that the individual's visual 
acuity will ever improve beyond the minimum standards described in 
subparagraph (3) of this paragraph. In this event, if the examination 
occurs during a taxable year for which the exemption is claimed, and the 
examining physician certifies that, in his opinion, the condition is 
irreversible, and a copy of this certification is filed with the return 
for that taxable year, then a statement described in subparagraph (3) of 
this paragraph need not be attached to such individual's return for 
subsequent taxable years so long as the condition remains irreversible. 
The taxpayer shall retain a copy of the certified opinion in his 
records, and a statement referring to such opinion shall be attached to 
future returns claiming the section 151(d) exemption.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 7114, 36 FR 
9018, May 18, 1971; T.D. 7230, 37 FR 28288, Dec. 22, 1972]



Sec. 1.151-2  Additional exemptions for dependents.

    (a) Section 151(e) allows to a taxpayer an exemption for each 
dependent (as defined in section 152) whose gross income (as defined in 
section 61) for the calendar year in which the taxable year of the 
taxpayer begins is less than the amount provided in section 151(e)(1)(A) 
applicable to the taxable year of the taxpayer, or who is a child of the 
taxpayer and who--
    (1) The taxable year of the taxpayer begins, or
    (2) Is a student, as defined in paragraph (b) of Sec. 1.151-3.

No exemption shall be allowed under section 151(e) for any dependent who 
has made a joint return with his spouse under section 6013 for the 
taxable year beginning in the calendar year in which the taxable year of 
the taxpayer begins. The amount provided in section 151(e)(1)(A) is $750 
in the case of a taxable year beginning after December 31, 1972; $700 in 
the case of a taxable year beginning after December 31, 1971, and before 
January 1, 1973; $650 in the case of a taxable year beginning after 
December 31, 1970, and before January 1, 1972; $625 in the case of a 
taxable year beginning after December 31, 1969, and before January 1, 
1971; and $600 in the case of a taxable year beginning before January 1, 
1970. For special rules in the case of a taxpayer whose taxable year is 
a fiscal year ending after December 31, 1969, and beginning before 
January 1, 1973, see section 21(d) and the regulations thereunder.
    (b) The only exemption allowed for a dependent of the taxpayer is 
that provided by section 151(e). The exemptions provided by section 
151(c) (old-age exemptions) and section 151(d) (exemptions for the 
blind) are allowed only for the taxpayer or his spouse. For example, 
where a taxpayer provides the entire support for his father who meets 
all the requirements of a dependent, he is entitled to only one 
exemption for his father (section 151(e)), even though his father is 
over the age of 65.

[T.D. 7114, 36 FR 9019, May 18, 1971]



Sec. 1.151-3  Definitions.

    (a) Child. For purposes of sections 151(e), 152, and the regulations 
thereunder, the term ``child'' means a son, stepson, daughter, 
stepdaughter, adopted son, adopted daughter, or for taxable years 
beginning after December 31,

[[Page 772]]

1958, a child who is a member of an individual's household if the child 
was placed with the individual by an authorized placement agency for 
legal adoption pursuant to a formal application filed by the individual 
with the agency (see paragraph (c)(2) of Sec. 1.152-2), or, for taxable 
years beginning after December 31, 1969, a foster child (if such foster 
child satisfies the requirements set forth in paragraph (b) of Sec. 
1.152-1 with respect to the taxpayer) of the taxpayer.
    (b) Student. For purposes of section 151(e) and section 152(d), and 
the regulations thereunder, the term ``student'' means an individual who 
during each of 5 calendar months during the calendar year in which the 
taxable year of the taxpayer begins is a full-time student at an 
educational institution or is pursuing a full-time course of 
institutional on-farm training under the supervision of an accredited 
agent of an educational institution or of a State or political 
subdivision of a State. An example of ``institutional on-farm training'' 
is that authorized by 38 U.S.C. 1652 (formerly section 252 of the 
Veterans' Readjustment Assistance Act of 1952), as described in section 
252 of such act. A full-time student is one who is enrolled for some 
part of 5 calendar months for the number of hours or courses which is 
considered to be full-time attendance. The 5 calendar months need not be 
consecutive. School attendance exclusively at night does not constitute 
full-time attendance. However, full-time attendance at an educational 
institution may include some attendance at night in connection with a 
full-time course of study.
    (c) Educational institution. For purposes of sections 151(e) and 
152, and the regulations thereunder, the term ``educational 
institution'' means a school maintaining a regular faculty and 
established curriculum, and having an organized body of students in 
attendance. It includes primary and secondary schools, colleges, 
universities, normal schools, technical schools, mechanical schools, and 
similar institutions, but does not include noneducational institutions, 
on-the-job training, correspondence schools, night schools, and so 
forth.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 7051, 35 FR 
11020, July 9, 1970]



Sec. 1.151-4  Amount of deduction for each exemption under section 151.

    The amount allowed as a deduction for each exemption under section 
151 is (a) $750 in the case of a taxable year beginning after December 
31, 1972; (b) $700 in the case of a taxable year beginning after 
December 31, 1971, and before January 1, 1973; (c) $650 in the case of a 
taxable year beginning after December 31, 1970, and before January 1, 
1972; (d) $625 in the case of a taxable year beginning after December 
31, 1969, and before January 1, 1971; and (e) $600 in the case of a 
taxable year beginning before January 1, 1970. For special rules in the 
case of a fiscal year ending after December 31, 1969, and beginning 
before January 1, 1973, see section 21(d) and the regulations 
thereunder.

[T.D. 7114, 36 FR 9019, May 18, 1971]



Sec. 1.152-1  General definition of a dependent.

    (a)(1) For purposes of the income taxes imposed on individuals by 
chapter 1 of the Code, the term ``dependent'' means any individual 
described in paragraphs (1) through (10) of section 152(a) over half of 
whose support, for the calendar year in which the taxable year of the 
taxpayer begins, was received from the taxpayer.
    (2)(i) For purposes of determining whether or not an individual 
received, for a given calendar year, over half of his support from the 
taxpayer, there shall be taken into account the amount of support 
received from the taxpayer as compared to the entire amount of support 
which the individual received from all sources, including support which 
the individual himself supplied. The term ``support'' includes food, 
shelter, clothing, medical and dental care, education, and the like. 
Generally, the amount of an item of support will be the amount of 
expense incurred by the one furnishing such item. If the item of support 
furnished an individual is in the form of property or lodging, it will 
be necessary to measure

[[Page 773]]

the amount of such item of support in terms of its fair market value.
    (ii) In computing the amount which is contributed for the support of 
an individual, there must be included any amount which is contributed by 
such individual for his own support, including income which is 
ordinarily excludable from gross income, such as benefits received under 
the Social Security Act (42 U.S.C. ch. 7). For example, a father 
receives $800 social security benefits, $400 interest, and $1,000 from 
his son during 1955, all of which sums represent his sole support during 
that year. The fact that the social security benefits of $800 are not 
includible in the father's gross income does not prevent such amount 
from entering into the computation of the total amount contributed for 
the father's support. Consequently, since the son's contribution of 
$1,000 was less than one-half of the father's support ($2,200) he may 
not claim his father as a dependent.
    (iii)(a) For purposes of determining the amount of support furnished 
for a child (or children) by a taxpayer for a given calendar year, an 
arrearage payment made in a year subsequent to a calendar year for which 
there is an unpaid liability shall not be treated as paid either during 
that calendar year or in the year of payment, but no amount shall be 
treated as an arrearage payment to the extent that there is an unpaid 
liability (determined without regard to such payment) with respect to 
the support of a child for the taxable year of payment; and
    (b) Similarly, payments made prior to any calendar year (whether or 
not made in the form of a lump sum payment in settlement of the parent's 
liability for support) shall not be treated as made during such calendar 
year, but payments made during any calendar year from amounts set aside 
in trust by a parent in a prior year, shall be treated as made during 
the calendar year in which paid.
    (b) Section 152(a)(9) applies to any individual (other than an 
individual who at any time during the taxable year was the spouse, 
determined without regard to section 153, of the taxpayer) who lives 
with the taxpayer and is a member of the taxpayer's household during the 
entire taxable year of the taxpayer. An individual is not a member of 
the taxpayer's household if at any time during the taxable year of the 
taxpayer the relationship between such individual and the taxpayer is in 
violation of local law. It is not necessary under section 152(a)(9) that 
the dependent be related to the taxpayer. For example, foster children 
may qualify as dependents. It is necessary, however, that the taxpayer 
both maintain and occupy the household. The taxpayer and dependent will 
be considered as occupying the household for such entire taxable year 
notwithstanding temporary absences from the household due to special 
circumstances. A nonpermanent failure to occupy the common abode by 
reason of illness, education, business, vacation, military service, or a 
custody agreement under which the dependent is absent for less than six 
months in the taxable year of the taxpayer, shall be considered 
temporary absence due to special circumstances. The fact that the 
dependent dies during the year shall not deprive the taxpayer of the 
deduction if the dependent lived in the household for the entire part of 
the year preceding his death. Likewise, the period during the taxable 
year preceding the birth of an individual shall not prevent such 
individual from qualifying as a dependent under section 152(a)(9). 
Moreover, a child who actually becomes a member of the taxpayer's 
household during the taxable year shall not be prevented from being 
considered a member of such household for the entire taxable year, if 
the child is required to remain in a hospital for a period following its 
birth, and if such child would otherwise have been a member of the 
taxpayer's household during such period.
    (c) In the case of a child of the taxpayer who is under 19 or who is 
a student, the taxpayer may claim the dependency exemption for such 
child provided he has furnished more than one-half of the support of 
such child for the calendar year in which the taxable year of the 
taxpayer begins, even though the income of the child for such calendar 
year may be equal to or in excess of the amount determined pursuant to 
Sec. 1.151-2 applicable to such calendar year. In such a case, there 
may

[[Page 774]]

be two exemptions claimed for the child: One on the parent's (or 
stepparent's) return, and one on the child's return. In determining 
whether the taxpayer does in fact furnish more than one-half of the 
support of an individual who is a child, as defined in paragraph (a) of 
Sec. 1.151-3, of the taxpayer and who is a student, as defined in 
paragraph (b) of Sec. 1.151-3, a special rule regarding scholarships 
applies. Amounts received as scholarships, as defined in paragraph (a) 
of Sec. 1.117-3, for study at an educational institution shall not be 
considered in determining whether the taxpayer furnishes more than one-
half the support of such individual. For example, A has a child who 
receives a $1,000 scholarship to the X college for 1 year. A contributes 
$500, which constitutes the balance of the child's support for that 
year. A may claim the child as a dependent, as the $1,000 scholarship is 
not counted in determining the support of the child. For purposes of 
this paragraph, amounts received for tuition payments and allowances by 
a veteran under the provisions of the Servicemen's Readjustment Act of 
1944 (58 Stat. 284) or the Veterans' Readjustment Assistance Act of 1952 
(38 U.S.C. ch. 38) are not amounts received as scholarships. See also 
Sec. 1.117-4. For definition of the terms ``child'', ``student'', and 
``educational institution'', as used in this paragraph, see Sec. 1.151-
3.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6603, 28 FR 
7094, July 11, 1963; T.D. 7099, 36 FR 5337, Mar. 20, 1971; T.D. 7114, 36 
FR 9019, May 18, 1971]



Sec. 1.152-2  Rules relating to general definition of dependent.

    (a)(1) Except as provided in subparagraph (2) of this paragraph, to 
qualify as a dependent an individual must be a citizen or resident of 
the United States or be a resident of the Canal Zone, the Republic of 
Panama, Canada, or Mexico, or, for taxable years beginning after 
December 31, 1971, a national of the United States, at some time during 
the calendar year in which the taxable year of the taxpayer begins. A 
resident of the Republic of the Philippines who was born to or legally 
adopted by the taxpayer in the Philippine Islands before January 1, 
1956, at a time when the taxpayer was a member of the Armed Forces of 
the United States, may also be claimed as a dependent if such resident 
otherwise qualifies as a dependent. For definition of ``Armed Forces of 
the United States,'' see section 7701(a)(15).
    (2)(i) For any taxable year beginning after December 31, 1957, a 
taxpayer who is a citizen, or, for any taxable year beginning after 
December 31, 1971, a national, of the United States is permitted under 
section 152(b)(3)(B) to treat as a dependent his legally adopted child 
who lives with him, as a member of his household, for the entire taxable 
year and who, but for the citizenship, nationality, or residence 
requirements of section 152(b)(3) and subparagraph (1) of this 
paragraph, would qualify as a dependent of the taxpayer for such taxable 
year.
    (ii) Under section 152(b)(3)(B) and this subparagraph, it is 
necessary that the taxpayer both maintain and occupy the household. The 
taxpayer and his legally adopted child will be considered as occupying 
the household for the entire taxable year of the taxpayer 
notwithstanding temporary absences from the household due to special 
circumstances. A nonpermanent failure to occupy the common abode by 
reason of illness, education, business, vacation, military service, or a 
custody agreement under which the legally adopted child is absent for 
less than six months in the taxable year of the taxpayer shall be 
considered temporary absence due to special circumstances. The fact that 
a legally adopted child dies during the year shall not deprive the 
taxpayer of the deduction if the child lived in the household for the 
entire part of the year preceding his death. The period during the 
taxable year preceding the birth of a child shall not prevent such child 
from qualifying as a dependent under this subparagraph. Moreover, a 
legally adopted child who actually becomes a member of the taxpayer's 
household during the taxable year shall not be prevented from being 
considered a member of such household for the entire taxable year, if 
the child is required to remain in a hospital for a period following its 
birth and if such child would otherwise have been a

[[Page 775]]

member of the taxpayer's household during such period.
    (iii) For purposes of section 152(b)(3)(B) and this subparagraph, 
any child whose legal adoption by the taxpayer (a citizen or national of 
the United States) becomes final at any time before the end of the 
taxable year of the taxpayer shall not be disqualified as a dependent of 
such taxpayer by reason of his citizenship, nationality, or residence, 
provided the child lived with the taxpayer and was a member of the 
taxpayer's household for the entire taxable year in which the legal 
adoption became final. For example, A, a citizen of the United States 
who makes his income tax returns on the basis of the calendar year, is 
employed in Brazil by an agency of the United States Government. In 
October 1958 he takes into his household C, a resident of Brazil who is 
not a citizen of the United States, for the purpose of initiating 
adoption proceedings. C lives with A and is a member of his household 
for the remainder of 1958 and for the entire calendar year 1959. On July 
1, 1959, the adoption proceedings were completed and C became the 
legally adopted child of A. If C otherwise qualifies as a dependent, he 
may be claimed as a dependent by A for 1959.
    (b) A payment to a wife which is includible in her gross income 
under section 71 or section 682 shall not be considered a payment by her 
husband for the support of any dependent.
    (c)(1) For purposes of determining the existence of any of the 
relationships specified in section 152 (a) or (b)(1), a legally adopted 
child of an individual shall be treated as a child of such individual by 
blood.
    (2) For any taxable year beginning after December 31, 1958, a child 
who is a member of an individual's household also shall be treated as a 
child of such individual by blood if the child was placed with the 
individual by an authorized placement agency for legal adoption pursuant 
to a formal application filed by the individual with the agency. For 
purposes of this subparagraph an authorized placement agency is any 
agency which is authorized by a State, the District of Columbia, a 
possession of the United States, a foreign country, or a political 
subdivision of any of the foregoing to place children for adoption. A 
taxpayer who claims as a dependent a child placed with him for adoption 
shall attach to his income tax return a statement setting forth the name 
of the child for whom the dependency deduction is claimed, the name and 
address of the authorized placement agency, and the date the formal 
application was filed with the agency.
    (3) The application of this paragraph may be illustrated by the 
following example:

    Example. On March 1, 1959, D, a resident of the United States, made 
formal application to an authorized child placement agency for the 
placement of E, a resident of the United States, with him for legal 
adoption. On June 1, 1959, E was placed with D for legal adoption. 
During the year 1959 E received over one-half of his support from D. D 
may claim E as a dependent for 1959. Since E was a resident of the 
United States, his qualification as a dependent is in no way based on 
the provisions of section 152(b)(3)(B). Therefore, it is immaterial that 
E was not a member of D's household during the entire taxable year.

    (4) For purposes of determining the existence of any of the 
relationships specified in section 152 (a) or (b)(1), a foster child of 
an individual (if such foster child satisfies the requirements set forth 
in paragraph (b) of Sec. 1.152-1 with respect to such individual) 
shall, for taxable years beginning after December 31, 1969, be treated 
as a child of such individual by blood. For purposes of this 
subparagraph, a foster child is a child who is in the care of a person 
or persons (other than the parents or adopted parents of the child) who 
care for the child as their own child. Status as a foster child is not 
dependent upon or affected by the circumstances under which the child 
became a member of the household.
    (d) In the case of a joint return it is not necessary that the 
prescribed relationship exist between the person claimed as a dependent 
and the spouse who furnishes the support; it is sufficient if the 
prescribed relationship exists with respect to either spouse. Thus, a 
husband and wife making a joint return may claim as a dependent a 
daughter of the wife's brother (wife's niece) even though the husband is 
the one who furnishes the chief support. The relationship of affinity 
once existing will not terminate by divorce or

[[Page 776]]

the death of a spouse. For example, a widower may continue to claim his 
deceased wife's father (his father-in-law) as a dependent provided he 
meets the other requirements of section 151.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6603, 28 FR 
7094, July 11, 1963; T.D. 7051, 35 FR 11020, July 9, 1970; T.D. 7291, 38 
FR 33396, Dec. 4, 1973]



Sec. 1.152-3  Multiple support agreements.

    (a) Section 152(c) provides that a taxpayer shall be treated as 
having contributed over half of the support of an individual for the 
calendar year (in cases where two or more taxpayers contributed to the 
support of such individual) if--
    (1) No one person contributed over half of the individual's support,
    (2) Each member of the group which collectively contributed more 
than half of the support of the individual would have been entitled to 
claim the individual as a dependent but for the fact that he did not 
contribute more than one-half of such support.
    (3) The member of the group claiming the individual as a dependent 
contributed more than 10 percent of the individual's support, and
    (4) Each other person in the group who contributed more than 10 
percent of such support furnishes to the taxpayer claiming the dependent 
a written declaration that such other person will not claim the 
individual as a dependent for any taxable year beginning in such 
calendar year.
    (b) Examples. Application of the rule contained in paragraph (a) of 
this section may be illustrated by the following examples:

    Example (1). During the taxable year, brothers A, B, C, and D 
contributed the entire support of their mother in the following 
percentages: A, 30 percent; B, 20 percent; C, 29 percent; and D, 21 
percent. Any one of the brothers, except for the fact that he did not 
contribute more than half of her support, would have been entitled to 
claim his mother as a dependent. Consequently, any one of the brothers 
could claim a deduction for the exemption of the mother if he obtained a 
written declaration (as provided in paragraph (a)(4) of this section) 
from each of the other brothers. Even though A and D together 
contributed more than one-half the support of the mother, A, if he 
wished to claim his mother as a dependent, would be required to obtain 
written declarations from B, C, and D, since each of those three 
contributed more than 10 percent of the support and, but for the failure 
to contribute more than half of the mother's support, would have been 
entitled to claim his mother as a dependent.
    Example (2). During the taxable year, E, an individual who resides 
with his son, S, received his entire support for that year as follows:

------------------------------------------------------------------------
                                                              Percentage
                           Source                              of total
------------------------------------------------------------------------
Social Security............................................           25
N, an unrelated neighbor...................................           11
B, a brother...............................................           14
D, a daughter..............................................           10
S, a son...................................................           40
    Total received by E....................................          100
------------------------------------------------------------------------

    B, D, and S are persons each of whom, but for the fact that none 
contributed more than half of E's support, could claim E as a dependent 
for the taxable year. The three together contributed 64 percent of E's 
support, and, thus, each is a member of the group to be considered for 
the purpose of section 152(c). B and S are the only members of such 
group who can meet all the requirements of section 152(c), and either 
one could claim E as a dependent for his taxable year if he obtained a 
written declaration (as provided in paragraph (a)(4) of this section) 
signed by the other, and furnished the other information required by the 
return with respect to all the contributions to E. Inasmuch as D did not 
contribute more than 10 percent of E's support, she is not entitled to 
claim E as a dependent for the taxable year nor is she required to 
furnish a written declaration with respect to her contributions to E. N 
contributed over 10 percent of the support of E, but, since he is an 
unrelated neighbor, he does not qualify as a member of the group for the 
purpose of the multiple support agreement under section 152(c).

    (c)(1) The member of a group of contributors who claims an 
individual as a dependent for a taxable year beginning before January 1, 
2002, under the multiple support agreement provisions of section 152(c) 
must attach to the member's income tax return for the year of the 
deduction a written declaration from each of the other persons who 
contributed more than 10 percent of the support of such individual and 
who, but for the failure to contribute more than half of the support of 
the individual, would have been entitled to claim the individual as a 
dependent.
    (2) The taxpayer claiming an individual as a dependent for a taxable

[[Page 777]]

year beginning after December 31, 2001, under the multiple support 
agreement provisions of section 152(c) must provide with the income tax 
return for the year of the deduction--
    (i) A statement identifying each of the other persons who 
contributed more than 10 percent of the support of the individual and 
who, but for the failure to contribute more than half of the support of 
the individual, would have been entitled to claim the individual as a 
dependent; and
    (ii) A statement indicating that the taxpayer obtained a written 
declaration from each of the persons described in section 152(c)(2) 
waiving the right to claim the individual as a dependent.
    (3) The taxpayer claiming the individual as a dependent for a 
taxable year beginning after December 31, 2001, must retain the waiver 
declarations and should be prepared to furnish the waiver declarations 
and any other information necessary to substantiate the claim, which may 
include a statement showing the names of all contributors (whether or 
not members of the group described in section 152(c)(2)) and the amount 
contributed by each to the support of the claimed dependent.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6603, 28 FR 
7094, July 11, 1963; T.D. 8989, 67 FR 20031, Apr. 24, 2002; T.D. 9040, 
68 FR 4920, Jan. 31, 2003]



Sec. 1.152-4  Support test in case of child of divorced or separated 
parents.

    (a) Applicability. For taxable years beginning after December 31, 
1966, the provisions of section 152(e) and this section relate to a 
determination of which of separated parents (that is, parents who are 
divorced or legally separated under a decree of divorce or separate 
maintenance, or separated under a written separation agreement) is to be 
treated for purposes of section 152(a) and Sec. 1.152-1 as having 
provided more than half of the support of a child, as defined in section 
151(e)(3) and Sec. 1.151-3(a). For section 152(e) and this section to 
apply either parent or both parents combined must provide more than one-
half of the child's total support, within the meaning of Sec. 1.152-
1(a)(2)(i) during the calendar year in which the taxable year of the 
parent who is claiming the child as a dependent begins; and such child 
must be in the custody of one or both of his parents for more than one-
half of the calendar year. Thus, section 152(e) and this section do not 
apply if a person other than the parents provides one-half or more for 
the support of such child during the calendar year or has custody of the 
child for one-half or more of the calendar year. In addition, section 
152(e) and this section do not apply in any case where over half of the 
support of the child is treated as having been received from a taxpayer 
pursuant to a multiple support agreement under the provisions of section 
152(c) and Sec. 1.152-3. Nor does section 152(e) and this section apply 
to a period for which a joint return signed by both parents is filed.
    (b) Custody. ``Custody,'' for purposes of this section, will be 
determined by the terms of the most recent decree of divorce or separate 
maintenance, or subsequent custody decree, or, if none, a written 
separation agreement. In the event of so-called ``split'' custody, or if 
neither a decree or agreement establishes who has custody, or if the 
validity or continuing effect of such decree or agreement is uncertain 
by reason of proceedings pending on the last day of the calendar year, 
``custody'' will be deemed to be with the parent who, as between both 
parents, has the physical custody of the child for the greater portion 
of the calendar year.
    (c) General rule. For purposes of section 152(a) and Sec. 1.152-1, 
a child shall be treated as receiving over half of his support during 
the calendar year from the parent (hereinafter referred to as the 
``custodial parent'') having custody within the meaning of paragraph (b) 
of this section for a greater portion of the calendar year unless the 
exceptions of paragraph (d) of this section apply. If the parents of 
such a child are divorced or separated for only a portion of a calendar 
year after having had joint custody of the child for the prior portion 
of the year, the parent who has custody for the greater portion of the 
remainder of the year after divorce or separation shall be treated as 
having custody for a greater portion of the calendar year. Except as 
provided in section 152(e)(2)(A) and paragraph (d)(2) of this

[[Page 778]]

section (relating to decree or agreement) parents who are unable to 
enter into a multiple support agreement under section 152(c) cannot 
enter into an agreement as to which parent is entitled to claim a child 
as a dependent. Therefore, in general, the custodial parent shall be 
allowed as a deduction the exemption for the dependent child, if the 
requirements of section 151(e) are met.
    (d) Exceptions--(1) In general. Notwithstanding paragraph (c) of 
this section, a child shall be treated as receiving over half of his 
support during the calendar year from the parent who is not the 
custodial parent (hereinafter referred to as the ``noncustodial 
parent'') if the conditions of subparagraph (2) or (3) of this paragraph 
are met.
    (2) Decree or agreement. A noncustodial parent who provides at least 
$600 for the support of a child during the calendar year shall be 
treated as having provided more than half the support of the child if 
the decree of divorce or of separate maintenance, or a written agreement 
between the parents applicable to the taxable year of the noncustodial 
parent beginning in such calendar year, provides that the noncustodial 
parent shall be entitled to any deduction allowable under section 151 as 
an exemption for the dependent child. In order for this subparagraph to 
apply, the noncustodial parent must provide at least $600 for the 
support of each child he claims as a dependent. For taxable years 
beginning after December 31, 1970, in the case of a written agreement or 
portion of a written agreement between the parents which allocates the 
deduction to the noncustodial parent, the noncustodial parent must 
attach to his return (or amended return) a copy of such agreement or 
such portion of such agreement which is applicable to the calendar year 
in which the taxable year of the noncustodial parent begins.
    (3) Actual support. A noncustodial parent who provides $1,200 or 
more support for the child (or, for taxable years beginning before 
October 5, 1976, if there is more than one child for which he claims an 
exemption, $1,200 or more for the combined support for all of such 
children) shall be treated as having provided more than half the support 
for the child (or children) notwithstanding any provision to the 
contrary contained in a decree of divorce or separation or in a written 
agreement, unless the custodial parent clearly established that the 
custodial parent provided, in fact, more for the support of the child 
during the calendar year than the noncustodial parent. Under section 
152(e)(2)(B) and this subparagraph, if the noncustodial parent 
established that the noncustodial parent has provided $1,200 or more for 
support of the child, then the custodial parent has the burden of 
establishing by a clear preponderance of the evidence that the custodial 
parent has provided more for the support of the child than has been 
established by the noncustodial parent in order to be treated as having 
provided over half of the support of the child. See paragraph (e) of 
this section with regard to notification and submission of itemized 
statements.
    (4) Amount of support. For purposes of this paragraph, amounts 
expended for the support of a child shall be treated as received from 
the noncustodial parent to the extent that the noncustodial parent 
provided amounts for the support of the child, whether or not such 
amounts provided by the noncustodial parent are actually expended for 
child support. Therefore, for example, if only the parents have provided 
support for the child during a calendar year, only the excess of the 
total amount expended for the support of the child over the amount so 
provided by the noncustodial parent shall be treated as provided by the 
custodial parent for the support of the child.
    (e) Itemized statement--(1) Exchange. (i) If a parent intends to 
claim for a taxable year a child as a dependent or a parent is uncertain 
whether he is entitled to claim a child and desires either to determine 
whether the second parent intends to or has claimed the same child as a 
dependent, or if the first parent desires to receive an itemized 
statement as provided in subparagraph (3) of this paragraph from the 
second parent, the first parent is entitled to receive such information 
from the second parent in writing upon request provided he both notifies 
the second parent of his intention (or possible intention) to so claim 
the child

[[Page 779]]

and sends the second parent a copy of such an itemized statement upon 
which the first parent's claim is based. A failure to make such a 
request shall not affect the right of the first parent to claim the 
child as a dependent. However, if the first parent makes such a request, 
and the second parent does not respond within a reasonable time, and it 
is determined that the first parent is not entitled to claim the child 
as a dependent, the inability of the first parent to obtain information 
will be taken into account in determining whether the addition to tax 
under section 6653, relating to failure to pay tax, is applicable.
    (ii) Upon receipt of such a request accompanied by an itemized 
statement, if the second parent intends to claim (with respect to the 
calendar year in which such taxable year of the first parent begins) or 
has claimed the same child as a dependent, the second parent shall so 
inform the first parent, and if so requested shall send him a copy of 
the itemized statement upon which the second parent's claim is based. A 
notification under this subparagraph that the parent is claiming or is 
not claiming the child as a dependent shall not affect the rights of the 
parent making such notification and does not constitute a waiver.
    (2) Attachment to return. For taxable years beginning after December 
31, 1970, if a parent intends to claim a child as a dependent and, prior 
to the filing of his return or the time prescribed by law for filing the 
return (determined without regard to any extension thereof), whichever 
is later, such parent makes or receives a request under the procedures 
provided under paragraph (e)(1) of this section, then unless he is 
reasonably certain that the other parent will not claim the child as a 
dependent, such parent must attach to his return (or if the return is 
already filed, to a corrected or amended return) a copy of the itemized 
statement upon which such parent's claim is based, as provided in 
subparagraph (3) of this paragraph, together with a copy of the other 
parent's itemized statement, if available, at the time the return is 
filed. Failure to attach an itemized statement to the extent required by 
this subparagraph will be taken into account in determining whether the 
addition to tax under section 6653, relating to failure to pay tax, is 
applicable in the event it is determined that the parent is not entitled 
to claim the child as a dependent.
    (3) Contents. The itemized statement referred to in subparagraphs 
(1) and (2) of this paragraph shall include--
    (i) The name of the child (or children) being claimed as a dependent 
as well as the name of both parents and, if known, the address and 
social security number of both parents;
    (ii) If known, the number of months the dependent child (or 
children) lived during the calendar year in the home of each parent or 
person other than the parents;
    (iii) If known, income for the taxable year of each dependent child;
    (iv) If known, the total amount of support furnished the child (or 
children) (including amounts furnished by persons other than the 
parents);
    (v) A list of amounts expended during the calendar year for the 
child (or children) made by the parent making the statement and itemized 
to show the amounts expended for medical and dental care, food, shelter, 
clothing, education, recreation, and transportation;
    (vi) Amounts actually paid by the parent making the statement during 
the calendar year for the support of the child (or children) pursuant to 
a decree of divorce or separate maintenance, or a written separation 
agreement; and
    (vii) Other amounts paid or expended by the parent making the 
statement during the calendar year, for the support of the child (or 
children).
    (4) Requirement by officer. Notwithstanding subparagraph (1), (2), 
or (3) of this paragraph, an internal revenue officer may require the 
submission of an itemized statement from either parent and may make it 
available to the other parent. Such itemized statement shall contain the 
information requested by the internal revenue officer and shall be filed 
within such reasonable time as may be designated by him. If the required 
statement is not furnished pursuant to the instructions of the internal 
revenue officer, the claim of support of the parent failing to comply

[[Page 780]]

with such requirement may be disallowed by the Internal Revenue Service.
    (f) Illustration of principles. The application of the provisions of 
this section may be illustrated by the following examples:

    Example (1). A, a child of B and C, who were divorced June 1, 1970, 
received $1,000 for support during the calendar year 1970, of which $400 
was provided by B and $300 was provided by C. No multiple support 
agreement was entered into. Prior to the divorce B and C jointly had 
custody of A, and for the remainder of 1970, B had custody of A for the 
months of October through December, while C had custody of A for the 
months of June through September. Since C had custody for 4 of the 7 
months following the divorce, C is the custodial parent for 1970 and is 
treated as having provided over half of the support for A during 1970.
    Example (2). Assume the same facts as in example (1) and that for 
the calendar year 1971, of $1,000 support expended for A during 1971, 
$400 was provided by B and $300 was provided by C. Furthermore, assume 
that in addition to having custody of A for the months of October 
through December 1971, B had custody for the first 5 months of 1971. 
Since B had custody of A for a total of 8 months in 1971, B is the 
custodial parent for 1971 and is treated as having provided over half of 
the support for A during 1971.
    Example (3). D received all of his support, $1,000, during the 
calendar year 1970, from his parents E and F, who are separated under a 
written separation agreement. F had custody of D for the entire year of 
1970, but under the agreement E was to provide $600 for the support of D 
during 1970, and E is entitled to any deduction allowable under section 
151 for the years 1970 and 1971. E, in fact, provides only $550 for the 
support of D during 1970, but makes up the arrearage of $50 early in 
1971. Nevertheless, F is treated as having provided over half of the 
support for D during 1970.
    Example (4). Assume the same facts as in example (3) and that F had 
custody of D for the entire year 1971, and of $2,350 expended for the 
support of D during 1971, E provided $650 while F provided $1,700. Since 
under the written separation agreement E is entitled to any deduction 
allowable under section 151 for D for the year 1971 and E provided at 
least $600 for the support of D, E is treated as having provided over 
half of the support of D, for 1971.
    Example (5). G and H are legally separated under a decree of 
separate maintenance. G has custody of I, the child of G and H, for the 
entire year, and G and H enter into a written agreement that G is 
entitled to any deduction allowable under section 151 for I for the 
calendar year 1970. However, during 1970, of the $2,000 provided for the 
support of I, H provided $1,300 while G provided only $700. H has 
provided more than $1,200 for the support of I, and G cannot establish 
that G provided more for the support of I, than did H. Therefore, 
notwithstanding the agreement, since H does not have custody of I, H is 
treated as having provided over half of the support for I for 1970.
    Example (6). J and K, the children of L and M, who are divorced, 
received a total of $3,400 for the support of both during the calendar 
year 1970 from their parents. L, who has custody of J and K for the 
entire year 1970, provided $1,800 for the support of both, while M, the 
noncustodial parent, provided $1,600 for such support. Under the decree 
of divorce, M is entitled to any deduction allowable under section 151 
for such children. Since M has provided at least $600 for the support of 
each child, M is treated as having provided over half the support for J 
and K for 1970. Furthermore, as J and K are determined under section 
152(e) and Sec. 1.152-4 to be dependents of M for purposes of section 
151(e), they are also considered to be dependents of M with respect to 
other provisions of the Code that are dependent upon such a 
determination for their operation. (For example, section 213.)
    Example (7). N, O, and P are the children of divorced parents Q and 
R, both calendar year taxpayers. During calendar year 1976, the children 
received over half their support from Q and R. Q, who has custody of the 
three children for the entire year 1976, provided $800 for the support 
of each of the three children. R, the noncustodial parent, provided 
$2,700 during 1976 for the combined support of the three children under 
the terms of the decree of divorce. So, for calendar year 1976, although 
R, the noncustodial parent, did not provide support in the amount $1,200 
per child under paragraph (d)(3) of this section, R, the noncustodial 
parent, is treated as having provided more than half the support of each 
child during 1976, since R provided more than $1,200 for the combined 
support of all the children and Q did not provide more for the support 
of either N, O, or P ($800 per child) during 1976 than R provided during 
1976 ($900 per child).
    Example (8). Assume the same facts that occurred in 1976 in example 
7 also occurred in 1977. For 1977 R does not satisfy the $1,200 support 
test under paragraph (d)(3) of this section because he has not provided 
$1,200 support for each individual child N, O, or P for calendar year 
1977. Therefore, R, the noncustodial parent, is not treated as having 
provided more than half the support of the children for calendar year 
1977.
    Example (9). A, B, and C, the children of divorced parents M and N, 
both calendar year taxpayers, receive all of their support, $5,900, from 
their parents during the calendar year

[[Page 781]]

1979. M has custody of A, B, and C and provides $2,700 for their 
collective support during 1979. Pursuant to the terms of the decree of 
divorce N provided $1,200 for the support of A, $1,000 for the support 
of B, and $1,000 for the support of C. Since N has provided $1,200 or 
more for the support of A, and M has provided $900 ($2,700/3) for the 
support of A during 1979, N is treated as having provided more than half 
the support for A during 1979. However, since N has not provided $1,200 
or more for the support of either B or C, N, the noncustodial parent, is 
not treated as having provided more than half the support of B or C 
during 1979.

[T.D. 7099, 36 FR 5337, Mar. 20, 1971, as amended by T.D. 7145, 36 FR 
20039, Oct. 15, 1971; T.D. 7639, 44 FR 48674, Aug. 20, 1979]



Sec. 1.152-4T  Dependency exemption in the case of a child of divorced 
parents, etc. (temporary).

    (a) In general.
    Q-1 Which parent may claim the dependency exemption in the case of a 
child of divorced or separated parents?
    A-1 Provided the parents together would have been entitled to the 
dependency exemption had they been married and filing a joint return, 
the parent having custody of a child for the greater portion of the year 
(the custodial parent) will generally be entitled to the dependency 
exemption. This rule applies to parents not living together during the 
last 6 months of the calendar year, as well as those divorced or 
separated under a separation agreement.
    Q-2 Are there any exceptions to the general rule in A-1?
    A-2 Yes, there are three exceptions. The general rule does not apply 
(i) if a multiple support agreement is in effect (see section 152(c)), 
(ii) if a decree or agreement executed prior to January 1, 1985 provides 
that the custodial parent has agreed to release his or her claim to the 
dependency exemption to the noncustodial parent and the noncustodial 
parent provides at least $600 of support to the child (see section 
152(e)(4)), or (iii) if the custodial parent relinquishes the exemption 
in the manner described in A-3.
    Q-3 How may the exemption for a dependent child be claimed by a 
noncustodial parent?
    A-3 A noncustodial parent may claim the exemption for a dependent 
child only if the noncustodial parent attaches to his/her income tax 
return for the year of the exemption a written declaration from the 
custodial parent stating that he/she will not claim the child as a 
dependent for the taxable year begining in such calendar year. The 
written declaration may be made on a form to be provided by the Service 
for this purpose. Once the Service has released the form, any 
declaration made other than on the official form shall conform to the 
substance of such form.
    Q-4 For what period may a custodial parent release to the 
noncustodial parent a claim to the exemption for a dependent child?
    A-4 The exemption may be released for a single year, for a number of 
specified years (for example, alternate years), or for all future years, 
as specified in the declaration. If the exemption is released for more 
than one year, the original release must be attached to the return of 
the noncustodial spouse and a copy of such release must be attached to 
his/her return for each succeeding taxable year for which he/she claims 
the dependency exemption.
    Q-5 May only the custodial parent claim a deduction under section 
213(d) for medical expenses paid by the parent or an income exclusion 
under section 105(b) for medical expenses paid by an employer for a 
dependent child?
    A-5 No. Under the new rules, if a child receives over half of his 
support during the calendar year from his parents who are divorced or 
legally separated under a decree of divorce or separate maintenance, or 
who are separated under a written separation agreement, that child will 
be treated as a dependent of both parents for purposes of sections 
105(b) and 213(d). Thus, a parent can deduct medical expenses paid by 
that parent for a child even though a dependency exemption for the child 
is claimed by the other parent. The special rule of sections 105(b) and 
213(d) does not apply where over half of the support of a child is 
treated as having been received from a person under the provisions of 
section 152(c) (relating to multiple support agreements).
    Q-6 When does section 152(e), as amended by the Tax Reform Act of 
1984, become effective?

[[Page 782]]

    A-6 Section 152(e), as amended, is effective with respect to 
dependency exemptions for taxable years beginning after December 31, 
1984.

(Secs. 1041(d)(4) (98 Stat. 798, 26 U.S.C. 1041(d)(4)), 152(e)(2)(A) (98 
Stat. 802, 26 U.S.C. 152(e)(2)(A)), 215(c) (98 Stat. 800, 26 U.S.C. 
215(c)) and 7805 (68A Stat. 917, 26 U.S.C. 7805) of the Internal Revenue 
Code of 1954)

[T.D. 7973, 49 FR 34459, Aug. 31, 1984]



Sec. 1.153-1  Determination of marital status.

    For the purpose of determining the right of an individual to claim 
an exemption for his spouse under section 151(b), the determination of 
whether such individual is married shall be made as of the close of his 
taxable year, unless his spouse dies during such year, in which case the 
determination shall be made as of the time of such death. An individual 
legally separated from his spouse under a decree of divorce or separate 
maintenance shall not be considered as married. The provisions of this 
section may be illustrated by the following examples:

    Example (1). A, who files his returns on the basis of a calendar 
year, married B on December 31, 1956. B, who had never previously 
married, had no gross income for the calendar year 1956 nor was she the 
dependent of another taxpayer for such year. A may claim an exemption 
for B for 1956.
    Example (2). C and his wife, D, were married in 1940. They remained 
married until July 1956 at which time D was granted a decree of divorce. 
C, who files his income tax returns on a calendar year basis, cannot 
claim an exemption for D on his 1956 return as C and D were not married 
on the last day of C's taxable year. Had D died instead of being 
divorced, C could have claimed an exemption for D for 1956 as their 
marital status would have been determined as of the date of D's death.



Sec. 1.154  Statutory provisions; cross references.

    Sec. 154. Cross references. (1) For definitions of ``husband'' and 
``wife'', as used in section 152(b)(4), see section 7701(a)(17).
    (2) For deductions of estates and trusts, in lieu of the exemptions 
under section 151, see section 642(b).
    (3) For exemptions of nonresident aliens, see section 873(b)(3).
    (4) For exemptions of citizens deriving income mainly from sources 
within possessions of the United States, see section 931(e).

[Sec. 154 as amended by sec. 103(c)(2), Foreign Investors Tax Act 1966 
(80 Stat. 1551)]

[TD 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as 
amended by T.D. 7332, 39 FR 44216, Dec. 23, 1974]

          Itemized Deductions for Individuals and Corporations



Sec. 1.161-1  Allowance of deductions.

    Section 161 provides for the allowance as deductions, in computing 
taxable income under section 63(a), of the items specified in Part VI 
(section 161 and following), Subchapter B, Chapter 1 of the Code, 
subject to the exceptions provided in Part IX (section 261 and 
following), of such Subchapter B, relating to items not deductible. 
Double deductions are not permitted. Amounts deducted under one 
provision of the Internal Revenue Code of 1954 cannot again be deducted 
under any other provision thereof. See also section 7852(c), relating to 
the taking into account, both in computing a tax under Subtitle A of the 
Internal Revenue Code of 1954 and a tax under Chapter 1 or 2 of the 
Internal Revenue Code of 1939, of the same item of deduction.



Sec. 1.162-1  Business expenses.

    (a) In general. Business expenses deductible from gross income 
include the ordinary and necessary expenditures directly connected with 
or pertaining to the taxpayer's trade or business, except items which 
are used as the basis for a deduction or a credit under provisions of 
law other than section 162. The cost of goods purchased for resale, with 
proper adjustment for opening and closing inventories, is deducted from 
gross sales in computing gross income. See paragraph (a) of Sec. 1.161-
3. Among the items included in business expenses are management 
expenses, commissions (but see section 263 and the regulations 
thereunder), labor, supplies, incidental repairs, operating expenses of 
automobiles used in the trade or business, traveling expenses while away 
from home solely in the pursuit of a trade or business (see Sec. 1.162-
2), advertising and other selling expenses, together with insurance 
premiums

[[Page 783]]

against fire, storm, theft, accident, or other similar losses in the 
case of a business, and rental for the use of business property. No such 
item shall be included in business expenses, however, to the extent that 
it is used by the taxpayer in computing the cost of property included in 
its inventory or used in determining the gain or loss basis of its 
plant, equipment, or other property. See section 1054 and the 
regulations thereunder. A deduction for an expense paid or incurred 
after December 30, 1969, which would otherwise be allowable under 
section 162 shall not be denied on the grounds that allowance of such 
deduction would frustrate a sharply defined public policy. See section 
162(c), (f), and (g) and the regulations thereunder. The full amount of 
the allowable deduction for ordinary and necessary expenses in carrying 
on a business is deductible, even though such expenses exceed the gross 
income derived during the taxable year from such business. In the case 
of any sports program to which section 114 (relating to sports programs 
conducted for the American National Red Cross) applies, expenses 
described in section 114(a)(2) shall be allowable as deductions under 
section 162(a) only to the extent that such expenses exceed the amount 
excluded from gross income under section 114(a).
    (b) Cross references. (1) For charitable contributions by 
individuals and corporations not deductible under section 162, see Sec. 
1.162-15.
    (2) For items not deductible, see sections 261-276, inclusive, and 
the regulations thereunder.
    (3) For research and experimental expenditures, see section 174 and 
regulations thereunder.
    (4) For soil and water conservation expenditures, see section 175 
and regulations thereunder.
    (5) For expenditures attributable to grant or loan by United States 
for encouragement of exploration for, or development or mining of, 
critical and strategic minerals or metals, see section 621 and 
regulations thereunder.
    (6) For treatment of certain rental payments with respect to public 
utility property, see section 167(1) and Sec. 1.167(1)-3.
    (7) For limitations on the deductibility of miscellaneous itemized 
deductions, see section 67 and Sec. Sec. 1.67-1T through 1.67-4T.
    (8) For the timing of deductions with respect to notional principal 
contracts. see Sec. 1.446-3.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6690, 28 FR 
12253, Nov. 19, 1963; T.D. 6996, 34 FR 835, Jan. 18, 1969; T.D. 7315, 39 
FR 20203, June 7, 1974, as amended by T.D. 7345, 40 FR 7437, Feb. 20, 
1975; T.D. 8189, 53 FR 9881, Mar. 28, 1988; T.D. 8491, 58 FR 53128, Oct. 
14, 1993]



Sec. 1.162-2  Traveling expenses.

    (a) Traveling expenses include travel fares, meals and lodging, and 
expenses incident to travel such as expenses for sample rooms, telephone 
and telegraph, public stenographers, etc. Only such traveling expenses 
as are reasonable and necessary in the conduct of the taxpayer's 
business and directly attributable to it may be deducted. If the trip is 
undertaken for other than business purposes, the travel fares and 
expenses incident to travel are personal expenses and the meals and 
lodging are living expenses. If the trip is solely on business, the 
reasonable and necessary traveling expenses, including travel fares, 
meals and lodging, and expenses incident to travel, are business 
expenses. For the allowance of traveling expenses as deductions in 
determining adjusted gross income, see section 62(2)(B) and the 
regulations thereunder.
    (b)(1) If a taxpayer travels to a destination and while at such 
destination engages in both business and personal activities, traveling 
expenses to and from such destination are deductible only if the trip is 
related primarily to the taxpayer's trade or business. If the trip is 
primarily personal in nature, the traveling expenses to and from the 
destination are not deductible even though the taxpayer engages in 
business activities while at such destination. However, expenses while 
at the destination which are properly allocable to the taxpayer's trade 
or business are deductible even though the traveling expenses to and 
from the destination are not deductible.
    (2) Whether a trip is related primarily to the taxpayer's trade or 
business or is primarily personal in nature

[[Page 784]]

depends on the facts and circumstances in each case. The amount of time 
during the period of the trip which is spent on personal activity 
compared to the amount of time spent on activities directly relating to 
the taxpayer's trade or business is an important factor in determining 
whether the trip is primarily personal. If, for example, a taxpayer 
spends one week while at a destination on activities which are directly 
related to his trade or business and subsequently spends an additional 
five weeks for vacation or other personal activities, the trip will be 
considered primarily personal in nature in the absence of a clear 
showing to the contrary.
    (c) Where a taxpayer's wife accompanies him on a business trip, 
expenses attributable to her travel are not deductible unless it can be 
adequately shown that the wife's presence on the trip has a bona fide 
business purpose. The wife's performance of some incidental service does 
not cause her expenses to qualify as deductible business expenses. The 
same rules apply to any other members of the taxpayer's family who 
accompany him on such a trip.
    (d) Expenses paid or incurred by a taxpayer in attending a 
convention or other meeting may constitute an ordinary and necessary 
business expense under section 162 depending upon the facts and 
circumstances of each case. No distinction will be made between self-
employed persons and employees. The fact that an employee uses vacation 
or leave time or that his attendance at the convention is voluntary will 
not necessarily prohibit the allowance of the deduction. The allowance 
of deductions for such expenses will depend upon whether there is a 
sufficient relationship between the taxpayer's trade of business and his 
attendance at the convention or other meeting so that he is benefiting 
or advancing the interests of his trade or business by such attendance. 
If the convention is for political, social or other purposes unrelated 
to the taxpayer's trade or business, the expenses are not deductible.
    (e) Commuters' fares are not considered as business expenses and are 
not deductible.
    (f) For rules with respect to the reporting and substantiation of 
traveling and other business expenses of employees for taxable years 
beginning after December 31, 1957, see Sec. 1.162-17.



Sec. 1.162-3  Cost of materials.

    Taxpayers carrying materials and supplies on hand should include in 
expenses the charges for materials and supplies only in the amount that 
they are actually consumed and used in operation during the taxable year 
for which the return is made, provided that the costs of such materials 
and supplies have not been deducted in determining the net income or 
loss or taxable income for any previous year. If a taxpayer carries 
incidental materials or supplies on hand for which no record of 
consumption is kept or of which physical inventories at the beginning 
and end of the year are not taken, it will be permissible for the 
taxpayer to include in his expenses and to deduct from gross income the 
total cost of such supplies and materials as were purchased during the 
taxable year for which the return is made, provided the taxable income 
is clearly reflected by this method.



Sec. 1.162-4  Repairs.

    The cost of incidental repairs which neither materially add to the 
value of the property nor appreciably prolong its life, but keep it in 
an ordinarily efficient operating condition, may be deducted as an 
expense, provided the cost of acquisition or production or the gain or 
loss basis of the taxpayer's plant, equipment, or other property, as the 
case may be, is not increased by the amount of such expenditures. 
Repairs in the nature of replacements, to the extent that they arrest 
deterioration and appreciably prolong the life of the property, shall 
either be capitalized and depreciated in accordance with section 167 or 
charged against the depreciation reserve if such an account is kept.



Sec. 1.162-5  Expenses for education.

    (a) General rule. Expenditures made by an individual for education 
(including research undertaken as part of his

[[Page 785]]

educational program) which are not expenditures of a type described in 
paragraph (b) (2) or (3) of this section are deductible as ordinary and 
necessary business expenses (even though the education may lead to a 
degree) if the education--
    (1) Maintains or improves skills required by the individual in his 
employment or other trade or business, or
    (2) Meets the express requirements of the individual's employer, or 
the requirements of applicable law or regulations, imposed as a 
condition to the retention by the individual of an established 
employment relationship, status, or rate of compensation.
    (b) Nondeductible educational expenditures--(1) In general. 
Educational expenditures described in subparagraphs (2) and (3) of this 
paragraph are personal expenditures or constitute an inseparable 
aggregate of personal and capital expenditures and, therefore, are not 
deductible as ordinary and necessary business expenses even though the 
education may maintain or improve skills required by the individual in 
his employment or other trade or business or may meet the express 
requirements of the individual's employer or of applicable law or 
regulations.
    (2) Minimum educational requirements. (i) The first category of 
nondeductible educational expenses within the scope of subparagraph (1) 
of this paragraph are expenditures made by an individual for education 
which is required of him in order to meet the minimum educational 
requirements for qualification in his employment or other trade or 
business. The minimum education necessary to qualify for a position or 
other trade or business must be determined from a consideration of such 
factors as the requirements of the employer, the applicable law and 
regulations, and the standards of the profession, trade, or business 
involved. The fact that an individual is already performing service in 
an employment status does not establish that he has met the minimum 
educational requirements for qualification in that employment. Once an 
individual has met the minimum educational requirements for 
qualification in his employment or other trade or business (as in effect 
when he enters the employment or trade or business), he shall be treated 
as continuing to meet those requirements even though they are changed.
    (ii) The minimum educational requirements for qualification of a 
particular individual in a position in an educational institution is the 
minimum level of education (in terms of aggregate college hours or 
degree) which under the applicable laws or regulations, in effect at the 
time this individual is first employed in such position, is normally 
required of an individual initially being employed in such a position. 
If there are no normal requirements as to the minimum level of education 
required for a position in an educational institution, then an 
individual in such a position shall be considered to have met the 
minimum educational requirements for qualification in that position when 
he becomes a member of the faculty of the educational institution. The 
determination of whether an individual is a member of the faculty of an 
educational institution must be made on the basis of the particular 
practices of the institution. However, an individual will ordinarily be 
considered to be a member of the faculty of an institution if (a) he has 
tenure or his years of service are being counted toward obtaining 
tenure; (b) the institution is making contributions to a retirement plan 
(other than Social Security or a similar program) in respect of his 
employment; or (c) he has a vote in faculty affairs.
    (iii) The application of this subparagraph may be illustrated by the 
following examples:

    Example (1). General facts:State X requires a bachelor's degree for 
beginning secondary school teachers which must include 30 credit hours 
of professional educational courses. In addition, in order to retain his 
position, a secondary school teacher must complete a fifth year of 
preparation within 10 years after beginning his employment. If an 
employing school official certifies to the State Department of Education 
that applicants having a bachelor's degree and the required courses in 
professional education cannot be found, he may hire individuals as 
secondary school teachers if they have completed a minimum of 90 
semester hours of college work. However, to be retained in his position, 
such an individual must obtain his bachelor's degree and complete the 
required professional educational courses within 3

[[Page 786]]

years after his employment commences. Under these facts, a bachelor's 
degree, without regard to whether it includes 30 credit hours of 
professional educational courses, is considered to be the minimum 
educational requirement for qualification as a secondary school teacher 
in State X. This is the case notwithstanding the number of teachers who 
are actually hired without such a degree. The following are examples of 
the application of these facts in particular situations:
    Situation 1. A, at the time he is employed as a secondary school 
teacher in State X, has a bachelor's degree including 30 credit hours of 
professional educational courses. After his employment, A completes a 
fifth college year of education and, as a result, is issued a standard 
certificate. The fifth college year of education undertaken by A is not 
education required to meet the minimum educational requirements for 
qualification as a secondary school teacher. Accordingly, the 
expenditures for such education are deductible unless the expenditures 
are for education which is part of a program of study being pursued by A 
which will lead to qualifying him in a new trade or business.
    Situation 2. Because of a shortage of applicants meeting the stated 
requirements, B, who has a bachelor's degree, is employed as a secondary 
school teacher in State X even though he has only 20 credit hours of 
professional educational courses. After his employment, B takes an 
additional 10 credit hours of professional educational courses. Since 
these courses do not constitute education required to meet the minimum 
educational requirements for qualification as a secondary school teacher 
which is a bachelor's degree and will not lead to qualifying B in a new 
trade or business, the expenditures for such courses are deductible.
    Situation 3. Because of a shortage of applicants meeting the stated 
requirements, C is employed as a secondary school teacher in State X 
although he has only 90 semester hours of college work toward his 
bachelor's degree. After his employment, C undertakes courses leading to 
a bachelor's degree. These courses (including any courses in 
professional education) constitute education required to meet the 
minimum educational requirements for qualification as a secondary school 
teacher. Accordingly, the expenditures for such education are not 
deductible.
    Situation 4. Subsequent to the employment of A, B, and C, but before 
they have completed a fifth college year of education, State X changes 
its requirements affecting secondary school teachers to provide that 
beginning teachers must have completed 5 college years of preparation. 
In the cases of A, B, and C, a fifth college year of education is not 
considered to be education undertaken to meet the minimum educational 
requirements for qualifications as a secondary school teacher. 
Accordingly, expenditures for a fifth year of college will be deductible 
unless the expenditures are for education which is part of a program 
being pursued by A, B, or C which will lead to qualifying him in a new 
trade or business.
    Example (2). D, who holds a bachelor's degree, obtains temporary 
employment as an instructor at University Y and undertakes graduate 
courses as a candidate for a graduate degree. D may become a faculty 
member only if he obtains a graduate degree and may continue to hold a 
position as instructor only so long as he shows satisfactory progress 
towards obtaining this graduate degree. The graduate courses taken by D 
constitute education required to meet the minimum educational 
requirements for qualification in D's trade or business and, thus, the 
expenditures for such courses are not deductible.
    Example (3). E, who has completed 2 years of a normal 3-year law 
school course leading to a bachelor of laws degree (LL.B.), is hired by 
a law firm to do legal research and perform other functions on a full-
time basis. As a condition to continued employment, E is required to 
obtain an LL.B. and pass the State bar examination. E completes his law 
school education by attending night law school, and he takes a bar 
review course in order to prepare for the State bar examination. The law 
courses and bar review course constitute education required to meet the 
minimum educational requirements for qualification in E's trade or 
business and, thus, the expenditures for such courses are not 
deductible.

    (3) Qualification for new trade or business. (i) The second category 
of nondeductible educational expenses within the scope of subparagraph 
(1) of this paragraph are expenditures made by an individual for 
education which is part of a program of study being pursued by him which 
will lead to qualifying him in a new trade or business. In the case of 
an employee, a change of duties does not constitute a new trade or 
business if the new duties involve the same general type of work as is 
involved in the individual's present employment. For this purpose, all 
teaching and related duties shall be considered to involve the same 
general type of work. The following are examples of changes in duties 
which do not constitute new trades or businesses:
    (a) Elementary to secondary school classroom teacher.
    (b) Classroom teacher in one subject (such as mathematics) to 
classroom teacher in another subject (such as science).

[[Page 787]]

    (c) Classroom teacher to guidance counselor.
    (d) Classroom teacher to principal.
    (ii) The application of this subparagraph to individuals other than 
teachers may be illustrated by the following examples:

    Example (1). A, a self-employed individual practicing a profession 
other than law, for example, engineering, accounting, etc., attends law 
school at night and after completing his law school studies receives a 
bachelor of laws degree. The expenditures made by A in attending law 
school are nondeductible because this course of study qualifies him for 
a new trade or business.
    Example (2). Assume the same facts as in example (1) except that A 
has the status of an employee rather than a self-employed individual, 
and that his employer requires him to obtain a bachelor of laws degree. 
A intends to continue practicing his nonlegal profession as an employee 
of such employer. Nevertheless, the expenditures made by A in attending 
law school are not deductible since this course of study qualifies him 
for a new trade or business.
    Example (3). B, a general practitioner of medicine, takes a 2-week 
course reviewing new developments in several specialized fields of 
medicine. B's expenses for the course are deductible because the course 
maintains or improves skills required by him in his trade or business 
and does not qualify him for a new trade or business.
    Example (4). C, while engaged in the private practice of psychiatry, 
undertakes a program of study and training at an accredited 
psychoanalytic institute which will lead to qualifying him to practice 
psychoanalysis. C's expenditures for such study and training are 
deductible because the study and training maintains or improves skills 
required by him in his trade or business and does not qualify him for a 
new trade or business.

    (c) Deductible educational expenditures--(1) Maintaining or 
improving skills. The deduction under the category of expenditures for 
education which maintains or improves skills required by the individual 
in his employment or other trade or business includes refresher courses 
or courses dealing with current developments as well as academic or 
vocational courses provided the expenditures for the courses are not 
within either category of nondeductible expenditures described in 
paragraph (b) (2) or (3) of this section.
    (2) Meeting requirements of employer. An individual is considered to 
have undertaken education in order to meet the express requirements of 
his employer, or the requirements of applicable law or regulations, 
imposed as a condition to the retention by the taxpayer of his 
established employment relationship, status, or rate of compensation 
only if such requirements are imposed for a bona fide business purpose 
of the individual's employer. Only the minimum education necessary to 
the retention by the individual of his established employment 
relationship, status, or rate of compensation may be considered as 
undertaken to meet the express requirements of the taxpayer's employer. 
However, education in excess of such minimum education may qualify as 
education undertaken in order to maintain or improve the skills required 
by the taxpayer in his employment or other trade or business (see 
subparagraph (1) of this paragraph). In no event, however, is a 
deduction allowable for expenditures for education which, even though 
for education required by the employer or applicable law or regulations, 
are within one of the categories of nondeductible expenditures described 
in paragraph (b) (2) and (3) of this section.
    (d) Travel as a form of education. Subject to the provisions of 
paragraph (b) and (e) of this section, expenditures for travel 
(including travel while on sabbatical leave) as a form of education are 
deductible only to the extent such expenditures are attributable to a 
period of travel that is directly related to the duties of the 
individual in his employment or other trade or business. For this 
purpose, a period of travel shall be considered directly related to the 
duties of an individual in his employment or other trade or business 
only if the major portion of the activities during such period is of a 
nature which directly maintains or improves skills required by the 
individual in such employment or other trade or business. The approval 
of a travel program by an employer or the fact that travel is accepted 
by an employer in the fulfillment of its requirements for retention of 
rate of compensation, status or employment, is not determinative that 
the required relationship exists between the travel involved and

[[Page 788]]

the duties of the individual in his particular position.
    (e) Travel away from home. (1) If an individual travels away from 
home primarily to obtain education the expenses of which are deductible 
under this section, his expenditures for travel, meals, and lodging 
while away from home are deductible. However, if as an incident of such 
trip the individual engages in some personal activity such as 
sightseeing, social visiting, or entertaining, or other recreation, the 
portion of the expenses attributable to such personal activity 
constitutes nondeductible personal or living expenses and is not 
allowable as a deduction. If the individual's travel away from home is 
primarily personal, the individual's expenditures for travel, meals and 
lodging (other than meals and lodging during the time spent in 
participating in deductible education pursuits) are not deductible. 
Whether a particular trip is primarily person or primarily to obtain 
education the expenses of which are deductible under this section 
depends upon all the facts and circumstances of each case. An important 
factor to be taken into consideration in making the determination is the 
relative amount of time devoted to personal activity as compared with 
the time devoted to educational pursuits. The rules set forth in this 
paragraph are subject to the provisions of section 162(a)(2), relating 
to deductibility of certain traveling expenses, and section 274 (c) and 
(d), relating to allocation of certain foreign travel expenses and 
substantiation required, respectively, and the regulations thereunder.
    (2) Examples. The application of this subsection may be illustrated 
by the following examples:

    Example (1). A, a self-employed tax practitioner, decides to take a 
1-week course in new developments in taxation, which is offered in City 
X, 500 miles away from his home. His primary purpose in going to X is to 
take the course, but he also takes a side trip to City Y (50 miles from 
X) for 1 day, takes a sightseeing trip while in X, and entertains some 
personal friends. A's transportation expenses to City X and return to 
his home are deductible but his transportation expenses to City Y are 
not deductible. A's expenses for meals and lodging while away from home 
will be allocated between his educational pursuits and his personal 
activities. Those expenses which are entirely personal, such as 
sightseeing and entertaining friends, are not deductible to any extent.
    Example (2). The facts are the same as in example (1) except that 
A's primary purpose in going to City X is to take a vacation. This 
purpose is indicated by several factors, one of which is the fact that 
he spends only 1 week attending the tax course and devotes 5 weeks 
entirely to personal activities. None of A's transportation expenses are 
deductible and his expenses for meals and lodging while away from home 
are not deductible to the extent attributable to personal activities. 
His expenses for meals and lodging allocable to the week attending the 
tax course are, however, deductible.
    Example (3). B, a high school mathematics teacher in New York City, 
in the summertime travels to a university in California in order to take 
a mathematics course the expense of which is deductible under this 
section. B pursues only one-fourth of a full course of study and the 
remainder of her time is devoted to personal activities the expense of 
which is not deductible. Absent a showing by B of a substantial 
nonpersonal reason for taking the course in the university in 
California, the trip is considered taken primarily for personal reasons 
and the cost of traveling from New York City to California and return 
would not be deductible. However, one-fourth of the cost of B's meals 
and lodging while attending the university in California may be 
considered properly allocable to deductible educational pursuits and, 
therefore, is deductible.

[T.D. 6918, 32 FR 6679, May 2, 1967]



Sec. 1.162-6  Professional expenses.

    A professional man may claim as deductions the cost of supplies used 
by him in the practice of his profession, expenses paid or accrued in 
the operation and repair of an automobile used in making professional 
calls, dues to professional societies and subscriptions to professional 
journals, the rent paid or accrued for office rooms, the cost of the 
fuel, light, water, telephone, etc., used in such offices, and the hire 
of office assistance. Amounts currently paid or accrued for books, 
furniture, and professional instruments and equipment, the useful life 
of which is short, may be deducted.



Sec. 1.162-7  Compensation for personal services.

    (a) There may be included among the ordinary and necessary expenses 
paid or incurred in carrying on any trade or

[[Page 789]]

business a reasonable allowance for salaries or other compensation for 
personal services actually rendered. The test of deductibility in the 
case of compensation payments is whether they are reasonable and are in 
fact payments purely for services.
    (b) The test set forth in paragraph (a) of this section and its 
practical application may be further stated and illustrated as follows:
    (1) Any amount paid in the form of compensation, but not in fact as 
the purchase price of services, is not deductible. An ostensible salary 
paid by a corporation may be a distribution of a dividend on stock. This 
is likely to occur in the case of a corporation having few shareholders, 
practically all of whom draw salaries. If in such a case the salaries 
are in excess of those ordinarily paid for similar services and the 
excessive payments correspond or bear a close relationship to the 
stockholdings of the officers or employees, it would seem likely that 
the salaries are not paid wholly for services rendered, but that the 
excessive payments are a distribution of earnings upon the stock. An 
ostensible salary may be in part payment for property. This may occur, 
for example, where a partnership sells out to a corporation, the former 
partners agreeing to continue in the service of the corporation. In such 
a case it may be found that the salaries of the former partners are not 
merely for services, but in part constitute payment for the transfer of 
their business.
    (2) The form or method of fixing compensation is not decisive as to 
deductibility. While any form of contingent compensation invites 
scrutiny as a possible distribution of earnings of the enterprise, it 
does not follow that payments on a contingent basis are to be treated 
fundamentally on any basis different from that applying to compensation 
at a flat rate. Generally speaking, if contingent compensation is paid 
pursuant to a free bargain between the employer and the individual made 
before the services are rendered, not influenced by any consideration on 
the part of the employer other than that of securing on fair and 
advantageous terms the services of the individual, it should be allowed 
as a deduction even though in the actual working out of the contract it 
may prove to be greater than the amount which would ordinarily be paid.
    (3) In any event the allowance for the compensation paid may not 
exceed what is reasonable under all the circumstances. It is, in 
general, just to assume that reasonable and true compensation is only 
such amount as would ordinarily be paid for like services by like 
enterprises under like circumstances. The circumstances to be taken into 
consideration are those existing at the date when the contract for 
services was made, not those existing at the date when the contract is 
questioned.
    (4) For disallowance of deduction in the case of certain transfers 
of stock pursuant to employees stock options, see section 421 and the 
regulations thereunder.



Sec. 1.162-8  Treatment of excessive compensation.

    The income tax liability of the recipient in respect of an amount 
ostensibly paid to him as compensation, but not allowed to be deducted 
as such by the payor, will depend upon the circumstances of each case. 
Thus, in the case of excessive payments by corporations, if such 
payments correspond or bear a close relationship to stockholdings, and 
are found to be a distribution of earnings or profits, the excessive 
payments will be treated as a dividend. If such payments constitute 
payment for property, they should be treated by the payor as a capital 
expenditure and by the recipient as part of the purchase price. In the 
absence of evidence to justify other treatment, excessive payments for 
salaries or other compensation for personal services will be included in 
gross income of the recipient.



Sec. 1.162-9  Bonuses to employees.

    Bonuses to employees will constitute allowable deductions from gross 
income when such payments are made in good faith and as additional 
compensation for the services actually rendered by the employees, 
provided such payments, when added to the stipulated salaries, do not 
exceed a reasonable compensation for the services rendered. It is 
immaterial whether such

[[Page 790]]

bonuses are paid in cash or in kind or partly in cash and partly in 
kind. Donations made to employees and others, which do not have in them 
the element of compensation or which are in excess of reasonable 
compensation for services, are not deductible from gross income.



Sec. 1.162-10  Certain employee benefits.

    (a) In general. Amounts paid or accrued by a taxpayer on account of 
injuries received by employees and lump sum amounts paid or accrued as 
compensation for injuries, are proper deductions as ordinary and 
necessary expenses. Such deductions are limited to the amount not 
compensated for by insurance or otherwise. Amounts paid or accrued 
within the taxable year for dismissal wages, unemployment benefits, 
guaranteed annual wages, vacations, or a sickness, accident, 
hospitalization, medical expense, recreational, welfare, or similar 
benefit plan, are deductible under section 162(a) if they are ordinary 
and necessary expenses of the trade or business. However, except as 
provided in paragraph (b) of this section, such amounts shall not be 
deductible under section 162(a) if, under any circumstances, they may be 
used to provide benefits under a stock bonus, pension, annuity, profit-
sharing, or other deferred compensation plan of the type referred to in 
section 404(a). In such an event, the extent to which these amounts are 
deductible from gross income shall be governed by the provisions of 
section 404 and the regulations issued thereunder.
    (b) Certain negotiated plans. (1) Subject to the limitations set 
forth in subparagraphs (2) and (3) of this paragraph, contributions paid 
by an employer under a plan under which such contributions are held in a 
welfare trust for the purpose of paying (either from principal or income 
or both) for the benefit of employees, their families, and dependents, 
at least medical or hospital care, and pensions on retirement or death 
of employees, are deductible when paid as business expenses under 
section 162(a).
    (2) For the purpose of subparagraph (1) of this paragraph, the word 
``plan'' means any plan established prior to January 1, 1954, as a 
result of an agreement between employee representatives and the 
Government of the United States, during a period of Government 
operation, under seizure powers, of a major part of the productive 
facilities of the industry in which the employer claiming the deduction 
is engaged. The phrase ``plan established prior to January 1, 1954, as a 
result of an agreement'' is intended primarily to cover a trust 
established under the terms of such an agreement. It also includes a 
trust established under a plan of an employer, or group of employers, 
who, by reason of producing the same commodity, are in competition with 
the employers whose facilities were seized and who would therefore be 
expected to establish such a trust as a reasonable measure to maintain a 
sound position in the labor market producing the commodity. For example, 
if a trust was established under such an agreement in the bituminous 
coal industry, a similar trust established in the anthracite coal 
industry within a reasonable time, but before January 1, 1954, would 
qualify under subparagraph (1) of this paragraph.
    (3) If any trust described in subparagraph (2) of this paragraph 
becomes qualified for exemption from tax under the provisions of section 
501(a), the deductibility of contributions by an employer to such trust 
on or after any date of such qualification shall no longer be governed 
by the provisions of section 162, even though the trust may later lose 
its exemption from tax under section 501(a).
    (c) Other plans providing deferred compensation. For rules relating 
to the deduction of amounts paid to or under a stock bonus, pension, 
annuity, or profit-sharing plan or amounts paid or accrued under any 
other plan deferring the receipt of compensation, see section 404 and 
the regulations thereunder.



Sec. 1.162-10T  Questions and answers relating to the deduction of 
employee benefits under the Tax Reform Act of 1984; certain limits 
on amounts deductible (temporary).

    Q-1: How does the amendment of section 404(b) by the Tax Reform Act 
of 1984 affect the deduction of employee benefits under section 162 of 
the Internal Revenue Code?

[[Page 791]]

    A-1: As amended by the Tax Reform Act of 1984, section 404(b) 
clarifies that section 404(a) and (d) (in the case of employees and 
nonemployees, respectively) shall govern the deduction of contributions 
paid or compensation paid or incurred under a plan, or method or 
arrangement, deferring the receipt of compensation or providing for 
deferred benefits. Section 404(a) and (d) requires that such a 
contribution or compensation be paid or incurred for purposes of section 
162 or 212 and satisfy the requirements for deductibility under either 
of these sections. However, notwithstanding the above, section 404 does 
not apply to contributions paid or accrued with respect to a ``welfare 
benefit fund'' (as defined in section 419(e)) after July 18, 1984, in 
taxable years of employers (and payors) ending after that date.
    Also, section 463 shall govern the deduction of vacation pay by a 
taxpayer that has elected the application of such section. Section 
404(b), as amended, generally applies to contributions paid and 
compensation paid or incurred after July 18, 1984, in taxable years of 
employers (and payors) ending after that date. See Q&A-3 of Sec. 
1.404(b)-1T. For rules relating to the deduction of contributions 
attributable to the provision of deferred benefits, see section 404 (a), 
(b) and (d) and Sec. 1.404(a)-1T, Sec. 1.404(b)-1T and Sec. 1.404(d)-
1T. For rules relating to the deduction of contributions paid or accrued 
with respect to a welfare benefit fund, see section 419, Sec. 1.419-1T 
and Sec. 1.419A-2T. For rules relating to the deduction of vacation pay 
for which an election is made under section 463, see Sec. 301.9100-16T 
of this chapter and Sec. 1.463-1T.
    Q-2: How does the enactment of section 419 by the Tax Reform Act of 
1984 affect the deduction of employee benefits under section 162?
    A-2: As enacted by the Tax Reform Act of 1984, section 419 shall 
govern the deduction of contributions paid or accrued by an employer (or 
a person receiving services under section 419(g)) with respect to a 
``welfare benefit fund'' (within the meaning of section 419(e)) after 
December 31, 1985, in taxable years of the employer (or person receiving 
the services) ending after that date. Section 419(a) requires that such 
a contribution be paid or accrued for purposes of section 162 or 212 and 
satisfy the requirements for deductibility under either of those 
sections. Generally, subject to a binding contract exception (as 
described in section 511(e)(5) of the Tax Reform Act of 1984), section 
419 shall also govern the deduction of the contribution of a facility 
(or other contribution used to acquire or improve a facility) to a 
welfare benefit fund after June 22, 1984. See Q&A-11 of Sec. 1.419-1T. 
In the case of a welfare benefit fund maintained pursuant to a 
collective bargaining agreement, section 419 applies to the extent 
provided under the special effective date rule described in Q&A-2 of 
Sec. 1.419-1T and the special rules of Sec. 1.419A-2T. For rules 
relating to the deduction of contributions paid or accrued with respect 
to a welfare benefit fund, see section 419 and Sec. 1.419-1T.

[T.D. 8073, 51 FR 4319, Feb. 4, 1986, as amended by T.D. 8435, 57 FR 
43896, Sept. 23, 1992]



Sec. 1.162-11  Rentals.

    (a) Acquisition of a leasehold. If a leasehold is acquired for 
business purposes for a specified sum, the purchaser may take as a 
deduction in his return an aliquot part of such sum each year, based on 
the number of years the lease has to run. Taxes paid by a tenant to or 
for a landlord for business property are additional rent and constitute 
a deductible item to the tenant and taxable income to the landlord, the 
amount of the tax being deductible by the latter. For disallowance of 
deduction for income taxes paid by a lessee corporation pursuant to a 
lease arrangement with the lessor corporation, see section 110 and the 
regulations thereunder. See section 178 and the regulations thereunder 
for rules governing the effect to be given renewal options in amortizing 
the costs incurred after July 28, 1958 of acquiring a lease. See Sec. 
1.197-2 for rules governing the amortization of costs to acquire limited 
interests in section 197 intangibles.
    (b) Improvements by lessee on lessor's property. (1) The cost to a 
lessee of erecting buildings or making permanent improvements on 
property of which he is the lessee is a capital investment, and is not 
deductible as a

[[Page 792]]

business expense. If the estimated useful life in the hands of the 
taxpayer of the building erected or of the improvements made, determined 
without regard to the terms of the lease, is longer than the remaining 
period of the lease, an annual deduction may be made from gross income 
of an amount equal to the total cost of such improvements divided by the 
number of years remaining in the term of the lease, and such deduction 
shall be in lieu of a deduction for depreciation. If, on the other hand, 
the useful life of such buildings or improvements in the hands of the 
taxpayer is equal to or shorter than the remaining period of the lease, 
this deduction shall be computed under the provisions of section 167 
(relating to depreciation).
    (2) If the lessee began improvements on leased property before July 
28, 1958, or if the lessee was on such date and at all times thereafter 
under a binding legal obligation to make such improvements, the matter 
of spreading the cost of erecting buildings or making permanent 
improvements over the term of the original lease, together with the 
renewal period or periods depends upon the facts in the particular case, 
including the presence or absence of an obligation of renewal and the 
relationship between the parties. As a general rule, unless the lease 
has been renewed or the facts show with reasonable certainty that the 
lease will be renewed, the cost or other basis of the lease, or the cost 
of improvements shall be spread only over the number of years the lease 
has to run without taking into account any right of renewal. The 
provisions of this subparagraph may be illustrated by the following 
examples:

    Example (1). A subsidiary corporation leases land from its parent at 
a fair rental for a 25-year period. The subsidiary erects on the land 
valuable factory buildings having an estimated useful life of 50 years. 
These facts show with reasonable certainty that the lease will be 
renewed, even though the lease contains no option of renewal. Therefore, 
the cost of the buildings shall be depreciated over the estimated useful 
life of the buildings in accordance with section 167 and the regulations 
thereunder.
    Example (2). A retail merchandising corporation leases land at a 
fair rental from an unrelated lessor for the longest period that the 
lessor is willing to lease the land (30 years). The lessee erects on the 
land a department store having an estimated useful life of 40 years. 
These facts do not show with reasonable certainty that the lease will be 
renewed. Therefore, the cost of the building shall be spread over the 
remaining term of the lease. An annual deduction may be made of an 
amount equal to the cost of the building divided by the number of years 
remaining in the term of the lease, and such deduction shall be in lieu 
of a deduction for depreciation.

    (3) See section 178 and the regulations thereunder for rules 
governing the effect to be given renewal options where a lessee begins 
improvements on leased property after July 28, 1958, other than 
improvements which on such date and at all times thereafter, the lessee 
was under a binding legal obligation to make.

[T.D. 6520, 25 FR 13692, Dec. 24, 1960; as amended by T.D. 8867, 65 FR 
3825, Jan. 25, 2000]



Sec. 1.162-12  Expenses of farmers.

    (a) Farms engaged in for profit. A farmer who operates a farm for 
profit is entitled to deduct from gross income as necessary expenses all 
amounts actually expended in the carrying on of the business of farming. 
The cost of ordinary tools of short life or small cost, such as hand 
tools, including shovels, rakes, etc., may be deducted. The purchase of 
feed and other costs connected with raising livestock may be treated as 
expense deductions insofar as such costs represent actual outlay, but 
not including the value of farm produce grown upon the farm or the labor 
of the taxpayer. For rules regarding the capitalization of expenses of 
producing property in the trade or business of farming, see section 263A 
and the regulations thereunder. For taxable years beginning after July 
12, 1972, where a farmer is engaged in producing crops and the process 
of gathering and disposal of such crops is not completed within the 
taxable year in which such crops were planted, expenses deducted may, 
with the consent of the Commissioner (see section 446 and the 
regulations thereunder), be determined upon the crop method, and such 
deductions must be taken in the taxable year in which the gross income 
from the crop has been realized. For taxable years beginning on or 
before July 12, 1972, where a farmer is engaged in producing

[[Page 793]]

crops which take more than a year from the time of planting to the 
process of gathering and disposal, expenses deducted may, with the 
consent of the Commissioner (see section 446 and the regulations 
thereunder), be determined upon the crop method, and such deductions 
must be taken in the taxable year in which the gross income from the 
crop has been realized. If a farmer does not compute income upon the 
crop method, the cost of seeds and young plants which are purchased for 
further development and cultivation prior to sale in later years may be 
deducted as an expense for the year of purchase, provided the farmer 
follows a consistent practice of deducting such costs as an expense from 
year to year. The preceding sentence does not apply to the cost of seeds 
and young plants connected with the planting of timber (see section 611 
and the regulations thereunder). For rules regarding the capitalization 
of expenses of producing property in the trade or business of farming, 
see section 263A of the Internal Revenue Code and Sec. 1.263A-4. The 
cost of farm machinery, equipment, and farm buildings represents a 
capital investment and is not an allowable deduction as an item of 
expense. Amounts expended in the development of farms, orchards, and 
ranches prior to the time when the productive state is reached may, at 
the election of the taxpayer, be regarded as investments of capital. For 
the treatment of soil and water conservation expenditures as expenses 
which are not chargeable to capital account, see section 175 and the 
regulations thereunder. For taxable years beginning after December 31, 
1959, in the case of expenditures paid or incurred by farmers for 
fertilizer, lime, etc., see section 180 and the regulations thereunder. 
Amounts expended in purchasing work, breeding, dairy, or sporting 
animals are regarded as investments of capital, and shall be depreciated 
unless such animals are included in an inventory in accordance with 
Sec. 1.61-4. The purchase price of an automobile, even when wholly used 
in carrying on farming operations, is not deductible, but is regarded as 
an investment of capital. The cost of gasoline, repairs, and upkeep of 
an automobile if used wholly in the business of farming is deductible as 
an expense; if used partly for business purposes and partly for the 
pleasure or convenience of the taxpayer or his family, such cost may be 
apportioned according to the extent of the use for purposes of business 
and pleasure or convenience, and only the proportion of such cost justly 
attributable to business purposes is deductible as a necessary expense.
    (b) Farms not engaged in for profit; taxable years beginning before 
January 1, 1970--(1) In general. If a farm is operated for recreation or 
pleasure and not on a commercial basis, and if the expenses incurred in 
connection with the farm are in excess of the receipts therefrom, the 
entire receipts from the sale of farm products may be ignored in 
rendering a return of income, and the expenses incurred, being regarded 
as personal expenses, will not constitute allowable deductions.
    (2) Effective date. The provisions of this paragraph shall apply 
with respect to taxable years beginning before January 1, 1970.
    (3) Cross reference. For provisions relating to activities not 
engaged in for profit, applicable to taxable years beginning after 
December 31, 1969, see section 183 and the regulations thereunder.

[T.D. 7198, 37 FR 13679, July 13, 1972, as amended by T.D. 8729, 62 FR 
44546, Aug. 22, 1997; T.D. 8897, 65 FR 50643, Aug. 21, 2000]



Sec. 1.162-13  Depositors' guaranty fund.

    Banking corporations which pursuant to the laws of the State in 
which they are doing business are required to set apart, keep, and 
maintain in their banks the amount levied and assessed against them by 
the State authorities as a ``Depositors' guaranty fund,'' may deduct 
from their gross income the amount so set apart each year to this fund 
provided that such fund, when set aside and carried to the credit of the 
State banking board or duly authorized State officer, ceases to be an 
asset of the bank and may be withdrawn in whole or in part upon demand 
by such board or State officer to meet the needs of these officers in 
reimbursing depositors in insolvent banks, and provided further that no 
portion of the amount thus set aside and credited is returnable under 
the laws of the State

[[Page 794]]

to the assets of the banking corporation. If, however, such amount is 
simply set up on the books of the bank as a reserve to meet a contingent 
liability and remains an asset of the bank, it will not be deductible 
except as it is actually paid out as required by law and upon demand of 
the proper State officers.



Sec. 1.162-14  Expenditures for advertising or promotion of good will.

    A corporation which has, for the purpose of computing its excess 
profits tax credit under Subchapter E, Chapter 2, or Subchapter D, 
Chapter 1 of the Internal Revenue Code of 1939, elected under section 
733 or section 451 (applicable to the excess profits tax imposed by 
Subchapter E of Chapter 2, and Subchapter D of Chapter 1, respectively) 
to charge to capital account for taxable years in its base period 
expenditures for advertising or the promotion of good will which may be 
regarded as capital investments, may not deduct similar expenditures for 
the taxable year. See section 263(b). Such a taxpayer has the burden of 
proving that expenditures for advertising or the promotion of good will 
which it seeks to deduct in the taxable year may not be regarded as 
capital investments under the provisions of the regulations prescribed 
under section 733 or section 451 of the Internal Revenue Code of 1939. 
See 26 CFR, 1938 ed., 35.733-2 (Regulations 112) and 26 CFR (1939) 
40.451-2 (Regulations 130). For the disallowance of deductions for the 
cost of advertising in programs of certain conventions of political 
parties, or in publications part of the proceeds of which directly or 
indirectly inures (or is intended to inure) to or for the use of a 
political party or political candidate, see Sec. 1.276-1.

[T.D. 6996, 34 FR 835, Jan. 18, 1969]



Sec. 1.162-15  Contributions, dues, etc.

    (a) Contributions to organizations described in section 170--(1) In 
general. No deduction is allowable under section 162(a) for a 
contribution or gift by an individual or a corporation if any part 
thereof is deductible under section 170. For example, if a taxpayer 
makes a contribution of $5,000 and only $4,000 of this amount is 
deductible under section 170(a) (whether because of the percentage 
limitation under either section 170(b) (1) or (2), the requirement as to 
time of payment, or both) no deduction is allowable under section 162(a) 
for the remaining $1,000.
    (2) Scope of limitations. The limitations provided in section 162(b) 
and this paragraph apply only to payments which are in fact 
contributions or gifts to organizations described in section 170. For 
example, payments by a transit company to a local hospital (which is a 
charitable organization within the meaning of section 170) in 
consideration of a binding obligation on the part of the hospital to 
provide hospital services and facilities for the company's employees are 
not contributions or gifts within the meaning of section 170 and may be 
deductible under section 162(a) if the requirements of section 162(a) 
are otherwise satisfied.
    (b) Other contributions. Donations to organizations other than those 
described in section 170 which bear a direct relationship to the 
taxpayer's business and are made with a reasonable expectation of a 
financial return commensurate with the amount of the donation may 
constitute allowable deductions as business expenses, provided the 
donation is not made for a purpose for which a deduction is not 
allowable by reason of the provisions of paragraph (b)(1)(i) or (c) of 
Sec. 1.162-20. For example, a transit company may donate a sum of money 
to an organization (of a class not referred to in section 170) intending 
to hold a convention in the city in which it operates, with a reasonable 
expectation that the holding of such convention will augment its income 
through a greater number of people using its transportation facilities.
    (c) Dues. Dues and other payments to an organization, such as a 
labor union or a trade association, which otherwise meet the 
requirements of the regulations under section 162, are deductible in 
full. For limitations on the deductibility of dues and other payments, 
see paragraph (b) and (c) of Sec. 1.162-20.
    (d) Cross reference. For provisions dealing with expenditures for 
institutional or ``good will'' advertising, see Sec. 1.162-20.

[T.D. 6819, 30 FR 5580, Apr. 20, 1965]

[[Page 795]]



Sec. 1.162-16  Cross reference.

    For special rules relating to expenses in connection with 
subdividing real property for sale, see section 1237 and the regulations 
thereunder.



Sec. 1.162-17  Reporting and substantiation of certain business expenses 
of employees.

    (a) Introductory. The purpose of the regulations in this section is 
to provide rules for the reporting of information on income tax returns 
by taxpayers who pay or incur ordinary and necessary business expenses 
in connection with the performance of services as an employee and to 
furnish guidance as to the type of records which will be useful in 
compiling such information and in its substantiation, if required. The 
rules prescribed in this section do not apply to expenses paid or 
incurred for incidentals, such as office supplies for the employer or 
local transportation in connection with an errand. Employees incurring 
such incidental expenses are not required to provide substantiation for 
such amounts. The term ``ordinary and necessary business expenses'' 
means only those expenses which are ordinary and necessary in the 
conduct of the taxpayer's business and are directly attributable to such 
business. The term does not include nondeductible personal, living or 
family expenses.
    (b) Expenses for which the employee is required to account to his 
employer--(1) Reimbursements equal to expenses. The employee need not 
report on his tax return (either itemized or in total amount) expenses 
for travel, transportation, entertainment, and similar purposes paid or 
incurred by him solely for the benefit of his employer for which he is 
required to account and does account to his employer and which are 
charged directly or indirectly to the employer (for example, through 
credit cards) or for which the employee is paid through advances, 
reimbursements, or otherwise, provided the total amount of such 
advances, reimbursements, and charges is equal to such expenses. In such 
a case the taxpayer need only state in his return that the total of 
amounts charged directly or indirectly to his employer through credit 
cards or otherwise and received from the employer as advances or 
reimbursements did not exceed the ordinary and necessary business 
expenses paid or incurred by the employee.
    (2) Reimbursements in excess of expenses. In case the total of 
amounts charged directly or indirectly to the employer and received from 
the employer as advances, reimbursements, or otherwise, exceeds the 
ordinary and necessary business expenses paid or incurred by the 
employee and the employee is required to and does account to his 
employer for such expenses, the taxpayer must include such excess in 
income and state on his return that he has done so.
    (3) Expenses in excess of reimbursements. If the employee's ordinary 
and necessary business expenses exceed the total of the amounts charged 
directly or indirectly to the employer and received from the employer as 
advances, reimbursements, or otherwise, and the employee is required to 
and does account to his employer for such expenses, the taxpayer may 
make the statement in his return required by subparagraph (1) of this 
paragraph unless he wishes to claim a deduction for such excess. If, 
however, he wishes to secure a deduction for such excess, he must submit 
a statement showing the following information as part of his tax return:
    (i) The total of any charges paid or borne by the employer and of 
any other amounts received from the employer for payment of expenses 
whether by means of advances, reimbursements or otherwise; and
    (ii) The nature of his occupation, the number of days away from home 
on business, and the total amount of ordinary and necessary business 
expenses paid or incurred by him (including those charged directly or 
indirectly to the employer through credit cards or otherwise) broken 
down into such broad categories as transportation, meals and lodging 
while away from home overnight, entertainment expenses, and other 
business expenses.
    (4) To ``account'' to his employer as used in this section means to 
submit an expense account or other required written statement to the 
employer showing the business nature and the amount of all the 
employee's expenses

[[Page 796]]

(including those charged directly or indirectly to the employer through 
credit cards or otherwise) broken down into such broad categories as 
transportation, meals and lodging while away from home overnight, 
entertainment expenses, and other business expenses. For this purpose, 
the Commissioner in his discretion may approve reasonable business 
practices under which mileage, per diem in lieu of subsistence, and 
similar allowances providing for ordinary and necessary business 
expenses in accordance with a fixed scale may be regarded as equivalent 
to an accounting to the employer.
    (c) Expenses for which the employee is not required to account to 
his employer. If the employee is not required to account to his employer 
for his ordinary and necessary business expenses, e.g., travel, 
transportation, entertainment, and similar items, or, though required, 
fails to account for such expenses, he must submit, as a part of his tax 
return, a statement showing the following information:
    (1) The total of all amounts received as advances or reimbursements 
from his employer in connection with the ordinary and necessary business 
expenses of the employee, including amounts charged directly or 
indirectly to the employer through credit cards or otherwise; and
    (2) The nature of his occupation, the number of days away from home 
on business, and the total amount of ordinary and necessary business 
expenses paid or incurred by him (including those charged directly or 
indirectly to the employer through credit cards or otherwise) broken 
down into such broad categories as transportation, meals and lodging 
while away from home overnight, entertainment expenses, and other 
business expenses.
    (d) Substantiation of items of expense. (1) Although the 
Commissioner may require any taxpayer to substantiate such information 
concerning expense accounts as may appear to be pertinent in determining 
tax liability, taxpayers ordinarily will not be called upon to 
substantiate expense account information except those in the following 
categories:
    (i) A taxpayer who is not required to account to his employer, or 
who does not account;
    (ii) A taxpayer whose expenses exceed the total of amounts charged 
to his employer and amounts received through advances, reimbursements or 
otherwise and who claims a deduction on his return for such excess;
    (iii) A taxpayer who is related to his employer within the meaning 
of section 267(b); and
    (iv) Other taxpayers in cases where it is determined that the 
accounting procedures used by the employer for the reporting and 
substantiation of expenses by employees are not adequate.
    (2) The Code contemplates that taxpayers keep such records as will 
be sufficient to enable the Commissioner to correctly determine income 
tax liability. Accordingly, it is to the advantage of taxpayers who may 
be called upon to substantiate expense account information to maintain 
as adequate and detailed records of travel, transportation, 
entertainment, and similar business expenses as practical since the 
burden of proof is upon the taxpayer to show that such expenses were not 
only paid or incurred but also that they constitute ordinary and 
necessary business expenses. One method for substantiating expenses 
incurred by an employee in connection with his employment is through the 
preparation of a daily diary or record of expenditures, maintained in 
sufficient detail to enable him to readily identify the amount and 
nature of any expenditure, and the preservation of supporting documents, 
especially in connection with large or exceptional expenditures. 
Nevertheless, it is recognized that by reason of the nature of certain 
expenses or the circumstances under which they are incurred, it is often 
difficult for an employee to maintain detailed records or to preserve 
supporting documents for all his expenses. Detailed records of small 
expenditures incurred in traveling or for transportation, as for 
example, tips, will not be required.
    (3) Where records are incomplete or documentary proof is 
unavailable, it may be possible to establish the amount of the 
expenditures by approximations based upon reliable secondary sources of 
information and collateral

[[Page 797]]

evidence. For example, in connection with an item of traveling expense a 
taxpayer might establish that he was in a travel status a certain number 
of days but that it was impracticable for him to establish the details 
of all his various items of travel expense. In such a case rail fares or 
plane fares can usually be ascertained with exactness and automobile 
costs approximated on the basis of mileage covered. A reasonable 
approximation of meals and lodging might be based upon receipted hotel 
bills or upon average daily rates for such accommodations and meals 
prevailing in the particular community for comparable accommodations. 
Since detailed records of incidental items are not required, deductions 
for these items may be based upon a reasonable approximation. In cases 
where a taxpayer is called upon to substantiate expense account 
information, the burden is on the taxpayer to establish that the amounts 
claimed as a deduction are reasonably accurate and constitute ordinary 
and necessary business expenses paid or incurred by him in connection 
with his trade or business. In connection with the determination of 
factual matters of this type, due consideration will be given to the 
reasonableness of the stated expenditures for the claimed purposes in 
relation to the taxpayer's circumstances (such as his income and the 
nature of his occupation), to the reliability and accuracy of records in 
connection with other items more readily lending themselves to detailed 
recordkeeping, and to all of the facts and circumstances in the 
particular case.
    (e) Applicability. (1) Except as provided in subparagraph (2) of 
this paragraph, the provisions of the regulations in this section are 
supplemental to existing regulations relating to information required to 
be submitted with income tax returns, and shall be applicable with 
respect to taxable years beginning after December 31, 1957, 
notwithstanding any existing regulation to the contrary.
    (2) With respect to taxable years ending after December 31, 1962, 
but only in respect of periods after such date, the provisions of the 
regulations in this section are superseded by the regulations under 
section 274(d) to the extent inconsistent therewith. See Sec. 1.274-5.
    (3) For taxable years beginning on or after January 1, 1989, the 
provisions of this section are superseded by the regulations under 
section 62(c) to the extent this section is inconsistent with those 
regulations. See Sec. 1.62-2.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6630, 27 FR 
12935, Dec. 29, 1962; T.D. 8276, 54 FR 51026, Dec. 12, 1989; T.D. 8324, 
55 FR 51695, Dec. 17, 1990]



Sec. 1.162-18  Illegal bribes and kickbacks.

    (a) Illegal payments to government officials or employees--(1) In 
general. No deduction shall be allowed under section 162(a) for any 
amount paid or incurred, directly or indirectly, to an official or 
employee of any government, or of any agency or other instrumentality of 
any government, if--
    (i) In the case of a payment made to an official or employee of a 
government other than a foreign government described in subparagraph (3) 
(ii) or (iii) of this paragraph, the payment constitutes an illegal 
bribe or kickback, or
    (ii) In the case of a payment made to an official or employee of a 
foreign government described in subparagraph (3) (ii) or (iii) of this 
paragraph, the making of the payment would be unlawful under the laws of 
the United States (if such laws were applicable to the payment and to 
the official or employee at the time the expenses were paid or 
incurred).

No deduction shall be allowed for an accrued expense if the eventual 
payment thereof would fall within the prohibition of this section. The 
place where the expenses are paid or incurred is immaterial. For 
purposes of subdivision (ii) of this subparagraph, lawfulness, or 
unlawfulness of the payment under the laws of the foreign country is 
immaterial.
    (2) Indirect payment. For purposes of this paragraph, an indirect 
payment to an individual shall include any payment which inures to his 
benefit or promotes his interests, regardless of the medium in which the 
payment is made and regardless of the identity of the immediate 
recipient or payor. Thus, for example, payment made to an

[[Page 798]]

agent, relative, or independent contractor of an official or employee, 
or even directly into the general treasury of a foreign country of which 
the beneficiary is an official or employee, may be treated as an 
indirect payment to the official or employee, if in fact such payment 
inures or will inure to his benefit or promotes or will promote his 
financial or other interests. A payment made by an agent or independent 
contractor of the taxpayer which benefits the taxpayer shall be treated 
as an indirect payment by the taxpayer to the official or employee.
    (3) Official or employee of a government. Any individual officially 
connected with--
    (i) The Government of the United States, a State, a territory or 
possession of the United States, the District of Columbia, or the 
Commonwealth of Puerto Rico,
    (ii) The government of a foreign country, or
    (iii) A political subdivision of, or a corporation or other entity 
serving as an agency or instrumentality of, any of the above,

in whatever capacity, whether on a permanent or temporary basis, and 
whether or not serving for compensation, shall be included within the 
term ``official or employee of a government'', regardless of the place 
of residence or post of duty of such individual. An independent 
contractor would not ordinarily be considered to be an official or 
employee. For purposes of section 162(c) and this paragraph, the term 
``foreign country'' shall include any foreign nation, whether or not 
such nation has been accorded diplomatic recognition by the United 
States. Individuals who purport to act on behalf of or as the government 
of a foreign nation, or an agency or instrumentality thereof, shall be 
treated under this section as officials or employees of a foreign 
government, whether or not such individuals in fact control such foreign 
nation, agency, or instrumentality, and whether or not such individuals 
are accorded diplomatic recognition. Accordingly, a group in rebellion 
against an established government shall be treated as officials or 
employees of a foreign government, as shall officials or employees of 
the government against which the group is in rebellion.
    (4) Laws of the United States. The term ``laws of the United 
States'', to which reference is made in paragraph (a)(1)(ii) of this 
section, shall be deemed to include only Federal statutes, including 
State laws which are assimilated into Federal law by Federal statute, 
and legislative and interpretative regulations thereunder. The term 
shall also be limited to statutes which prohibit some act or acts, for 
the violation of which there is a civil or criminal penalty.
    (5) Burden of proof. In any proceeding involving the issue of 
whether, for purposes of section 162(c)(1), a payment made to a 
government official or employee constitutes an illegal bribe or kickback 
(or would be unlawful under the laws of the United States) the burden of 
proof in respect of such issue shall be upon the Commissioner to the 
same extent as he bears the burden of proof in civil fraud cases under 
section 7454 (i.e., he must prove the illegality of the payment by clear 
and convincing evidence).
    (6) Example. The application of this paragraph may be illustrated by 
the following example:

    Example. X Corp. is in the business of selling hospital equipment in 
State Y. During 1970, X Corp. employed A who at the time was employed 
full time by State Y as Superintendent of Hospitals. The purpose of A's 
employment by X Corp. was to procure for it an improper advantage over 
other concerns in the making of sales to hospitals in respect of which 
A, as Superintendent, had authority. X Corp. paid A $5,000 during 1970. 
The making of this payment was illegal under the laws of State Y. Under 
section 162(c)(1), X Corp. is precluded from deducting as a trade or 
business expense the $5,000 paid to A.

    (b) Other illegal payments--(1) In general. No deduction shall be 
allowed under section 162(a) for any payment (other than a payment 
described in paragraph (a) of this section) made, directly or 
indirectly, to any person, if the payment constitutes an illegal bribe, 
illegal kickback, or other illegal payment under the laws of the United 
States (as defined in paragraph (a)(4) of this section), or under any 
State law (but only if such State law is generally enforced), which 
subjects the payor to

[[Page 799]]

a criminal penalty or the loss (including a suspension) of license or 
privilege to engage in a trade or business (whether or not such penalty 
or loss is actually imposed upon the taxpayer). For purposes of this 
paragraph, a kickback includes a payment in consideration of the 
referral of a client, patient, or customer. This paragraph applies only 
to payments made after December 30, 1969.
    (2) State law. For purposes of this paragraph, State law means a 
statute of a State or the District of Columbia.
    (3) Generally enforced. For purposes of this paragraph, a State law 
shall be considered to be generally enforced unless it is never enforced 
or the only persons normally charged with violations thereof in the 
State (or the District of Columbia) enacting the law are infamous or 
those whose violations are extraordinarily flagrant. For example, a 
criminal statute of a State shall be considered to be generally enforced 
unless violations of the statute which are brought to the attention of 
appropriate enforcement authorities do not result in any enforcement 
action in the absence of unusual circumstances.
    (4) Burden of proof. In any proceeding involving the issue of 
whether, for purposes of section 162(c)(2), a payment constitutes an 
illegal bribe, illegal kickback, or other illegal payment the burden of 
proof in respect of such issue shall be upon the Commissioner to the 
same extent as he bears the burden of proof in civil fraud cases under 
section 7454 (i.e., he must prove the illegality of the payment by clear 
and convincing evidence).
    (5) Example. The application of this paragraph may be illustrated by 
the following example:

    Example. X Corp., a calendar-year taxpayer, is engaged in the ship 
repair business in State Y. During 1970, repairs on foreign ships 
accounted for a substantial part of its total business. It was X Corp.'s 
practice to kick back approximately 10 percent of the repair bill to the 
captain and chief engineer of all foreign-owned vessels, which kickbacks 
are illegal under a law of State Y (which is generally enforced) and 
potentially subject X Corp. to fines. During 1970, X Corp. paid $50,000 
in such kickbacks. On X Corp.'s return for 1970, a deduction under 
section 162 was taken for the $50,000. The deduction of the $50,000 of 
illegal kickbacks during 1970 is disallowed under section 162(c)(2), 
whether or not X Corp. is prosecuted with respect to the kickbacks.

    (c) Kickbacks, rebates, and bribes under medicare and medicaid. No 
deduction shall be allowed under section 162(a) for any kickback, 
rebate, or bribe (whether or not illegal) made on or after December 10, 
1971, by any provider of services, supplier, physician, or other person 
who furnishes items or services for which payment is or may be made 
under the Social Security Act, as amended, or in whole or in part out of 
Federal funds under a State plan approved under such Act, if such 
kickback, rebate, or bribe is made in connection with the furnishing of 
such items or services or the making or receipt of such payments. For 
purposes of this paragraph, a kickback includes a payment in 
consideration of the referral of a client, patient, or customer.

[T.D. 7345, 40 FR 7437, Feb. 20, 1975; 40 FR 8948, Mar. 4, 1975]



Sec. 1.162-19  Capital contributions to Federal National Mortgage 
Association.

    (a) In general. The initial holder of stock of the Federal National 
Mortgage Association (FNMA) which is issued pursuant to section 303(c) 
of the Federal National Mortgage Association Charter Act (12 U.S.C., 
section 1718) in a taxable year beginning after December 31, 1959, shall 
treat the excess, if any, of the issuance price (the amount of capital 
contributions evidenced by a share of stock) over the fair market value 
of the stock as of the issue date of such stock as an ordinary and 
necessary business expense paid or incurred during the year in which 
occurs the date of issuance of the stock. To the extent that a sale to 
FNMA of mortgage paper gives rise to the issuance of a share of FNMA 
stock during a taxable year beginning after December 31, 1959, such sale 
is to be treated in a manner consistent with the purpose for, and the 
legislative intent underlying the enactment of, the provisions of 
section 8, Act of September 14, 1960 (Pub. L. 86-779, 74 Stat. 1003). 
Thus, for the purpose of determining an initial holder's gain or loss 
from the sale to FNMA of mortgage paper, with respect to which a share 
of FNMA stock

[[Page 800]]

is issued in a taxable year beginning after December 31, 1959 
(irrespective of when the sale is made), the amount realized by the 
initial holder from the sale of the mortgage paper is the amount of the 
``FNMA purchase price''. The ``FNMA purchase price'' is the gross amount 
of the consideration agreed upon between FNMA and the initial holder for 
the purchase of the mortgage paper, without regard to any deduction 
therefrom as, for example, a deduction representing a capital 
contribution or a purchase or marketing fee. The date of issuance of the 
stock is the date which appears on the stock certificates of the initial 
holder as the date of issue. The initial holder is the original 
purchaser who is issued stock of the Federal National Mortgage 
Association pursuant to section 303(c) of the Act, and who appears on 
the books of FNMA as the initial holder. In determining the period for 
which the initial holder has held such stock, such period shall begin 
with the date of issuance.
    (b) Examples. The provisions of paragraph (a) of this section may be 
illustrated by the following examples:

    Example (1). A, a banking institution which reports its income on a 
calendar year basis, sold mortgage paper with an outstanding principal 
balance of $12,500 to FNMA on October 17, 1960. The FNMA purchase price 
was $11,500. A's basis for the mortgage paper was $10,500. In accordance 
with the terms of the contract, FNMA deducted $375 ($250 representing 
capital contribution and $125 representing purchase and marketing fee) 
from the amount of the purchase price. FNMA credited A's account with 
the amount of the capital contribution. A stock certificate evidencing 
two shares of FNMA common stock of $100 par value was mailed to A and 
FNMA deducted $200 from A's account, leaving a net balance of $50 in 
such account. The stock certificate, bearing an issue date of November 
1, 1960, was received by A on November 7, 1960. The fair market value of 
a share of FNMA stock on October 17, 1960, was $65, on November 1, 1960, 
was $67, and on November 7, 1960, was $68. A may deduct $66 the 
difference between the issuance price ($200) and the fair market value 
($134) of the two shares of stock on the date of issuance (November 1, 
1960), as a business expense for the taxable year 1960. The basis of 
each share of stock issued as of November 1, 1960 will be $67. See 
section 1054 and Sec. 1.1054-1. A's gain from the sale of the mortgage 
paper is $875 computed as follows:

Amount realized in FNMA purchase price........................   $11,500
A's basis in mortgage paper.........................   $10,500
Purchase and marketing fee..........................       125
                                                     ----------
                                                      ........    10,625
                                                               ---------
Gain on sale..................................................       875
 

    Example (2). Assume the same facts as in Example (1), and, in 
addition, that A sold to FNMA on December 15, 1960, additional mortgage 
paper having an outstanding principal balance of $12,500. FNMA deducted 
from the FNMA purchase price $250 representing capital contribution and 
credited A's account with this amount. A then had a total credit of $300 
to his account consisting of the $50 balance from the transaction 
described in Example (1) and $250 from the December 15th transaction. A 
stock certificate evidencing three shares of FNMA common stock of $100 
par value was mailed to A and FNMA deducted $300 from A's account. The 
stock certificate, bearing an issue date of January 1, 1961, was 
received by A on January 9, 1961. The fair market value of a share of 
FNMA stock on January 1, 1961, was $69. A may deduct $93, the difference 
between the issuance price ($300) and the fair market value ($207) of 
the three shares of stock on the date of issuance (January 1, 1961), as 
a business expense for the taxable year 1961. The gain or loss on the 
sale of mortgage paper on December 15, 1960, is reportable for the 
taxable year 1960.

[T.D. 6690, 28 FR 12253, Nov. 19, 1963]



Sec. 1.162-20  Expenditures attributable to lobbying, political 
campaigns, attempts to influence legislation, etc., and certain 
advertising.

    (a) In general--(1) Scope of section. This section contains rules 
governing the deductibility or nondeductibility of expenditures for 
lobbying purposes, for the promotion or defeat of legislation, for 
political campaign purposes (including the support of or opposition to 
any candidate for public office) or for carrying on propaganda 
(including advertising) related to any of the foregoing purposes. For 
rules applicable to such expenditures in respect of taxable years 
beginning before January 1, 1963, and for taxable years beginning after 
December 31, 1962, see paragraphs (b) and (c), respectively, of this 
section. This section also deals with expenditures for institutional or 
``good will'' advertising.
    (2) Institutional or ``good will'' advertising. Expenditures for 
institutional or ``good will'' advertising which keeps the taxpayer's 
name before the public are generally deductible as ordinary

[[Page 801]]

and necessary business expenses provided the expenditures are related to 
the patronage the taxpayer might reasonably expect in the future. For 
example, a deduction will ordinarily be allowed for the cost of 
advertising which keeps the taxpayer's name before the public in 
connection with encouraging contributions to such organizations as the 
Red Cross, the purchase of United States Savings Bonds, or participation 
in similar causes. In like fashion, expenditures for advertising which 
presents views on economic, financial, social, or other subjects of a 
general nature, but which does not involve any of the activities 
specified in paragraph (b) or (c) of this section for which a deduction 
is not allowable, are deductible if they otherwise meet the requirements 
of the regulations under section 162.
    (b) Taxable years beginning before January 1, 1963--(1) In general. 
(i) For taxable years beginning before January 1, 1963, expenditures for 
lobbying purposes, for the promotion or defeat of legislation, for 
political campaign purposes (including the support of or opposition to 
any candidate for public office), or for carrying on propaganda 
(including advertising) related to any of the foregoing purposes are not 
deductible from gross income. For example, the cost of advertising to 
promote or defeat legislation or to influence the public with respect to 
the desirability or undesirability of proposed legislation is not 
deductible as a business expense, even though the legislation may 
directly affect the taxpayer's business.
    (ii) If a substantial part of the activities of an organization, 
such as a labor union or a trade association, consists of one or more of 
the activities specified in the first sentence of this subparagraph, 
deduction will be allowed only for such portion of the dues or other 
payments to the organization as the taxpayer can clearly establish is 
attributable to activities other than those so specified. The 
determination of whether such specified activities constitute a 
substantial part of an organization's activities shall be based on all 
the facts and circumstances. In no event shall special assessments or 
similar payments (including an increase in dues) made to any 
organization for any of such specified purposes be deductible. For other 
provisions relating to the deductibility of dues and other payments to 
an organization, such as a labor union or a trade association, see 
paragraph (c) of Sec. 1.162-15.
    (2) Expenditures for promotion or defeat of legislation. For 
purposes of this paragraph, expenditures for the promotion or the defeat 
of legislation include, but shall not be limited to, expenditures for 
the purpose of attempting to--
    (i) Influence members of a legislative body directly, or indirectly 
by urging or encouraging the public to contact such members for the 
purpose of proposing, supporting, or opposing legislation, or
    (ii) Influence the public to approve or reject a measure in a 
referendum, initiative, vote on a constitutional amendment, or similar 
procedure.
    (c) Taxable years beginning after December 31, 1962--(1) In general. 
For taxable years beginning after December 31, 1962, certain types of 
expenses incurred with respect to legislative matters are deductible 
under section 162(a) if they otherwise meet the requirements of the 
regulations under section 162. These deductible expenses are described 
in subparagraph (2) of this paragraph. All other expenditures for 
lobbying purposes, for the promotion or defeat of legislation (see 
paragraph (b)(2) of this section), for political campaign purposes 
(including the support of or opposition to any candidate for public 
office), or for carrying on propaganda (including advertising) relating 
to any of the foregoing purposes are not deductible from gross income 
for such taxable years. For the disallowance of deductions for bad debts 
and worthless securities of a political party, see Sec. 1.271-1. For 
the disallowance of deductions for certain indirect political 
contributions, such as the cost of certain advertising and the cost of 
admission to certain dinners, programs, and inaugural events, see Sec. 
1.276-1.
    (2) Appearances, etc., with respect to legislation--(i) General 
rule. Pursuant to the provisions of section 162(e), expenses incurred 
with respect to legislative matters which may be deductible are those 
ordinary and necessary expenses (including, but not limited to, 
traveling expenses described in section

[[Page 802]]

162(a)(2) and the cost of preparing testimony) paid or incurred by the 
taxpayer during a taxable year beginning after December 31, 1962, in 
carrying on any trade or business which are in direct connection with--
    (a) Appearances before, submission of statements to, or sending 
communications to, the committees, or individual members of Congress or 
of any legislative body of a State, a possession of the United States, 
or a political subdivision of any of the foregoing with respect to 
legislation or proposed legislation of direct interest to the taxpayer, 
or
    (b) Communication of information between the taxpayer and an 
organization of which he is a member with respect to legislation or 
proposed legislation of direct interest to the taxpayer and to such 
organization.

For provisions relating to dues paid or incurred with respect to an 
organization of which the taxpayer is a member, see subparagraph (3) of 
this paragraph.
    (ii) Legislation or proposed legislation of direct interest to the 
taxpayer--(a) Legislation or proposed legislation. The term 
``legislation or proposed legislation'' includes bills and resolutions 
introduced by a member of Congress or other legislative body referred to 
in subdivision (i)(a) of this subparagraph for consideration by such 
body as well as oral or written proposals for legislative action 
submitted to the legislative body or to a committee or member of such 
body.
    (b) Direct interest--(1) In general. (i) Legislation or proposed 
legislation is of direct interest to a taxpayer if the legislation or 
proposed legislation is of such a nature that it will, or may reasonably 
be expected to, affect the trade or business of the taxpayer. It is 
immaterial whether the effect, or expected effect, on the trade or 
business will be beneficial or detrimental to the trade or business or 
whether it will be immediate. If legislation or proposed legislation has 
such a relationship to a trade or business that the expenses of any 
appearance or communication in connection with the legislation meets the 
ordinary and necessary test of section 162(a), then such legislation 
ordinarily meets the direct interest test of section 162(e). However, if 
the nature of the legislation or proposed legislation is such that the 
likelihood of its having an effect on the trade or business of the 
taxpayer is remote or speculative, the legislation or proposed 
legislation is not of direct interest to the taxpayer. Legislation or 
proposed legislation which will not affect the trade or business of the 
taxpayer is not of direct interest to the taxpayer even though such 
legislation will affect the personal, living, or family activities or 
expenses of the taxpayer. Legislation or proposed legislation is not of 
direct interest to a taxpayer merely because it may affect business in 
general; however, if the legislation or proposed legislation will, or 
may reasonably be expected to, affect the taxpayer's trade or business 
it will be of direct interest to the taxpayer even though it also will 
affect the trade or business of other taxpayers or business in general. 
To meet the direct interest test, it is not necessary that all 
provisions of the legislation or proposed legislation have an effect, or 
expected effect, on the taxpayer's trade or business. The test will be 
met if one of the provisions of the legislation has the specified 
effect. Legislation or proposed legislation will be considered to be of 
direct interest to a membership organization if it is of direct interest 
to the organization, as such, or if it is of direct interest to one or 
more of its members.
    (ii) Legislation which would increase or decrease the taxes 
applicable to the trade or business, increase or decrease the operating 
costs or earnings of the trade or business, or increase or decrease the 
administrative burdens connected with the trade or business meets the 
direct interest test. Legislation which would increase the social 
security benefits or liberalize the right to such benefits meets the 
direct interest test because such changes in the social security 
benefits may reasonably be expected to affect the retirement benefits 
which the employer will be asked to provide his employees or to increase 
his taxes. Legislation which would impose a retailer's sales tax is of 
direct interest to a retailer because, although the tax may be passed on 
to his customers, collection of the tax will

[[Page 803]]

impose additional burdens on the retailer, and because the increased 
cost of his products to the consumer may reduce the demand for them. 
Legislation which would provide an income tax credit or exclusion for 
shareholders is of direct interest to a corporation, because those tax 
benefits may increase the sources of capital available to the 
corporation. Legislation which would favorably or adversely affect the 
business of a competitor so as to affect the taxpayer's competitive 
position is of direct interest to the taxpayer. Legislation which would 
improve the school system of a community is of direct interest to a 
membership organization comprised of employers in the community because 
the improved school system is likely to make the community more 
attractive to prospective employees of such employers. On the other 
hand, proposed legislation relating to Presidential succession in the 
event of the death of the President has only a remote and speculative 
effect on any trade or business and therefore does not meet the direct 
interest test. Similarly, if a corporation is represented before a 
congressional committee to oppose an appropriation bill merely because 
of a desire to bring increased Government economy with the hope that 
such economy will eventually cause a reduction in the Federal income 
tax, the legislation does not meet the direct interest test because any 
effect it may have upon the corporation's trade or business is highly 
speculative.
    (2) Appearances, etc., by expert witnesses. (i) An appearance or 
communication (of a type described in paragraph (c)(2)(i)(a) of this 
section) by an individual in connection with legislation or proposed 
legislation shall be considered to be with respect to legislation of 
direct interest to such individual if the legislation is in a field in 
which he specializes as an employee, if the appearance or communication 
is not on behalf of his employer, and if it is customary for individuals 
in his type of employment to publicly express their views in respect of 
matters in their field of competence. Expenses incurred by such an 
individual in connection with such an appearance of communication, 
including traveling expenses properly allocable thereto, represent 
ordinary and necessary business expenses and are, therefore, deductible 
under section 162. For example, if a university professor who teaches in 
the field of money and banking appears, on his own behalf, before a 
legislative committee to testify on proposed legislation regarding the 
banking system, his expenses incurred in connection with such appearance 
are deductible under section 162 since university professors customarily 
take an active part in the development of the law in their field of 
competence and publicly communicate the results of their work.
    (ii) An appearance or communication (of a type described in 
paragraph (c)(2)(i)(a) of this section) by an employee or self-employed 
individual in connection with legislation or proposed legislation shall 
be considered to be with respect to legislation of direct interest to 
such person if the legislation is in the field in which he specializes 
in his business (or as an employee) and if the appearance or 
communication is made pursuant to an invitation extended to him 
individually for the purpose of receiving his expert testimony. Expenses 
incurred by an employee or self-employed individual in connection with 
such an appearance or communication, including traveling expenses 
properly allocable thereto, represent ordinary and necessary business 
expenses and are, therefore, deductible under section 162. For example, 
if a self-employed individual is personally invited by a congressional 
committee to testify on proposed legislation in the field in which he 
specializes in his business, his expenses incurred in connection with 
such appearance are deductible under section 162. If a self-employed 
individual makes an appearance, on his own behalf, before a legislative 
committee without having been extended an invitation his expenses will 
be deductible to the extent otherwise provided in this paragraph.
    (3) Nominations, etc. A taxpayer does not have a direct interest in 
matters such as nominations, appointments, or the operation of the 
legislative body.
    (iii) Allowable expenses. To be deductible under section 162(a), 
expenditures which meet the tests of deductibility under the provisions 
of this paragraph

[[Page 804]]

must also qualify as ordinary and necessary business expenses under 
section 162(a) and, in addition, be in direct connection with the 
carrying on of the activities specified in subdivision (i)(a) or (i)(b) 
of this subparagraph. For example, a taxpayer appearing before a 
committee of the Congress to present testimony concerning legislation or 
proposed legislation in which he has a direct interest may deduct the 
ordinary and necessary expenses directly connected with his appearance, 
such as traveling expenses described in section 162(a)(2), and the cost 
of preparing testimony.
    (3) Deductibility of dues and other payments to an organization. If 
a substantial part of the activities of an organization, such as a labor 
union or a trade association, consists of one or more of the activities 
to which this paragraph relates (legislative matters, political 
campaigns, etc.), exclusive of any activity constituting an appearance 
or communication with respect to legislation or proposed legislation of 
direct interest to the organization (see subparagraph (c)(2)(ii)(b)(1)), 
a deduction will be allowed only for such portion of the dues or other 
payments to the organization as the taxpayer can clearly establish is 
attributable to activities to which this paragraph does not relate and 
to any activity constituting an appearance or communication with respect 
to legislation or proposed legislation of direct interest to the 
organization. The determination of whether a substantial part of an 
organization's activities consists of one or more of the activities to 
which this paragraph relates (exclusive of appearances or communications 
with respect to legislation or proposed legislation of direct interest 
to the organization) shall be based on all the facts and circumstances. 
In no event shall a deduction be allowed for that portion of a special 
assessment or similar payment (including an increase in dues) made to 
any organization for any activity to which this paragraph relates if the 
activity does not constitute an appearance or communication with respect 
to legislation or proposed legislation of direct interest to the 
organization. If an organization pays or incurs expenses allocable to 
legislative activities which meet the tests of subdivisions (i) and (ii) 
of subparagraph (2) of this paragraph (appearances or communications 
with respect to legislation or proposed legislation of direct interest 
to the organization), on behalf of its members, the dues paid by a 
taxpayer are deductible to the extent used for such activities. Dues 
paid by a taxpayer will be considered to be used for such an activity, 
and thus deductible, although the legislation or proposed legislation 
involved is not of direct interest to the taxpayer, if, pursuant to the 
provisions of subparagraph (2)(ii)(b)(1) of this paragraph, the 
legislation or proposed legislation is of direct interest to the 
organization, as such, or is of direct interest to one or more members 
of the organization. For other provisions relating to the deductibility 
of dues and other payments to an organization, such as a labor union or 
a trade association, see paragraph (c) of Sec. 1.162-15.
    (4) Limitations. No deduction shall be allowed under section 162(a) 
for any amount paid or incurred (whether by way of contribution, gift, 
or otherwise) in connection with any attempt to influence the general 
public, or segments thereof, with respect to legislative matters, 
elections, or referendums. For example, no deduction shall be allowed 
for any expenses incurred in connection with ``grassroot'' campaigns or 
any other attempts to urge or encourage the public to contact members of 
a legislative body for the purpose of proposing, supporting, or opposing 
legislation.
    (5) Expenses paid or incurred after December 31, 1993, in connection 
with influencing legislation other than certain local legislation. The 
provisions of paragraphs (c)(1) through (3) of this section are 
superseded for expenses paid or incurred after December 31, 1993, in 
connection with influencing legislation (other than certain local 
legislation) to the extent inconsistent with section 162(e)(1)(A) (as 
limited by section 162(e)(2)) and Sec. Sec. 1.162-20(d) and 1.162-29.
    (d) Dues allocable to expenditures after 1993. No deduction is 
allowed under section 162(a) for the portion of dues or other similar 
amounts paid by the taxpayer to an organization exempt from tax (other 
than an organization described in section 501(c)(3)) which the

[[Page 805]]

organization notifies the taxpayer under section 6033(e)(1)(A)(ii) is 
allocable to expenditures to which section 162(e)(1) applies. The first 
sentence of this paragraph (d) applies to dues or other similar amounts 
whether or not paid on or before December 31, 1993. Section 1.162-
20(c)(3) is superseded to the extent inconsistent with this paragraph 
(d).

[T.D. 6819, 30 FR 5581, Apr. 20, 1965, as amended by T.D. 6996, 34 FR 
835, Jan. 18, 1969; T.D. 8602, 60 FR 37573, July 21, 1995]



Sec. 1.162-21  Fines and penalties.

    (a) In general. No deduction shall be allowed under section 162(a) 
for any fine or similar penalty paid to--
    (1) The government of the United States, a State, a territory or 
possession of the United States, the District of Columbia, or the 
Commonwealth of Puerto Rico;
    (2) The government of a foreign country; or
    (3) A political subdivision of, or corporation or other entity 
serving as an agency or instrumentality of, any of the above.
    (b) Definition. (1) For purposes of this section a fine or similar 
penalty includes an amount--
    (i) Paid pursuant to conviction or a plea of guilty or nolo 
contendere for a crime (felony or misdemeanor) in a criminal proceeding;
    (ii) Paid as a civil penalty imposed by Federal, State, or local 
law, including additions to tax and additional amounts and assessable 
penalties imposed by chapter 68 of the Internal Revenue Code of 1954;
    (iii) Paid in settlement of the taxpayer's actual or potential 
liability for a fine or penalty (civil or criminal); or
    (iv) Forfeited as collateral posted in connection with a proceeding 
which could result in imposition of such a fine or penalty.
    (2) The amount of a fine or penalty does not include legal fees and 
related expenses paid or incurred in the defense of a prosecution or 
civil action arising from a violation of the law imposing the fine or 
civil penalty, nor court costs assessed against the taxpayer, or 
stenographic and printing charges. Compensatory damages (including 
damages under section 4A of the Clayton Act (15 U.S.C. 15a), as amended) 
paid to a government do not constitute a fine or penalty.
    (c) Examples. The application of this section may be illustrated by 
the following examples:

    Example (1). M Corp. was indicted under section 1 of the Sherman 
Anti-Trust Act (15 U.S.C. 1) for fixing and maintaining prices of 
certain electrical products. M Corp. was convicted and was fined 
$50,000. The United States sued M Corp. under section 4A of the Clayton 
Act (15 U.S.C. 15a) for $100,000, the amount of the actual damages 
resulting from the price fixing of which M Corp. was convicted. Pursuant 
to a final judgment entered in the civil action. M Corp. paid the United 
States $100,000 in damages. Section 162(f) precludes M Corp. from 
deducting the fine of $50,000 as a trade or business expense. Section 
162(f) does not preclude it from deducting the $100,000 paid to the 
United States as actual damages.
    Example (2). N Corp. was found to have violated 33 U.S.C. 1321(b)(3) 
when a vessel it operated discharged oil in harmful quantities into the 
navigable waters of the United States. A civil penalty under 33 U.S.C. 
1321(b)(6) of $5,000 was assessed against N Corp. with respect to the 
discharge. N Corp. paid $5,000 to the Coast Guard in payment of the 
civil penalty. Section 162(f) precludes N Corp. from deducting the 
$5,000 penalty.
    Example (3). O Corp., a manufacturer of motor vehicles, was found to 
have violated 42 U.S.C. 1857f-2(a)(1) by selling a new motor vehicle 
which was not covered by the required certificate of conformity. 
Pursuant to 42 U.S.C. 1857f-4, O Corp. was required to pay, and did pay, 
a civil penalty of $10,000. In addition, pursuant to 42 U.S.C. 1857f-
5a(c)(1), O Corp. was required to expend, and did expend, $500 in order 
to remedy the nonconformity of that motor vehicle. Section 162(f) 
precludes O Corp. from deducting the $10,000 penalty as a trade or 
business expense, but does not preclude it from deducting the $500 which 
it expended to remedy the nonconformity.
    Example (4). P Corp. was the operator of a coal mine in which 
occurred a violation of a mandatory safety standard prescribed by the 
Federal Coal Mine Health and Safety Act of 1969 (30 U.S.C. 801 et seq.). 
Pursuant to 30 U.S.C. 819(a), a civil penalty of $10,000 was assessed 
against P Corp., and P Corp. paid the penalty. Section 162(f) precludes 
P Corp. from deducting the $10,000 penalty.
    Example (5). Q Corp., a common carrier engaged in interstate 
commerce by railroad, hauled a railroad car which was not equipped with 
efficient hand brakes, in violation of 45 U.S.C. 11. Q Corp. was found 
to be liable for a penalty of $250 pursuant to 45 U.S.C. 13. Q

[[Page 806]]

Corp. paid that penalty. Section 162(f) precludes Q Corp. from deducting 
the $250 penalty.
    Example (6). R Corp. owned and operated on the highways of State X a 
truck weighing in excess of the amount permitted under the law of State 
X. R Corp. was found to have violated the law and was assessed a fine of 
$85 which it paid to State X. Section 162(f) precludes R Corp. from 
deducting the amount so paid.
    Example (7). S Corp. was found to have violated a law of State Y 
which prohibited the emission into the air of particulate matter in 
excess of a limit set forth in a regulation promulgated under that law. 
The Environmental Quality Hearing Board of State Y assessed a fine of 
$500 against S Corp. The fine was payable to State Y, and S Corp. paid 
it. Section 162(f) precludes S Corp. from deducting the $500 fine.
    Example (8). T Corp. was found by a magistrate of City Z to be 
operating in such city an apartment building which did not conform to a 
provision of the city housing code requiring operable fire escapes on 
apartment buildings of that type. Upon the basis of the magistrate's 
finding, T Corp. was required to pay, and did pay, a fine of $200 to 
City Z. Section 162(f) precludes T Corp. from deducting the $200 fine.

[T.D. 7345, 40 FR 7437, Feb. 20, 1975; 40 FR 8948, Mar. 4, 1975, as 
amended by T.D. 7366, 40 FR 29290, July 11, 1975]



Sec. 1.162-22  Treble damage payments under the antitrust laws.

    (a) In general. In the case of a taxpayer who after December 31, 
1969, either is convicted in a criminal action of a violation of the 
Federal antitrust laws or enters a plea of guilty or nolo contendere to 
an indictment or information charging such a violation, and whose 
conviction or plea does not occur in a new trial following an appeal of 
a conviction on or before such date, no deduction shall be allowed under 
section 162(a) for two-thirds of any amount paid or incurred after 
December 31, 1969, with respect to--
    (1) Any judgment for damages entered against the taxpayer under 
section 4 of the Clayton Act (15 U.S.C. 15), as amended, on account of 
such violation or any related violation of the Federal antitrust laws, 
provided such related violation occurred prior to the date of the final 
judgment of such conviction, or
    (2) Settlement of any action brought under such section 4 on account 
of such violation or related violation.

For the purposes of this section, where a civil judgment has been 
entered or a settlement made with respect to a violation of the 
antitrust laws and a criminal proceeding is based upon the same 
violation, the criminal proceeding need not have been brought prior to 
the civil judgment or settlement. If, in his return for any taxable 
year, a taxpayer claims a deduction for an amount paid or incurred with 
respect to a judgment or settlement described in the first sentence of 
this paragraph and is subsequently convicted of a violation of the 
antitrust laws which makes a portion of such amount unallowable, then 
the taxpayer shall file an amended return for such taxable year on which 
the amount of the deduction is appropriately reduced. Attorney's fees, 
court costs, and other amounts paid or incurred in connection with a 
controversy under such section 4 which meet the requirements of section 
162 are deductible under that section. For purposes of subparagraph (2) 
of this paragraph, the amount paid or incurred in settlement shall not 
include amounts attributable to the plaintiff's costs of suit and 
attorney's fees, to the extent that such costs or fees have actually 
been paid.
    (b) Conviction. For purposes of paragraph (a) of this section, a 
taxpayer is convicted of a violation of the antitrust laws if a judgment 
of conviction (whether or not a final judgment) with respect to such 
violation has been entered against him, provided a subsequent final 
judgment of acquittal has not been entered or criminal prosecution with 
respect to such violation terminated without a final judgment of 
conviction. During the pendency of an appeal or other action directly 
contesting a judgment of conviction, the taxpayer should file a 
protective claim for credit or refund to avoid being barred by the 
period of limitations on credit or refund under section 6511.
    (c) Related violation. For purposes of this section, a violation of 
the Federal antitrust laws is related to a subsequent violation if (1) 
with respect to the subsequent violation the United States obtains both 
a judgment in a criminal proceeding and an injunction against the 
taxpayer, and (2) the taxpayer's actions which constituted the

[[Page 807]]

prior violation would have contravened such injunction if such 
injunction were applicable at the time of the prior violation.
    (d) Settlement following a dismissal of an action or amendment of 
the complaint. For purposes of paragraph (a)(2) of this section, an 
amount may be considered as paid in settlement of an action even though 
the action is dismissed or otherwise disposed of prior to such 
settlement or the complaint is amended to eliminate the claim with 
respect to the violation or related violation.
    (e) Antitrust laws. The term ``antitrust laws'' as used in section 
162(g) and this section shall include the Federal acts enumerated in 
paragraph (1) of section 1 of the Clayton Act (15 U.S.C. 12), as 
amended.
    (f) Examples. The application of this section may be illustrated by 
the following examples:

    Example (1). In 1970, the United States instituted a criminal 
prosecution against X Co., Y Co., A, the president of X Co., and B, the 
president of Y Co., under section 1 of the Sherman Anti-Trust Act, 15 
U.S.C. 1. In the indictment, the defendants were charged with conspiring 
to fix and maintain prices of electrical transformers from 1965 to 1970. 
All defendants entered pleas of nolo contendere to these charges. These 
pleas were accepted and judgments of conviction entered. In a companion 
civil suit, the United States obtained an injunction prohibiting the 
defendants from conspiring to fix and maintain prices in the electrical 
transformer market. Thereafter, Z Co. sued X Co. and Y Co. for $300,000 
in treble damages under section 4 of the Clayton Act. Z Co.'s complaint 
alleged that the criminal conspiracy between X Co. and Y Co. forced Z 
Co. to pay excessive prices for electrical transformers. X Co. and Y Co. 
each paid Z Co. $85,000 in full settlement of Z Co.'s action. Of each 
$85,000 paid, $10,000 was attributable to court costs and attorney's 
fees actually paid by Z Co. Under section 162(g), X Co. and Y Co. are 
each precluded from deducting as a trade or business expense more than 
$35,000 of the $85,000 paid to Z Co. in settlement--

$10,000+[($85,000-$10,000)/3]

    Example (2). Assume the same facts as in example (1) except that Z 
Co.'s claim for treble damages was based on a conspiracy to fix and 
maintain prices in the sale of electrical transformers during 1963. 
Although the criminal prosecution of the defendants did not involve 1963 
(a year barred by the applicable criminal statute of limitations when 
the prosecution was instituted), Z Co.'s pleadings alleged that the 
civil statute of limitations had been tolled by the defendants' 
fraudulent concealment of their conspiracy. Since the United States has 
obtained both a judgment in a criminal proceeding and an injunction 
against the defendants in connection with their activities from 1965 to 
1970, and the alleged actions of the defendants in 1963 would have 
contravened such injunction if it were applicable in 1963, the alleged 
violation in 1963 is related to the violation from 1965 to 1970. 
Accordingly, the tax consequences to X Co. and Y Co. of the payments of 
$85,000 in settlement of Z Co.'s claim against X Co. and Y Co. are the 
same as in example (1).
    Example (3). Assume the same facts as in example (1) except that Z 
Co.'s claim for treble damages was based on a conspiracy to fix and 
maintain prices with respect to electrical insulators for high-tension 
power poles. Since the civil action was not based on the same violation 
of the Federal antitrust laws as the criminal action, or on a related 
violation (a violation which would have contravened the injunction if it 
were applicable), X Co. and Y Co. are not precluded by section 162(g) 
from deducting as a trade or business expense the entire $85,000 paid by 
each in settlement of the civil action.

[T.D. 7217, 37 FR 23916, Nov. 10, 1972]



Sec. 1.162-25  Deductions with respect to noncash fringe benefits.

    (a) [Reserved]
    (b) Employee. If an employer provides the use of a vehicle (as 
defined in Sec. 1.61-21(e)(2)) to an employee as a noncash fringe 
benefit and includes the entire value of the benefit in the employee's 
gross income without taking into account any exclusion for a working 
condition fringe allowable under section 132 and the regulations 
thereunder, the employee may deduct that value multiplied by the 
percentage of the total use of the vehicle that is in connection with 
the employer's trade or business (business value). For taxable years 
beginning before January 1, 1990, the employee may deduct the business 
value from gross income in determining adjusted gross income. For 
taxable years beginning on or after January 1, 1990, the employee may 
deduct the business value only as a miscellaneous itemized deduction in 
determining taxable income, subject to the 2-percent floor provided in 
section 67. If the employer determines the value of the noncash fringe 
benefit under a special accounting rule that allows the employer to

[[Page 808]]

treat the value of benefits provided during the last two months of the 
calendar year or any shorter period as paid during the subsequent 
calendar year, then the employee must determine the deduction allowable 
under this paragraph (b) without regard to any use of the benefit during 
those last two months or any shorter period. The employee may not use a 
cents-per-mile valuation method to determine the deduction allowable 
under this paragraph (b).

[T.D. 8451, 57 FR 57669, Dec. 7, 1992; 57 FR 60568, Dec. 21, 1992]



Sec. 1.162-25T  Deductions with respect to noncash fringe benefits 
(temporary).

    (a) Employer. If an employer includes the value of a noncash fringe 
benefit in an employee's gross income, the employer may not deduct this 
amount as compensation for services, but rather may deduct only the 
costs incurred by the employer in providing the benefit to the employee. 
The employer may be allowed a cost recovery deduction under section 168 
or a deduction under section 179 for an expense not chargeable to 
capital account, or, if the noncash fringe benefit is property leased by 
the employer, a deduction for the ordinary and necessary business 
expense of leasing the property.
    (b) [Reserved]
    (c) Examples. The following examples illustrate the provisions of 
this section.

    Example (1). On January 1, 1986, X Company owns and provides the use 
of an automobile with a fair market value of $20,000 to E, an employee, 
for the entire calendar year. Both X and E compute taxable income on the 
basis of the calendar year. Seventy percent of the use of the automobile 
by E is in connection with X's trade or business. If X uses the special 
rule provided in Sec. 1.61-2T for valuing the availability of the 
automobile and takes into account the amount excludable as a working 
condition fringe, X would include $1,680 ($5,600, the Annual Lease 
Value, less 70 percent of $5,600) in E's gross income for 1986. X may 
not deduct the amount included in E's income as compensation for 
services. X may, however, determine a cost recovery deduction under 
section 168, subject to the limitations under section 280F, for taxable 
year 1986.
    Example (2). The facts are the same as in example (1), except that X 
includes $5,600 in E's gross income, the value of the noncash fringe 
benefit without taking into account the amount excludable as a working 
condition fringe. X may not deduct that amount as compensation for 
services, but may determine a cost recovery deduction under section 168, 
subject to the limitations under section 280F. For purposes of 
determining adjusted gross income, E may deduct $3,920 ($5,600 
multiplied by the percent of business use).

[T.D. 8061, 50 FR 46013, Nov. 6, 1985, as amended by T.D. 8063, 50 FR 
52312, Dec. 23, 1985; T.D. 8276, 54 FR 51026, Dec. 12, 1989; T.D. 8451, 
57 FR 57669, Dec. 7, 1992]



Sec. 1.162-27  Certain employee remuneration in excess of $1,000,000.

    (a) Scope. This section provides rules for the application of the $1 
million deduction limit under section 162(m) of the Internal Revenue 
Code. Paragraph (b) of this section provides the general rule limiting 
deductions under section 162(m). Paragraph (c) of this section provides 
definitions of generally applicable terms. Paragraph (d) of this section 
provides an exception from the deduction limit for compensation payable 
on a commission basis. Paragraph (e) of this section provides an 
exception for qualified performance-based compensation. Paragraphs (f) 
and (g) of this section provide special rules for corporations that 
become publicly held corporations and payments that are subject to 
section 280G, respectively. Paragraph (h) of this section provides 
transition rules, including the rules for contracts that are 
grandfathered and not subject to section 162(m). Paragraph (j) of this 
section contains the effective date provisions. For rules concerning the 
deductibility of compensation for services that are not covered by 
section 162(m) and this section, see section 162(a)(1) and Sec. 1.162-
7. This section is not determinative as to whether compensation meets 
the requirements of section 162(a)(1).
    (b) Limitation on deduction. Section 162(m) precludes a deduction 
under chapter 1 of the Internal Revenue Code by any publicly held 
corporation for compensation paid to any covered employee to the extent 
that the compensation for the taxable year exceeds $1,000,000.
    (c) Definitions--(1) Publicly held corporation--(i) General rule. A 
publicly held corporation means any corporation

[[Page 809]]

issuing any class of common equity securities required to be registered 
under section 12 of the Exchange Act. A corporation is not considered 
publicly held if the registration of its equity securities is voluntary. 
For purposes of this section, whether a corporation is publicly held is 
determined based solely on whether, as of the last day of its taxable 
year, the corporation is subject to the reporting obligations of section 
12 of the Exchange Act.
    (ii) Affiliated groups. A publicly held corporation includes an 
affiliated group of corporations, as defined in section 1504 (determined 
without regard to section 1504(b)). For purposes of this section, 
however, an affiliated group of corporations does not include any 
subsidiary that is itself a publicly held corporation. Such a publicly 
held subsidiary, and its subsidiaries (if any), are separately subject 
to this section. If a covered employee is paid compensation in a taxable 
year by more than one member of an affiliated group, compensation paid 
by each member of the affiliated group is aggregated with compensation 
paid to the covered employee by all other members of the group. Any 
amount disallowed as a deduction by this section must be prorated among 
the payor corporations in proportion to the amount of compensation paid 
to the covered employee by each such corporation in the taxable year.
    (2) Covered employee--(i) General rule. A covered employee means any 
individual who, on the last day of the taxable year, is--
    (A) The chief executive officer of the corporation or is acting in 
such capacity; or
    (B) Among the four highest compensated officers (other than the 
chief executive officer).
    (ii) Application of rules of the Securities and Exchange Commission. 
Whether an individual is the chief executive officer described in 
paragraph (c)(2)(i)(A) of this section or an officer described in 
paragraph (c)(2)(i)(B) of this section is determined pursuant to the 
executive compensation disclosure rules under the Exchange Act.
    (3) Compensation--(i) In general. For purposes of the deduction 
limitation described in paragraph (b) of this section, compensation 
means the aggregate amount allowable as a deduction under chapter 1 of 
the Internal Revenue Code for the taxable year (determined without 
regard to section 162(m)) for remuneration for services performed by a 
covered employee, whether or not the services were performed during the 
taxable year.
    (ii) Exceptions. Compensation does not include--
    (A) Remuneration covered in section 3121(a)(5)(A) through section 
3121(a)(5)(D) (concerning remuneration that is not treated as wages for 
purposes of the Federal Insurance Contributions Act); and
    (B) Remuneration consisting of any benefit provided to or on behalf 
of an employee if, at the time the benefit is provided, it is reasonable 
to believe that the employee will be able to exclude it from gross 
income. In addition, compensation does not include salary reduction 
contributions described in section 3121(v)(1).
    (4) Compensation Committee. The compensation committee means the 
committee of directors (including any subcommittee of directors) of the 
publicly held corporation that has the authority to establish and 
administer performance goals described in paragraph (e)(2) of this 
section, and to certify that performance goals are attained, as 
described in paragraph (e)(5) of this section. A committee of directors 
is not treated as failing to have the authority to establish performance 
goals merely because the goals are ratified by the board of directors of 
the publicly held corporation or, if applicable, any other committee of 
the board of directors. See paragraph (e)(3) of this section for rules 
concerning the composition of the compensation committee.
    (5) Exchange Act. The Exchange Act means the Securities Exchange Act 
of 1934.
    (6) Examples. This paragraph (c) may be illustrated by the following 
examples:

    Example 1. Corporation X is a publicly held corporation with a July 
1 to June 30 fiscal year. For Corporation X's taxable year ending on 
June 30, 1995, Corporation X pays compensation of $2,000,000 to A, an 
employee. However, A's compensation is not required to be reported to 
shareholders under the executive compensation disclosure rules of the

[[Page 810]]

Exchange Act because A is neither the chief executive officer nor one of 
the four highest compensated officers employed on the last day of the 
taxable year. A's compensation is not subject to the deduction 
limitation of paragraph (b) of this section.
    Example 2. C, a covered employee, performs services and receives 
compensation from Corporations X, Y, and Z, members of an affiliated 
group of corporations. Corporation X, the parent corporation, is a 
publicly held corporation. The total compensation paid to C from all 
affiliated group members is $3,000,000 for the taxable year, of which 
Corporation X pays $1,500,000; Corporation Y pays $900,000; and 
Corporation Z pays $600,000. Because the compensation paid by all 
affiliated group members is aggregated for purposes of section 162(m), 
$2,000,000 of the aggregate compensation paid is nondeductible. 
Corporations X, Y, and Z each are treated as paying a ratable portion of 
the nondeductible compensation. Thus, two thirds of each corporation's 
payment will be nondeductible. Corporation X has a nondeductible 
compensation expense of $1,000,000 ($1,500,000x$2,000,000/$3,000,000). 
Corporation Y has a nondeductible compensation expense of $600,000 
($900,000x$2,000,000/$3,000,000). Corporation Z has a nondeductible 
compensation expense of $400,000 ($600,000x$2,000,000/$3,000,000).
    Example 3. Corporation W, a calendar year taxpayer, has total assets 
equal to or exceeding $5 million and a class of equity security held of 
record by 500 or more persons on December 31, 1994. However, under the 
Exchange Act, Corporation W is not required to file a registration 
statement with respect to that security until April 30, 1995. Thus, 
Corporation W is not a publicly held corporation on December 31, 1994, 
but is a publicly held corporation on December 31, 1995.
    Example 4. The facts are the same as in Example 3, except that on 
December 15, 1996, Corporation W files with the Securities and Exchange 
Commission to disclose that Corporation W is no longer required to be 
registered under section 12 of the Exchange Act and to terminate its 
registration of securities under that provision. Because Corporation W 
is no longer subject to Exchange Act reporting obligations as of 
December 31, 1996, Corporation W is not a publicly held corporation for 
taxable year 1996, even though the registration of Corporation W's 
securities does not terminate until 90 days after Corporation W files 
with the Securities and Exchange Commission.

    (d) Exception for compensation paid on a commission basis. The 
deduction limit in paragraph (b) of this section shall not apply to any 
compensation paid on a commission basis. For this purpose, compensation 
is paid on a commission basis if the facts and circumstances show that 
it is paid solely on account of income generated directly by the 
individual performance of the individual to whom the compensation is 
paid. Compensation does not fail to be attributable directly to the 
individual merely because support services, such as secretarial or 
research services, are utilized in generating the income. However, if 
compensation is paid on account of broader performance standards, such 
as income produced by a business unit of the corporation, the 
compensation does not qualify for the exception provided under this 
paragraph (d).
    (e) Exception for qualified performance-based compensation--
    (1) In general. The deduction limit in paragraph (b) of this section 
does not apply to qualified performance-based compensation. Qualified 
performance-based compensation is compensation that meets all of the 
requirements of paragraphs (e)(2) through (e)(5) of this section.
    (2) Performance goal requirement--(i) Preestablished goal. Qualified 
performance-based compensation must be paid solely on account of the 
attainment of one or more preestablished, objective performance goals. A 
performance goal is considered preestablished if it is established in 
writing by the compensation committee not later than 90 days after the 
commencement of the period of service to which the performance goal 
relates, provided that the outcome is substantially uncertain at the 
time the compensation committee actually establishes the goal. However, 
in no event will a performance goal be considered to be preestablished 
if it is established after 25 percent of the period of service (as 
scheduled in good faith at the time the goal is established) has 
elapsed. A performance goal is objective if a third party having 
knowledge of the relevant facts could determine whether the goal is met. 
Performance goals can be based on one or more business criteria that 
apply to the individual, a business unit, or the corporation as a whole. 
Such business criteria could include, for example, stock price, market 
share, sales, earnings per share, return on equity, or costs. A 
performance goal need not, however, be

[[Page 811]]

based upon an increase or positive result under a business criterion and 
could include, for example, maintaining the status quo or limiting 
economic losses (measured, in each case, by reference to a specific 
business criterion). A performance goal does not include the mere 
continued employment of the covered employee. Thus, a vesting provision 
based solely on continued employment would not constitute a performance 
goal. See paragraph (e)(2)(vi) of this section for rules on compensation 
that is based on an increase in the price of stock.
    (ii) Objective compensation formula. A preestablished performance 
goal must state, in terms of an objective formula or standard, the 
method for computing the amount of compensation payable to the employee 
if the goal is attained. A formula or standard is objective if a third 
party having knowledge of the relevant performance results could 
calculate the amount to be paid to the employee. In addition, a formula 
or standard must specify the individual employees or class of employees 
to which it applies.
    (iii) Discretion.
    (A) The terms of an objective formula or standard must preclude 
discretion to increase the amount of compensation payable that would 
otherwise be due upon attainment of the goal. A performance goal is not 
discretionary for purposes of this paragraph (e)(2)(iii) merely because 
the compensation committee reduces or eliminates the compensation or 
other economic benefit that was due upon attainment of the goal. 
However, the exercise of negative discretion with respect to one 
employee is not permitted to result in an increase in the amount payable 
to another employee. Thus, for example, in the case of a bonus pool, if 
the amount payable to each employee is stated in terms of a percentage 
of the pool, the sum of these individual percentages of the pool is not 
permitted to exceed 100 percent. If the terms of an objective formula or 
standard fail to preclude discretion to increase the amount of 
compensation merely because the amount of compensation to be paid upon 
attainment of the performance goal is based, in whole or in part, on a 
percentage of salary or base pay and the dollar amount of the salary or 
base pay is not fixed at the time the performance goal is established, 
then the objective formula or standard will not be considered 
discretionary for purposes of this paragraph (e)(2)(iii) if the maximum 
dollar amount to be paid is fixed at that time.
    (B) If compensation is payable upon or after the attainment of a 
performance goal, and a change is made to accelerate the payment of 
compensation to an earlier date after the attainment of the goal, the 
change will be treated as an increase in the amount of compensation, 
unless the amount of compensation paid is discounted to reasonably 
reflect the time value of money. If compensation is payable upon or 
after the attainment of a performance goal, and a change is made to 
defer the payment of compensation to a later date, any amount paid in 
excess of the amount that was originally owed to the employee will not 
be treated as an increase in the amount of compensation if the 
additional amount is based either on a reasonable rate of interest or on 
one or more predetermined actual investments (whether or not assets 
associated with the amount originally owed are actually invested 
therein) such that the amount payable by the employer at the later date 
will be based on the actual rate of return of a specific investment 
(including any decrease as well as any increase in the value of an 
investment). If compensation is payable in the form of property, a 
change in the timing of the transfer of that property after the 
attainment of the goal will not be treated as an increase in the amount 
of compensation for purposes of this paragraph (e)(2)(iii). Thus, for 
example, if the terms of a stock grant provide for stock to be 
transferred after the attainment of a performance goal and the transfer 
of the stock also is subject to a vesting schedule, a change in the 
vesting schedule that either accelerates or defers the transfer of stock 
will not be treated as an increase in the amount of compensation payable 
under the performance goal.
    (C) Compensation attributable to a stock option, stock appreciation 
right, or other stock-based compensation

[[Page 812]]

does not fail to satisfy the requirements of this paragraph (e)(2) to 
the extent that a change in the grant or award is made to reflect a 
change in corporate capitalization, such as a stock split or dividend, 
or a corporate transaction, such as any merger of a corporation into 
another corporation, any consolidation of two or more corporations into 
another corporation, any separation of a corporation (including a 
spinoff or other distribution of stock or property by a corporation), 
any reorganization of a corporation (whether or not such reorganization 
comes within the definition of such term in section 368), or any partial 
or complete liquidation by a corporation.
    (iv) Grant-by-grant determination. The determination of whether 
compensation satisfies the requirements of this paragraph (e)(2) 
generally shall be made on a grant-by-grant basis. Thus, for example, 
whether compensation attributable to a stock option grant satisfies the 
requirements of this paragraph (e)(2) generally is determined on the 
basis of the particular grant made and without regard to the terms of 
any other option grant, or other grant of compensation, to the same or 
another employee. As a further example, except as provided in paragraph 
(e)(2)(vi), whether a grant of restricted stock or other stock-based 
compensation satisfies the requirements of this paragraph (e)(2) is 
determined without regard to whether dividends, dividend equivalents, or 
other similar distributions with respect to stock, on such stock-based 
compensation are payable prior to the attainment of the performance 
goal. Dividends, dividend equivalents, or other similar distributions 
with respect to stock that are treated as separate grants under this 
paragraph (e)(2)(iv) are not performance-based compensation unless they 
separately satisfy the requirements of this paragraph (e)(2).
    (v) Compensation contingent upon attainment of performance goal. 
Compensation does not satisfy the requirements of this paragraph (e)(2) 
if the facts and circumstances indicate that the employee would receive 
all or part of the compensation regardless of whether the performance 
goal is attained. Thus, if the payment of compensation under a grant or 
award is only nominally or partially contingent on attaining a 
performance goal, none of the compensation payable under the grant or 
award will be considered performance-based. For example, if an employee 
is entitled to a bonus under either of two arrangements, where payment 
under a nonperformance-based arrangement is contingent upon the failure 
to attain the performance goals under an otherwise performance-based 
arrangement, then neither arrangement provides for compensation that 
satisfies the requirements of this paragraph (e)(2). Compensation does 
not fail to be qualified performance-based compensation merely because 
the plan allows the compensation to be payable upon death, disability, 
or change of ownership or control, although compensation actually paid 
on account of those events prior to the attainment of the performance 
goal would not satisfy the requirements of this paragraph (e)(2). As an 
exception to the general rule set forth in the first sentence of 
paragraph (e)(2)(iv) of this section, the facts-and-circumstances 
determination referred to in the first sentence of this paragraph 
(e)(2)(v) is made taking into account all plans, arrangements, and 
agreements that provide for compensation to the employee.
    (vi) Application of requirements to stock options and stock 
appreciation rights--(A) In general. Compensation attributable to a 
stock option or a stock appreciation right is deemed to satisfy the 
requirements of this paragraph (e)(2) if the grant or award is made by 
the compensation committee; the plan under which the option or right is 
granted states the maximum number of shares with respect to which 
options or rights may be granted during a specified period to any 
employee; and, under the terms of the option or right, the amount of 
compensation the employee could receive is based solely on an increase 
in the value of the stock after the date of the grant or award. 
Conversely, if the amount of compensation the employee will receive 
under the grant or award is not based solely on an increase in the value 
of the stock after the date of grant or award (e.g., in the case of 
restricted stock, or an option that is granted with an exercise

[[Page 813]]

price that is less than the fair market value of the stock as of the 
date of grant), none of the compensation attributable to the grant or 
award is qualified performance-based compensation because it does not 
satisfy the requirement of this paragraph (e)(2)(vi)(A). Whether a stock 
option grant is based solely on an increase in the value of the stock 
after the date of grant is determined without regard to any dividend 
equivalent that may be payable, provided that payment of the dividend 
equivalent is not made contingent on the exercise of the option. The 
rule that the compensation attributable to a stock option or stock 
appreciation right must be based solely on an increase in the value of 
the stock after the date of grant or award does not apply if the grant 
or award is made on account of, or if the vesting or exercisability of 
the grant or award is contingent on, the attainment of a performance 
goal that satisfies the requirements of this paragraph (e)(2).
    (B) Cancellation and repricing. Compensation attributable to a stock 
option or stock appreciation right does not satisfy the requirements of 
this paragraph (e)(2) to the extent that the number of options granted 
exceeds the maximum number of shares for which options may be granted to 
the employee as specified in the plan. If an option is canceled, the 
canceled option continues to be counted against the maximum number of 
shares for which options may be granted to the employee under the plan. 
If, after grant, the exercise price of an option is reduced, the 
transaction is treated as a cancellation of the option and a grant of a 
new option. In such case, both the option that is deemed to be canceled 
and the option that is deemed to be granted reduce the maximum number of 
shares for which options may be granted to the employee under the plan. 
This paragraph (e)(2)(vi)(B) also applies in the case of a stock 
appreciation right where, after the award is made, the base amount on 
which stock appreciation is calculated is reduced to reflect a reduction 
in the fair market value of stock.
    (vii) Examples. This paragraph (e)(2) may be illustrated by the 
following examples:

    Example 1. No later than 90 days after the start of a fiscal year, 
but while the outcome is substantially uncertain, Corporation S 
establishes a bonus plan under which A, the chief executive officer, 
will receive a cash bonus of $500,000, if year-end corporate sales are 
increased by at least 5 percent. The compensation committee retains the 
right, if the performance goal is met, to reduce the bonus payment to A 
if, in its judgment, other subjective factors warrant a reduction. The 
bonus will meet the requirements of this paragraph (e)(2).
    Example 2. The facts are the same as in Example 1, except that the 
bonus is based on a percentage of Corporation S's total sales for the 
fiscal year. Because Corporation S is virtually certain to have some 
sales for the fiscal year, the outcome of the performance goal is not 
substantially uncertain, and therefore the bonus does not meet the 
requirements of this paragraph (e)(2).
    Example 3. The facts are the same as in Example 1, except that the 
bonus is based on a percentage of Corporation S's total profits for the 
fiscal year. Although some sales are virtually certain for virtually all 
public companies, it is substantially uncertain whether a company will 
have profits for a specified future period even if the company has a 
history of profitability. Therefore, the bonus will meet the 
requirements of this paragraph (e)(2).
    Example 4. B is the general counsel of Corporation R, which is 
engaged in patent litigation with Corporation S. Representatives of 
Corporation S have informally indicated to Corporation R a willingness 
to settle the litigation for $50,000,000. Subsequently, the compensation 
committee of Corporation R agrees to pay B a bonus if B obtains a formal 
settlement for at least $50,000,000. The bonus to B does not meet the 
requirement of this paragraph (e)(2) because the performance goal was 
not established at a time when the outcome was substantially uncertain.
    Example 5. Corporation S, a public utility, adopts a bonus plan for 
selected salaried employees that will pay a bonus at the end of a 3-year 
period of $750,000 each if, at the end of the 3 years, the price of S 
stock has increased by 10 percent. The plan also provides that the 10-
percent goal will automatically adjust upward or downward by the 
percentage change in a published utilities index. Thus, for example, if 
the published utilities index shows a net increase of 5 percent over a 
3-year period, then the salaried employees would receive a bonus only if 
Corporation S stock has increased by 15 percent. Conversely, if the 
published utilities index shows a net decrease of 5 percent over a 3-
year period, then the salaried employees would receive a bonus if 
Corporation S stock has increased by 5 percent. Because these automatic 
adjustments in the performance goal

[[Page 814]]

are preestablished, the bonus meets the requirement of this paragraph 
(e)(2), notwithstanding the potential changes in the performance goal.
    Example 6. The facts are the same as in Example 5, except that the 
bonus plan provides that, at the end of the 3-year period, a bonus of 
$750,000 will be paid to each salaried employee if either the price of 
Corporation S stock has increased by 10 percent or the earnings per 
share on Corporation S stock have increased by 5 percent. If both the 
earnings-per-share goal and the stock-price goal are preestablished, the 
compensation committee's discretion to choose to pay a bonus under 
either of the two goals does not cause any bonus paid under the plan to 
fail to meet the requirement of this paragraph (e)(2) because each goal 
independently meets the requirements of this paragraph (e)(2). The 
choice to pay under either of the two goals is tantamount to the 
discretion to choose not to pay under one of the goals, as provided in 
paragraph (e)(2)(iii) of this section.
    Example 7. Corporation U establishes a bonus plan under which a 
specified class of employees will participate in a bonus pool if certain 
preestablished performance goals are attained. The amount of the bonus 
pool is determined under an objective formula. Under the terms of the 
bonus plan, the compensation committee retains the discretion to 
determine the fraction of the bonus pool that each employee may receive. 
The bonus plan does not satisfy the requirements of this paragraph 
(e)(2). Although the aggregate amount of the bonus plan is determined 
under an objective formula, a third party could not determine the amount 
that any individual could receive under the plan.
    Example 8. The facts are the same as in Example 7, except that the 
bonus plan provides that a specified share of the bonus pool is payable 
to each employee, and the total of these shares does not exceed 100% of 
the pool. The bonus plan satisfies the requirements of this paragraph 
(e)(2). In addition, the bonus plan will satisfy the requirements of 
this paragraph (e)(2) even if the compensation committee retains the 
discretion to reduce the compensation payable to any individual 
employee, provided that a reduction in the amount of one employee's 
bonus does not result in an increase in the amount of any other 
employee's bonus.
    Example 9. Corporation V establishes a stock option plan for 
salaried employees. The terms of the stock option plan specify that no 
salaried employee shall receive options for more than 100,000 shares 
over any 3-year period. The compensation committee grants options for 
50,000 shares to each of several salaried employees. The exercise price 
of each option is equal to or greater than the fair market value at the 
time of each grant. Compensation attributable to the exercise of the 
options satisfies the requirements of this paragraph (e)(2). If, 
however, the terms of the options provide that the exercise price is 
less than fair market value at the date of grant, no compensation 
attributable to the exercise of those options satisfies the requirements 
of this paragraph (e)(2) unless issuance or exercise of the options was 
contingent upon the attainment of a preestablished performance goal that 
satisfies this paragraph (e)(2).
    Example 10. The facts are the same as in Example 9, except that, 
within the same 3-year grant period, the fair market value of 
Corporation V stock is significantly less than the exercise price of the 
options. The compensation committee reprices those options to that lower 
current fair market value of Corporation V stock. The repricing of the 
options for 50,000 shares held by each salaried employee is treated as 
the grant of new options for an additional 50,000 shares to each 
employee. Thus, each of the salaried employees is treated as having 
received grants for 100,000 shares. Consequently, if any additional 
options are granted to those employees during the 3-year period, 
compensation attributable to the exercise of those additional options 
would not satisfy the requirements of this paragraph (e)(2). The results 
would be the same if the compensation committee canceled the outstanding 
options and issued new options to the same employees that were 
exercisable at the fair market value of Corporation V stock on the date 
of reissue.
    Example 11. Corporation W maintains a plan under which each 
participating employee may receive incentive stock options, nonqualified 
stock options, stock appreciation rights, or grants of restricted 
Corporation W stock. The plan specifies that each participating employee 
may receive options, stock appreciation rights, restricted stock, or any 
combination of each, for no more than 20,000 shares over the life of the 
plan. The plan provides that stock options may be granted with an 
exercise price of less than, equal to, or greater than fair market value 
on the date of grant. Options granted with an exercise price equal to, 
or greater than, fair market value on the date of grant do not fail to 
meet the requirements of this paragraph (e)(2) merely because the 
compensation committee has the discretion to determine the types of 
awards (i.e., options, rights, or restricted stock) to be granted to 
each employee or the discretion to issue options or make other 
compensation awards under the plan that would not meet the requirements 
of this paragraph (e)(2). Whether an option granted under the plan 
satisfies the requirements of this paragraph (e)(2) is determined on the 
basis of the specific terms of the option and without regard to other 
options or awards under the plan.
    Example 12. Corporation X maintains a plan under which stock 
appreciation rights may

[[Page 815]]

be awarded to key employees. The plan permits the compensation committee 
to make awards under which the amount of compensation payable to the 
employee is equal to the increase in the stock price plus a percentage 
``gross up'' intended to offset the tax liability of the employee. In 
addition, the plan permits the compensation committee to make awards 
under which the amount of compensation payable to the employee is equal 
to the increase in the stock price, based on the highest price, which is 
defined as the highest price paid for Corporation X stock (or offered in 
a tender offer or other arms-length offer) during the 90 days preceding 
exercise. Compensation attributable to awards under the plan satisfies 
the requirements of paragraph (e)(2)(vi) of this section, provided that 
the terms of the plan specify the maximum number of shares for which 
awards may be made.
    Example 13. Corporation W adopts a plan under which a bonus will be 
paid to the CEO only if there is a 10% increase in earnings per share 
during the performance period. The plan provides that earnings per share 
will be calculated without regard to any change in accounting standards 
that may be required by the Financial Accounting Standards Board after 
the goal is established. After the goal is established, such a change in 
accounting standards occurs. Corporation W's reported earnings, for 
purposes of determining earnings per share under the plan, are adjusted 
pursuant to this plan provision to factor out this change in standards. 
This adjustment will not be considered an exercise of impermissible 
discretion because it is made pursuant to the plan provision.
    Example 14. Corporation X adopts a performance-based incentive pay 
plan with a four-year performance period. Bonuses under the plan are 
scheduled to be paid in the first year after the end of the performance 
period (year 5). However, in the second year of the performance period, 
the compensation committee determines that any bonuses payable in year 5 
will instead, for bona fide business reasons, be paid in year 10. The 
compensation committee also determines that any compensation that would 
have been payable in year 5 will be adjusted to reflect the delay in 
payment. The adjustment will be based on the greater of the future rate 
of return of a specified mutual fund that invests in blue chip stocks or 
of a specified venture capital investment over the five-year deferral 
period. Each of these investments, considered by itself, is a 
predetermined actual investment because it is based on the future rate 
of return of an actual investment. However, the adjustment in this case 
is not based on predetermined actual investments within the meaning of 
paragraph (e)(2)(iii)(B) of this section because the amount payable by 
Corporation X in year 10 will be based on the greater of the two 
investment returns and, thus, will not be based on the actual rate of 
return on either specific investment.
    Example 15. The facts are the same as in Example 14, except that the 
increase will be based on Moody's Average Corporate Bond Yield over the 
five-year deferral period. Because this index reflects a reasonable rate 
of interest, the increase in the compensation payable that is based on 
the index's rate of return is not considered an impermissible increase 
in the amount of compensation payable under the formula.
    Example 16. The facts are the same as in Example 14, except that the 
increase will be based on the rate of return for the Standard & Poor's 
500 Index. This index does not measure interest rates and thus does not 
represent a reasonable rate of interest. In addition, this index does 
not represent an actual investment. Therefore, any additional 
compensation payable based on the rate of return of this index will 
result in an impermissible increase in the amount payable under the 
formula. If, in contrast, the increase were based on the rate of return 
of an existing mutual fund that is invested in a manner that seeks to 
approximate the Standard & Poor's 500 Index, the increase would be based 
on a predetermined actual investment within the meaning of paragraph 
(e)(2)(iii)(B) of this section and thus would not result in an 
impermissible increase in the amount payable under the formula.

    (3) Outside directors--(i) General rule. The performance goal under 
which compensation is paid must be established by a compensation 
committee comprised solely of two or more outside directors. A director 
is an outside director if the director--
    (A) Is not a current employee of the publicly held corporation;
    (B) Is not a former employee of the publicly held corporation who 
receives compensation for prior services (other than benefits under a 
tax-qualified retirement plan) during the taxable year;
    (C) Has not been an officer of the publicly held corporation; and
    (D) Does not receive remuneration from the publicly held 
corporation, either directly or indirectly, in any capacity other than 
as a director. For this purpose, remuneration includes any payment in 
exchange for goods or services.
    (ii) Remuneration received. For purposes of this paragraph (e)(3), 
remuneration is received, directly or indirectly, by a director in each 
of the following circumstances:
    (A) If remuneration is paid, directly or indirectly, to the director 
personally

[[Page 816]]

or to an entity in which the director has a beneficial ownership 
interest of greater than 50 percent. For this purpose, remuneration is 
considered paid when actually paid (and throughout the remainder of that 
taxable year of the corporation) and, if earlier, throughout the period 
when a contract or agreement to pay remuneration is outstanding.
    (B) If remuneration, other than de minimis remuneration, was paid by 
the publicly held corporation in its preceding taxable year to an entity 
in which the director has a beneficial ownership interest of at least 5 
percent but not more than 50 percent. For this purpose, remuneration is 
considered paid when actually paid or, if earlier, when the publicly 
held corporation becomes liable to pay it.
    (C) If remuneration, other than de minimis remuneration, was paid by 
the publicly held corporation in its preceding taxable year to an entity 
by which the director is employed or self-employed other than as a 
director. For this purpose, remuneration is considered paid when 
actually paid or, if earlier, when the publicly held corporation becomes 
liable to pay it.
    (iii) De minimis remuneration--(A) In general. For purposes of 
paragraphs (e)(3)(ii)(B) and (C) of this section, remuneration that was 
paid by the publicly held corporation in its preceding taxable year to 
an entity is de minimis if payments to the entity did not exceed 5 
percent of the gross revenue of the entity for its taxable year ending 
with or within that preceding taxable year of the publicly held 
corporation.
    (B) Remuneration for personal services and substantial owners. 
Notwithstanding paragraph (e)(3)(iii)(A) of this section, remuneration 
in excess of $60,000 is not de minimis if the remuneration is paid to an 
entity described in paragraph (e)(3)(ii)(B) of this section, or is paid 
for personal services to an entity described in paragraph (e)(3)(ii)(C) 
of this section.
    (iv) Remuneration for personal services. For purposes of paragraph 
(e)(3)(iii)(B) of this section, remuneration from a publicly held 
corporation is for personal services if--
    (A) The remuneration is paid to an entity for personal or 
professional services, consisting of legal, accounting, investment 
banking, and management consulting services (and other similar services 
that may be specified by the Commissioner in revenue rulings, notices, 
or other guidance published in the Internal Revenue Bulletin), performed 
for the publicly held corporation, and the remuneration is not for 
services that are incidental to the purchase of goods or to the purchase 
of services that are not personal services; and
    (B) The director performs significant services (whether or not as an 
employee) for the corporation, division, or similar organization (within 
the entity) that actually provides the services described in paragraph 
(e)(3)(iv)(A) of this section to the publicly held corporation, or more 
than 50 percent of the entity's gross revenues (for the entity's 
preceding taxable year) are derived from that corporation, subsidiary, 
or similar organization.
    (v) Entity defined. For purposes of this paragraph (e)(3), entity 
means an organization that is a sole proprietorship, trust, estate, 
partnership, or corporation. The term also includes an affiliated group 
of corporations as defined in section 1504 (determined without regard to 
section 1504(b)) and a group of organizations that would be an 
affiliated group but for the fact that one or more of the organizations 
are not incorporated. However, the aggregation rules referred to in the 
preceding sentence do not apply for purposes of determining whether a 
director has a beneficial ownership interest of at least 5 percent or 
greater than 50 percent.
    (vi) Employees and former officers. Whether a director is an 
employee or a former officer is determined on the basis of the facts at 
the time that the individual is serving as a director on the 
compensation committee. Thus, a director is not precluded from being an 
outside director solely because the director is a former officer of a 
corporation that previously was an affiliated corporation of the 
publicly held corporation. For example, a director of a parent 
corporation of an affiliated group is not precluded from being an

[[Page 817]]

outside director solely because that director is a former officer of an 
affiliated subsidiary that was spun off or liquidated. However, an 
outside director would no longer be an outside director if a corporation 
in which the director was previously an officer became an affiliated 
corporation of the publicly held corporation.
    (vii) Officer. Solely for purposes of this paragraph (e)(3), officer 
means an administrative executive who is or was in regular and continued 
service. The term implies continuity of service and excludes those 
employed for a special and single transaction. An individual who merely 
has (or had) the title of officer but not the authority of an officer is 
not considered an officer. The determination of whether an individual is 
or was an officer is based on all of the facts and circumstances in the 
particular case, including without limitation the source of the 
individual's authority, the term for which the individual is elected or 
appointed, and the nature and extent of the individual's duties.
    (viii) Members of affiliated groups. For purposes of this paragraph 
(e)(3), the outside directors of the publicly held member of an 
affiliated group are treated as the outside directors of all members of 
the affiliated group.
    (ix) Examples. This paragraph (e)(3) may be illustrated by the 
following examples:

    Example 1. Corporations X and Y are members of an affiliated group 
of corporations as defined in section 1504, until July 1, 1994, when Y 
is sold to another group. Prior to the sale, A served as an officer of 
Corporation Y. After July 1, 1994, A is not treated as a former officer 
of Corporation X by reason of having been an officer of Y.
    Example 2. Corporation Z, a calendar-year taxpayer, uses the 
services of a law firm by which B is employed, but in which B has a 
less-than-5-percent ownership interest. The law firm reports income on a 
July 1 to June 30 basis. Corporation Z appoints B to serve on its 
compensation committee for calendar year 1998 after determining that, in 
calendar year 1997, it did not become liable to the law firm for 
remuneration exceeding the lesser of $60,000 or five percent of the law 
firm's gross revenue (calculated for the year ending June 30, 1997). On 
October 1, 1998, Corporation Z becomes liable to pay remuneration of 
$50,000 to the law firm on June 30, 1999. For the year ending June 30, 
1998, the law firm's gross revenue was less than $1 million. Thus, in 
calendar year 1999, B is not an outside director. However, B may satisfy 
the requirements for an outside director in calendar year 2000, if, in 
calendar year 1999, Corporation Z does not become liable to the law firm 
for additional remuneration. This is because the remuneration actually 
paid on June 30, 1999 was considered paid on October 1, 1998 under 
paragraph (e)(3)(ii)(C) of this section.
    Example 3. Corporation Z, a publicly held corporation, purchases 
goods from Corporation A. D, an executive and less- than-5-percent owner 
of Corporation A, sits on the board of directors of Corporation Z and on 
its compensation committee. For 1997, Corporation Z obtains 
representations to the effect that D is not eligible for any commission 
for D's sales to Corporation Z and that, for purposes of determining D's 
compensation for 1997, Corporation A's sales to Corporation Z are not 
otherwise treated differently than sales to other customers of 
Corporation A (including its affiliates, if any) or are irrelevant. In 
addition, Corporation Z has no reason to believe that these 
representations are inaccurate or that it is otherwise paying 
remuneration indirectly to D personally. Thus, in 1997, no remuneration 
is considered paid by Corporation Z indirectly to D personally under 
paragraph (e)(3)(ii)(A) of this section.
    Example 4. (i) Corporation W, a publicly held corporation, purchases 
goods from Corporation T. C, an executive and less- than-5-percent owner 
of Corporation T, sits on the board of directors of Corporation W and on 
its compensation committee. Corporation T develops a new product and 
agrees on January 1, 1998 to pay C a bonus of $500,000 if Corporation W 
contracts to purchase the product. Even if Corporation W purchases the 
new product, sales to Corporation W will represent less than 5 percent 
of Corporation T's gross revenues. In 1999, Corporation W contracts to 
purchase the new product and, in 2000, C receives the $500,000 bonus 
from Corporation T. In 1998, 1999, and 2000, Corporation W does not 
obtain any representations relating to indirect remuneration to C 
personally (such as the representations described in Example 3).
    (ii) Thus, in 1998, 1999, and 2000, remuneration is considered paid 
by Corporation W indirectly to C personally under paragraph 
(e)(3)(ii)(A) of this section. Accordingly, in 1998, 1999, and 2000, C 
is not an outside director of Corporation W. The result would have been 
the same if Corporation W had obtained appropriate representations but 
nevertheless had reason to believe that it was paying remuneration 
indirectly to C personally.
    Example 5. Corporation R, a publicly held corporation, purchases 
utility service from Corporation Q, a public utility. The chief 
executive officer, and less-than-5-percent

[[Page 818]]

owner, of Corporation Q is a director of Corporation R. Corporation R 
pays Corporation Q more than $60,000 per year for the utility service, 
but less than 5 percent of Corporation Q's gross revenues. Because 
utility services are not personal services, the fees paid are not 
subject to the $60,000 de minimis rule for remuneration for personal 
services within the meaning of paragraph (e)(3)(iii)(B) of this section. 
Thus, the chief executive officer qualifies as an outside director of 
Corporation R, unless disqualified on some other basis.
    Example 6. Corporation A, a publicly held corporation, purchases 
management consulting services from Division S of Conglomerate P. The 
chief financial officer of Division S is a director of Corporation A. 
Corporation A pays more than $60,000 per year for the management 
consulting services, but less than 5 percent of Conglomerate P's gross 
revenues. Because management consulting services are personal services 
within the meaning of paragraph (e)(3)(iv)(A) of this section, and the 
chief financial officer performs significant services for Division S, 
the fees paid are subject to the $60,000 de minimis rule as remuneration 
for personal services. Thus, the chief financial officer does not 
qualify as an outside director of Corporation A.
    Example 7. The facts are the same as in Example 6, except that the 
chief executive officer, and less-than-5-percent owner, of the parent 
company of Conglomerate P is a director of Corporation A and does not 
perform significant services for Division S. If the gross revenues of 
Division S do not constitute more than 50 percent of the gross revenues 
of Conglomerate P for P's preceding taxable year, the chief executive 
officer will qualify as an outside director of Corporation A, unless 
disqualified on some other basis.

    (4) Shareholder approval requirement--(i) General rule. The material 
terms of the performance goal under which the compensation is to be paid 
must be disclosed to and subsequently approved by the shareholders of 
the publicly held corporation before the compensation is paid. The 
requirements of this paragraph (e)(4) are not satisfied if the 
compensation would be paid regardless of whether the material terms are 
approved by shareholders. The material terms include the employees 
eligible to receive compensation; a description of the business criteria 
on which the performance goal is based; and either the maximum amount of 
compensation that could be paid to any employee or the formula used to 
calculate the amount of compensation to be paid to the employee if the 
performance goal is attained (except that, in the case of a formula 
based, in whole or in part, on a percentage of salary or base pay, the 
maximum dollar amount of compensation that could be paid to the employee 
must be disclosed).
    (ii) Eligible employees. Disclosure of the employees eligible to 
receive compensation need not be so specific as to identify the 
particular individuals by name. A general description of the class of 
eligible employees by title or class is sufficient, such as the chief 
executive officer and vice presidents, or all salaried employees, all 
executive officers, or all key employees.
    (iii) Description of business criteria--(A) In general. Disclosure 
of the business criteria on which the performance goal is based need not 
include the specific targets that must be satisfied under the 
performance goal. For example, if a bonus plan provides that a bonus 
will be paid if earnings per share increase by 10 percent, the 10-
percent figure is a target that need not be disclosed to shareholders. 
However, in that case, disclosure must be made that the bonus plan is 
based on an earnings-per-share business criterion. In the case of a plan 
under which employees may be granted stock options or stock appreciation 
rights, no specific description of the business criteria is required if 
the grants or awards are based on a stock price that is no less than 
current fair market value.
    (B) Disclosure of confidential information. The requirements of this 
paragraph (e)(4) may be satisfied even though information that otherwise 
would be a material term of a performance goal is not disclosed to 
shareholders, provided that the compensation committee determines that 
the information is confidential commercial or business information, the 
disclosure of which would have an adverse effect on the publicly held 
corporation. Whether disclosure would adversely affect the corporation 
is determined on the basis of the facts and circumstances. If the 
compensation committee makes such a determination, the disclosure to 
shareholders must state the compensation committee's

[[Page 819]]

belief that the information is confidential commercial or business 
information, the disclosure of which would adversely affect the company. 
In addition, the ability not to disclose confidential information does 
not eliminate the requirement that disclosure be made of the maximum 
amount of compensation that is payable to an individual under a 
performance goal. Confidential information does not include the identity 
of an executive or the class of executives to which a performance goal 
applies or the amount of compensation that is payable if the goal is 
satisfied.
    (iv) Description of compensation. Disclosure as to the compensation 
payable under a performance goal must be specific enough so that 
shareholders can determine the maximum amount of compensation that could 
be paid to any employee during a specified period. If the terms of the 
performance goal do not provide for a maximum dollar amount, the 
disclosure must include the formula under which the compensation would 
be calculated. Thus, for example, if compensation attributable to the 
exercise of stock options is equal to the difference in the exercise 
price and the current value of the stock, disclosure would be required 
of the maximum number of shares for which grants may be made to any 
employee and the exercise price of those options (e.g., fair market 
value on date of grant). In that case, shareholders could calculate the 
maximum amount of compensation that would be attributable to the 
exercise of options on the basis of their assumptions as to the future 
stock price.
    (v) Disclosure requirements of the Securities and Exchange 
Commission. To the extent not otherwise specifically provided in this 
paragraph (e)(4), whether the material terms of a performance goal are 
adequately disclosed to shareholders is determined under the same 
standards as apply under the Exchange Act.
    (vi) Frequency of disclosure. Once the material terms of a 
performance goal are disclosed to and approved by shareholders, no 
additional disclosure or approval is required unless the compensation 
committee changes the material terms of the performance goal. If, 
however, the compensation committee has authority to change the targets 
under a performance goal after shareholder approval of the goal, 
material terms of the performance goal must be disclosed to and 
reapproved by shareholders no later than the first shareholder meeting 
that occurs in the fifth year following the year in which shareholders 
previously approved the performance goal.
    (vii) Shareholder vote. For purposes of this paragraph (e)(4), the 
material terms of a performance goal are approved by shareholders if, in 
a separate vote, a majority of the votes cast on the issue (including 
abstentions to the extent abstentions are counted as voting under 
applicable state law) are cast in favor of approval.
    (viii) Members of affiliated group. For purposes of this paragraph 
(e)(4), the shareholders of the publicly held member of the affiliated 
group are treated as the shareholders of all members of the affiliated 
group.
    (ix) Examples. This paragraph (e)(4) may be illustrated by the 
following examples:

    Example 1. Corporation X adopts a plan that will pay a specified 
class of its executives an annual cash bonus based on the overall 
increase in corporate sales during the year. Under the terms of the 
plan, the cash bonus of each executive equals $100,000 multiplied by the 
number of percentage points by which sales increase in the current year 
when compared to the prior year. Corporation X discloses to its 
shareholders prior to the vote both the class of executives eligible to 
receive awards and the annual formula of $100,000 multiplied by the 
percentage increase in sales. This disclosure meets the requirements of 
this paragraph (e)(4). Because the compensation committee does not have 
the authority to establish a different target under the plan, 
Corporation X need not redisclose to its shareholders and obtain their 
reapproval of the material terms of the plan until those material terms 
are changed.
    Example 2. The facts are the same as in Example 1 except that 
Corporation X discloses only that bonuses will be paid on the basis of 
the annual increase in sales. This disclosure does not meet the 
requirements of this paragraph (e)(4) because it does not include the 
formula for calculating the compensation or a maximum amount of 
compensation to be paid if the performance goal is satisfied.
    Example 3. Corporation Y adopts an incentive compensation plan in 
1995 that will pay a specified class of its executives a bonus

[[Page 820]]

every 3 years based on the following 3 factors: increases in earnings 
per share, reduction in costs for specified divisions, and increases in 
sales by specified divisions. The bonus is payable in cash or in 
Corporation Y stock, at the option of the executive. Under the terms of 
the plan, prior to the beginning of each 3-year period, the compensation 
committee determines the specific targets under each of the three 
factors (i.e., the amount of the increase in earnings per share, the 
reduction in costs, and the amount of sales) that must be met in order 
for the executives to receive a bonus. Under the terms of the plan, the 
compensation committee retains the discretion to determine whether a 
bonus will be paid under any one of the goals. The terms of the plan 
also specify that no executive may receive a bonus in excess of 
$1,500,000 for any 3-year period. To satisfy the requirements of this 
paragraph (e)(4), Corporation Y obtains shareholder approval of the plan 
at its 1995 annual shareholder meeting. In the proxy statement issued to 
shareholders, Corporation Y need not disclose to shareholders the 
specific targets that are set by the compensation committee. However, 
Corporation Y must disclose that bonuses are paid on the basis of 
earnings per share, reductions in costs, and increases in sales of 
specified divisions. Corporation Y also must disclose the maximum amount 
of compensation that any executive may receive under the plan is 
$1,500,000 per 3-year period. Unless changes in the material terms of 
the plan are made earlier, Corporation Y need not disclose the material 
terms of the plan to the shareholders and obtain their reapproval until 
the first shareholders' meeting held in 2000.
    Example 4. The same facts as in Example 3, except that prior to the 
beginning of the second 3-year period, the compensation committee 
determines that different targets will be set under the plan for that 
period with regard to all three of the performance criteria (i.e., 
earnings per share, reductions in costs, and increases in sales). In 
addition, the compensation committee raises the maximum dollar amount 
that can be paid under the plan for a 3-year period to $2,000,000. The 
increase in the maximum dollar amount of compensation under the plan is 
a changed material term. Thus, to satisfy the requirements of this 
paragraph (e)(4), Corporation Y must disclose to and obtain approval by 
the shareholders of the plan as amended.
    Example 5. In 1998, Corporation Z establishes a plan under which a 
specified group of executives will receive a cash bonus not to exceed 
$750,000 each if a new product that has been in development is completed 
and ready for sale to customers by January 1, 2000. Although the 
completion of the new product is a material term of the performance goal 
under this paragraph (e)(4), the compensation committee determines that 
the disclosure to shareholders of the performance goal would adversely 
affect Corporation Z because its competitors would be made aware of the 
existence and timing of its new product. In this case, the requirements 
of this paragraph (e)(4) are satisfied if all other material terms, 
including the maximum amount of compensation, are disclosed and the 
disclosure affirmatively states that the terms of the performance goal 
are not being disclosed because the compensation committee has 
determined that those terms include confidential information, the 
disclosure of which would adversely affect Corporation Z.

    (5) Compensation committee certification. The compensation committee 
must certify in writing prior to payment of the compensation that the 
performance goals and any other material terms were in fact satisfied. 
For this purpose, approved minutes of the compensation committee meeting 
in which the certification is made are treated as a written 
certification. Certification by the compensation committee is not 
required for compensation that is attributable solely to the increase in 
the value of the stock of the publicly held corporation.
    (f) Companies that become publicly held, spinoffs, and similar 
transactions--(1) In general. In the case of a corporation that was not 
a publicly held corporation and then becomes a publicly held 
corporation, the deduction limit of paragraph (b) of this section does 
not apply to any remuneration paid pursuant to a compensation plan or 
agreement that existed during the period in which the corporation was 
not publicly held. However, in the case of such a corporation that 
becomes publicly held in connection with an initial public offering, 
this relief applies only to the extent that the prospectus accompanying 
the initial public offering disclosed information concerning those plans 
or agreements that satisfied all applicable securities laws then in 
effect. In accordance with paragraph (c)(1)(ii) of this section, a 
corporation that is a member of an affiliated group that includes a 
publicly held corporation is considered publicly held and, therefore, 
cannot rely on this paragraph (f)(1).
    (2) Reliance period. Paragraph (f)(1) of this section may be relied 
upon until the earliest of--

[[Page 821]]

    (i) The expiration of the plan or agreement;
    (ii) The material modification of the plan or agreement, within the 
meaning of paragraph (h)(1)(iii) of this section;
    (iii) The issuance of all employer stock and other compensation that 
has been allocated under the plan; or
    (iv) The first meeting of shareholders at which directors are to be 
elected that occurs after the close of the third calendar year following 
the calendar year in which the initial public offering occurs or, in the 
case of a privately held corporation that becomes publicly held without 
an initial public offering, the first calendar year following the 
calendar year in which the corporation becomes publicly held.
    (3) Stock-based compensation. Paragraph (f)(1) of this section will 
apply to any compensation received pursuant to the exercise of a stock 
option or stock appreciation right, or the substantial vesting of 
restricted property, granted under a plan or agreement described in 
paragraph (f)(1) of this section if the grant occurs on or before the 
earliest of the events specified in paragraph (f)(2) of this section.
    (4) Subsidiaries that become separate publicly held corporations--
(i) In general. If a subsidiary that is a member of the affiliated group 
described in paragraph (c)(1)(ii) of this section becomes a separate 
publicly held corporation (whether by spinoff or otherwise), any 
remuneration paid to covered employees of the new publicly held 
corporation will satisfy the exception for performance-based 
compensation described in paragraph (e) of this section if the 
conditions in either paragraph (f)(4)(ii) or (f)(4)(iii) of this section 
are satisfied.
    (ii) Prior establishment and approval. Remuneration satisfies the 
requirements of this paragraph (f)(4)(ii) if the remuneration satisfies 
the requirements for performance-based compensation set forth in 
paragraphs (e)(2), (e)(3), and (e)(4) of this section (by application of 
paragraphs (e)(3)(viii) and (e)(4)(viii) of this section) before the 
corporation becomes a separate publicly held corporation, and the 
certification required by paragraph (e)(5) of this section is made by 
the compensation committee of the new publicly held corporation (but if 
the performance goals are attained before the corporation becomes a 
separate publicly held corporation, the certification may be made by the 
compensation committee referred to in paragraph (e)(3)(viii) of this 
section before it becomes a separate publicly held corporation). Thus, 
this paragraph (f)(4)(ii) requires that the outside directors and 
shareholders (within the meaning of paragraphs (e)(3)(viii) and 
(e)(4)(viii) of this section) of the corporation before it becomes a 
separate publicly held corporation establish and approve, respectively, 
the performance-based compensation for the covered employees of the new 
publicly held corporation in accordance with paragraphs (e)(3) and 
(e)(4) of this section.
    (iii) Transition period. Remuneration satisfies the requirements of 
this paragraph (f)(4)(iii) if the remuneration satisfies all of the 
requirements of paragraphs (e)(2), (e)(3), and (e)(5) of this section. 
The outside directors (within the meaning of paragraph (e)(3)(viii) of 
this section) of the corporation before it becomes a separate publicly 
held corporation, or the outside directors of the new publicly held 
corporation, may establish and administer the performance goals for the 
covered employees of the new publicly held corporation for purposes of 
satisfying the requirements of paragraphs (e)(2) and (e)(3) of this 
section. The certification required by paragraph (e)(5) of this section 
must be made by the compensation committee of the new publicly held 
corporation. However, a taxpayer may rely on this paragraph (f)(4)(iii) 
to satisfy the requirements of paragraph (e) of this section only for 
compensation paid, or stock options, stock appreciation rights, or 
restricted property granted, prior to the first regularly scheduled 
meeting of the shareholders of the new publicly held corporation that 
occurs more than 12 months after the date the corporation becomes a 
separate publicly held corporation. Compensation paid, or stock options, 
stock appreciation rights, or restricted property granted, on or after 
the date of that meeting of shareholders must satisfy all requirements 
of paragraph (e) of this section, including the shareholder approval 
requirement of paragraph (e)(4) of this section, in order to satisfy

[[Page 822]]

the requirements for performance-based compensation.
    (5) Example. The following example illustrates the application of 
paragraph (f)(4)(ii) of this section:

    Example. Corporation P, which is publicly held, decides to spin off 
Corporation S, a wholly owned subsidiary of Corporation P. After the 
spinoff, Corporation S will be a separate publicly held corporation. 
Before the spinoff, the compensation committee of Corporation P, 
pursuant to paragraph (e)(3)(viii) of this section, establishes a bonus 
plan for the executives of Corporation S that provides for bonuses 
payable after the spinoff and that satisfies the requirements of 
paragraph (e)(2) of this section. If, pursuant to paragraph (e)(4)(viii) 
of this section, the shareholders of Corporation P approve the plan 
prior to the spinoff, that approval will satisfy the requirements of 
paragraph (e)(4) of this section with respect to compensation paid 
pursuant to the bonus plan after the spinoff. However, the compensation 
committee of Corporation S will be required to certify that the goals 
are satisfied prior to the payment of the bonuses in order for the 
bonuses to be considered performance-based compensation.

    (g) Coordination with disallowed excess parachute payments. The 
$1,000,000 limitation in paragraph (b) of this section is reduced (but 
not below zero) by the amount (if any) that would have been included in 
the compensation of the covered employee for the taxable year but for 
being disallowed by reason of section 280G. For example, assume that 
during a taxable year a corporation pays $1,500,000 to a covered 
employee and no portion satisfies the exception in paragraph (d) of this 
section for commissions or paragraph (e) of this section for qualified 
performance-based compensation. Of the $1,500,000, $600,000 is an excess 
parachute payment, as defined in section 280G(b)(1) and is disallowed by 
reason of that section. Because the excess parachute payment reduces the 
limitation of paragraph (b) of this section, the corporation can deduct 
$400,000, and $500,000 of the otherwise deductible amount is 
nondeductible by reason of section 162(m).
    (h) Transition rules--(1) Compensation payable under a written 
binding contract which was in effect on February 17, 1993--(i) General 
rule. The deduction limit of paragraph (b) of this section does not 
apply to any compensation payable under a written binding contract that 
was in effect on February 17, 1993. The preceding sentence does not 
apply unless, under applicable state law, the corporation is obligated 
to pay the compensation if the employee performs services. However, the 
deduction limit of paragraph (b) of this section does apply to a 
contract that is renewed after February 17, 1993. A written binding 
contract that is terminable or cancelable by the corporation after 
February 17, 1993, without the employee's consent is treated as a new 
contract as of the date that any such termination or cancellation, if 
made, would be effective. Thus, for example, if the terms of a contract 
provide that it will be automatically renewed as of a certain date 
unless either the corporation or the employee gives notice of 
termination of the contract at least 30 days before that date, the 
contract is treated as a new contract as of the date that termination 
would be effective if that notice were given. Similarly, for example, if 
the terms of a contract provide that the contract will be terminated or 
canceled as of a certain date unless either the corporation or the 
employee elects to renew within 30 days of that date, the contract is 
treated as renewed by the corporation as of that date. Alternatively, if 
the corporation will remain legally obligated by the terms of a contract 
beyond a certain date at the sole discretion of the employee, the 
contract will not be treated as a new contract as of that date if the 
employee exercises the discretion to keep the corporation bound to the 
contract. A contract is not treated as terminable or cancelable if it 
can be terminated or canceled only by terminating the employment 
relationship of the employee.
    (ii) Compensation payable under a plan or arrangement. If a 
compensation plan or arrangement meets the requirements of paragraph 
(h)(1)(i) of this section, the compensation paid to an employee pursuant 
to the plan or arrangement will not be subject to the deduction limit of 
paragraph (b) of this section even though the employee was not eligible 
to participate in the plan as of February 17, 1993. However, the 
preceding sentence does not apply unless the employee was employed on 
February 17, 1993, by the corporation that

[[Page 823]]

maintained the plan or arrangement, or the employee had the right to 
participate in the plan or arrangement under a written binding contract 
as of that date.
    (iii) Material modifications. (A) Paragraph (h)(1)(i) of this 
section will not apply to any written binding contract that is 
materially modified. A material modification occurs when the contract is 
amended to increase the amount of compensation payable to the employee. 
If a binding written contract is materially modified, it is treated as a 
new contract entered into as of the date of the material modification. 
Thus, amounts received by an employee under the contract prior to a 
material modification are not affected, but amounts received subsequent 
to the material modification are not treated as paid under a binding, 
written contract described in paragraph (h)(1)(i) of this section.
    (B) A modification of the contract that accelerates the payment of 
compensation will be treated as a material modification unless the 
amount of compensation paid is discounted to reasonably reflect the time 
value of money. If the contract is modified to defer the payment of 
compensation, any compensation paid in excess of the amount that was 
originally payable to the employee under the contract will not be 
treated as a material modification if the additional amount is based on 
either a reasonable rate of interest or one or more predetermined actual 
investments (whether or not assets associated with the amount originally 
owed are actually invested therein) such that the amount payable by the 
employer at the later date will be based on the actual rate of return of 
the specific investment (including any decrease as well as any increase 
in the value of the investment).
    (C) The adoption of a supplemental contract or agreement that 
provides for increased compensation, or the payment of additional 
compensation, is a material modification of a binding, written contract 
where the facts and circumstances show that the additional compensation 
is paid on the basis of substantially the same elements or conditions as 
the compensation that is otherwise paid under the written binding 
contract. However, a material modification of a written binding contract 
does not include a supplemental payment that is equal to or less than a 
reasonable cost-of-living increase over the payment made in the 
preceding year under that written binding contract. In addition, a 
supplemental payment of compensation that satisfies the requirements of 
qualified performance-based compensation in paragraph (e) of this 
section will not be treated as a material modification.
    (iv) Examples. The following examples illustrate the exception of 
this paragraph (h)(1):

    Example 1. Corporation X executed a 3-year compensation arrangement 
with C on February 15, 1993, that constitutes a written binding contract 
under applicable state law. The terms of the arrangement provide for 
automatic extension after the 3-year term for additional 1-year periods, 
unless the corporation exercises its option to terminate the arrangement 
within 30 days of the end of the 3-year term or, thereafter, within 30 
days before each anniversary date. Termination of the compensation 
arrangement does not require the termination of C's employment 
relationship with Corporation X. Unless terminated, the arrangement is 
treated as renewed on February 15, 1996, and the deduction limit of 
paragraph (b) of this section applies to payments under the arrangement 
after that date.
    Example 2. Corporation Y executed a 5-year employment agreement with 
B on January 1, 1992, providing for a salary of $900,000 per year. 
Assume that this agreement constitutes a written binding contract under 
applicable state law. In 1992 and 1993, B receives the salary of 
$900,000 per year. In 1994, Corporation Y increases B's salary with a 
payment of $20,000. The $20,000 supplemental payment does not constitute 
a material modification of the written binding contract because the 
$20,000 payment is less than or equal to a reasonable cost-of-living 
increase from 1993. However, the $20,000 supplemental payment is subject 
to the limitation in paragraph (b) of this section. On January 1, 1995, 
Corporation Y increases B's salary to $1,200,000. The $280,000 
supplemental payment is a material modification of the written binding 
contract because the additional compensation is paid on the basis of 
substantially the same elements or conditions as the compensation that 
is otherwise paid under the written binding contract and it is greater 
than a reasonable, annual cost-of-living increase. Because the written 
binding contract is materially modified as of January 1, 1995, all 
compensation paid to B in 1995 and

[[Page 824]]

thereafter is subject to the deduction limitation of section 162(m).
    Example 3. Assume the same facts as in Example 2, except that 
instead of an increase in salary, B receives a restricted stock grant 
subject to B's continued employment for the balance of the contract. The 
restricted stock grant is not a material modification of the binding 
written contract because any additional compensation paid to B under the 
grant is not paid on the basis of substantially the same elements and 
conditions as B's salary because it is based both on the stock price and 
B's continued service. However, compensation attributable to the 
restricted stock grant is subject to the deduction limitation of section 
162(m).

    (2) Special transition rule for outside directors. A director who is 
a disinterested director is treated as satisfying the requirements of an 
outside director under paragraph (e)(3) of this section until the first 
meeting of shareholders at which directors are to be elected that occurs 
on or after January 1, 1996. For purposes of this paragraph (h)(2) and 
paragraph (h)(3) of this section, a director is a disinterested director 
if the director is disinterested within the meaning of Rule 16b-
3(c)(2)(i), 17 CFR 240.16b-3(c)(2)(i), under the Exchange Act (including 
the provisions of Rule 16b-3(d)(3), as in effect on April 30, 1991).
    (3) Special transition rule for previously-approved plans--(i) In 
general. Any compensation paid under a plan or agreement approved by 
shareholders before December 20, 1993, is treated as satisfying the 
requirements of paragraphs (e)(3) and (e)(4) of this section, provided 
that the directors administering the plan or agreement are disinterested 
directors and the plan was approved by shareholders in a manner 
consistent with Rule 16b-3(b), 17 CFR 240.16b-3(b), under the Exchange 
Act or Rule 16b-3(a), 17 CFR 240.16b-3(a) (as contained in 17 CFR part 
240 revised April 1, 1990). In addition, for purposes of satisfying the 
requirements of paragraph (e)(2)(vi) of this section, a plan or 
agreement is treated as stating a maximum number of shares with respect 
to which an option or right may be granted to any employee if the plan 
or agreement that was approved by the shareholders provided for an 
aggregate limit, consistent with Rule 16b-3(b), 17 CFR 250.16b-3(b), on 
the shares of employer stock with respect to which awards may be made 
under the plan or agreement.
    (ii) Reliance period. The transition rule provided in this paragraph 
(h)(3) shall continue and may be relied upon until the earliest of--
    (A) The expiration or material modification of the plan or 
agreement;
    (B) The issuance of all employer stock and other compensation that 
has been allocated under the plan; or
    (C) The first meeting of shareholders at which directors are to be 
elected that occurs after December 31, 1996.
    (iii) Stock-based compensation. This paragraph (h)(3) will apply to 
any compensation received pursuant to the exercise of a stock option or 
stock appreciation right, or the substantial vesting of restricted 
property, granted under a plan or agreement described in paragraph 
(h)(3)(i) of this section if the grant occurs on or before the earliest 
of the events specified in paragraph (h)(3)(ii) of this section.
    (iv) Example. The following example illustrates the application of 
this paragraph (h)(3):

    Example. Corporation Z adopted a stock option plan in 1991. Pursuant 
to Rule 16b-3 under the Exchange Act, the stock option plan has been 
administered by disinterested directors and was approved by Corporation 
Z shareholders. Under the terms of the plan, shareholder approval is not 
required again until 2001. In addition, the terms of the stock option 
plan include an aggregate limit on the number of shares available under 
the plan. Option grants under the Corporation Z plan are made with an 
exercise price equal to or greater than the fair market value of 
Corporation Z stock. Compensation attributable to the exercise of 
options that are granted under the plan before the earliest of the dates 
specified in paragraph (h)(3)(ii) of this section will be treated as 
satisfying the requirements of paragraph (e) of this section for 
qualified performance-based compensation, regardless of when the options 
are exercised.

    (i) [Reserved]
    (j) Effective date--(1) In general. Section 162(m) and this section 
apply to compensation that is otherwise deductible by the corporation in 
a taxable year beginning on or after January 1, 1994.
    (2) Delayed effective date for certain provisions--(i) Date on which 
remuneration is considered paid. Notwithstanding paragraph (j)(1) of 
this section, the

[[Page 825]]

rules in the second sentence of each of paragraphs (e)(3)(ii)(A), 
(e)(3)(ii)(B), and (e)(3)(ii)(C) of this section for determining the 
date or dates on which remuneration is considered paid to a director are 
effective for taxable years beginning on or after January 1, 1995. Prior 
to those taxable years, taxpayers must follow the rules in paragraphs 
(e)(3)(ii)(A), (e)(3)(ii)(B), and (e)(3)(ii)(C) of this section or 
another reasonable, good faith interpretation of section 162(m) with 
respect to the date or dates on which remuneration is considered paid to 
a director.
    (ii) Separate treatment of publicly held subsidiaries. 
Notwithstanding paragraph (j)(1) of this section, the rule in paragraph 
(c)(1)(ii) of this section that treats publicly held subsidiaries as 
separately subject to section 162(m) is effective as of the first 
regularly scheduled meeting of the shareholders of the publicly held 
subsidiary that occurs more than 12 months after December 2, 1994. The 
rule for stock-based compensation set forth in paragraph (f)(3) of this 
section will apply for this purpose, except that the grant must occur 
before the shareholder meeting specified in this paragraph (j)(2)(ii). 
Taxpayers may choose to rely on the rule referred to in the first 
sentence of this paragraph (j)(2)(ii) for the period prior to the 
effective date of the rule.
    (iii) Subsidiaries that become separate publicly held corporations. 
Notwithstanding paragraph (j)(1) of this section, if a subsidiary of a 
publicly held corporation becomes a separate publicly held corporation 
as described in paragraph (f)(4)(i) of this section, then, for the 
duration of the reliance period described in paragraph (f)(2) of this 
section, the rules of paragraph (f)(1) of this section are treated as 
applying (and the rules of paragraph (f)(4) of this section do not 
apply) to remuneration paid to covered employees of that new publicly 
held corporation pursuant to a plan or agreement that existed prior to 
December 2, 1994, provided that the treatment of that remuneration as 
performance-based is in accordance with a reasonable, good faith 
interpretation of section 162(m). However, if remuneration is paid to 
covered employees of that new publicly held corporation pursuant to a 
plan or agreement that existed prior to December 2, 1994, but that 
remuneration is not performance-based under a reasonable, good faith 
interpretation of section 162(m), the rules of paragraph (f)(1) of this 
section will be treated as applying only until the first regularly 
scheduled meeting of shareholders that occurs more than 12 months after 
December 2, 1994. The rules of paragraph (f)(4) of this section will 
apply as of that first regularly scheduled meeting. The rule for stock-
based compensation set forth in paragraph (f)(3) of this section will 
apply for purposes of this paragraph (j)(2)(iii), except that the grant 
must occur before the shareholder meeting specified in the preceding 
sentence if the remuneration is not performance-based under a 
reasonable, good faith interpretation of section 162(m). Taxpayers may 
choose to rely on the rules of paragraph (f)(4) of this section for the 
period prior to the applicable effective date referred to in the first 
or second sentence of this paragraph (j)(2)(iii).
    (iv) Bonus pools. Notwithstanding paragraph (j)(1) of this section, 
the rules in paragraph (e)(2)(iii)(A) that limit the sum of individual 
percentages of a bonus pool to 100 percent will not apply to 
remuneration paid before January 1, 2001, based on performance in any 
performance period that began prior to December 20, 1995.
    (v) Compensation based on a percentage of salary or base pay. 
Notwithstanding paragraph (j)(1) of this section, the requirement in 
paragraph (e)(4)(i) of this section that, in the case of certain 
formulas based on a percentage of salary or base pay, a corporation 
disclose to shareholders the maximum dollar amount of compensation that 
could be paid to the employee, will apply only to plans approved by 
shareholders after April 30, 1995.

[T.D. 8650, 60 FR 65537, Dec. 20, 1995, as amended by T.D. 8650, 61 FR 
4350, Feb. 6, 1996]



Sec. 1.162-28  Allocation of costs to lobbying activities.

    (a) Introduction--(1) In general. Section 162(e)(1) denies a 
deduction for certain amounts paid or incurred in connection with 
activities described in section 162(e)(1) (A) and (D) (lobbying 
activities). To determine the nondeductible amount, a taxpayer must 
allocate

[[Page 826]]

costs to lobbying activities. This section describes costs that must be 
allocated to lobbying activities and prescribes rules permitting a 
taxpayer to use a reasonable method to allocate those costs. This 
section does not apply to taxpayers subject to section 162(e)(5)(A). In 
addition, this section does not apply for purposes of sections 4911 and 
4945 and the regulations thereunder.
    (2) Recordkeeping. For recordkeeping requirements, see section 6001 
and the regulations thereunder.
    (b) Reasonable method of allocating costs--(1) In general. A 
taxpayer must use a reasonable method to allocate the costs described in 
paragraph (c) of this section to lobbying activities. A method is not 
reasonable unless it is applied consistently and is consistent with the 
special rules in paragraph (g) of this section. Except as provided in 
paragraph (b)(2) of this section, reasonable methods of allocating costs 
to lobbying activities include (but are not limited to)--
    (i) The ratio method described in paragraph (d) of this section;
    (ii) The gross-up method described in paragraph (e) of this section; 
and
    (iii) A method that applies the principles of section 263A and the 
regulations thereunder (see paragraph (f) of this section).
    (2) Taxpayers not permitted to use certain methods. A taxpayer 
(other than one subject to section 6033(e)) that does not pay or incur 
reasonable labor costs for persons engaged in lobbying activities may 
not use the gross-up method. For example, a partnership or sole 
proprietorship in which the lobbying activities are performed by the 
owners who do not receive a salary or guaranteed payment for services 
does not pay or incur reasonable labor costs for persons engaged in 
those activities and may not use the gross-up method.
    (c) Costs allocable to lobbying activities--(1) In general. Costs 
properly allocable to lobbying activities include labor costs and 
general and administrative costs.
    (2) Labor costs. For each taxable year, labor costs include costs 
attributable to full-time, part-time, and contract employees. Labor 
costs include all elements of compensation, such as basic compensation, 
overtime pay, vacation pay, holiday pay, sick leave pay, payroll taxes, 
pension costs, employee benefits, and payments to a supplemental 
unemployment benefit plan.
    (3) General and administrative costs. For each taxable year, general 
and administrative costs include depreciation, rent, utilities, 
insurance, maintenance costs, security costs, and other administrative 
department costs (for example, payroll, personnel, and accounting).
    (d) Ratio method--(1) In general. Under the ratio method described 
in this paragraph (d), a taxpayer allocates to lobbying activities the 
sum of its third-party costs (as defined in paragraph (d)(5) of this 
section) allocable to lobbying activities and the costs determined by 
using the following formula:
[GRAPHIC] [TIFF OMITTED] TR21JY95.001


    (2) Lobbying labor hours. Lobbying labor hours are the hours that a 
taxpayer's personnel spend on lobbying activities during the taxable 
year. A taxpayer may use any reasonable method to determine the number 
of labor hours spent on lobbying activities and may use the de minimis 
rule of paragraph (g)(1) of this section. A taxpayer may treat as zero 
the lobbying labor hours of personnel engaged in secretarial, clerical, 
support, and other administrative activities (as opposed to activities 
involving significant judgment with respect to lobbying activities). 
Thus, for example, the hours spent on lobbying activities by para-
professionals and analysts may not be treated as zero.
    (3) Total labor hours. Total labor hours means the total number of 
hours that a taxpayer's personnel spend on a taxpayer's trade or 
business during the taxable year. A taxpayer may make reasonable 
assumptions concerning total hours spent by personnel on the taxpayer's 
trade or business. For example, it may be reasonable, based on all the 
facts and circumstances, to assume that all full-time personnel spend 
1,800 hours per year on a taxpayer's trade or business. If, under 
paragraph (d)(2) of this section, a taxpayer treats as zero the lobbying 
labor hours of personnel

[[Page 827]]

engaged in secretarial, clerical, support, and other administrative 
activities, the taxpayer must also treat as zero the total labor hours 
of all personnel engaged in those activities.
    (4) Total costs of operations. A taxpayer's total costs of 
operations means the total costs of the taxpayer's trade or business for 
a taxable year, excluding third-party costs (as defined in paragraph 
(d)(5) of this section).
    (5) Third-party costs. Third-party costs are amounts paid or 
incurred in whole or in part for lobbying activities conducted by third 
parties (such as amounts paid to taxpayers subject to section 
162(e)(5)(A) or dues or other similar amounts that are not deductible in 
whole or in part under section 162(e)(3)) and amounts paid or incurred 
for travel (including meals and lodging while away from home) and 
entertainment relating in whole or in part to lobbying activities.
    (6) Example. The provisions of this paragraph (d) are illustrated by 
the following example.

    Example. (i) In 1996, three full-time employees, A, B, and C, of 
Taxpayer W engage in both lobbying activities and nonlobbying 
activities. A spends 300 hours, B spends 1,700 hours, and C spends 1,000 
hours on lobbying activities, for a total of 3,000 hours spent on 
lobbying activities for W. W reasonably assumes that each of its three 
employees spends 2,000 hours a year on W's business.
    (ii) W's total costs of operations are $300,000. W has no third-
party costs.
    (iii) Under the ratio method, X allocates $150,000 to its lobbying 
activities for 1996, as follows:
[GRAPHIC] [TIFF OMITTED] TR21JY95.002

    (e) Gross-up method--(1) In general. Under the gross-up method 
described in this paragraph (e)(1), the taxpayer allocates to lobbying 
activities the sum of its third-party costs (as defined in paragraph 
(d)(5) of this section) allocable to lobbying activities and 175 percent 
of its basic lobbying labor costs (as defined in paragraph (e)(3) of 
this section) of all personnel.
    (2) Alternative gross-up method. Under the alternative gross-up 
method described in this paragraph (e)(2), the taxpayer allocates to 
lobbying activities the sum of its third-party costs (as defined in 
paragraph (d)(5) of this section) allocable to lobbying activities and 
225 percent of its basic lobbying labor costs (as defined in paragraph 
(e)(3)), excluding the costs of personnel who engage in secretarial, 
clerical, support, and other administrative activities (as opposed to 
activities involving significant judgment with respect to lobbying 
activities).
    (3) Basic lobbying labor costs. For purposes of this paragraph (e), 
basic lobbying labor costs are the basic costs of lobbying labor hours 
(as defined in paragraph (d)(2) of this section) determined for the 
appropriate personnel. For purposes of this paragraph (e), basic costs 
of lobbying labor hours are wages or other similar costs of labor, 
including, for example, guaranteed payments for services. Basic costs do 
not include pension, profit-sharing, employee benefits, and supplemental 
unemployment benefit plan costs, or other similar costs.
    (4) Example. The provisions of this paragraph (e) are illustrated by 
the following example.

    Example. (i) In 1996, three employees, A, B, and C, of Taxpayer X 
engage in both lobbying activities and nonlobbying activities. A spends 
300 hours, B spends 1,700 hours, and C spends 1,000 hours on lobbying 
activities.
    (ii) X has no third-party costs.
    (iii) For purposes of the gross-up method, X determines that its 
basic labor costs are $20 per hour for A, $30 per hour for B, and $25 
per hour for C. Thus, its basic lobbying labor costs are 
($20x300)+($30x1,700)+($25x1,000), or

[[Page 828]]

($6,000+$51,000+$25,000), for total basic lobbying labor costs for 1996 
of $82,000.
    (iv) Under the gross-up method, X allocates $143,500 to its lobbying 
activities for 1996, as follows:
[GRAPHIC] [TIFF OMITTED] TR21JY95.003

    (f) Section 263A cost allocation methods--(1) In general. A taxpayer 
may allocate its costs to lobbying activities under the principles set 
forth in section 263A and the regulations thereunder, except to the 
extent inconsistent with paragraph (g) of this section. For this 
purpose, lobbying activities are considered a service department or 
function. Therefore, a taxpayer may allocate costs to lobbying 
activities by applying the methods provided in Sec. Sec. 1.263A-1 
through 1.263A-3. See Sec. 1.263A-1(e)(4), which describes service 
costs generally; Sec. 1.263A-1(f), which sets forth cost allocation 
methods available under section 263A; and Sec. 1.263A-1(g)(4), which 
provides methods of allocating service costs.
    (2) Example. The provisions of this paragraph (f) are illustrated by 
the following example.

    Example. (i) Three full-time employees, A, B, and C, work in the 
Washington office of Taxpayer Y, a manufacturing concern. They each 
engage in lobbying activities and nonlobbying activities. In 1996, A 
spends 75 hours, B spends 1,750 hours, and C spends 2,000 hours on 
lobbying activities. A's hours are not spent on direct contact lobbying 
as defined in paragraph (g)(2) of this section. All three work 2,000 
hours during 1996. The Washington office also employs one secretary, D, 
who works exclusively for A, B, and C.
    (ii) In addition, three departments in the corporate headquarters in 
Chicago benefit the Washington office: Public affairs, human resources, 
and insurance.
    (iii) Y is subject to section 263A and uses the step-allocation 
method to allocate its service costs. Prior to the amendments to section 
162(e), the Washington office was treated as an overall management 
function for purposes of section 263A. As such, its costs were fully 
deductible and no further allocations were made under Y's step 
allocation. Following the amendments to section 162(e), Y adopts its 
263A step-allocation methodology to allocate costs to lobbying 
activities. Y adds a lobbying department to its step-allocation program, 
which results in an allocation of costs to the lobbying department from 
both the Washington office and the Chicago office.
    (iv) Y develops a labor ratio to allocate its Washington office 
costs between the newly defined lobbying department and the overall 
management department. To determine the hours allocable to lobbying 
activities, Y uses the de minimis rule of paragraph (g)(1) of this 
section. Under this rule, A's hours spent on lobbying activities are 
treated as zero because less than 5 percent of A's time is spent on 
lobbying (75/2,000 = 3.75%). In addition, because D works exclusively 
for personnel engaged in lobbying activities, D's hours are not used to 
develop the allocation ratio. Y assumes that D's allocation of time 
follows the average time of all the personnel engaged in lobbying 
activities. Thus, Y's labor ratio is determined as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                    Departments
                                                                 -----------------------------------------------
                            Employee                                                  Overall
                                                                  Lobbying hours    management      Total hours
                                                                                       hours
----------------------------------------------------------------------------------------------------------------
A...............................................................               0           2,000           2,000
B...............................................................           1,750             250           2,000
C...............................................................           2,000               0           2,000
                                                                 -----------------------------------------------
      Totals....................................................           3,750           2,250           6,000
----------------------------------------------------------------------------------------------------------------


[[Page 829]]

[GRAPHIC] [TIFF OMITTED] TR21JY95.004

    (v) In 1996, the Washington office has the following costs:

------------------------------------------------------------------------
                           Account                               Amount
------------------------------------------------------------------------
Professional Salaries and Benefits...........................   $660,000
Clerical Salaries and Benefits...............................     50,000
Rent Expense.................................................    100,000
Depreciation on Furniture and Equip..........................     40,000
Utilities....................................................     15,000
Outside Payroll Service......................................      5,000
Miscellaneous................................................     10,000
Third-Party Lobbying (Law Firm)..............................     90,000
                                                              ----------
      Total Washington Costs.................................   $970,000
------------------------------------------------------------------------

    (vi) In addition, $233,800 of costs from the public affairs 
department, $30,000 of costs from the insurance department, and $5,000 
of costs from the human resources department are allocable to the 
Washington office from departments in Chicago. Therefore, the Washington 
office costs are allocated to the Lobbying and Overall Management 
departments as follows:

Total Washington department costs from above...............    $970,000
Plus Costs Allocated From Other Departments................     268,800
Less third-party costs directly allocable to lobbying......     (90,000)
                                                            ------------
      Total Washington office costs........................   1,148,800
 


------------------------------------------------------------------------
                                                               Overall
                                                  Lobbying    management
                                                 department   department
------------------------------------------------------------------------
Department Allocation Ratios..................        62.5%        37.5%
x Washington Office Costs.....................   $1,148,800   $1,148,800
 = Costs Allocated to Departments.............     $718,000     $430,800
------------------------------------------------------------------------

    (vii) Y's step-allocation for its Lobbying Department is determined 
as follows:

------------------------------------------------------------------------
                                                               Lobbying
                     Y's step-allocation                      department
------------------------------------------------------------------------
Washington costs allocated to lobbying department...........    $718,000
Plus third-party costs......................................      90,000
                                                             -----------
      Total costs of lobbying activities....................     808,000
------------------------------------------------------------------------

    (g) Special rules. The following rules apply to any reasonable 
method of allocating costs to lobbying activities.
    (1) De minimis rule for labor hours. Subject to the exception 
provided in paragraph (g)(2) of this section, a taxpayer may treat time 
spent by an individual on lobbying activities as zero if less than five 
percent of the person's time is spent on lobbying activities. Reasonable 
methods must be used to determine if less than five percent of a 
person's time is spent on lobbying activities.
    (2) Direct contact lobbying labor hours. Notwithstanding paragraph 
(g)(1) of this section, a taxpayer must treat all hours spent by a 
person on direct contact lobbying (as well as the hours that person 
spends in connection with direct contact lobbying, including time spent 
traveling that is allocable to the direct contact lobbying) as labor 
hours allocable to lobbying activities. An activity is direct contact 
lobbying if it is a meeting, telephone conversation, letter, or other 
similar means of communication with a legislator (other than a local 
legislator) or covered executive branch official (as defined in section 
162(e)(6)) and otherwise qualifies as a lobbying activity. A person who 
engages in research, preparation, and other background activities 
related to direct contact lobbying but who does not make direct contact 
with a legislator or covered executive branch official is not engaged in 
direct contact lobbying.
    (3) Taxpayer defined. For purposes of this section, a taxpayer 
includes a tax-exempt organization subject to section 6033(e).
    (h) Effective date. This section is effective for amounts paid or 
incurred on or after July 21, 1995. Taxpayers must adopt a reasonable 
interpretation of sections 162(e)(1)(A) and (D) for amounts paid or 
incurred before this date.

[T.D. 8602, 60 FR 37573, July 21, 1995]



Sec. 1.162-29  Influencing legislation.

    (a) Scope. This section provides rules for determining whether an 
activity is influencing legislation for purposes of section 
162(e)(1)(A). This section does not apply for purposes of sections 4911 
and 4945 and the regulations thereunder.
    (b) Definitions. For purposes of this section--
    (1) Influencing legislation. Influencing legislation means--

[[Page 830]]

    (i) Any attempt to influence any legislation through a lobbying 
communication; and
    (ii) All activities, such as research, preparation, planning, and 
coordination, including deciding whether to make a lobbying 
communication, engaged in for a purpose of making or supporting a 
lobbying communication, even if not yet made. See paragraph (c) of this 
section for rules for determining the purposes for engaging in an 
activity.
    (2) Attempt to influence legislation. An attempt to influence any 
legislation through a lobbying communication is making the lobbying 
communication.
    (3) Lobbying communication. A lobbying communication is any 
communication (other than any communication compelled by subpoena, or 
otherwise compelled by Federal or State law) with any member or employee 
of a legislative body or any other government official or employee who 
may participate in the formulation of the legislation that--
    (i) Refers to specific legislation and reflects a view on that 
legislation; or
    (ii) Clarifies, amplifies, modifies, or provides support for views 
reflected in a prior lobbying communication.
    (4) Legislation. Legislation includes any action with respect to 
Acts, bills, resolutions, or other similar items by a legislative body. 
Legislation includes a proposed treaty required to be submitted by the 
President to the Senate for its advice and consent from the time the 
President's representative begins to negotiate its position with the 
prospective parties to the proposed treaty.
    (5) Specific legislation. Specific legislation includes a specific 
legislative proposal that has not been introduced in a legislative body.
    (6) Legislative bodies. Legislative bodies are Congress, state 
legislatures, and other similar governing bodies, excluding local 
councils (and similar governing bodies), and executive, judicial, or 
administrative bodies. For this purpose, administrative bodies include 
school boards, housing authorities, sewer and water districts, zoning 
boards, and other similar Federal, State, or local special purpose 
bodies, whether elective or appointive.
    (7) Examples. The provisions of this paragraph (b) are illustrated 
by the following examples.

    Example 1. Taxpayer P's employee, A, is assigned to approach members 
of Congress to gain their support for a pending bill. A drafts and P 
prints a position letter on the bill. P distributes the letter to 
members of Congress. Additionally, A personally contacts several members 
of Congress or their staffs to seek support for P's position on the 
bill. The letter and the personal contacts are lobbying communications. 
Therefore, P is influencing legislation.
    Example 2. Taxpayer R is invited to provide testimony at a 
congressional oversight hearing concerning the implementation of The 
Financial Institutions Reform, Recovery, and Enforcement Act of 1989. 
Specifically, the hearing concerns a proposed regulation increasing the 
threshold value of commercial and residential real estate transactions 
for which an appraisal by a state licensed or certified appraiser is 
required. In its testimony, R states that it is in favor of the proposed 
regulation. Because R does not refer to any specific legislation or 
reflect a view on any such legislation, R has not made a lobbying 
communication. Therefore, R is not influencing legislation.
    Example 3. State X enacts a statute that requires the licensing of 
all day-care providers. Agency B in State X is charged with writing 
rules to implement the statute. After the enactment of the statute, 
Taxpayer S sends a letter to Agency B providing detailed proposed rules 
that S recommends Agency B adopt to implement the statute on licensing 
of day-care providers. Because the letter to Agency B neither refers to 
nor reflects a view on any specific legislation, it is not a lobbying 
communication. Therefore, S is not influencing legislation.
    Example 4. Taxpayer T proposes to a State Park Authority that it 
purchase a particular tract of land for a new park. Even if T's proposal 
would necessarily require the State Park Authority eventually to seek 
appropriations to acquire the land and develop the new park, T has not 
made a lobbying communication because there has been no reference to, 
nor any view reflected on, any specific legislation. Therefore, T's 
proposal is not influencing legislation.
    Example 5. (i) Taxpayer U prepares a paper that asserts that lack of 
new capital is hurting State X's economy. The paper indicates that State 
X residents either should invest more in local businesses or increase 
their savings so that funds will be available to others interested in 
making investments. U forwards a summary of the unpublished paper to 
legislators in State X with a cover letter that states in part:
    You must take action to improve the availability of new capital in 
the state.

[[Page 831]]

    (ii) Because neither the summary nor the cover letter refers to any 
specific legislative proposal and no other facts or circumstances 
indicate that they refer to an existing legislative proposal, forwarding 
the summary to legislators in State X is not a lobbying communication. 
Therefore, U is not influencing legislation.
    (iii) Q, a member of the legislature of State X, calls U to request 
a copy of the unpublished paper from which the summary was prepared. U 
forwards the paper with a cover letter that simply refers to the 
enclosed materials. Because U's letter to Q and the unpublished paper do 
not refer to any specific legislation or reflect a view on any such 
legislation, the letter is not a lobbying communication. Therefore, U is 
not influencing legislation.
    Example 6. (i) Taxpayer V prepares a paper that asserts that lack of 
new capital is hurting the national economy. The paper indicates that 
lowering the capital gains rate would increase the availability of 
capital and increase tax receipts from the capital gains tax. V forwards 
the paper to its representatives in Congress with a cover letter that 
says, in part:
    I urge you to support a reduction in the capital gains tax rate.
    (ii) V's communication is a lobbying communication because it refers 
to and reflects a view on a specific legislative proposal (i.e., 
lowering the capital gains rate). Therefore, V is influencing 
legislation.
    Example 7. Taxpayer W, based in State A, notes in a letter to a 
legislator of State A that State X has passed a bill that accomplishes a 
stated purpose and then says that State A should pass such a bill. No 
such bill has been introduced into the State A legislature. The 
communication is a lobbying communication because it refers to and 
reflects a view on a specific legislative proposal. Therefore, W is 
influencing legislation.
    Example 8. (i) Taxpayer Y represents citrus fruit growers. Y writes 
a letter to a United States senator discussing how pesticide O has 
benefited citrus fruit growers and disputing problems linked to its use. 
The letter discusses a bill pending in Congress and states in part:
    This bill would prohibit the use of pesticide O. If citrus growers 
are unable to use this pesticide, their crop yields will be severely 
reduced, leading to higher prices for consumers and lower profits, even 
bankruptcy, for growers.
    (ii) Y's views on the bill are reflected in this statement. Thus, 
the communication is a lobbying communication, and Y is influencing 
legislation.
    Example 9. (i) B, the president of Taxpayer Z, an insurance company, 
meets with Q, who chairs the X state legislature's committee with 
jurisdiction over laws regulating insurance companies, to discuss the 
possibility of legislation to address current problems with surplus-line 
companies. B recommends that legislation be introduced that would create 
minimum capital and surplus requirements for surplus-line companies and 
create clearer guidelines concerning the risks that surplus-line 
companies can insure. B's discussion with Q is a lobbying communication 
because B refers to and reflects a view on a specific legislative 
proposal. Therefore, Z is influencing legislation.
    (ii) Q is not convinced that the market for surplus-line companies 
is substantial enough to warrant such legislation and requests that B 
provide information on the amount and types of risks covered by surplus-
line companies. After the meeting, B has employees of Z prepare 
estimates of the percentage of property and casualty insurance risks 
handled by surplus-line companies. B sends the estimates with a cover 
letter that simply refers to the enclosed materials. Although B's 
follow-up letter to Q does not refer to specific legislation or reflect 
a view on such legislation, B's letter supports the views reflected in 
the earlier communication. Therefore, the letter is a lobbying 
communication and Z is influencing legislation.

    (c) Purpose for engaging in an activity--(1) In general. The 
purposes for engaging in an activity are determined based on all the 
facts and circumstances. Facts and circumstances include, but are not 
limited to--
    (i) Whether the activity and the lobbying communication are 
proximate in time;
    (ii) Whether the activity and the lobbying communication relate to 
similar subject matter;
    (iii) Whether the activity is performed at the request of, under the 
direction of, or on behalf of a person making the lobbying 
communication;
    (iv) Whether the results of the activity are also used for a 
nonlobbying purpose; and
    (v) Whether, at the time the taxpayer engages in the activity, there 
is specific legislation to which the activity relates.
    (2) Multiple purposes. If a taxpayer engages in an activity both for 
the purpose of making or supporting a lobbying communication and for 
some nonlobbying purpose, the taxpayer must treat the activity as 
engaged in partially for a lobbying purpose and partially for a 
nonlobbying purpose. This division of the activity must result in a 
reasonable allocation of costs to influencing legislation. See Sec. 
1.162-28

[[Page 832]]

(allocation rules for certain expenditures to which section 162(e)(1) 
applies). A taxpayer's treatment of these multiple-purpose activities 
will, in general, not result in a reasonable allocation if it allocates 
to influencing legislation--
    (i) Only the incremental amount of costs that would not have been 
incurred but for the lobbying purpose; or
    (ii) An amount based solely on the number of purposes for engaging 
in that activity without regard to the relative importance of those 
purposes.
    (3) Activities treated as having no purpose to influence 
legislation. A taxpayer that engages in any of the following activities 
is treated as having done so without a purpose of making or supporting a 
lobbying communication--
    (i) Before evidencing a purpose to influence any specific 
legislation referred to in paragraph (c)(3)(i)(A) or (B) of this section 
(or similar legislation)--
    (A) Determining the existence or procedural status of specific 
legislation, or the time, place, and subject of any hearing to be held 
by a legislative body with respect to specific legislation; or
    (B) Preparing routine, brief summaries of the provisions of specific 
legislation;
    (ii) Performing an activity for purposes of complying with the 
requirements of any law (for example, satisfying state or federal 
securities law filing requirements);
    (iii) Reading any publications available to the general public or 
viewing or listening to other mass media communications; and
    (iv) Merely attending a widely attended speech.
    (4) Examples. The provisions of this paragraph (c) are illustrated 
by the following examples.

    Example 1. (i) Facts. In 1997, Agency F issues proposed regulations 
relating to the business of Taxpayer W. There is no specific legislation 
during 1997 that is similar to the regulatory proposal. W undertakes a 
study of the impact of the proposed regulations on its business. W 
incorporates the results of that study in comments sent to Agency F in 
1997. In 1998, legislation is introduced in Congress that is similar to 
the regulatory proposal. Also in 1998, W writes a letter to Senator P 
stating that it opposes the proposed legislation. W encloses with the 
letter a copy of the comments it sent to Agency F.
    (ii) Analysis. W's letter to Senator P refers to and reflects a view 
on specific legislation and therefore is a lobbying communication. 
Although W's study of the impact of the proposed regulations is 
proximate in time and similar in subject matter to its lobbying 
communication, W performed the study and incorporated the results in 
comments sent to Agency F when no legislation with a similar subject 
matter was pending (a nonlobbying use). On these facts, W engaged in the 
study solely for a nonlobbying purpose.
    Example 2. (i) Facts. The governor of State Q proposes a budget that 
includes a proposed sales tax on electricity. Using its records of 
electricity consumption, Taxpayer Y estimates the additional costs that 
the budget proposal would impose upon its business. In the same year, Y 
writes to members of the state legislature and explains that it opposes 
the proposed sales tax. In its letter, Y includes its estimate of the 
costs that the sales tax would impose on its business. Y does not 
demonstrate any other use of its estimates.
    (ii) Analysis. The letter is a lobbying communication (because it 
refers to and reflects a view on specific legislation, the governor's 
proposed budget). Y's estimate of additional costs under the proposal 
supports the lobbying communication, is proximate in time and similar in 
subject matter to a specific legislative proposal then in existence, and 
is not used for a nonlobbying purpose. Based on these facts, Y estimated 
its additional costs under the budget proposal solely to support the 
lobbying communication.
    Example 3. (i) Facts. A senator in the State Q legislature announces 
her intention to introduce legislation to require health insurers to 
cover a particular medical procedure in all policies sold in the state. 
Taxpayer Y has different policies for two groups of employees, one of 
which covers the procedure and one of which does not. After the bill is 
introduced, Y's legislative affairs staff asks Y's human resources staff 
to estimate the additional cost to cover the procedure for both groups 
of employees. Y's human resources staff prepares a study estimating Y's 
increased costs and forwards it to the legislative affairs staff. Y's 
legislative staff then writes to members of the state legislature and 
explains that it opposes the proposed change in insurance coverage based 
on the study. Y's legislative affairs staff thereafter forwards the 
study, prepared for its use in opposing the statutory proposal, to its 
labor relations staff for use in negotiations with employees scheduled 
to begin later in the year.
    (ii) Analysis. The letter to legislators is a lobbying communication 
(because it refers to and reflects a view on specific legislation). The 
activity of estimating Y's additional costs under the proposed 
legislation relates to the same subject as the lobbying communication, 
occurs close in time to the lobbying communication, is conducted at the

[[Page 833]]

request of a person making a lobbying communication, and relates to 
specific legislation then in existence. Although Y used the study in its 
labor negotiations, mere use for that purpose does not establish that Y 
estimated its additional costs under the proposed legislation in part 
for a nonlobbying purpose. Thus, based on all the facts and 
circumstances, Y estimated the additional costs it would incur under the 
proposal solely to make or support the lobbying communication.
    Example 4. (i) Facts. After several years of developmental work 
under various contracts, in 1996, Taxpayer A contracts with the 
Department of Defense (DOD) to produce a prototype of a new generation 
military aircraft. A is aware that DOD will be able to fund the contract 
only if Congress appropriates an amount for that purpose in the upcoming 
appropriations process. In 1997, A conducts simulation tests of the 
aircraft and revises the specifications of the aircraft's expected 
performance capabilities, as required under the contract. A submits the 
results of the tests and the revised specifications to DOD. In 1998, 
Congress considers legislation to appropriate funds for the contract. In 
that connection, A summarizes the results of the simulation tests and of 
the aircraft's expected performance capabilities, and submits the 
summary to interested members of Congress with a cover letter that 
encourages them to support appropriations of funds for the contract.
    (ii) Analysis. The letter is a lobbying communication (because it 
refers to specific legislation (i.e., appropriations) and requests 
passage). The described activities in 1996, 1997, and 1998 relate to the 
same subject as the lobbying communication. The summary was prepared 
specifically for, and close in time to, that communication. Based on 
these facts, the summary was prepared solely for a lobbying purpose. In 
contrast, A conducted the tests and revised the specifications to comply 
with its production contract with DOD. A conducted the tests and revised 
the specifications solely for a nonlobbying purpose.
    Example 5. (i) Facts. C, president of Taxpayer W, travels to the 
state capital to attend a two-day conference on new manufacturing 
processes. C plans to spend a third day in the capital meeting with 
state legislators to explain why W opposes a pending bill unrelated to 
the subject of the conference. At the meetings with the legislators, C 
makes lobbying communications by referring to and reflecting a view on 
the pending bill.
    (ii) Analysis. C's traveling expenses (transportation and meals and 
lodging) are partially for the purpose of making or supporting the 
lobbying communications and partially for a nonlobbying purpose. As a 
result, under paragraph (c)(2) of this section, W must reasonably 
allocate C's traveling expenses between these two purposes. Allocating 
to influencing legislation only C's incremental transportation expenses 
(i.e., the taxi fare to meet with the state legislators) does not result 
in a reasonable allocation of traveling expenses.
    Example 6. (i) Facts. On February 1, 1997, a bill is introduced in 
Congress that would affect Company E. Employees in E's legislative 
affairs department, as is customary, prepare a brief summary of the bill 
and periodically confirm the procedural status of the bill through 
conversations with employees and members of Congress. On March 31, 1997, 
the head of E's legislative affairs department meets with E's President 
to request that B, a chemist, temporarily help the legislative affairs 
department analyze the bill. The President agrees, and suggests that B 
also be assigned to draft a position letter in opposition to the bill. 
Employees of the legislative affairs department continue to confirm 
periodically the procedural status of the bill. On October 31, 1997, B's 
position letter in opposition to the bill is delivered to members of 
Congress.
    (ii) Analysis. B's letter is a lobbying communication because it 
refers to and reflects a view on specific legislation. Under paragraph 
(c)(3)(i) of this section, the assignment of B to assist the legislative 
affairs department in analyzing the bill and in drafting a position 
letter in opposition to the bill evidences a purpose to influence 
legislation. Neither the activity of periodically confirming the 
procedural status of the bill nor the activity of preparing the routine, 
brief summary of the bill before March 31 constitutes influencing 
legislation. In contrast, periodically confirming the procedural status 
of the bill on or after March 31 relates to the same subject as, and is 
close in time to, the lobbying communication and is used for no 
nonlobbying purpose. Consequently, after March 31, E determined the 
procedural status of the bill for the purpose of supporting the lobbying 
communication by B.

    (d) Lobbying communication made by another. If a taxpayer engages in 
activities for a purpose of supporting a lobbying communication to be 
made by another person (or by a group of persons), the taxpayer's 
activities are treated under paragraph (b) of this section as 
influencing legislation. For example, if a taxpayer or an employee of 
the taxpayer (as a volunteer or otherwise) engages in an activity to 
assist a trade association in preparing its lobbying communication, the 
taxpayer's activities are influencing legislation even if the lobbying 
communication is made by the trade association and not

[[Page 834]]

the taxpayer. If, however, the taxpayer's employee, acting outside the 
employee's scope of employment, volunteers to engage in those 
activities, then the taxpayer is not influencing legislation.
    (e) No lobbying communication. Paragraph (e) of this section applies 
if a taxpayer engages in an activity for a purpose of making or 
supporting a lobbying communication, but no lobbying communication that 
the activity supports has yet been made.
    (1) Before the filing date. Under this paragraph (e)(1), if on the 
filing date of the return for any taxable year the taxpayer no longer 
expects, under any reasonably foreseeable circumstances, that a lobbying 
communication will be made that is supported by the activity, then the 
taxpayer will be treated as if it did not engage in the activity for a 
purpose of making or supporting a lobbying communication. Thus, the 
taxpayer need not treat any amount allocated to that activity for that 
year under Sec. 1.162-28 as an amount to which section 162(e)(1)(A) 
applies. The filing date for purposes of paragraph (e) of this section 
is the earlier of the time the taxpayer files its timely return for the 
year or the due date of the timely return.
    (2) After the filing date--(i) In general. If, at any time after the 
filing date, the taxpayer no longer expects, under any reasonably 
foreseeable circumstances, that a lobbying communication will be made 
that is supported by the activity, then any amount previously allocated 
under Sec. 1.162-28 to the activity and disallowed under section 
162(e)(1)(A) is treated as an amount that is not subject to section 
162(e)(1)(A) and that is paid or incurred only at the time the taxpayer 
no longer expects that a lobbying communication will be made.
    (ii) Special rule for certain tax-exempt organizations. For a tax-
exempt organization subject to section 6033(e), the amounts described in 
paragraph (e)(2)(i) of this section are treated as reducing (but not 
below zero) its expenditures to which section 162(e)(1) applies 
beginning with that year and continuing for subsequent years to the 
extent not treated in prior years as reducing those expenditures.
    (f) Anti-avoidance rule. If a taxpayer, alone or with others, 
structures its activities with a principal purpose of achieving results 
that are unreasonable in light of the purposes of section 162(e)(1)(A) 
and section 6033(e), the Commissioner can recast the taxpayer's 
activities for federal tax purposes as appropriate to achieve tax 
results that are consistent with the intent of section 162(e)(1)(A), 
section 6033(e) (if applicable), and this section, and the pertinent 
facts and circumstances.
    (g) Taxpayer defined. For purposes of this section, a taxpayer 
includes a tax-exempt organization subject to section 6033(e).
    (h) Effective date. This section is effective for amounts paid or 
incurred on or after July 21, 1995. Taxpayers must adopt a reasonable 
interpretation of section 162(e)(1)(A) for amounts paid or incurred 
before this date.

[T.D. 8602, 60 FR 37575, July 21, 1995]



Sec. 1.163-1  Interest deduction in general.

    (a) Except as otherwise provided in sections 264 to 267, inclusive, 
interest paid or accrued within the taxable year on indebtedness shall 
be allowed as a deduction in computing taxable income. For rules 
relating to interest on certain deferred payments, see section 483 and 
the regulations thereunder.
    (b) Interest paid by the taxpayer on a mortgage upon real estate of 
which he is the legal or equitable owner, even though the taxpayer is 
not directly liable upon the bond or note secured by such mortgage, may 
be deducted as interest on his indebtedness. Pursuant to the provisions 
of section 163(c), any annual or periodic rental payment made by a 
taxpayer on or after January 1, 1962, under a redeemable ground rent, as 
defined in section 1055(c) and paragraph (b) of Sec. 1.1055-1, is 
required to be treated as interest on an indebtedness secured by a 
mortgage and, accordingly, may be deducted by the taxpayer as interest 
on his indebtedness. Section 163(c) has no application in respect of any 
annual or periodic rental payment made prior to January 1, 1962, or 
pursuant to an arrangement which does not constitute a ``redeemable 
ground rent''

[[Page 835]]

as defined in section 1055(c) and paragraph (b) of Sec. 1.1055-1. 
Accordingly, annual or periodic payments of Pennsylvania ground rents 
made before, on, or after January 1, 1962, are deductible as interest if 
the ground rent is redeemable. An annual or periodic rental payment 
under a Maryland redeemable ground rent made prior to January 1, 1962, 
is deductible in accordance with the rules and regulations applicable at 
the time such payment was made. Any annual or periodic rental payment 
under a Maryland redeemable ground rent made by the taxpayer on or after 
January 1, 1962, is, pursuant to the provisions of section 163(c), 
treated as interest on an indebtedness secured by a mortgage and, 
accordingly, is deductible by the taxpayer as interest on his 
indebtedness. In any case where the ground rent is irredeemable, any 
annual or periodic ground rent payment shall be treated as rent and 
shall be deductible only to the extent that the payment constitutes a 
proper business expense. Amounts paid in redemption of a ground rent 
shall not be treated as interest. For treatment of redeemable ground 
rents and real property held subject to liabilities under redeemable 
ground rents, see section 1055 and the regulations thereunder.
    (c) Interest calculated for costkeeping or other purposes on account 
of capital or surplus invested in the business which does not represent 
a charge arising under an interest-bearing obligation, is not an 
allowable deduction from gross income. Interest paid by a corporation on 
scrip dividends is an allowable deduction. So-called interest on 
preferred stock, which is in reality a dividend thereon, cannot be 
deducted in computing taxable income. (See, however, section 583.) In 
the case of banks and loan or trust companies, interest paid within the 
year on deposits, such as interest paid on moneys received for 
investment and secured by interest-bearing certificates of indebtedness 
issued by such bank or loan or trust company, may be deducted from gross 
income.
    (d) To the extent of assistance payments made in respect of an 
indebtedness of the taxpayer during the taxable year by the Department 
of Housing and Urban Development under section 235 of the National 
Housing Act (12 U.S.C. 1715z), as amended, no deduction shall be allowed 
under section 163 and this section for interest paid or accrued with 
respect to such indebtedness. However, such payments shall not affect 
the amount of any deduction under any section of the Code other than 
section 163. The provisions of this paragraph shall apply to taxable 
years beginning after December 31, 1974.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6821, 30 FR 
6216, May 4, 1965; T.D. 6873, 31 FR 941, Jan. 25, 1966; T.D. 7408, 41 FR 
9547, Mar. 5, 1976]



Sec. 1.163-2  Installment purchases where interest charge is not 
separately stated.

    (a) In general. (1) Whenever there is a contract with a seller for 
the purchase of personal property providing for payment of part or all 
of the purchase price in installments and there is a separately stated 
carrying charge (including a finance charge, service charge, and the 
like) but the actual interest charge cannot be ascertained, a portion of 
the payments made during the taxable year under the contract shall be 
treated as interest and is deductible under section 163 and this 
section. Section 163(b) contains a formula, described in paragraph (b) 
of this section, in accordance with which the amount of interest 
deductible in the taxable year must be computed. This formula is 
designed to operate automatically in the case of any installment 
purchase, without regard to whether payments under the contract are made 
when due or are in default. For applicable limitations when an 
obligation to pay is terminated, see paragraph (c) of this section.
    (2) Whenever there is a contract with an educational institution for 
the purchase of educational services providing for payment of part or 
all of the purchase price in installments and there is a separately 
stated carrying charge (including a finance charge, service charge, and 
the like) but the actual interest charge cannot be ascertained, a 
portion of the payments made during the taxable year under the contract 
shall be treated as interest and is deductible under section 163 and 
this section. See paragraphs (b) and (c) of this

[[Page 836]]

section for the applicable computation and limitations rules. For 
purposes of section 163(b) and this section, the term ``educational 
services'' means any service (including lodging) which is purchased from 
an educational institution (as defined in section 151(e)(4) and 
paragraph (c) of Sec. 1.151-3) and which is provided for a student of 
such institution.
    (3) Section 163(b) and this section do not apply to a contract for 
the loan of money, even if the loan is to be repaid in installments and 
even if the borrowed amount is used to purchase personal property or 
educational services. In cases to which the preceding sentence applies, 
the portion of the installment payment which constitutes interest (as 
distinguished from payments of principal and charges such as payments 
for credit life insurance) is deductible under section 163(a) and Sec. 
1.163-1.
    (b) Computation. The portion of any such payments to be treated as 
interest shall be equal to 6 percent of the average unpaid balance under 
the contract during the taxable year. For purposes of this computation, 
the average unpaid balance under the contract is the sum of the unpaid 
balance outstanding on the first day of each month beginning during the 
taxable year, divided by 12.
    (c) Limitations. The amount treated as interest under section 163(b) 
and this section for any taxable year shall not exceed the amount of the 
payments made under the contract during the taxable year nor the 
aggregate carrying charges properly attributable to each contract for 
such taxable year. In computing the amount to be treated as interest if 
the obligation to pay is terminated as, for example, in the case of a 
repossession of the property, the unpaid balance on the first day of the 
month during which the obligation is terminated shall be zero.
    (d) Illustrations. The provisions of this section may be illustrated 
by the following examples:

    Example (1). On January 20, 1955, A purchased a television set for 
$400, including a stated carrying charge of $25. The down payment was 
$50, and the balance was paid in 14 monthly installments of $25 each, on 
the 20th day of each month commencing with February. Assuming that A is 
a cash method, calendar year taxpayer and that no other installment 
purchases were made, the amount to be treated as interest in 1955 is 
$12.38, computed as follows:

                                Year 1955
------------------------------------------------------------------------
                                                                Unpaid
                        First day of                           balance
                                                             outstanding
------------------------------------------------------------------------
January....................................................           0
February...................................................        $350
March......................................................         325
April......................................................         300
May........................................................         275
June.......................................................         250
July.......................................................         225
August.....................................................         200
September..................................................         175
October....................................................         150
November...................................................         125
December...................................................         100
                                                            ------------
                                                                  2,475
------------------------------------------------------------------------

    Sum of unpaid balances $2,475/12 = $206.25; 6 percent thereof = 
$12.38.
    Example (2). On November 20, 1955, B purchased a furniture set for 
$1,250, including a stated carrying charge of $48. The down payment was 
$50 and the balance was payable in 12 monthly installments of $100 each, 
on the first day of each month commencing with December 1955. Assume 
that B is a cash method, calendar year taxpayer and that no other 
installment purchases were made. Assume further that B made the first 
payment when due, but made only one other payment on June 1, 1956. The 
amount to be treated as interest in 1955 is $4, and the amount to be 
treated as interest in 1956 is $33, computed as follows:

                                Year 1955
------------------------------------------------------------------------
                                                                Unpaid
                        First day of                           balance
                                                             outstanding
------------------------------------------------------------------------
December...................................................      $1,200
------------------------------------------------------------------------

    Sum of unpaid balances $1,200/12 = $100; 6 percent thereof = $6.
    Carrying charges attributable to 1955 = $4.

                                Year 1956
------------------------------------------------------------------------
                                                                Unpaid
                        First day of                           balance
                                                             outstanding
------------------------------------------------------------------------
January....................................................      $1,100
February...................................................       1,000
March......................................................         900
April......................................................         800
May........................................................         700
June.......................................................         600
July.......................................................         500

[[Page 837]]

 
August.....................................................         400
September..................................................         300
October....................................................         200
November...................................................         100
                                                            ------------
                                                                  6,600
------------------------------------------------------------------------

    Sum of unpaid balances $6,600/12 = $550; 6 percent thereof = $33.
    Carrying charges attributable to 1956 = $44 ($4x11).
    Example (3). Assume the same facts as in example (2), except that 
the furniture was repossessed and B's obligation to pay terminated as of 
July 15, 1956. The amount to be treated as interest in 1955 is $4, 
computed as in example (2) above. The amount to be treated as interest 
in 1956 is $25.50, computed as follows:

                                Year 1956
------------------------------------------------------------------------
                                                                Unpaid
                        First day of                           balance
                                                             outstanding
------------------------------------------------------------------------
January....................................................      $1,100
February...................................................       1,000
March......................................................         900
April......................................................         800
May........................................................         700
June.......................................................         600
July-November..............................................           0
                                                            ------------
                                                                  5,100
------------------------------------------------------------------------

    Sum of unpaid balances $5,100/12 = $425. 6 percent thereof = $25.50.
    Carrying charges attributable to 1956 = $44 ($4x11).
    Example (4). (i) On September 15, 1968, C registered at X University 
for the 1968-69 academic year. C entered into an agreement with the X 
University for the purchase during such academic year of educational 
services (including lodging and tuition) for a total fee of $1,000, 
including a separately stated carrying charge of $50. Under the terms of 
the agreement, an initial payment of $200 was to be made by C on 
September 15, 1968, and the balance was to be paid in 8 monthly 
installments of $100 each, on the 15th day of each month commencing with 
October 1968. C made all of the required 1968 payments. Assuming that C 
is a cash method, calendar year taxpayer and that no other installment 
purchases of services or property were made, the amount to be treated as 
interest in 1968 is $10.50, computed as follows:

                                Year 1968
------------------------------------------------------------------------
                                                                Unpaid
                        First day of                           balance
                                                             outstanding
------------------------------------------------------------------------
January-September..........................................           0
October....................................................        $800
November...................................................         700
December...................................................         600
                                                            ------------
    Total..................................................       2,100
------------------------------------------------------------------------


The sum of unpaid balances ($2,100) divided by 12 is $175; 6 percent 
thereof is $10.50. The carrying charges attributable to 1968 are $18.75 
(i.e., the total carrying charges ($50), divided by the total number of 
payments (8), multiplied by the number of payments made in 1968 (3)). 
Since the amount to be treated as interest in 1968 ($10.50) does not 
exceed the carrying charges attributable to 1968 ($18.75), the 
limitation set forth in paragraph (c) of this section is not applicable.
    (ii) The result in this example would be the same even if the X 
University assigned the agreement to a bank or other financial 
institution and C made his payments directly to the bank or other 
financial institution.
    Example (5). On September 15, 1968, D registered at Y University for 
the 1968-69 academic year. The tuition for such year was $1,500. In 
order to pay his tuition, D borrowed $1,500 from the M Corporation, a 
lending institution, and remitted that sum to the Y University. The loan 
agreement between M Corporation and D provided that D was to repay the 
loan, plus a service charge, in 10 equal monthly installments, on the 
first day of each month commencing with October 1968. The service charge 
consisted of interest and the cost of credit life insurance on D's life. 
Since section 163(b) and this section do not apply to a contract for the 
loan of money, D is not entitled to compute his interest deduction with 
respect to his loan from M Corporation under such sections. D may deduct 
that portion of each installment payment which constitutes interest (as 
distinguished from payments of principal and the charge for credit life 
insurance) under section 163(a) and Sec. 1.163-1, provided that the 
amount of such interest can be ascertained.

    (e) Effective date. Except in the case of payments made under a 
contract for educational services, the rule provided in section 163(b) 
and this section applies to payments made during taxable years beginning 
after December 31, 1953, and ending after August 16, 1954, regardless of 
when the contract of sale was made. In the case of payments made under a 
contract for educational services, the rule provided in section

[[Page 838]]

163(b) and this section applies to payments made during taxable years 
beginning after December 31, 1963, regardless of when the contract for 
educational services was made.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6991, 34 FR 
742, Jan. 17, 1969]



Sec. 1.163-3  Deduction for discount on bond issued on or before May 
27, 1969.

    (a) Discount upon issuance. (1) If bonds are issued by a corporation 
at a discount, the net amount of such discount is deductible and should 
be prorated or amortized over the life of the bonds. For purposes of 
this section, the amortizable bond discount equals the excess of the 
amount payable at maturity (or, in the case of a callable bond, at the 
earlier call date) over the issue price of the bond (as defined in 
paragraph (b)(2) of Sec. 1.1232-3).
    (2) In the case of a bond issued by a corporation after December 31, 
1954, as part of an investment unit consisting of an obligation and an 
option, the issue price of the bond is determined by allocating the 
amount received for the investment unit to the individual elements of 
the unit in the manner set forth in subdivision (ii)(a) of Sec. 1.1232-
3(b)(2). Discount with respect to bonds issued by a corporation as part 
of investment units consisting of obligations and options after December 
31, 1954, and before Dec. 24, 1968--
    (i) Increased by any amount treated as bond premium which has been 
included in gross income with respect to such bonds prior to Dec. 24, 
1968, or
    (ii) Decreased by any amount which has been deducted by the issuer 
as discount attributable to such bonds prior to Dec. 24, 1968, and
    (iii) Decreased by any amount which has been deducted by the issuer 
prior to Dec. 24, 1968 upon the exercise or sale by investors of options 
issued in investment units with such bonds,

should be amortized, starting with the first taxable year ending on or 
after Dec. 24, 1968 over the remaining life of such bonds.
    (b) Examples. The rules in paragraph (a) of this section are 
illustrated by the following examples:

    Example (1). M Corporation, on January 1, 1960, the beginning of its 
taxable year issued for $95,000, 3 percent bonds, maturing 10 years from 
the date of issue, with a stated redemption price at maturity of 
$100,000. M Corporation should treat $5,000 ($100,000-$95,000) as the 
total amount to be amortized over the life of the bonds.
    Example (2). Assume the same facts as example (1), except that the 
bonds are convertible into common stock of M Corporation. Since the 
issue price of the bonds includes any amount attributable to the 
conversion privilege, the result is the same as in example (1).
    Example (3). Assume the same facts as example (1), except that the 
bonds are issued as part of an investment unit consisting of an 
obligation and an option. Assume further that the issue price of the 
bonds as determined under the rules of allocation set forth in 
subdivision (ii)(a) of Sec. 1.1232-3(b)(2) is $94,000. Accordingly, M 
Corporation should treat $6,000 ($100,000-$94,000) as the total amount 
to be amortized over the life of the bonds.
    Example (4). Assume in example (3), that prior to Dec. 24, 1968, M 
Corporation had only treated $5,000 as the bond discount to be amortized 
and deducted only $4,000 of this amount. Starting with the first taxable 
year ending on or after Dec. 24, 1968, M Corporation should amortize 
$2,000 ($6,000 discount, less $4,000 previously deducted) over the 
remaining life of the bonds.
    Example (5). N Corporation, on January 1, 1956, for a consideration 
of $102,000, issued 20-year bonds in the face amount of $100,000, 
together with options to purchase stock of N Corporation. The issue 
price of the bonds as determined under the rules of allocation set forth 
in subdivision (ii)(a) of Sec. 1.1232-3(b)(2) is $99,000. Until Dec. 
24, 1968, N Corporation has treated as bond premium, $2,000, 
representing the excess of the consideration received for the bond-
option investment units over the maturity value of the bonds, and has 
accordingly prorated and included in income $1,200 of such amount. 
Starting with the first taxable year beginning on or after Dec. 24, 
1968, N Corporation may amortize as a deduction over the remaining life 
of the bonds the amount of $2,200 ($1,000 discount, plus $1,200 
previously included in income).
    Example (6). O Corporation, on January 1, 1956, for a consideration 
of $100,000, issued 20-year bonds with a $100,000 face value, together 
with options to purchase stock of O Corporation, which could be 
exercised at any time up to 5 years from the date of issue. The issue 
price of the bonds as determined under the rules of allocation set forth 
in subdivision (ii)(a) of Sec. 1.1232-3(b)(2) is $98,000. O 
Corporation, upon the exercise of the options prior to Dec. 24, 1968, 
had deducted from income their fair market value at the time of 
exercise, which is assumed for purposes of

[[Page 839]]

this example to have been $3,000. Even though the bonds are considered 
to have been issued at a discount under paragraph (a)(1) of this 
section, O Corporation would have no deduction over the remaining life 
of the bonds, inasmuch as O Corporation, in computing the amount of such 
deduction, is required under paragraph (a)(2)(iii) of this section to 
reduce the amount which would otherwise be treated as bond discount, 
$2,000 ($100,000-$98,000), by the amount deducted from income upon the 
exercise of the options, in this case, $3,000.

    (c) Deduction upon repurchase. (1) Except as provided in 
subparagraphs (2) and (3) of this paragraph, if bonds are issued by a 
corporation and are subsequently repurchased by the corporation at a 
price in excess of the issue price plus any amount of discount deducted 
prior to repurchase, or (in the case of bonds issued subsequent to Feb. 
28, 1913) minus any amount of premium returned as income prior to 
repurchase, the excess of the purchase price over the issue price 
adjusted for amortized premium or discount is a deductible expense for 
the taxable year.
    (2) In the case of a convertible bond (except a bond which the 
corporation, before Sept. 5, 1968, has obligated itself to repurchase at 
a specified price), the deduction allowable under subparagraph (1) of 
this paragraph may not exceed an amount equal to 1 year's interest at 
the rate specified in the bond, except to the extent that the 
corporation can demonstrate to the satisfaction of the Commissioner or 
his delegate that an amount in excess of 1 year's interest does not 
include any amount attributable to the conversion feature.
    (3) No deduction shall be allowed under subparagraph (1) of this 
paragraph to the extent a deduction is disallowed under subparagraph (2) 
of this paragraph or to the extent a deduction is disallowed by section 
249 (relating to limitation on deduction of bond premium on repurchase 
of convertible obligation) and the regulations thereunder. See paragraph 
(f) of Sec. 1.249-1 for effective date limitation on section 249.
    (d) Definition. For purposes of this section, a debenture, note, 
certificate other evidence of indebtedness, issued by a corporation and 
bearing interest shall be given the same treatment as a bond.
    (e) Effective date. The provisions of this section shall not apply 
in respect of a bond issued after May 27, 1969, unless issued pursuant 
to a written commitment which was binding on that date and at all times 
thereafter.

[T.D. 6984, 33 FR 19175, Dec. 24, 1968, as amended at 36 FR 24996, Dec. 
28, 1971; T.D. 7259, 38 FR 4253, Feb. 12, 1973]



Sec. 1.163-4  Deduction for original issue discount on certain 
obligations issued after May 27, 1969.

    (a) In general. (1) If an obligation is issued by a corporation with 
original issue discount, the amount of such discount is deductible as 
interest and shall be prorated or amortized over the life of the 
obligation. For purposes of this section the term ``obligation'' shall 
have the same meaning as in Sec. 1.1232-1 (without regard to whether 
the obligation is a capital asset in the hands of the holder) and the 
term ``original issue discount'' shall have the same meaning as in 
section 1232(b)(1) (without regard to the one-fourth of 1 percent 
limitation in the second sentence thereof). Thus, in general, the amount 
of original issue discount equals the excess of the amount payable at 
maturity over the issue price of the bond (as defined in paragraph 
(b)(2) of Sec. 1.1232-3), regardless of whether that amount is less 
than one-fourth of 1 percent of the redemption price at maturity 
multiplied by the number of complete years to maturity. For the rule as 
to whether there is original issue discount in the case of an obligation 
issued in an exchange for property other than money, and the amount 
thereof, see paragraph (b)(2)(iii) of Sec. 1.1232-3. In any case in 
which original issue discount is carried over from one corporation to 
another corporation under section 381(c)(9) or from an obligation 
exchanged to an obligation received in any exchange under paragraph 
(b)(1)(iv) of Sec. 1.1232-3, such discount shall be carried over for 
purposes of this section. The amount of original issue discount carried 
over in an exchange of obligations under the preceding sentence shall be 
prorated or amortized over the life of the obligation issued in such 
exchange. For computation of issue price and the amount of original 
issue discount in the case of

[[Page 840]]

serial obligations, see paragraph (b)(2)(iv) of Sec. 1.1232-3.
    (2) In the case of an obligation issued by a corporation as part of 
an investment unit (as defined in paragraph (b)(2)(ii)(a) of Sec. 
1.1232-3) consisting of an obligation and other property, the issue 
price of the obligation is determined by allocating the amount received 
for the investment unit to the individual elements of the unit in the 
manner set forth in paragraph (b)(2)(ii) of Sec. 1.1232-3.
    (3) Recovery or retention of amounts previously deducted. In any 
taxable year in which an amount of original issue discount which was 
deducted as interest under this section is retained or recovered by the 
taxpayer, such as, for example, by reason of a fine, penalty, 
forfeiture, or other withdrawal fee, such amount shall be includible in 
the gross income of such taxpayer for such taxable year.
    (b) Examples. The rules in paragraph (a) of this section are 
illustrated by the following examples:

    Example (1). N Corporation, which uses the calendar year as its 
taxable year, on January 1, 1970, issued for $99,000, 9 percent bonds 
maturing 10 years from the date of issue, with a stated redemption price 
at maturity of $100,000. The original issue discount on each bond (as 
determined under section 1232(b)(1) without regard to the one-fourth-of-
1-percent limitation in the second sentence thereof) is $1,000, i.e., 
redemption price, $100,000, minus issue price, $99,000. N shall treat 
$1,000 as the total amount to be amortized over the life of the bonds.
    Example (2). Assume the same facts as example (1), except that the 
bonds are convertible into common stock of N Corporation. Since the 
issue price of the bonds includes any amount attributable to the 
conversion privilege, the result is the same as in example (1).
    Example (3). Assume the same facts as example (1), except that the 
bonds are issued as part of an investment unit consisting of an 
obligation and an option. Assume further that the issue price of the 
bonds as determined under the rules of allocation set forth in paragraph 
(b)(2)(ii) of Sec. 1.1232-3 is $94,000. The original issue discount on 
the bond (as determined under section 1232(b)(1) without regard to the 
one-fourth-of-1-percent limitation in the second sentence thereof) is 
$6,000, i.e., redemption price, $100,000, minus issue price, $94,000. N 
shall treat $6,000 as the total amount to be amortized over the life of 
the bonds.
    Example (4). On January 1, 1971, a commercial bank which uses the 
calendar year as its taxable year, issued a certificate of deposit for 
$10,000. The certificate of deposit is not redeemable until December 31, 
1975, except in an emergency as defined in, and subject to the 
qualifications provided by Regulations Q of the Board of Governors of 
the Federal Reserve. See 12 CFR Sec. 217.4(d). The stated redemption 
price at maturity is $13,382.26. The certificate is an obligation to 
which section 1232(a)(3)(A) applies (see paragraph (d) of Sec. 1.1232-
1), and the original issue discount with respect to the certificate (as 
determined under section 1232(b)(1) without regard to the one-fourth-of-
1-percent limitation in the second sentence thereof) is $3,382.26 (i.e., 
redemption price, $13,382.26, minus issued price, $10,000). Y shall 
treat $3,382.26 as the total amount to be amortized over the life of the 
certificate.

    (c) Deduction upon repurchase. (1) Except as provided in 
subparagraph (2) of this paragraph, if bonds are issued by a corporation 
and are subsequently repurchased by the corporation at a price in excess 
of the issue price plus any amount of original issue discount deducted 
prior to repurchase, or minus any amount of premium returned as income 
prior to repurchase, the excess of the repurchase price over the issue 
price adjusted for amortized premium or deducted discount is deductible 
as interest for the taxable year.
    (2) The provisions of subparagraph (1) of this paragraph shall not 
apply to the extent a deduction is disallowed by section 249 (relating 
to limitation on deduction of bond premium or repurchase of convertible 
obligation) and the regulations thereunder.
    (d) Effective date. The provisions of this section shall apply in 
respect of obligations issued after May 27, 1969, other than--
    (1) Obligations issued pursuant to a written commitment which was 
binding on May 27, 1969, and at all times thereafter, and
    (2) Deposits made before January 1, 1971, in the case of 
certificates of deposit, time deposits, bonus plans, and other deposit 
arrangements with banks, domestic building and loan associations, and 
similar financial institutions.

[36 FR 24996, Dec. 28, 1971, as amended by T.D. 7213, 37 FR 21991, Oct. 
18, 1972; T.D. 7259, 38 FR 4253, Feb. 12, 1973]

[[Page 841]]



Sec. 1.163-5  Denial of interest deduction on certain obligations issued 
after December 31, 1982, unless issued in registered form.

    (a)-(b) [Reserved]
    (c) Obligations issued to foreign persons after September 21, 1984--
(1) In general. A determination of whether an obligation satisfies each 
of the requirements of this paragraph shall be made on an obligation-by-
obligation basis. An obligation issued directly (or through affiliated 
entities) in bearer form by, or guaranteed by, a United States 
Government-owned agency or a United States Government-sponsored 
enterprise, such as the Federal National Mortgage Association, the 
Federal Home Loan Banks, the Federal Loan Mortgage Corporation, the Farm 
Credit Administration, and the Student Loan Marketing Association, may 
not satisfy this paragraph (c). An obligation issued after September 21, 
1984 is described in this paragraph if--
    (i) There are arrangements reasonably designed to ensure that such 
obligation will be sold (or resold in connection with its original 
issuance) only to a person who is not a United States person or who is a 
United States person that is a financial institution (as defined in 
Sec. 1.165-12(c)(1)(v)) purchasing for its own account or for the 
account of a customer and that agrees to comply with the requirements of 
section 165(j)(3) (A), (B), or (C) and the regulations thereunder, and
    (ii) In the case of an obligation which is not in registered form--
    (A) Interest on such obligation is payable only outside the United 
States and its possessions, and
    (B) Unless the obligation is described in subparagraph (2)(i)(C) of 
this paragraph or is a temporary global security, the following 
statement in English either appears on the face of the obligation and on 
any interest coupons which may be detached therefrom or, if the 
obligation is evidenced by a book entry, appears in the book or record 
in which the book entry is made: ``Any United States person who holds 
this obligation will be subject to limitations under the United States 
income tax laws, including the limitations provided in sections 165(j) 
and 1287(a) of the Internal Revenue Code.'' For purposes of this 
paragraph, the term ``temporary global security'' means a security which 
is held for the benefit of the purchasers of the obligations of the 
issuer and interests in which are exchangeable for securities in 
definitive registered or bearer form prior to its stated maturity.
    (2) Rules for the application of this paragraph--(i) Arrangements 
reasonably designed to ensure sale to non-United States persons. An 
obligation will be considered to satisfy paragraph (c)(1)(i) of this 
section if the conditions of paragraph (c)(2)(i) (A), (B), (C), or (D) 
of this section are met in connection with the original issuance of the 
obligation. An exchange of one obligation for another is considered an 
original issuance if and only if the exchange constitutes a disposition 
of property for purposes of section 1001 of the Code. However, an 
exchange of one obligation for another will not be considered a new 
issuance if the obligation received is identical in all respects to the 
obligation surrendered in exchange therefor, except that the obligor of 
the obligation received need not be the same obligor as the obligor of 
the obligation surrendered. Obligations that meet the conditions of 
paragraph (c)(2)(i) (A), (B), (C) or (D) of this section may be issued 
in a single public offering. The preceding sentence does not apply to 
certificates of deposit issued under the conditions of paragraph 
(c)(2)(i)(C) of this section by a United States person or by a 
controlled foreign corporation within the meaning of section 957(a) that 
is engaged in the active conduct of a banking business within the 
meaning of section 954(c)(3)(B) as in effect prior to the Tax Reform Act 
of 1986, and the regulations thereunder. A temporary global security 
need not satisfy the conditions of paragraph (c)(2)(i) (A), (B) or (C) 
of this section, but must satisfy the applicable requirements of 
paragraph (c)(2)(i)(D) of this section.
    (A) In connection with the original issuance of an obligation, the 
obligation is offered for sale or resale only outside of the United 
States and its possessions, is delivered only outside the United States 
and its possessions and is not registered under the Securities Act of 
1933 because it is intended for distribution to persons who are not

[[Page 842]]

United States persons. An obligation will not be considered to be 
required to be registered under the Securities Act of 1933 if the 
issuer, in reliance on the written opinion of counsel received prior to 
the issuance thereof, determines in good faith that the obligation need 
not be registered under the Securities Act of 1933 for the reason that 
it is intended for distribution to persons who are not United States 
persons. Solely for purposes of this subdivision (i)(A), the term 
``United States person'' has the same meaning as it has for purposes of 
determining whether an obligation is intended for distribution to 
persons under the Securities Act of 1933. Except as provided in 
paragraph (c)(3) of this section, this paragraph (c)(2)(i)(A) applies 
only to obligations issued on or before September 7, 1990.
    (B) The obligation is registered under the Securities Act of 1933, 
is exempt from registration by reason of section 3 or section 4 of such 
Act, or does not qualify as a security under the Securities Act of 1933; 
all of the conditions set forth in paragraph (c)(2)(i)(B) (1), (2), (3), 
(4), and (5) of this section are met with respect to such obligations; 
and, except as provided in paragraph (c)(3) of this section, the 
obligation is issued on or before September 7, 1990.
    (1) In connection with the original issuance of an obligation in 
bearer form, the obligation is offered for sale or resale only outside 
the United States and its possessions.
    (2) The issuer does not, and each underwriter and each member of the 
selling group, if any, covenants that it will not, in connection with 
the original issuance of the obligation, offer to sell or resell the 
obligation in bearer form to any person inside the United States or to a 
United States person unless such United States person is a financial 
institution as defined in Sec. 1.165-12(c)(v) purchasing for its own 
account or for the account of a customer, which financial institution, 
as a condition of the purchase, agrees to provide on delivery of the 
obligation (or on issuance, if the obligation is not in definitive form) 
the certificate required under paragraph (c)(2)(i)(B)(4).
    (3) In connection with its sale or resale during the original 
issuance of the obligation in bearer form, each underwriter and each 
member of the selling group, if any, or the issuer, if there is no 
underwriter or selling group, sends a confirmation to the purchaser of 
the bearer obligation stating that the purchaser represents that it is 
not a United States person or, if it is a United States person, it is a 
financial institution as defined in Sec. 1.165-12(c)(v) purchasing for 
its own account or for the account of a customer and that the financial 
institution will comply with the requirements of section 165(j)(3) (A), 
(B), or (C) and the regulations thereunder. The confirmation must also 
state that, if the purchaser is a dealer, it will send similar 
confirmations to whomever purchases from it.
    (4) In connection with the original issuance of the obligation in 
bearer form it is delivered in definitive form (or issued, if the 
obligation is not in definitive form) to the person entitled to physical 
delivery thereof only outside the United States and its possessions and 
only upon presentation of a certificate signed by such person to the 
issuer, underwriter, or member of the selling group, which certificate 
states that the obligation is not being acquired by or on behalf of a 
United States person, or for offer to resell or for resale to a United 
States person or any person inside the United States, or, if a 
beneficial interest in the obligation is being acquired by a United 
States person, that such person is a financial institution as defined in 
Sec. 1.165.12(c)(1)(v) or is acquiring through a financial institution 
and that the obligation is held by a financial institution that has 
agreed to comply with the requirements of section 165(j)(3) (A), (B), or 
(C) and the regulations thereunder and that is not purchasing for offer 
to resell or for resale inside the United States. When a certificate is 
provided by a clearing organization, it must be based on statements 
provided to it by its member organizations. A clearing organization is 
an entity which is in the business of holding obligations for member 
organizations and transferring obligations among such members by credit 
or debit to the account of a member without the necessity of physical 
delivery of the obligation. For purposes of paragraph (c)(2)(i)(B), the 
term ``delivery'' does

[[Page 843]]

not include the delivery of an obligation to an underwriter or member of 
the selling group, if any.
    (5) The issuer, underwriter, or member of the selling group does not 
have actual knowledge that the certificate described in paragraph 
(c)(2)(i)(B)(4) of this section is false. The issuer, underwriter, or 
member of the selling group shall be deemed to have actual knowledge 
that the certificate described in paragraph (c)(2)(i)(B)(4) of this 
section is false if the issuer, underwriter, or member of the selling 
group has a United States address for the beneficial owner (other than a 
financial institution as defined in Sec. 1.165-12(c)(v) that represents 
that it will comply with the requirements of section 165(j)(3) (A), (B), 
or (C) and the regulations thereunder) and does not have documentary 
evidence as described in Sec. 1.6049-5(c)(1) that the beneficial owner 
is not a United States person.
    (C) The obligation is issued only outside the United States and its 
possessions by an issuer that does not significantly engage in 
interstate commerce with respect to the issuance of such obligation 
either directly or through its agent, an underwriter, or a member of the 
selling group. In the case of an issuer that is a United States person, 
such issuer may only satisfy the test set forth in this paragraph 
(c)(2)(i)(C) if--
    (1) It is engaged through a branch in the active conduct of a 
banking business, within the meaning of section 954(c)(3)(B) as in 
effect before the Tax Reform Act of 1986, and the regulations 
thereunder, outside the United States;
    (2) The obligation is issued outside of the United States by the 
branch in connection with that trade or business;
    (3) The obligation that is so issued is sold directly to the public 
and is not issued as a part of a larger issuance made by means of a 
public offering; and
    (4) The issuer either maintains documentary evidence as described in 
subdivision (iii) of A-5 of Sec. 35a.9999-4T that the purchaser is not 
a United States person (provided that the issuer has no actual knowledge 
that the documentary evidence is false) or on delivery of the obligation 
the issuer receives a statement signed by the person entitled to 
physical delivery thereof and stating either that the obligation is not 
being acquired by or on behalf of a United States person or that, if a 
beneficial interest in the obligation is being acquired by a United 
States person, such person is a financial institution as defined in 
Sec. 1.165-12(c)(v) or is acquiring through a financial institution and 
the obligation is held by a financial institution that has agreed to 
comply with the requirements of 165(j)(3) (A), (B) or (C) and the 
regulations thereunder and that it is not purchasing for offer to resell 
or for resale inside the United States (provided that the issuer has no 
actual knowledge that the statement is false).

In addition, an issuer that is a controlled foreign corporation within 
the meaning of section 957 (a) that is engaged in the active conduct of 
a banking business outside the United States within the meaning of 
section 954(c)(3)(B) as in effect before the Tax Reform Act of 1986, and 
the regulations thereunder, can only satisfy the provisions of this 
paragraph (c)(2)(i)(C), if it meets the requirements of this paragraph 
(c)(2)(i)(C)(2), (3) and (4).
    (D) The obligation is issued after September 7, 1990, and all of the 
conditions set forth in this paragraph (c)(2)(i)(D) are met with respect 
to such obligation.
    (1) Offers and sales--(i) Issuer. The issuer does not offer or sell 
the obligation during the restricted period to a person who is within 
the United States or its possessions or to a United States person.
    (ii) Distributors. (A) The distributor of the obligation does not 
offer or sell the obligation during the restricted period to a person 
who is within the United States or its possessions or to a United States 
person.
    (B) The distributor of the obligation will be deemed to satisfy the 
requirements of paragraph (c)(2)(i)(D)(1)(ii)(A) of this section if the 
distributor of the obligation convenants that it will not offer or sell 
the obligation during the restricted period to a person who is within 
the United States or its possessions or to a United States person; and 
the distributor of the obligation has in effect, in connection with the 
offer and sale of the obligation during the restricted period, 
procedures reasonably

[[Page 844]]

designed to ensure that its employees or agents who are directly engaged 
in selling the obligation are aware that the obligation cannot be 
offered or sold during the restricted period to a person who is within 
the United States or its possessions or is a United States person.
    (iii) Certain rules. For purposes of paragraph (c)(2)(i)(D)(1) (i) 
and (ii) of this section:
    (A) An offer or sale will be considered to be made to a person who 
is within the United States or its possessions if the offeror or seller 
of the obligation has an address within the United States or its 
possessions for the offeree or buyer of the obligation with respect to 
the offer or sale.
    (B) An offer or sale of an obligation will not be treated as made to 
a person within the United States or its possessions or to a United 
States person if the person to whom the offer or sale is made is: An 
exempt distributor, as defined in paragraph (c)(2)(i)(D)(5) of this 
section; An international organization as defined in section 7701(a)(18) 
and the regulations thereunder, or a foreign central bank as defined in 
section 895 and the regulations thereunder; or The foreign branch of a 
United States financial institution as described in paragraph 
(c)(2)(i)(D)(6)(i) of this section.

Paragraph (c)(2)(i)(D)(1)(iii)(B) regarding an exempt distributor will 
only apply to an offer to the United States office of an exempt 
distributor, and paragraph (c)(2)(i)(D)(1)(iii)(B) regarding an 
international organization or foreign central bank will only apply to an 
offer to an international organization or foreign central bank, if such 
offer is made directly and specifically to the United States office, 
organization or bank.
    (C) A sale of an obligation will not be treated as made to a person 
within the United States or its possessions or to a United States person 
if the person to whom the sale is made is a person described in 
paragraph (c)(2)(i)(D)(6)(ii) of this section.
    (2) Delivery. In connection with the sale of the obligation during 
the restricted period, neither the issuer nor any distributor delivers 
the obligation in definitive form within the United States or it 
possessions.
    (3) Certification--(i) In general. On the earlier of the date of the 
first actual payment of interest by the issuer on the obligation or the 
date of delivery by the issuer of the obligation in definitive form, a 
certificate is provided to the issuer of the obligation stating that on 
such date:
    (A) The obligation is owned by a person that is not a United States 
person:
    (B) The obligation is owned by a United States person described in 
paragraph (c)(2)(i)(D)(6) of this section; or
    (C) The obligation is owned by a financial institution for purposes 
of resale during the restricted period, and such financial institution 
certifies in addition that it has not acquired the obligation for 
purposes of resale directly or indirectly to a United States person or 
to a person within the United States or its possessions.

A certificate described in paragraph (c)(2)(i)(D)(3)(i) (A) or (B) of 
this section may not be given with respect to an obligation that is 
owned by a financial institution for purposes of resale during the 
restricted period. For purposes of paragraph (c)(2)(i)(D) (2) and (3) of 
this section, a temporary global security (as defined in Sec. 1.163-5 
(c)(1)(ii)(B)) is not considered to be an obligation in definitive form. 
If the issuer does not make the obligation available for delivery in 
definitive form within a reasonable period of time after the end of the 
restricted period, then the obligation shall be treated as not 
satisfying the requirements of this paragraph (c)(2)(i)(D)(3). The 
certificate must be signed (or sent, as provided in paragraph 
(c)(2)(i)(D)(3)(ii) of this section) either by the owner of the 
obligation or by a financial institution or clearing organization 
through which the owner holds the obligation, directly or indirectly. 
For purposes of this paragraph (c)(2)(i)(D)(3), the term ``financial 
institution'' means a financial institution described in Sec. 1.165-
12(c)(i)(v). When a certificate is provided by a clearing organization, 
the certificate must be based on statements provided to it by its member 
organizations. The requirement of this paragraph (c)(1)(D)(3) shall be 
deemed not to be satisfied with respect to an obligation if the issuer

[[Page 845]]

knows or has reason to know that the certificate with respect to such 
obligation is false. The certificate must be retained by the issuer (and 
statements by member organizations must be retained by the clearing 
organization, in the case of certificates based on such statements) for 
a period of four calendar years following the year in which the 
certificate is received.
    (ii) Electronic certification. The certificate required by paragraph 
(c)(2)(i)(D)(3)(i) of this section (including a statement provided to a 
clearing organization by a member organization) may be provided 
electronically, but only if the person receiving such electronic 
certificate maintains adequate records, for the retention period 
described in paragraph (c)(2)(i)(D)(3)(i) of this section, establishing 
that such certificate was received in respect of the subject obligation, 
and only if there is a written agreement entered into prior to the time 
of certification (including the written membership rules of a clearing 
organization) to which the sender and recipient are subject, providing 
that the electronic certificate shall have the effect of a signed 
certificate described in paragraph (c)(2)(i)(D)(3)(i) of this section.
    (iii) Exception for certain obligations. This paragraph 
(c)(2)(i)(D)(3) shall not apply, and no certificate shall be required, 
in the case of an obligation that is sold during the restricted period 
and that satisfies all of the following requirements:
    (A) The interest and principal with respect to the obligation are 
denominated only in the currency of a single foreign country.
    (B) The interest and principal with respect to the obligation are 
payable only within that foreign country (according to rules similar to 
those set forth in Sec. 1.163-5(c)(2)(v)).
    (C) The obligation is offered and sold in accordance with practices 
and documentation customary in that foreign country.
    (D) The distributor covenants to use reasonable efforts to sell the 
obligation within that foreign country.
    (E) The obligation is not listed, or the subject of an application 
for listing, on an exchange located outside that foreign country.
    (F) The Commissioner has designated that foreign country as a 
foreign country in which certification under paragraph 
(c)(2)(i)(D)(3)(i) of this section is not permissible.
    (G) The issuance of the obligation is subject to guidelines or 
restrictions imposed by governmental, banking or securities authorities 
in that foreign country.
    (H) More than 80 percent by value of the obligations included in the 
offering of which the obligation is a part are offered and sold to non-
distributors by distributors maintaining an office located in that 
foreign country. Foreign currency denominated obligations that are 
convertible into U.S. dollar denominated obligations or that by their 
terms are linked to the U.S. dollar in a way which effectively converts 
the obligations to U.S. dollar denominated obligations do not satisfy 
the requirements of this paragraph (c)(2)(i)(D)(3)(iii). A foreign 
currency denominated obligation will not be treated as linked, by its 
terms, to the U.S. dollar solely because the obligation is the subject 
of a swap transaction.
    (4) Distributor. For purposes of this paragraph (c)(2)(i)(D), the 
term ``distributor'' means:
    (i) A person that offers or sells the obligation during the 
restricted period pursuant to a written contract with the issuer;
    (ii) Any person that offers or sells the obligation during the 
restricted period pursuant to a written contract with a person described 
in paragraph (c)(2)(i)(D) (4) (i); and
    (iii) Any affiliate that acquires the obligation from another member 
of its affiliated group for the purpose of offering or selling the 
obligation during the restricted period, but only if the transferor 
member of the group is the issuer or a person described in paragraph 
(c)(2)(i)(D) (4)(i) or (ii) of this section. The terms ``affiliate'' and 
``affiliated group'' have the same meanings as in section 1504(a) of the 
Code, but without regard to the exceptions contained in section 1504(b) 
and substituting ``50 percent'' for ``80 percent'' each time it appears.

For purposes of this paragraph (c)(2)(i)(D)(4), a written contract does

[[Page 846]]

not include a confirmation or other notice of the transaction.
    (5) Exempt distributor. For purposes of this paragraph (c)(2)(i)(D), 
the term ``exempt distributor'' means a distributor that convenants in 
its contract with the issuer or with a distributor described in 
paragraph (c)(2)(i)(D)(4)(i) that it is buying the obligation for the 
purpose of resale in connection with the original issuance of the 
obligation, and that if it retains the obligation for its own account, 
it will only do so in accordance with the requirements of paragraph 
(c)(2)(i)(D)(6) of this section. In the latter case, the convenant will 
constitute the certificate required under paragraph (c)(2)(i)(D)(6). The 
provisions of paragraph (c)(2)(i)(D)(7) governing the restricted period 
for unsold allotments or subscriptions shall apply to any obligation 
retained for investment by an exempt distributor.
    (6) Certain United States persons. A person is described in this 
paragraph (c)(2)(i)(D)(6) if the requirements of this paragraph are 
satisfied and the person is:
    (i) The foreign branch of a United States financial institution 
purchasing for its own account or for resale, or
    (ii) A United States person who acquired the obligation through the 
foreign branch of a United States financial institution and who, for 
purposes of the certification required in paragraph (c)(2)(i)(D)(3) of 
this section, holds the obligation through such financial institution on 
the date of certification.

For purposes of paragraph (c)(2)(i)(D)(6)(ii) of this section, a United 
States person will be considered to acquire and hold an obligation 
through the foreign branch of a United States financial institution if 
the United States person has an account with the United States office of 
a financial institution, and the transaction is executed by a foreign 
office of that financial institution, or by the foreign office of 
another financial institution acting on behalf of that financial 
institution. This paragraph (c)(2)(i)(D)(6) will apply, however, only if 
the United States financial institution (or the United States office of 
a foreign financial institution) holding the obligation provides a 
certificate to the issuer or distributor selling the obligation within a 
reasonable time stating that it agrees to comply with the requirements 
of section 165(j)(3)(A), (B), or (C) and the regulations thereunder. For 
purposes of this paragraph (c)(2)(i)(D)(6), the term ``financial 
institution'' means a financial institution as defined in Sec. 1.165-
12(c)(1)(v). As an alternative to the certification required above, a 
financial institution may provide a blanket certificate to the issuer or 
distributor selling the obligation stating that the financial 
institution will comply with the requirements of section 165(j)(3)(A), 
(B) or (C) and the regulations thereunder. A blanket certificate must be 
received by the issuer or the distributor in the year of the issuance of 
the obligation or in either of the preceding two calendar years, and 
must be retained by the issuer or distributor for at least four years 
after the end of the last calendar year to which it relates.
    (7) Restricted period. For purposes of this paragraph (c)(2)(i)(D), 
the restricted period with respect to an obligation begins on the 
earlier of the closing date (or the date on which the issuer receives 
the loan proceeds, if there is no closing with respect to the 
obligation), or the first date on which the obligation is offered to 
persons other than a distributor. The restricted period with respect to 
an obligation ends on the expiration of the forty day period beginning 
on the closing date (or the date on which the issuer receives the loan 
proceeds, if there is no closing with respect to the obligation). 
Notwithstanding the preceding sentence, any offer or sale of the 
obligation by the issuer or a distributor shall be deemed to be during 
the restricted period if the issuer or distributor holds the obligation 
as part of an unsold allotment or subscription.
    (8) Clearing organization. For purposes of this paragraph 
(c)(2)(i)(D), a ``clearing organization'' is an entity which is in the 
business of holding obligations for member organizations and 
transferring obligations among such members by credit or debit to the 
account of a member without the necessity of physical delivery of the 
obligation.

[[Page 847]]

    (ii) Special rules. An obligation shall not be considered to be 
described in paragraph (c)(2)(i)(C) of this section if it is--
    (A) Guaranteed by a United States shareholder of the issuer;
    (B) Convertible into a debt or equity interest in a United States 
shareholder of the issuer; or
    (C) Substantially identical to an obligation issued by a United 
States shareholder of the issuer.

For purposes of this paragraph (c)(2)(ii), the term ``United States 
shareholder'' is defined as it is defined in section 951 (b) and the 
regulations thereunder. For purposes of this paragraph (c)(2)(ii)(C), 
obligations are substantially identical if the face amount, interest 
rate, term of the issue, due dates for payments, and maturity date of 
each is substantially identical to the other.
    (iii) Interstate commerce. For purposes of this paragraph, the term 
``interstate commerce'' means trade or commerce in obligations or any 
transportation or communication relating thereto between any foreign 
country and the United States or its possessions.
    (A) An issuer will not be considered to engage significantly in 
interstate commerce with respect to the issuance of an obligation if the 
only activities with respect to which the issuer uses the means or 
instrumentalities of interstate commerce are activities of a preparatory 
or auxiliary character that do not involve communication between a 
prospective purchaser and an issuer, its agent, an underwriter, or 
member of the selling group if either is inside the United States or its 
possessions. Activities of a preparatory or auxiliary character include, 
but are not limited to, the following activities:
    (1) Establishment or participation in establishment of policies 
concerning the issuance of obligations and the allocation of funding by 
a United States shareholder with respect to obligations issued by a 
foreign corporation or by a United States office with respect to 
obligations issued by a foreign branch;
    (2) Negotiation between the issuer and underwriters as to the terms 
and pricing of an issue;
    (3) Transfer of funds to an office of an issuer in the United States 
or its possessions by a foreign branch or to a United States shareholder 
by a foreign corporation;
    (4) Consultation by an issuer with accountants and lawyers or other 
financial advisors in the United States or its possessions regarding the 
issuance of an obligation;
    (5) Document drafting and printing; and
    (6) Provision of payment or delivery instructions to members of the 
selling group by an issuer's office or agent that is located in the 
United States or its possessions.
    (B) Activities that will not be considered to be of a preparatory or 
auxiliary character include, but are not limited to, any of the 
following activities:
    (1) Negotiation or communication between a prospective purchaser and 
an issuer, its agent, an underwriter, or a member of the selling group 
concerning the sale of an obligation if either is inside the United 
States or its possessions;
    (2) Involvement of an issuer's office, its agent, an underwriter, or 
a member of the selling group in the United States or its possessions in 
the offer or sale of a particular obligation, either directly with the 
prospective purchaser, or through the issuer in a foreign country;
    (3) Delivery of an obligation in the United States or its 
possessions; or
    (4) Advertising or otherwise promoting an obligation in the United 
States or its possessions.
    (C) The following examples illustrate the application of this 
subdivision (iii) of Sec. 1.163-5(c)(2).

    Example (1). Foreign corporation A, a corporation organized in and 
doing business in foreign country Z, and not a controlled foreign 
corporation within the meaning of section 957(a) that is engaged in the 
conduct of a banking business within the meaning of section 954(c)(3)(B) 
as in effect before the Tax Reform Act of 1986, issues its debentures 
outside the United States. The debentures are not guaranteed by a United 
States shareholder of A, nor are they convertible into a debt or equity 
interest of a United States shareholder of A, nor are they substantially 
identical to an obligation issued by a United States shareholder of A. A 
consults its accountants and lawyers in the United States for certain 
securities and tax advice regarding the debt offering. The underwriting 
and selling group in respect to A's offering is

[[Page 848]]

composed entirely of foreign securities firms, some of which are foreign 
subsidiaries of United States securities firms. A U.S. affiliate of the 
foreign underwriter communicates payment and delivery instructions to 
the selling group. All offering circulars for the offering are mailed 
and delivered outside the United States and its possessions. All 
debentures are delivered and paid for outside the United States and its 
possessions. No office located in the United States or in a United 
States possession is involved in the sale of debentures. Interest on the 
debentures is payable only outside the United States and its 
possessions. A is not significantly engaged in interstate commerce with 
respect to the offering.
    Example (2). B, a United States bank, does business in foreign 
country X through a branch located in X. The branch is a staffed and 
operating unit engaged in the active conduct of a banking business 
consisting of one or more of the activities set forth in Sec. 1.954-
2(d)(2)(ii). As part of its ongoing business, the branch in X issues 
negotiable certificates of deposit with a maturity in excess of one year 
to customers upon request. The certificates of deposit are not 
guaranteed by a United States shareholder of B, nor are they convertible 
into a debt or equity interest of a United States shareholder of B, nor 
are they substantially identical to an obligation issued by a United 
States shareholder of B. Policies regarding the issuance of negotiable 
certificates of deposit and funding allocations for foreign branches are 
set in the United States at B's main office. Branch personnel decide 
whether to issue a negotiable certificate of deposit based on the 
guidelines established by the United States offices of B, but without 
communicating with the United States offices of B with respect to the 
issuance of a particular obligation. Negotiable certificates of deposits 
are delivered and paid for outside the United States and its 
possessions. Interest on the negotiable certificates of deposit is 
payable only outside the United States and its possessions. B maintains 
documentary evidence described in Sec. 1.163-5(c)(2)(i)(C)(4). After 
the issuance of negotiable certificates of deposit by the foreign branch 
of B, the foreign branch sends the funds to a United States branch of B 
for use in domestic operations. B is not significantly engaged in 
interstate commerce with respect to the issuance of such obligation.
    Example (3). The facts in Example (2) apply except that the foreign 
branch of B consulted, by telephone, the main office in the United 
States to request approval of the issuance of the certificate of deposit 
at a particular rate of interest. The main office granted permission to 
issue the negotiable certificate of deposit to the customer by a telex 
sent from the main office of B to the branch in X. B is significantly 
engaged in interstate commerce with respect to the issuance of the 
obligation as a result of involvement of B's United States office in the 
issuance of the obligation.
    Example (4). The facts in Example (2) apply with the additional fact 
that a customer contacted the foreign branch of B through a telex 
originating in the United States or its possessions. Subsequent to the 
telex, the foreign branch issued the negotiable certificate of deposit 
and recorded it on the books. B is significantly engaged in interstate 
commerce with respect to the issuance of the obligation as a result of 
its communication by telex with a customer in the United States.

    (iv) Possessions. For purposes of this section, the term 
``possessions'' includes Puerto Rico, the U.S. Virgin Islands, Guam, 
American Samoa, Wake Island, and Northern Mariana Islands.
    (v) Interest payable outside of the United States. Interest will be 
considered payable only outside the United States and its possessions if 
payment of such interest can be made only upon presentation of a coupon, 
or upon making of any other demand for payment, outside of the United 
States and its possessions to the issuer or a paying agent. The fact 
that payment is made by a draft drawn on a United States bank account or 
by a wire or other electronic transfer from a United States account does 
not affect this result. Interest payments will be considered to be made 
within the United States if the payments are made by a transfer of funds 
into an account maintained by the payee in the United States or mailed 
to an address in the United States, if--
    (A) The interest is paid on an obligation issued by either a United 
States person, a controlled foreign corporation as defined in section 
957 (a), or a foreign corporation if 50 percent or more of the gross 
income of the foreign corporation from all sources of the 3-year period 
ending with the close of its taxable year preceding the original 
issuance of the obligation (or for such part of the period that the 
foreign corporation has been in existence) was effectively connected 
with the conduct of a trade or business within the United States; and
    (B) The interest is paid to a person other than--
    (1) A person who may satisfy the requirements of section 165 (j)(3) 
(A), (B),

[[Page 849]]

or (C) and the regulations thereunder; and
    (2) A financial institution as a step in the clearance of funds and 
such interest is promptly credited to an account maintained outside the 
United States for such financial institution or for persons for which 
the financial institution has collected such interest.

Interest is considered to be paid within the United States and its 
possessions if a coupon is presented, or a demand for payment is 
otherwise made, to the issuer or a paying agent (whether a United States 
or foreign person) in the United States and its possessions even if the 
funds paid are credited to an account maintained by the payee outside 
the United States and its possessions. Interest will be considered 
payable only outside the United States and its possessions 
notwithstanding that such interest may become payable at the office of 
the issuer or its United States paying agent under the following 
conditions: the issuer has appointed paying agents located outside the 
United States and its possessions with the reasonable expectation that 
such paying agents will be able to pay the interest in United States 
dollars, and the full amount of such payment at the offices of all such 
paying agents is illegal or effectively precluded because of the 
imposition of exchange controls or other similar restrictions on the 
full payment or receipt of interest in United States dollars. A lawsuit 
brought in the United States or its possessions for payment of the 
obligation or interest thereon as a result of a default shall not be 
considered to be a demand for payment. For purposes of this subdivision 
(v), interest includes original issue discount as defined in section 
1273(a). Therefore, an amount equal to the original issue discount as 
defined in section 1273(a) is payable only outside the United States and 
its possessions. The amount of market discount as defined in section 
1278(a) does not affect the amount of interest to be considered payable 
only outside the United States and its possessions.
    (vi) Rules relating to obligations issued after December 31, 1982 
and on or before September 21, 1984. Whether an obligation originally 
issued after December 31, 1982 and on or before September 21, 1984, or 
an obligation originally issued after September 21, 1984 pursuant to the 
exercise of a warrant or the conversion of a convertible obligation, 
which warrant or obligation (including conversion privilege) was issued 
after December 31, 1982 and on or before September 21, 1984, is 
described in section 163(f)(2)(B) shall be determined under the rules 
provided in Sec. 5f.163-1(c) as in effect prior to its removal. 
Notwithstanding the preceding sentence, an issuer will be considered to 
satisfy the requirements of section 163(f)(2)(B) with respect to an 
obligation issued after December 31, 1982 and on or before September 21, 
1984 or after September 21, 1984 pursuant to the exercise of a warrant 
or the conversion of a convertible obligation, which warrant or 
obligation (including conversion privilege) was issued after December 
31, 1982 and on or before September 21, 1984, if the issuer 
substantially complied with the proposed regulations provided in Sec. 
1.163-5(c), which were published in the Federal Register on September 2, 
1983 (48 FR 39953) and superseded by temporary regulations published in 
the Federal Register on August 22, 1984 (49 FR 33228).
    (3) Effective date--(i) In general. These regulations apply 
generally to obligations issued after January 20, 1987. A taxpayer may 
choose to apply the rules of Sec. 1.163-5(c) with respect to an 
obligation issued after December 31, 1982 and on or before January 20, 
1987. If this choice is made, the rules of Sec. 1.163-5(c) will apply 
in lieu of Sec. 1.163-5T(c) except that the legend requirement under 
Sec. 1.163-5(c)(l)(ii)(B) does not apply with respect to a bearer 
obligation evidenced exclusively by a book entry and that the 
certification requirement under Sec. 1.163-5T(c)(2)(B)(4) applies in 
lieu of the certification under Sec. 1.163-5(c)(2)(i)(B)(4).
    (ii) Special rules. If an obligation is originally issued after 
September 7, 1990 pursuant to the exercise of a warrant or the 
conversion of a convertible obligation, which warrant or obligation 
(including conversion privilege) was issued on or before May 10, 1990, 
then the issuer may choose to apply either the rules of Sec. 1.163-
5(c)(2)(i)(A) or Sec. 1.163-5(c)(2)(i)(B), or the rules of Sec. 1.163-
5(c)(2)(i)(D). The issuer of an obligation

[[Page 850]]

may choose to apply either the rules of Sec. 1.163-5(c)(2)(i) (A) or 
(B), or the rules of Sec. 1.163-5(c)(2)(i)(D), to an obligation that is 
originally issued after May 10, 1990, and on or before September 7, 
1990. However, any issuer choosing to apply the rules of Sec. 1.163-
5(c)(2)(i)(A) must apply the definition of United States person used for 
such purposes on December 31, 1989, and must obtain any certificates 
that would have been required under applicable law on December 31, 1989.

[T.D. 8110, 51 FR 45456, Dec. 19, 1986, as amended by T.D. 8203, 53 FR 
17926, May 19, 1988; T.D. 8300, 55 FR 19624, May 10, 1990; T.D. 8734, 62 
FR 53416, Oct. 14, 1997]



Sec. 1.163-5T  Denial of interest deduction on certain obligations 
issued after December 31, 1982, unless issued in registered form 
(temporary).

    (a)--(c) [Reserved]
    (d) Pass-through certificates. (1) A pass-through or participation 
certificate evidencing an interest in a pool of mortgage loans which 
under subpart E of subchapter J of the Code is treated as a trust of 
which the grantor is the owner (or similar evidence of interest in a 
similar pooled fund or pooled trust treated as a grantor trust) (``pass-
through certificate'') is considered to be a ``registration-required 
obligation'' under section 163(f)(2)(A) and Sec. 1.163-5(c) if the 
pass-through certificate is described in section 163(f)(2)(A) and Sec. 
1.163-5(c) without regard to whether any obligation held by the fund or 
trust to which the pass-through certificate relates is described in 
section 163(f)(2)(A) and Sec. 1.163-5(c). A pass-through certificate is 
considered to be described in section 163(f)(2)(B) and Sec. 1.163-5(c) 
if the pass-through certificate is described in section 163(f)(2)(B) and 
Sec. 1.163-5(c) without regard to whether any obligation held by the 
fund or trust to which the pass-through certificate relates is described 
in section 163(f)(2)(B) and Sec. 1.163-5(c).
    (2) An obligation held by a fund or trust in which ownership 
interests are represented by pass-through certificates is considered to 
be in registered form under section 149(a) and the regulations 
thereunder or to be described in section 163(f)(2) (A) or (B), if the 
obligation held by the fund or trust is in registered form under section 
149(a) and the regulations thereunder or is described in section 
163(f)(2) (A) or (B), respectively, without regard to whether the pass-
through certificates are so considered.
    (3) For purposes of section 4701, a pass-through certificate is 
considered to be issued solely by the recipient of the proceeds from the 
issuance of the pass-through certificate (hereinafter the ``sponsor''). 
The sponsor is therefore liable for any excise tax under section 4701 
that may be imposed with reference to the principal amount of the pass-
through certificate.
    (4) In order to implement the purpose of section 163, Sec. 1.163-
5(c) and this section, the Commissioner may characterize a certificate 
or other evidence of interest in a fund or trust which under subpart E 
of subchapter J of the Code is treated as a trust of which the grantor 
is the owner and any obligation held by such fund or trust in accordance 
with the substance of the arrangement they represent and may impose the 
penalties provided under sections 163(f)(1) and 4701 in the appropriate 
amounts and on the appropriate persons. This provision may be applied, 
for example, where a corporation issues obligations purportedly in 
registered form, contributes them to a grantor trust as its only assets, 
and arranges for the sale to investors of bearer certificates of 
interest in the trust which do not meet the requirements of section 
163(f)(2)(B). If this provision is applied, the obligations held by the 
fund or trust will not be considered to be issued in registered form or 
to meet the requirements of section 163(f)(2)(B). The corporation will 
not be allowed a deduction for the payment of interest on the 
obligations held by the trust, and the excise tax under section 4701, 
calculated with reference to the principal amount of the obligations 
held by the trust will be imposed on the corporation may be collected 
from the corporation and its agents. This paragraph (d)(4) will not be 
applied so as to alter the tax consequences of transactions as to which 
rulings have been issued by the Internal Revenue Service prior to 
September 19, 1985.
    (5) The rules set forth in this paragraph (d) apply solely for 
purposes of

[[Page 851]]

sections 4701, 163(f)(2)(A), 163(f)(2)(B), Sec. 1.163-5(c), and any 
other section that refers to this section for the definition of the term 
``registration-required obligation'' (such as the regulations under 
sections 871(h) and 881(c)). The treatment of obligations described in 
this paragraph (d) for purposes of section 163(f)(2) (A) and (B) does 
not affect the determination of whether bearer obligations that are 
issued or guaranteed by the United States Government, a United States 
Government-owned agency, a United States Government sponsored enterprise 
(within the meaning of Sec. 1.163-5(c)(1)) or that are backed (as 
described in the Treasury Department News Release R-2835 of September 
10, 1984 and Treasury Department News Release R-2847 of September 14, 
1984) by obligations issued by the United States Government, a United 
States Government-owned agency, or a United States Government sponsored 
enterprise comply with the requirements of section 163(f)(2)(B) and the 
regulations thereunder.
    (6) The provisions of paragraphs (d) (1) through (5) may be 
illustrated by the following example:

    Commercial Bank K forms a pool of 1000 residential mortgage loans, 
each made to a different individual homeowner, by assigning them to 
Commercial Bank L, an unrelated entity serving as trustee of the pool. 
Commercial Bank L immediately sells in a public offering certificates of 
interest in the trust of a maturity of 10 years in registered form. 
Commercial Bank L transfers the cash proceeds of the offering to 
Commercial Bank K. The certificates of interest in the trust are of a 
type offered to the public and are not described in section 
163(f)(2)(B). Pursuant to paragraph (d)(1), the certificates of interest 
in the pool are registration-required obligations without regard to the 
fact that the obligations held by the trust are not registration-
required obligations.

    (e) Regular interests in REMICS. (1) A regular interest in a REMIC, 
as defined in sections 860D and 860G and the regulations thereunder, is 
considered to be a ``registration-required obligation'' under section 
163(f)(2)(A) and Sec. 1.163-5(c) if the regular interest is described 
in section 163(f)(2)(A) and Sec. 1.163-5(c), without regard to whether 
any obligation held by the REMIC to which the regular interest relates 
is described in section 163(f)(2)(A) and Sec. 1.163-5(c). A regular 
interest in a REMIC is considered to be described in section 
163(f)(2)(B) and Sec. 1.163-5(c), if the regular interest is described 
in section 163(f)(2)(B) and Sec. 1.163(c), without regard to whether 
any obligation held by the REMIC to which the regular interest relates 
is described in section 163(f)(2)(B) and Sec. 1.163-5(c).
    (2) An obligation held by a REMIC is considered to be described in 
section 163(f)(2) (A) or (B) if such obligation is described in section 
163(f)(2) (A) or (B), respectively, without regard to whether the 
regular interests in the REMIC are so considered.
    (3) For purposes of section 4701, a regular interest is considered 
to be issued solely by the recipient of the proceeds from the issuance 
of the regular interest (hereinafter the ``sponsor''). The sponsor is 
therefore liable for any excise tax under section 4701 that may be 
imposed with reference to the principal amount of the regular interest.
    (4) In order to implement the purpose of section 163, Sec. 1.163-
5(c), and this section, the Commissioner may characterize a regular 
interest in a REMIC and any obligation held by such REMIC in accordance 
with the substance of the arrangement they represent and may impose the 
penalties provided under sections 163(f)(1) and 4701 in the appropriate 
amounts and on the appropriate persons. This provision may be applied, 
for example, where a corporation issues an obligation that is 
purportedly in registered form and that will qualify as a ``qualified 
mortgage'' within the meaning of section 860G(a)(3) in the hands of a 
REMIC, contributes the obligation to a REMIC as its only asset, and 
arranges for the sale to investors of regular interests in the REMIC in 
bearer form that do not meet the requirements of section 163(f)(2)(B). 
If this provision is applied, the obligation held by the REMIC will not 
be considered to be issued in registered form or to meet the 
requirements of section 163(f)(2)(B). The corporation will not be 
allowed a deduction for the payment of interest on the obligation held 
by the REMIC, and the excise tax under section 4701, calculated with 
reference to the principal amount of the obligation held by the REMIC, 
will be imposed on

[[Page 852]]

the corporation and may be collected from the corporation and its 
agents.

[T.D. 8202, 53 FR 17928, May 19, 1988, as amended by T.D. 8300, 55 FR 
19626, May 10, 1990]



Sec. 1.163-6T  Reduction of deduction where section 25 credit taken 
(temporary).

    (a) In general. The amount of the deduction under section 163 for 
interest paid or accrued during any taxable year on a certified 
indebtedness amount with respect to a mortgage credit certificate which 
has been issued under section 25 shall be reduced by the amount of the 
credit allowable with respect to such interest under section 25 
(determined without regard to section 26).
    (b) Cross reference. See Sec. Sec. 1.25-1T through 1.25-8T with 
respect to rules relating to mortgage credit certificates.

[T.D. 8023, 50 FR 19355, May 8, 1985]



Sec. 1.163-7  Deduction for OID on certain debt instruments.

    (a) General rule. Except as otherwise provided in paragraph (b) of 
this section, an issuer (including a transferee) determines the amount 
of OID that is deductible each year under section 163(e)(1) by using the 
constant yield method described in Sec. 1.1272-1(b). This 
determination, however, is made without regard to section 1272(a)(7) 
(relating to acquisition premium) and Sec. 1.1273-1(d) (relating to de 
minimis OID). An issuer is permitted a deduction under section 163(e)(1) 
only to the extent the issuer is primarily liable on the debt 
instrument. For certain limitations on the deductibility of OID, see 
sections 163(e) and 1275(b)(2). To determine the amount of interest 
(OID) that is deductible each year on a debt instrument that provides 
for contingent payments, see Sec. 1.1275-4.
    (b) Special rules for de minimis OID--(1) Stated interest. If a debt 
instrument has a de minimis amount of OID (within the meaning of Sec. 
1.1273-1(d)), the issuer treats all stated interest on the debt 
instrument as qualified stated interest. See Sec. Sec. 1.446-2(b) and 
1.461-1 for the treatment of qualified stated interest.
    (2) Deduction of de minimis OID on other than a constant yield 
basis. In lieu of deducting de minimis OID under the general rule of 
paragraph (a) of this section, an issuer of a debt instrument with a de 
minimis amount of OID (other than a de minimis amount treated as 
qualified stated interest under paragraph (b)(1) of this section) may 
choose to deduct the OID at maturity, on a straight-line basis over the 
term of the debt instrument, or in proportion to stated interest 
payments. The issuer makes this choice by reporting the de minimis OID 
in a manner consistent with the method chosen on the issuer's timely 
filed Federal income tax return for the taxable year in which the debt 
instrument is issued.
    (c) Deduction upon repurchase. Except to the extent disallowed by 
any other section of the Internal Revenue Code (e.g., section 249) or 
this paragraph (c), if a debt instrument is repurchased by the issuer 
for a price in excess of its adjusted issue price (as defined in Sec. 
1.1275-1(b)), the excess (repurchase premium) is deductible as interest 
for the taxable year in which the repurchase occurs. If the issuer 
repurchases a debt instrument in a debt-for-debt exchange, the 
repurchase price is the issue price of the newly issued debt instrument 
(reduced by any unstated interest within the meaning of section 483). 
However, if the issue price of the newly issued debt instrument is 
determined under either section 1273(b)(4) or section 1274, any 
repurchase premium is not deductible in the year of the repurchase, but 
is amortized over the term of the newly issued debt instrument in the 
same manner as if it were OID.
    (d) Choice of accrual periods to determine whether a debt instrument 
is an applicable high yield discount obligation (AHYDO). Section 
163(e)(5) affects an issuer's OID deductions for certain high yield debt 
instruments that have significant OID. For purposes of section 
163(i)(2), which defines significant OID, the issuer's choice of accrual 
periods to determine OID accruals is used to determine whether a debt 
instrument has significant OID. See Sec. 1.1275-2(e) for rules relating 
to the issuer's obligation to disclose certain information to holders.
    (e) Qualified reopening--(1) In general. In a qualified reopening of 
an issue of debt instruments, if a holder pays more

[[Page 853]]

or less than the adjusted issue price of the original debt instruments 
to acquire an additional debt instrument, the issuer treats this 
difference as an adjustment to the issuer's interest expense for the 
original and additional debt instruments. As provided by paragraphs 
(e)(2) through (5) of this section, the adjustment is taken into account 
over the term of the instrument using constant yield principles.
    (2) Positive adjustment. If the difference is positive (that is, the 
holder pays more than the adjusted issue price of the original debt 
instrument), then, with respect to the issuer but not the holder, the 
difference increases the aggregate adjusted issue prices of all of the 
debt instruments in the issue, both original and additional.
    (3) Negative adjustment. If the difference is negative (that is, the 
holder pays less than the adjusted issue price of the original debt 
instrument), then, with respect to the issuer but not the holder, the 
difference reduces the aggregate adjusted issue prices of all of the 
debt instruments in the issue, both original and additional.
    (4) Determination of issuer's interest accruals. As of the reopening 
date, the issuer must redetermine the yield of the debt instruments in 
the issue for purposes of applying the constant yield method described 
in Sec. 1.1272-1(b) to determine the issuer's accruals of interest 
expense over the remaining term of the debt instruments in the issue. 
This redetermined yield is based on the aggregate adjusted issue prices 
of the debt instruments in the issue (as determined under this paragraph 
(e)) and the remaining payment schedule of the debt instruments in the 
issue. If the aggregate adjusted issue prices of the debt instruments in 
the issue (as determined under this paragraph (e)) are less than the 
aggregate stated redemption price at maturity of the instruments 
(determined as of the reopening date) by a de minimis amount (within the 
meaning of Sec. 1.1273-1(d)), the issuer may use the rules in paragraph 
(b) of this section to determine the issuer's accruals of interest 
expense.
    (5) Effect of adjustments on issuer's adjusted issue price. The 
adjustments made under this paragraph (e) are taken into account for 
purposes of determining the issuer's adjusted issue price under Sec. 
1.1275-1(b).
    (6) Definitions. The terms additional debt instrument, original debt 
instrument, qualified reopening, and reopening date have the same 
meanings as in Sec. 1.1275-2(k).
    (f) Effective dates. This section (other than paragraph (e) of this 
section) applies to debt instruments issued on or after April 4, 1994. 
Taxpayers, however, may rely on this section (other than paragraph (e) 
of this section) for debt instruments issued after December 21, 1992, 
and before April 4, 1994. Paragraph (e) of this section applies to 
qualified reopenings where the reopening date is on or after March 13, 
2001.

[T.D. 8517, 59 FR 4804, Feb. 2, 1994, as amended by T.D. 8674, 61 FR 
30138, June 14, 1996; T.D. 8934, 66 FR 2815, Jan. 12, 2001]



Sec. 1.163-8T  Allocation of interest expense among expenditures 
(temporary).

    (a) In general--(1) Application. This section prescribes rules for 
allocating interest expense for purposes of applying sections 469 (the 
``passive loss limitation'') and 163 (d) and (h) (the ``nonbusiness 
interest limitations'').
    (2) Cross-references. This paragraph provides an overview of the 
manner in which interest expense is allocated for the purposes of 
applying the passive loss limitation and nonbusiness interest 
limitations and the manner in which interest expense allocated under 
this section is treated. See paragraph (b) of this section for 
definitions of certain terms, paragraph (c) for the rules for allocating 
debt and interest expense among expenditures, paragraphs (d) and (e) for 
the treatment of debt repayments and refinancings, paragraph (j) for the 
rules for reallocating debt upon the occurrence of certain events, 
paragraph (m) for the coordination of the rules in this section with 
other limitations on the deductibility of interest expense, and 
paragraph (n) of this section for effective date and transitional rules.
    (3) Manner of allocation. In general, interest expense on a debt is 
allocated in the same manner as the debt to which such interest expense 
relates is allocated. Debt is allocated by tracing disbursements of the 
debt proceeds to

[[Page 854]]

specific expenditures. This section prescribes rules for tracing debt 
proceeds to specific expenditures.
    (4) Treatment of interest expenses--(i) General rule. Except as 
otherwise provided in paragraph (m) of this section (relating to 
limitations on interest expense other than the passive loss and 
nonbusiness interest limitations), interest expense allocated under the 
rules of this section is treated in the following manner:
    (A) Interest expense allocated to a trade or business expenditure 
(as defined in paragraph (b)(7) of this section) is taken into account 
under section 163 (h)(2)(A);
    (B) Interest expense allocated to a passive activity expenditure (as 
defined in paragraph (b)(4) of this section) or a former passive 
activity expenditure (as defined in paragraph (b)(2) of this section) is 
taken into account for purposes of section 469 in determining the income 
or loss from the activity to which such expenditure relates;
    (C) Interest expense allocated to an investment expenditure (as 
defined in paragraph (b)(3) of this section) is treated for purposes of 
section 163(d) as investment interest;
    (D) Interest expense allocated to a personal expenditure (as defined 
in paragraph (b)(5) of this section) is treated for purposes of section 
163(h) as personal interest; and
    (E) Interest expense allocated to a portfolio expenditure (as 
defined in paragraph (b)(6) of this section) is treated for purposes of 
section 469(e)(2)(B)(ii) as interest expense described in section 
469(e)(1)(A)(i)(III).
    (ii) Examples. The following examples illustrate the application of 
this paragraph (a)(4):

    Example (1). Taxpayer A, an individual, incurs interest expense 
allocated under the rules of this section to the following expenditures:

$6,000 Passive activity expenditure.
$4,000 Personal expenditure.


The $6,000 interest expense allocated to the passive activity 
expenditure is taken into account for purposes of section 469 in 
computing A's income or loss from the activity to which such interest 
relates. Pursuant to section 163(h), A may not deduct the $4,000 
interest expense allocated to the personal expenditure (except to the 
extent such interest is qualified residence interest, within the meaning 
of section 163(h)(3)).
    Example (2). (i) Corporation M, a closely held C corporation (within 
the meaning of section 469 (j)(1)) has $10,000 of interest expense for a 
taxable year. Under the rules of this section, M's interest expense is 
allocated to the following expenditures:

$2,000 Passive activity expenditure.
$3,000 Portfolio expenditure.
$5,000 Other expenditures.

    (ii) Under section 163(d)(3)(D) and this paragraph (a)(4), the 
$2,000 interest expense allocated to the passive activity expenditure is 
taken into account in computing M's passive activity loss for the 
taxable year, but, pursuant to section 469(e)(1) and this paragraph 
(a)(4), the interest expense allocated to the portfolio expenditure and 
the other expenditures is not taken into account for such purposes.
    (iii) Since M is a closely held C corporation, its passive activity 
loss is allowable under section 469(e)(2)(A) as a deduction from net 
active income. Under section 469(e)(2)(B) and this paragraph (a)(4), the 
$5,000 interest expense allocated to other expenditures is taken into 
account in computing M's net active income, but the interest expense 
allocated to the passive activity expenditure and the portfolio 
expenditure is not taken into account for such purposes.
    (iv) Since M is a corporation, the $3,000 interest expense allocated 
to the portfolio expenditure is allowable without regard to section 
163(d). If M were an individual, however, the interest expense allocated 
to the portfolio expenditure would be treated as investment interest for 
purposes of applying the limitation of section 163(d).

    (b) Definitions. For purposes of this section--
    (1) ``Former passive activity'' means an activity described in 
section 469(f)(3), but only if an unused deduction or credit (within the 
meaning of section 469(f)(1) (A) or (B)) is allocable to the activity 
under section 469(b) for the taxable year.
    (2) ``Former passive activity expenditure'' means an expenditure 
that is taken into account under section 469 in computing the income or 
loss from a former passive activity of the taxpayer or an expenditure 
(including an expenditure properly chargeable to capital account) that 
would be so taken into account if such expenditure were otherwise 
deductible.
    (3) ``Investment expenditure'' means an expenditure (other than a 
passive activity expenditure) properly chargeable to capital account 
with respect to

[[Page 855]]

property held for investment (within the meaning of section 
163(d)(5)(A)) or an expenditure in connection with the holding of such 
property.
    (4) ``Passive activity expenditure'' means an expenditure that is 
taken into account under section 469 in computing income or loss from a 
passive activity of the taxpayer or an expenditure (including an 
expenditure properly chargeable to capital account) that would be so 
taken into account if such expenditure were otherwise deductible. For 
purposes of this section, the term ``passive activity expenditure'' does 
not include any expenditure with respect to any low-income housing 
project in any taxable year in which any benefit is allowed with respect 
to such project under section 502 of the Tax Reform Act of 1986.
    (5) ``Personal expenditure'' means an expenditure that is not a 
trade or business expenditure, a passive activity expenditure, or an 
investment expenditure.
    (6) ``Portfolio expenditure'' means an investment expenditure 
properly chargeable to capital account with respect to property 
producing income of a type described in section 469(e)(1)(A) or an 
investment expenditure for an expense clearly and directly allocable to 
such income.
    (7) ``Trade or business expenditure'' means an expenditure (other 
than a passive activity expenditure or an investment expenditure) in 
connection with the conduct of any trade or business other than the 
trade or business of performing services as an employee.
    (c) Allocation of debt and interest expense--(1) Allocation in 
accordance with use of proceeds. Debt is allocated to expenditures in 
accordance with the use of the debt proceeds and, except as provided in 
paragraph (m) of this section, interest expense accruing on a debt 
during any period is allocated to expenditures in the same manner as the 
debt is allocated from time to time during such period. Except as 
provided in paragraph (m) of this section, debt proceeds and related 
interest expense are allocated solely by reference to the use of such 
proceeds, and the allocation is not affected by the use of an interest 
in any property to secure the repayment of such debt or interest. The 
following example illustrates the principles of this paragraph (c)(1):

    Example. Taxpayer A, an individual, pledges corporate stock held for 
investment as security for a loan and uses the debt proceeds to purchase 
an automobile for personal use. Interest expense accruing on the debt is 
allocated to the personal expenditure to purchase the automobile even 
though the debt is secured by investment property.

    (2) Allocation period--(i) Allocation of debt. Debt is allocated to 
an expenditure for the period beginning on the date the proceeds of the 
debt are used or treated as used under the rules of this section to make 
the expenditure and ending on the earlier of--
    (A) The date the debt is repaid; or
    (B) The date the debt is reallocated in accordance with the rules in 
paragraphs (c)(4) and (j) of this section.
    (ii) Allocation of interest expense--(A) In general. Except as 
otherwise provided in paragraph (m) of this section, interest expense 
accruing on a debt for any period is allocated in the same manner as the 
debt is allocated from time to time, regardless of when the interest is 
paid.
    (B) Effect of compounding. Accrued interest is treated as a debt 
until it is paid and any interest accruing on unpaid interest is 
allocated in the same manner as the unpaid interest is allocated. For 
the taxable year in which a debt is reallocated under the rules in 
paragraphs (c)(4) and (j) of this section, however, compound interest 
accruing on such debt (other than compound interest accruing on interest 
that accrued before the beginning of the year) may be allocated between 
the original expenditure and the new expenditure on a straight-line 
basis (i.e., by allocating an equal amount of such interest expense to 
each day during the taxable year). In addition, a taxpayer may treat a 
year as consisting of 12 30-day months for purposes of allocating 
interest on a straight-line basis.
    (C) Accrual of interest expense. For purposes of this paragraph 
(c)(2)(ii), the amount of interest expense that accrues during any 
period is determined by taking into account relevant provisions of the 
loan agreement and any applicable law such as sections 163(e), 483, and 
1271 through 1275.

[[Page 856]]

    (iii) Examples. The following examples illustrate the principles of 
this paragraph (c)(2):

    Example (1). (i) On January 1, taxpayer B, a calendar year taxpayer, 
borrows $1,000 at an interest rate of 11 percent, compounded 
semiannually. B immediately uses the debt proceeds to purchase an 
investment security. On July 1, B sells the investment security for 
$1,000 and uses the sales proceeds to make a passive activity 
expenditure. On December 31, B pays accrued interest on the $1,000 debt 
for the entire year.
    (ii) Under this paragraph (c)(2) and paragraph (j) of this section, 
the $1,000 debt is allocated to the investment expenditure for the 
period from January 1 through June 30, and to the passive activity 
expenditure from July 1 through December 31. Interest expense accruing 
on the $1,000 debt is allocated in accordance with the allocation of the 
debt from time to time during the year even though the debt was 
allocated to the passive activity expenditure on the date the interest 
was paid. Thus, the $55 interest expense for the period from January 1 
through June 30 is allocated to the investment expenditure. In addition, 
during the period from July 1 through December 31, the interest expense 
allocated to the investment expenditure is a debt, the proceeds of which 
are treated as used to make an investment expenditure. Accordingly, an 
additional $3 of interest expense for the period from July 1 through 
December 31 ($55x.055) is allocated to the investment expenditure. The 
remaining $55 of interest expense for the period from July 1 through 
December 31 ($1,000x.055) is allocated to the passive activity 
expenditure.
    (iii) Alternatively, under the rule in paragraph (c)(2)(ii)(B) of 
this section, B may allocate the interest expense on a straight-line 
basis and may also treat the year as consisting of 12 30-day months for 
this purpose. In that case, $56.50 of interest expense (180/360x$113) 
would be allocated to the investment expenditure and the remaining 
$56.50 of interest expense would be allocated to the passive activity 
expenditure.
    Example (2). On January 1, 1988, taxpayer C borrows $10,000 at an 
interest rate of 11 percent, compounded annually. All interest and 
principal on the debt is payable in a lump sum on December 31, 1992. C 
immediately uses the debt proceeds to make a passive activity 
expenditure. C materially participates in the activity in 1990, 1991, 
and 1992. Therefore, under paragraphs (c)(2) (i) and (j) of this 
section, the debt is allocated to a passive activity expenditure from 
January 1, 1988, through December 31, 1989, and to a former passive 
activity expenditure from January 1, 1990, through December 31, 1992. In 
accordance with the loan agreement (and consistent with Sec. 1.1272-
1(d)(1) of the proposed regulations, 51 FR 12022, April 8, 1986), 
interest expense accruing during any period is determined on the basis 
of annual compounding. Accordingly, the interest expense on the debt is 
allocated as follows:

----------------------------------------------------------------------------------------------------------------
                 Year                                  Amount                                 Expenditure
----------------------------------------------------------------------------------------------------------------
1988..................................  $10,000 x .11                          $1,100  Passive activity.
1989..................................  11,100 x .11                            1,221  Passive activity.
1990..................................  12,321 x .11 = 1,355                 ........  .........................
                                        1,355 x 2,321/12,321                      255  Passive activity.
                                        1,355 x 10,000/12,321                   1,100  Former passive activity.
                                                                            ----------
                                        ...................................     1,355  .........................
1991..................................  13,676 x .11 = 1,504                 ........  .........................
                                        1,504 x 2,576/13,676                      283  Passive activity.
                                        1,504 x 11,100/13,676                   1,221  Former passive activity.
                                                                            ----------
                                        ...................................     1,504  .........................
1992..................................  15,180 x .11 = 1,670                 ........  .........................
                                        1,670 x 2,859/15,180                      315  Passive activity.
                                        1,670 x 12,321/15,180                   1,355  Former passive activity.
                                                                            ----------
                                        ...................................     1,670  .........................
----------------------------------------------------------------------------------------------------------------

    (3) Allocation of debt; proceeds not disbursed to borrower--(i) 
Third-party financing. If a lender disburses debt proceeds to a person 
other than the borrower in consideration for the sale or use of 
property, for services, or for any other purpose, the debt is treated 
for purposes of this section as if the borrower used an amount of the 
debt proceeds equal to such disbursement to make an expenditure for such 
property, services, or other purpose.
    (ii) Debt assumptions not involving cash disbursements. If a 
taxpayer incurs or assumes a debt in consideration for the sale or use 
of property, for services, or

[[Page 857]]

for any other purpose, or takes property subject to a debt, and no debt 
proceeds are disbursed to the taxpayer, the debt is treated for purposes 
of this section as if the taxpayer used an amount of the debt proceeds 
equal to the balance of the debt outstanding at such time to make an 
expenditure for such property, services, or other purpose.
    (4) Allocation of debt; proceeds deposited in borrower's account--
(i) Treatment of deposit. For purposes of this section, a deposit of 
debt proceeds in an account is treated as an investment expenditure, and 
amounts held in an account (whether or not interest bearing) are treated 
as property held for investment. Debt allocated to an account under this 
paragraph (c)(4)(i) must be reallocated as required by paragraph (j) of 
this section whenever debt proceeds held in the account are used for 
another expenditure. This paragraph (c)(4) provides rules for 
determining when debt proceeds are expended from the account. The 
following example illustrates the principles of this paragraph 
(c)(4)(i):

    Example. Taxpayer C, a calendar year taxpayer, borrows $100,000 on 
January 1 and immediately uses the proceeds to open a noninterest-
bearing checking account. No other amounts are deposited in the account 
during the year, and no portion of the principal amount of the debt is 
repaid during the year. On April 1, C uses $20,000 of the debt proceeds 
held in the account for a passive activity expenditure. On September 1, 
C uses an additional $40,000 of the debt proceeds held in the account 
for a personal expenditure. Under this paragraph (c)(4)(i), from January 
1 through March 31 the entire $100,000 debt is allocated to an 
investment expenditure for the account. From April 1 through August 31, 
$20,000 of the debt is allocated to the passive activity expenditure, 
and $80,000 of the debt is allocated to the investment expenditure for 
the account. From September 1 through December 31, $40,000 of the debt 
is allocated to the personal expenditure, $20,000 is allocated to the 
passive activity expenditure, and $40,000 is allocated to an investment 
expenditure for the account.

    (ii) Expenditures from account; general ordering rule. Except as 
provided in paragraph (c)(4)(iii) (B) or (C) of this section, debt 
proceeds deposited in an account are treated as expended before--
    (A) Any unborrowed amounts held in the account at the time such debt 
proceeds are deposited; and
    (B) Any amounts (borrowed or unborrowed) that are deposited in the 
account after such debt proceeds are deposited.
    The following example illustrates the application of this paragraph 
(c)(4)(ii):

    Example. On January 10, taxpayer E opens a checking account, 
depositing $500 of proceeds of Debt A and $1,000 of unborrowed funds. 
The following chart summarizes the transactions which occur during the 
year with respect to the account:

------------------------------------------------------------------------
                   Date                              Transaction
------------------------------------------------------------------------
Jan. 10...................................  $500 proceeds of Debt A and
                                             $1,000 unborowed funds
                                             deposited.
Jan. 11...................................  $500 proceeds of Debt B
                                             deposited.
Feb. 17...................................  $800 personal expenditure.
Feb. 26...................................  $700 passive activity
                                             expenditure.
June 21...................................  $1,000 proceeds of Debt C
                                             deposited.
Nov. 24...................................  $800 investment expenditure.
Dec. 20...................................  $600 personal expenditure.
------------------------------------------------------------------------


The $800 personal expenditure is treated as made from the $500 proceeds 
of Debt A and $300 of the proceeds of Debt B. The $700 passive activity 
expenditure is treated as made from the remaining $200 proceeds of Debt 
B and $500 of unborrowed funds. The $800 investment expenditure is 
treated as made entirely from the proceeds of Debt C. The $600 personal 
expenditure is treated as made from the remaining $200 proceeds of Debt 
C and $400 of unborrowed funds. Under paragraph (c)(4)(i) of this 
section, debt is allocated to an investment expenditure for periods 
during which debt proceeds are held in the account.

    (iii) Expenditures from account; supplemental ordering rules--(A) 
Checking or similar accounts. Except as otherwise provided in this 
paragraph (c)(4)(iii), an expenditure from a checking or similar account 
is treated as made at the time the check is written on the account, 
provided the check is delivered or mailed to the payee within a 
reasonable period after the writing of the check. For this purpose, the 
taxpayer may treat checks written on the same day as written in any 
order. In the absence of evidence to the contrary, a check is presumed 
to be written on the date appearing on the check and to be delivered or 
mailed to the payee within a reasonable period thereafter. Evidence to 
the contrary may include the fact that a check does not clear within a 
reasonable period after the date appearing on the check.

[[Page 858]]

    (B) Expenditures within 15 days after deposit of borrowed funds. The 
taxpayer may treat any expenditure made from an account within 15 days 
after debt proceeds are deposited in such account as made from such 
proceeds to the extent thereof even if under paragraph (c)(4)(ii) of 
this section the debt proceeds would be treated as used to make one or 
more other expenditures. Any such expenditures and the debt proceeds 
from which such expenditures are treated as made are disregarded in 
applying paragraph (c)(4)(ii) of this section. The following examples 
illustrate the application of this paragraph (c)(4)(iii)(B):

    Example (1). Taxpayer D incurs a $1,000 debt on June 5 and 
immediately deposits the proceeds in an account (``Account A''). On June 
17, D transfers $2,000 from Account A to another account (``Account 
B''). On June 30, D writes a $1,500 check on Account B for a passive 
activity expenditure. In addition, numerous deposits of borrowed and 
unborrowed amounts and expenditures occur with respect to both accounts 
throughout the month of June. Notwithstanding these other transactions, 
D may treat $1,000 of the deposit to Account B on June 17 as an 
expenditure from the debt proceeds deposited in Account A on June 5. In 
addition, D may similarly treat $1,000 of the passive activity 
expenditure on June 30 as made from debt proceeds treated as deposited 
in Account B on June 17.
    Example (2). The facts are the same as in the example in paragraph 
(c)(4)(ii) of this section, except that the proceeds of Debt B are 
deposited on February 11 rather than on January 11. Since the $700 
passive activity expenditure occurs within 15 days after the proceeds of 
Debt B are deposited in the account, E may treat such expenditure as 
being made from the proceeds of Debt B to the extent thereof. If E 
treats the passive activity expenditure in this manner, the expenditures 
from the account are treated as follows: The $800 personal expenditure 
is treated as made from the $500 proceeds of Debt A and $300 of 
unborrrowed funds. The $700 passive activity expenditure is treated as 
made from the $500 proceeds of Debt B and $200 of unborrowed funds. The 
remaining expenditures are treated as in the example in paragraph 
(c)(4)(ii) of this section.

    (C) Interest on segregated account. In the case of an account 
consisting solely of the proceeds of a debt and interest earned on such 
account, the taxpayer may treat any expenditure from such account as 
made first from amounts constituting interest (rather than debt 
proceeds) to the extent of the balance of such interest in the account 
at the time of the expenditure, determined by applying the rules in this 
paragraph (c)(4). To the extent any expenditure is treated as made from 
interest under this paragraph (c)(4)(iii)(C), the expenditure is 
disregarded in applying paragraph (c)(4)(ii) of this section.
    (iv) Optional method for determining date of reallocation. Solely 
for the purpose of determining the date on which debt allocated to an 
account under paragraph (c)(4)(i) of this section is reallocated, the 
taxpayer may treat all expenditures made during any calendar month from 
debt proceeds in the account as occurring on the later of the first day 
of such month or the date on which such debt proceeds are deposited in 
the account. This paragraph (c)(4)(iv) applies only if all expenditures 
from an account during the same calendar month are similarly treated. 
The following example illustrates the application of this paragraph 
(c)(4)(iv):

    Example. On January 10, taxpayer G opens a checking account, 
depositing $500 of proceeds of Debt A and $1,000 of unborrowed funds. 
The following chart summarizes the transactions which occur during the 
year with respect to the account (note that these facts are the same as 
the facts of the example in paragraph (c)(4)(ii) of this section):

------------------------------------------------------------------------
                   Date                              Transaction
------------------------------------------------------------------------
Jan. 10...................................  $500 proceeds of Debt A and
                                             $1,000 unborrowed funds
                                             deposited.
Jan. 11...................................  $500 proceeds of Debt B
                                             deposited.
Feb. 17...................................  $800 personal expenditure.
Feb. 26...................................  $700 passive activity
                                             expenditure.
June 21...................................  $1,000 proceeds of Debt C
                                             deposited.
Nov. 24...................................  $800 investment expenditure.
Dec. 20...................................  $600 personal expenditure.
------------------------------------------------------------------------


Assume that G chooses to apply the optional rule of this paragraph 
(c)(4)(iv) to all expenditures. For purposes of determining the date on 
which debt is allocated to the $800 personal expenditure made on 
February 17, the $500 treated as made from the proceeds of Debt A and 
the $300 treated as made from the proceeds of Debt B are treated as 
expenditures occurring on February 1. Accordingly, Debt A is allocated 
to an investment expenditure for the account from January 10 through 
January 31 and to the personal expenditure from February 1 through 
December 31, and $300 of Debt B is allocated to an investment 
expenditure for the account from January 11 through January 31 and to 
the personal expenditure from February 1 through December 31. The 
remaining $200 of

[[Page 859]]

Debt B is allocated to an investment expenditure for the account from 
January 11 through January 31 and to the passive activity expenditure 
from February 1 through December 31. The $800 of Debt C used to make the 
investment expenditure on November 24 is allocated to an investment 
expenditure for the account from June 21 through October 31 and to an 
investment expenditure from November 1 through December 31. The 
remaining $200 of Debt C is allocated to an investment expenditure for 
the account from June 21 through November 30 and to a personal 
expenditure from December 1 through December 31.

    (v) Simultaneous deposits--(A) In general. If the proceeds of two or 
more debts are deposited in an account simultaneously, such proceeds are 
treated for purposes of this paragraph (c)(4) as deposited in the order 
in which the debts were incurred.
    (B) Order in which debts incurred. If two or more debts are incurred 
simultaneously or are treated under applicable law as incurred 
simultaneously, the debts are treated for purposes of this paragraph 
(c)(4)(v) as incurred in any order the taxpayer selects.
    (C) Borrowings on which interest accrues at different rates. If 
interest does not accrue at the same fixed or variable rate on the 
entire amount of a borrowing, each portion of the borrowing on which 
interest accrues at a different fixed or variable rate is treated as a 
separate debt for purposes of this paragraph (c)(4)(v).
    (vi) Multiple accounts. The rules in this paragraph (c)(4) apply 
separately to each account of a taxpayer.
    (5) Allocation of debt; proceeds received in cash--(i) Expenditure 
within 15 days of receiving debt proceeds. If a taxpayer receives the 
proceeds of a debt in cash, the taxpayer may treat any cash expenditure 
made within 15 days after receiving the cash as made from such debt 
proceeds to the extent thereof and may treat such expenditure as made on 
the date the taxpayer received the cash. The following example 
illustrates the rule in this paragraph (c)(5)(i):

    Example. Taxpayer F incurs a $1,000 debt on August 4 and receives 
the debt proceeds in cash. F deposits $1,500 cash in an account on 
August 15 and on August 27 writes a check on the account for a passive 
activity expenditure. In addition, F engages in numerous other cash 
transactions throughout the month of August, and numerous deposits of 
borrowed and unborrowed amounts and expenditures occur with respect to 
the account during the same period. Notwithstanding these other 
transactions, F may treat $1,000 of the deposit on August 15 as an 
expenditure made from the debt proceeds on August 4. In addition, under 
the rule in paragraph (c)(4)(v)(B) of this section, F may treat the 
passive activity expenditure on August 27 as made from the $1,000 debt 
proceeds treated as deposited in the account.

    (ii) Other expenditures. Except as provided in paragraphs (c)(5) (i) 
and (iii) of this section, any debt proceeds a taxpayer (other than a 
corporation) receives in cash are treated as used to make personal 
expenditures. For purposes of this paragraph (c)(5), debt proceeds are 
received in cash if, for example, a withdrawal of cash from an account 
is treated under the rules of this section as an expenditure of debt 
proceeds.
    (iii) Special rules for certain taxpayers. [Reserved]
    (6) Special rules--(i) Qualified residence debt. [Reserved]
    (ii) Debt used to pay interest. To the extent proceeds of a debt are 
used to pay interest, such debt is allocated in the same manner as the 
debt on which such interest accrued is allocated from time to time. The 
following example illustrates the application of this paragraph 
(c)(6)(ii):

    Example. On January 1, taxpayer H incurs a debt of $1,000, bearing 
interest at an annual rate of 10 percent, compounded annually, payable 
at the end of each year (``Debt A''). H immediately opens a checking 
account, in which H deposits the proceeds of Debt A. No other amounts 
are deposited in the account during the year. On April 1, H writes a 
check for a personal expenditure in the amount of $1,000. On December 
31, H borrows $100 (``Debt B'') and immediately uses the proceeds of 
Debt B to pay the accrued interest of $100 on Debt A. From January 1 
through March 31, Debt A is allocated, under the rule in paragraph 
(c)(4)(i) of this section, to the investment expenditure for the 
account. From April 1 through December 31, Debt A is allocated to the 
personal expenditure. Under the rule in paragraph (c)(2)(ii) of this 
section, $25 of the interest on Debt A for the year is allocated to the 
investment expenditure, and $75 of the interest on Debt A for the year 
is allocated to the personal expenditure. Accordingly, for the purpose 
of allocating the interest on Debt B for all periods until Debt B is 
repaid, $25 of Debt B is allocated to the investment expenditure, and 
$75

[[Page 860]]

of Debt B is allocated to the personal expenditure.

    (iii) Debt used to pay borrowing costs--(A) Borrowing costs with 
respect to different debt. To the extent the proceeds of a debt (the 
``ancillary debt'') are used to pay borrowing costs (other than 
interest) with respect to another debt (the ``primary debt''), the 
ancillary debt is allocated in the same manner as the primary debt is 
allocated from time to time. To the extent the primary debt is repaid, 
the ancillary debt will continue to be allocated in the same manner as 
the primary debt was allocated immediately before its repayment. The 
following example illustrates the rule in this paragraph (c)(6)(iii)(A):

    Example. Taxpayer I incurs debts of $60,000 (``Debt A'') and $10,000 
(``Debt B''). I immediately uses $30,000 of the proceeds of Debt A to 
make a trade or business expenditure, $20,000 to make a passive activity 
expenditure, and $10,000 to make an investment expenditure. I 
immediately use $3,000 of the proceeds of Debt B to pay borrowing costs 
(other than interest) with respect to Debt A (such as loan origination, 
loan commitment, abstract, and recording fees) and deposits the 
remaining $7,000 in an account. Under the rule in this paragraph 
(c)(6)(iii)(A), the $3,000 of Debt B used to pay expenses of incurring 
Debt A is allocated $1,500 to the trade or business expenditure ($3,000 
x $30,000/$60,000), $1,000 to the passive activity expenditure ($3,000 x 
$20,000/$60,000), and $500 ($3,000 x $10,000/$60,000) to the investment 
expenditure. The manner in which the $3,000 of Debt B used to pay 
expenses of incurring Debt A is allocated may change if the allocation 
of Debt A changes, but such allocation will be unaffected by any 
repayment of Debt A. The remaining $7,000 of Debt B is allocated to an 
investment expenditure for the account until such time, if any, as this 
amount is used for a different expenditure.

    (B) Borrowing costs with respect to same debt. To the extent the 
proceeds of a debt are used to pay borrowing costs (other than interest) 
with respect to such debt, such debt is allocated in the same manner as 
the remaining debt is allocated from time to time. The remaining debt 
for this purpose is the portion of the debt that is not used to pay 
borrowing costs (other than interst) with respect to such debt. Any 
repayment of the debt is treated as a repayment of the debt allocated 
under this paragraph (c)(6)(iii)(B) and the remaining debt is the same 
proportion as such amount bear to each other. The following example 
illustrates the application of this paragraph (c)(6)(iii)(B):

    Example. (i) Taxpayer J borrows $85,000. The lender disburses 
$80,000 of this amount to J, retaining $5,000 for borrowing costs (other 
than interest) with respect to the loan. J immediately uses $40,000 of 
the debt proceeds to make a personal expenditure, $20,000 to make a 
passive activity expenditure, and $20,000 to make an investment 
expenditure. Under the rule in this paragraph (c)(6)(iii)(B), the $5,000 
used to pay borrowing costs is allocated $2,500 ($5,000 x $40,000/
$80,000) to the personal expenditure, $1,250 ($5,000 x $20,000/$80,000) 
to the investment expenditure. The manner in which this $5,000 is 
allocated may change if the allocation of the remaining $80,000 of debt 
is changed.
    (ii) Assume that J repays $50,000 of the debt. The repayment is 
treated as a repayment of $2,941 ($50,000 x $5,000/$85,000) of the debt 
used to pay borrowing costs and a repayment of $47,059 ($50,000 x 
$80,000/$85,000) of the remaining debt. Under paragraph (d) of this 
section, J is treated as repaying the $42,500 of debt allocated to the 
personal expenditure ($2,500 of debt used to pay borrowing costs and 
$40,000 of remaining debt). In addition, assuming that under paragraph 
(d)(2) J chooses to treat the allocation to the passive activity 
expenditure as having occurred before the allocation to the investment 
expenditure, J is treated as repaying $7,500 of debt allocated to the 
passive activity expenditure ($441 of debt used to pay borrowing costs 
and $7,059 of remaining debt).

    (iv) Allocation of debt before actual receipt of debt proceeds. If 
interest properly accrues on a debt during any period before the debt 
proceeds are actually received or used to make an expenditure, the debt 
is allocated to an investment expenditure for such period.
    (7) Antiabuse rules. [Reserved]
    (d) Debt repayments--(1) General ordering rule. If, at the time any 
portion of a debt is repaid, such debt is allocated to more than one 
expenditure, the debt is treated for purposes of this section as repaid 
in the following order:
    (i) Amounts allocated to personal expenditures;
    (ii) Amounts allocated to investment expenditures and passive 
activity expenditures (other than passive activity expenditures 
described in paragraph (d)(1)(iii) of this section);
    (iii) Amounts allocated to passive activity expenditures in 
connection with

[[Page 861]]

a rental real estate activity with respect to which the taxpayer 
actively participates (within the meaning of section 469(i));
    (iv) Amounts allocated to former passive activity expenditures; and
    (v) Amounts allocated to trade or business expenditures and to 
expenditures described in the last sentence of paragraph (b)(4) of this 
section.
    (2) Supplemental ordering rules for expenditures in same class. 
Amounts allocated to two or more expenditures that are described in the 
subdivision of paragraph (d)(1) of this section (e.g., amounts allocated 
to different personal expenditures) are treated as repaid in the order 
in which the amounts were allocated (or reallocated) to such 
expenditures. For purposes of this paragraph (d)(2), the taxpayer may 
treat allocations and reallocations that occur on the same day as 
occurring in any order (without regard to the order in which 
expenditures are treated as made under paragraph (c)(4)(iii)(A) of this 
section).
    (3) Continuous borrowings. In the case of borrowings pursuant to a 
line of credit or similar account or arrangement that allows a taxpayer 
to borrow funds periodically under a single loan agreement--
    (i) All borrowings on which interest accrues at the same fixed or 
variable rate are treated as a single debt; and
    (ii) Borrowings or portions of borrowings on which interest accrues 
at different fixed or variable rates are treated as different debts, and 
such debts are treated as repaid for purposes of this paragraph (d) in 
the order in which such borrowings are treated as repaid under the loan 
agreement.
    (4) Examples. The following examples illustrate the application of 
this paragraph (d):

    Example (1). Taxpayer B borrows $100,000 (``Debt A'') on July 12, 
immediately deposits the proceeds in an account, and uses the debt 
proceeds to make the following expenditures on the following dates:

August 31--$40,000 passive activity expenditure 1.
October 5--$20,000 passive activity expenditure 2.
December 24--$40,000 personal expenditure.


On January 19 of the following year, B repays $90,000 of Debt A (leaving 
$10,000 of Debt A outstanding). The $40,000 of Debt A allocated to the 
personal expenditure, the $40,000 allocated to passive activity 
expenditure 1, and $10,000 of the $20,000 allocated to passive 
activity expenditure 2 are treated as repaid.
    Example (2). (i) Taxpayer A obtains a line of credit. Interest on 
any borrowing on the line of credit accrues at the lender's ``prime 
lending rate'' on the date of the borrowing plus two percentage points. 
The loan documents provide that borrowings on the line of credit are 
treated as repaid in the order the borrowings were made. A borrows 
$30,000 (``Borrowing 1'') on the line of credit and immediately 
uses $20,000 of the debt proceeds to make a personal expenditure 
(``personal expenditure 1'') and $10,000 to make a trade or 
business expenditure (``trade or business expenditure 1''). A 
subsequently borrows another $20,000 (``Borrowing 2'') on the 
line of credit and immediately uses $15,000 of the debt proceeds to make 
a personal expenditure (``personal expenditure 2'') and $5,000 
to make a trade or business expenditure (``trade or business expenditure 
2''). A then repays $40,000 of the borrowings.
    (ii) If the prime lending rate plus two percentage points was the 
same on both the date of Borrowing 1 and the date of Borrowing 
2, the borrowings are treated for purposes of this paragraph 
(d) as a single debt, and A is treated as having repaid $35,000 of debt 
allocated to personal expenditure 1 and personal expenditure 
2, and $5,000 of debt allocated to trade or business 
expenditure 1.
    (iii) If the prime lending rate plus two percentage points was 
different on the date of Borrowing 1 and Borrowing 2, 
the borrowings are treated as two debts, and, in accordance with the 
loan agreement, the $40,000 repaid amount is treated as a repayment of 
Borrowing 1 and $10,000 of Borrowing 2. Accordingly, A 
is treated as having repaid $20,000 of debt allocated to personal 
expenditure 1, $10,000 of debt allocated to trade or business 
expenditure 1, and $10,000 of debt allocated to personal 
expenditure 2.

    (e) Debt refinancings--(1) In general. To the extent proceeds of any 
debt (the ``replacement debt'') are used to repay any portion of a debt, 
the replacement debt is allocated to the expenditures to which the 
repaid debt was allocated. The amount of replacement debt allocated to 
any such expenditure is equal to the amount of debt allocated to such 
expenditure that was repaid with proceeds of the replacement debt. To 
the extent proceeds of the replacement debt are used for expenditures 
other than repayment of a debt, the replacement debt is allocated to 
expenditures

[[Page 862]]

in accordance with the rules of this section.
    (2) Example. The following example illustrates the application of 
this paragraph (e):

    Example. Taxpayer C borrows $100,000 (``Debt A'') on July 12, 
immediately deposits the debt proceeds in an account, and uses the 
proceeds to make the following expenditures on the following dates (note 
that the facts of this example are the same as the facts of example (1) 
in paragraph (d)(4) of this section):

August 31--$40,000 passive activity expenditure 1.
October 5--$20,000 passive activity expenditure 2.
December 24--$40,000 personal expenditure 1.


On January 19 of the following year, C borrows $120,000 (``Debt B'') and 
uses $90,000 of the proceeds of repay $90,000 of Debt A (leaving $10,000 
of Debt A outstanding). In addition, C uses $30,000 of the proceeds of 
Debt B to make a personal expenditure (``personal expenditure 
2''). Debt B is allocated $40,000 to personal expenditure 
1, $40,000 to passive activity expenditure 1, $10,000 
to passive activity expenditure 2, and $30,000 to personal 
expenditure 2. Under paragraph (d)(1) of this section, Debt B 
will be treated as repaid in the following order: (1) amounts allocated 
to personal expenditure 1, (2) amounts allocated to personal 
expenditure 2, (3) amounts allocated to passive activity 
expenditure 1, and (4) amounts allocated to passive activity 
expenditure 2.

    (f) Debt allocated to distributions by passthrough entities. 
[Reserved]
    (g) Repayment of passthrough entity debt. [Reserved]
    (h) Debt allocated to expenditures for interests in passthrough 
entities. [Reserved]
    (i) Allocation of debt to loans between passthrough entities and 
interest holders. [Reserved]
    (j) Reallocation of debt--(1) Debt allocated to capital 
expenditures--(i) Time of reallocation. Except as provided in paragraph 
(j)(2) of this section, debt allocated to an expenditure properly 
chargeable to capital account with respect to an asset (the ``first 
expenditure'') is reallocated to another expenditure on the earlier of--
    (A) The date on which proceeds from a disposition of such asset are 
used for another expenditure; or
    (B) The date on which the character of the first expenditure changes 
(e.g., from a passive activity expenditure to an expenditure that is not 
a passive activity expenditure) by reason of a change in the use of the 
asset with respect to which the first expenditure was capitalized.
    (ii) Limitation on amount reallocated. The amount of debt 
reallocated under paragraph (j)(1)(i)(A) of this section may not exceed 
the proceeds from the disposition of the asset. The amount of debt 
reallocated under paragraph (j)(1)(i)(B) of this section may not exceed 
the fair market value of the asset on the date of the change in use. In 
applying this paragraph (j)(1)(ii) with respect to a debt in any case in 
which two or more debts are allocable to expenditures properly 
chargeable to capital account with respect to the same asset, only a 
ratable portion (determined with respect to any such debt by dividing 
the amount of such debt by the aggregate amount of all such debts) of 
the fair market value or proceeds from the disposition of such asset 
shall be taken into account.
    (iii) Treatment of loans made by the taxpayer. Except as provided in 
paragraph (j)(1)(iv) of this section, an expenditure to make a loan is 
treated as an expenditure properly chargeable to capital account with 
respect to an asset, and for purposes of paragraph (j)(1)(i)(A) of this 
section any repayment of the loan is treated as a disposition of the 
asset. Paragraph (j)(3) of this section applies to any repayment of a 
loan in installments.
    (iv) Treatment of accounts. Debt allocated to an account under 
paragraph (c)(4)(i) of this section is treated as allocated to an 
expenditure properly chargeable to capital account with respect to an 
asset, and any expenditure from the account is treated as a disposition 
of the asset. See paragraph (c)(4) of this section for rules under which 
debt proceeds allocated to an account are treated as used for another 
expenditure.
    (2) Disposition proceeds in excess of debt. If the proceeds from the 
disposition of an asset exceed the amount of debt reallocated by reason 
of such disposition, or two or more debts are reallocated by reason of 
the disposition of an asset, the proceeds of the disposition are treated 
as an account to which

[[Page 863]]

the rules in paragraph (c)(4) of this section apply.
    (3) Special rule for deferred payment sales. If any portion of the 
proceeds of a disposition of an asset are received subsequent to the 
disposition--
    (i) The portion of the proceeds to be received subsequent to the 
disposition is treated for periods prior to the receipt as used to make 
an investment expenditure; and
    (ii) Debt reallocated by reason of the disposition is allocated to 
such investment expenditure to the extent such debt exceeds the proceeds 
of the disposition previously received (other than proceeds used to 
repay such debt).
    (4) Examples. The following examples illustrate the application of 
this paragraph (j):

    Example (1). On January 1, 1988, taxpayer D sells an asset for 
$25,000. Immediately before the sale, the amount of debt allocated to 
expenditures properly chargeable to capital account with respect to the 
asset was $15,000. The proceeds of the disposition are treated as an 
account consisting of $15,000 of debt proceeds and $10,000 of unborrowed 
funds to which paragraph (c)(4) of this section applies. Thus, if D 
immediately makes a $10,000 personal expenditure from the proceeds and 
within 15 days deposits the remaining proceeds in an account, D may, 
pursuant to paragraph (c)(4)(iii)(B) of this section, treat the entire 
$15,000 deposited in the account as proceeds of a debt.
    Example (2). The facts are the same as in example (1) except that, 
instead of receiving all $25,000 of the sale proceeds on January 1, 
1988, D receives 5,000 on that date, $10,000 on January 1, 1989, and 
$10,000 on January 1, 1990. D does not use any portion of the sale 
proceeds to repay the debt. Between January 1, 1988, and December 31, 
1988, D is treated under paragraph (j)(3) of this section as making an 
investment expenditure of $20,000 to which $10,000 of debt is allocated. 
In addition, the remaining $5,000 of debt is reallocated on January 1, 
1988, in accordance with D's use of the sales proceeds received on that 
date. Between January 1, 1989, and December 31, 1989, D is treated as 
making an investment expenditure of $10,000 to which no debt is 
allocated. In addition, as of January 1, 1989, $10,000 of debt is 
reallocated in accordance with D's use of the sales proceeds received on 
that date.
    Example 3. The facts are the same as in example (2), except that D 
immediately uses the $5,000 sale proceeds received on January 1, 1988, 
to repay $5,000 of the $15,000 debt. Between January 1, 1988, and 
December 31, 1988, D is treated as making an investment expenditure of 
$20,000 to which the remaining balance ($10,000) of the debt is 
reallocated. The results in 1989 are as described in example (2).

    (k) Modification of rules in the case of interest expense allocated 
to foreign source income. [Reserved]
    (l) [Reserved]
    (m) Coordination with other provisions--(1) Effect of other 
limitations--(i) In general. All debt is allocated among expenditures 
pursuant to the rules in this section, without regard to any limitations 
on the deductibility of interest expense on such debt. The applicability 
of the passive loss and nonbusiness interest limitations to interest on 
such debt, however, may be affected by other limitations on the 
deductibility of interest expense.
    (ii) Disallowance provisions. (Interest expense that is not 
allowable as a deduction by reason of a disallowance provision (within 
the meaning of paragraph (m)(7)(ii) of this section) is not taken into 
account for any taxable year for purposes of applying the passive loss 
and nonbusiness interest limitations.
    (iii) Deferral provisions. Interest expense that is not allowable as 
a deduction for the taxable year in which paid or accrued by reason of a 
deferral provision (within the meaning of paragraph (m)(7)(iii) of this 
section) is allocated in the same manner as the debt giving rise to the 
interest expense is allocated for such taxable year. Such interest 
expense is taken into account for purposes of applying the passive loss 
and nonbusiness interest limitations for the taxable year in which such 
interest expense is allowable under such deferral provision.
    (iv) Capitalization provisions. Interest expense that is capitalized 
pursuant to a capitalization provision (within the meaning of paragraph 
(m)(7)(i) of this section) is not taken into account as interest for any 
taxable year for purposes of applying the passive loss and nonbusiness 
interest limitations.
    (2) Effect on other limitations--(i) General rule. Except as 
provided in paragraph (m)(2)(ii) of this section, any limitation on the 
deductibility of an item (other than the passive loss and nonbusiness 
interest limitations) applies without regard to the manner in

[[Page 864]]

which debt is allocated under this section. Thus, for example, interest 
expense treated under section 265(a)(2) as interest on indebtedness 
incurred or continued to purchase or carry obligations the interest on 
which is wholly exempt from Federal income tax is not deductible 
regardless of the expenditure to which the underlying debt is allocated 
under this section.
    (ii) Exception. Capitalization provisions (within the meaning of 
paragraph (m)(7)(i) of this section) do not apply to interest expense 
allocated to any personal expenditure under the rules of this section.
    (3) Qualified residence interest. Qualified residence interest 
(within the meaning of section 163(h)(3)) is allowable as a deduction 
without regard to the manner in which such interest expense is allocated 
under the rules of this section. In addition, qualified residence 
interest is not taken into account in determining the income or loss 
from any activity for purposes of section 469 or in determining the 
amount of investment interest for purposes of section 163(d). The 
following example illustrates the rule in this paragraph (m)(3):

    Example. Taxpayer E, an individual, incurs a $20,000 debt secured by 
a residence and immediately uses the proceeds to purchase an automobile 
exclusively for E's personal use. Under the rules in this section, the 
debt and interest expense on the debt are allocated to a personal 
expenditure. If, however, the interest on the debt is qualified 
residence interest within the meaning of section 163(h)(3), the interest 
is not treated as personal interest for purposes of section 163(h).

    (4) Interest described in section 163(h)(2)(E). Interest described 
in section 163(h)(2)(E) is allowable as a deduction without regard to 
the rules of this section.
    (5) Interest on deemed distributee debt. [Reserved]
    (6) Examples. The following examples illustrate the relationship 
between the passive loss and nonbusiness interest limitations and other 
limitations on the deductibility of interest expense:

    Example (1). Debt is allocated pursuant to the rules in this section 
to an investment expenditure for the purchase of taxable investment 
securities. Pursuant to section 265(a)(2), the debt is treated as 
indebtedness incurred or continued to purchase or carry obligations the 
interest on which is wholly exempt from Federal income tax, and, 
accordingly, interest on the debt is disallowed. If section 265(a)(2) 
subsequently ceases to apply (because, for example, the taxpayer ceases 
to hold any tax-exempt obligations), and the debt at such time continues 
to be allocated to an investment expenditure, interest on the debt that 
accrues after such time is subject to section 163(d).
    Example (2). An accrual method taxpayer incurs a debt payable to a 
cash method lender who is related to the taxpayer within the meaning of 
section 267(b). During the period in which interest on the debt is not 
deductible by reason of section 267(a)(2), the debt is allocated to a 
passive activity expenditure. Thus, interest that accrues on the debt 
for such period is also allocated to the passive activity expenditure. 
When such interest expense becomes deductible under section 267(a)(2), 
it will be allocated to the passive activity expenditure, regardless of 
how the debt is allocated at such time.
    Example (3). A taxpayer incurs debt that is allocated under the 
rules of this section to an investment expenditure. Under section 
263A(f), however, interest expense on such debt is capitalized during 
the production period (within the meaning of section 263A(f)(4)(B)) of 
property used in a passive activity of the taxpayer. The capitalized 
interest expense is not allocated to the investment expenditure, and 
depreciation deductions attributable to the capitalized interest expense 
are subject to the passive loss limitation as long as the property is 
used in a passive activity. However, interest expense on the debt for 
periods after the production period is allocated to the investment 
expenditure as long as the debt remains allocated to the investment 
expenditure.

    (7) Other limitations on interest expense--(i) Capitalization 
provisions. A capitalization provision is any provision that requires or 
allows interest expense to be capitalized. Capitalization provisions 
include sections 263(g), 263A(f), and 266.
    (ii) Disallowance provisions. A disallowance provision is any 
provision (other than the passive loss and nonbusiness interest 
limitations) that disallows a deduction for interest expense for all 
taxable years and is not a capitalization provision. Disallowance 
provisions include sections 163(f)(2), 264(a)(2), 264(a)(4), 265(a)(2), 
265(b)(2), 279(a), 291(e)(1)(B)(ii), 805(b)(1), and 834(c)(5).
    (iii) Deferral provisions. A deferral provision is any provision 
(other than

[[Page 865]]

the passive loss and nonbusiness interest limitations) that disallows a 
deduction for interest expense for any taxable year and is not a 
capitalization or disallowance provision. Deferral provisions include 
sections 267(a)(2), 465, 1277, and 1282.
    (n) Effective date--(1) In general. This section applies to interest 
expense paid or accrued in taxable years beginning after December 31, 
1986.
    (2) Transitional rule for certain expenditures. For purposes of 
determining whether debt is allocated to expenditures made on or before 
August 3, 1987, paragraphs (c)(4)(iii)(B) and (c)(5)(i) of this section 
are applied by substituting ``90 days'' for ``15 days.''
    (3) Transitional rule for certain debt--(i) General rule. Except as 
provided in paragraph (n)(3)(ii) of this section, any debt outstanding 
on December 31, 1986, that is properly attributable to a business or 
rental activity is treated for purposes of this section as debt 
allocated to expenditures properly chargeable to capital account with 
respect to the assets held for use or for sale to customers in such 
business or rental activity. Debt is properly attributable to a business 
or rental activity for purposes of this section (regardless of whether 
such debt otherwise would be allocable under this section to 
expenditures in connection with such activity) if the taxpayer has 
properly and consistently deducted interest expense (including interest 
subject to limitation under section 163(d) as in effect prior to the Tax 
Reform Act of 1986) on such debt on Schedule C, E, or F of Form 1040 in 
computing income or loss from such business or rental activity for 
taxable years beginning before January 1, 1987. For purposes of this 
paragraph (n)(3), amended returns filed after July 2, 1987 are 
disregarded in determining whether a taxpayer has consistently deducted 
interest expense on Schedule C, E, or F of Form 1040 in computing income 
or loss from a business or rental activity.
    (ii) Exceptions--(A) Debt financed distributions by passthrough 
entities. [Reserved]
    (B) Election out. This paragraph (n)(3) does not apply with respect 
to debt of a taxpayer who elects under paragraph (n)(3) (viii) of this 
section to allocate debt outstanding on December 31, 1986, in accordance 
with the provisions of this section other than this paragraph (n)(3) 
(i.e., in accordance with the use of the debt proceeds).
    (iii) Business or rental activity. For purposes of this paragraph 
(n)(3), a business or rental activity is any trade or business or rental 
activity of the taxpayer. For this purpose--
    (A) A trade or business includes a business or profession the income 
and deductions of which (or, in the case of a partner or S corporation 
shareholder, the taxpayer's share thereof) are properly reported on 
Schedule C, E, or F of Form 1040; and
    (B) A rental activity includes an activity of renting property the 
income and deductions of which (or, in the case of a partner or S 
corporation shareholder, the taxpayer's share thereof) are properly 
reported on Schedule E of Form 1040.
    (iv) Example. The following example illustrates the circumstances in 
which debt is properly attributable to a business or rental activity:

    Example. Taxpayer H incurred a debt in 1979 and properly deducted 
the interest expense on the debt on Schedule C of Form 1040 for each 
year from 1979 through 1986. Under this paragraph (n) (3), the debt is 
properly attributable to the business the results of which are reported 
on Schedule C.

    (v) Allocation requirement--(A) In general. Debt outstanding on 
December 31, 1986, that is properly attributable (within the meaning of 
paragraph (n)(3)(i) of this section) to a business or rental activity 
must be allocated in a reasonable and consistent manner among the assets 
held for use or for sale to customers in such activity on the last day 
of the taxable year that includes December 31, 1986. The taxpayer shall 
specify the manner in which such debt is allocated by filing a statement 
in accordance with paragraph (n)(3)(vii) of this section. If the 
taxpayer does not file such a statement or fails to allocate such debt 
in a reasonable and consistent manner, the Commissioner shall allocate 
the debt.
    (B) Reasonable and consistent manner--examples of improper 
allocation. For purposes of this paragraph (n)(3)(v), debt is not 
treated as allocated in a reasonable and consistent manner if--

[[Page 866]]

    (1) The amount of debt allocated to goodwill exceeds the basis of 
the goodwill; or
    (2) The amount of debt allocated to an asset exceeds the fair market 
value of the asset, and the amount of debt allocated to any other asset 
is less than the fair market value (lesser of basis or fair market value 
in the case of goodwill) of such other asset.
    (vi) Coordination with other provisions. The effect of any events 
occurring after the last day of the taxable year that includes December 
31, 1986, shall be determined under the rules of this section, applied 
by treating the debt allocated to an asset under paragraph (n)(3)(v) of 
this section as if proceeds of such debt were used to make an 
expenditure properly chargeable to capital account with respect to such 
asset on the last day of the taxable year that includes December 31, 
1986. Thus, debt that is allocated to an asset in accordance with this 
paragraph (n)(3) must be reallocated in accordance with paragraph (j) of 
this section upon the occurrence with respect to such asset of any event 
described in such paragraph (j). Similarly, such debt is treated as 
repaid in the order prescribed in paragraph (d) of this section. In 
addition, a replacement debt (within the meaning of paragraph (e) of 
this section) is allocated to an expenditure properly chargeable to 
capital account with respect to an asset to the extent the proceeds of 
such debt are used to repay the portion of a debt allocated to such 
asset under this paragraph (n)(3).
    (vii) Form for allocation of debt. A taxpayer shall allocate debt 
for purposes of this paragraph (n)(3) by attaching to the taxpayer's 
return for the first taxable year beginning after December 31, 1986, a 
statement that is prominently identified as a transitional allocation 
statement under Sec. 1.163-8T(n)(3) and includes the following 
information:
    (A) A description of the business or rental activity to which the 
debt is properly attributable;
    (B) The amount of debt allocated;
    (C) The assets among which the debt is allocated;
    (D) The manner in which the debt is allocated;
    (E) The amount of debt allocated to each asset; and
    (F) Such other information as the Commissioner may require.
    (viii) Form for election out. A taxpayer shall elect to allocate 
debt outstanding on December 31, 1986, in accordance with the provisions 
of this section other than this paragraph (n)(3) by attaching to the 
taxpayer's return (or amended return) for the first taxable year 
beginning after December 31, 1986, a statement to that effect, 
prominently identified as as election out under Sec. 1.163-8T(n)(3).
    (ix) Special rule for partnerships and S corporations. For purposes 
of paragraph (n)(3)(ii)(B), (v), (vii) and (viii) of this section 
(relating to the allocation of debt and election out), a partnership or 
S corporation shall be treated as the taxpayer with respect to the debt 
of the partnership or S corporation.
    (x) Irrevocability. An allocation or election filed in accordance 
with paragraph (n)(3) (vii) or (viii) of this section may not be revoked 
or modified except with the consent of the Commissioner.

[T.D. 8145, 52 FR 24999, July 2, 1987, as amended by T.D. 8145, 62 FR 
40270, July 28, 1997]



Sec. 1.163-9T  Personal interest (temporary).

    (a) In general. No deduction under any provision of Chapter 1 of the 
Internal Revenue Code shall be allowed for personal interest paid or 
accrued during the taxable year by a taxpayer other than a corporation.
    (b) Personal interest--(1) Definition. For purposes of this section, 
personal interest is any interest expense other than--
    (i) Interest paid or accrued on indebtedness properly allocable 
(within the meaning of Sec. 1.163-8T) to the conduct of trade or 
business (other than the trade or business of performing services as an 
employee),
    (ii) Any investment interest (within the meaning of section 
163(d)(3)),
    (iii) Any interest that is taken into account under section 469 in 
computing income or loss from a passive activity of the taxpayer,
    (iv) Any qualified residence interest (within the meaning of section 
163(h)(3) and Sec. 1.163-10T), and
    (v) Any interest payable under section 6601 with respect to the 
unpaid portion of the tax imposed by section

[[Page 867]]

2001 for the period during which an extension of time for payment of 
such tax is in effect under section 6163, 6166, or 6166A (as in effect 
before its repeal by the Economic Recovery Tax Act of 1981).
    (2) Interest relating to taxes--(i) In general. Except as provided 
in paragraph (b)(2)(iii) of this section, personal interest includes 
interest--
    (A) Paid on underpayments of individual Federal, State or local 
income taxes and on indebtedness used to pay such taxes (within the 
meaning of Sec. 1.163-8T), regardless of the source of the income 
generating the tax liability;
    (B) Paid under section 453(e)(4)(B) (interest on deferred tax 
resulting from certain installment sales) and section 1291(c) (interest 
on deferred tax attributable to passive foreign investment companies); 
or
    (C) Paid by a trust, S corporation, or other pass-through entity on 
underpayments of State or local income taxes and on indebtedness used to 
pay such taxes.
    (ii) Example. A, an individual, owns stock of an S corporation. On 
its return for 1987, the corporation underreports its taxable income. 
Consequently, A underreports A's share of that income on A's tax return. 
In 1989, A pays the resulting deficiency plus interest to the Internal 
Revenue Service. The interest paid by A in 1989 on the tax deficiency is 
personal interest, notwithstanding the fact that the additional tax 
liability may have arisen out of income from a trade or business. The 
result would be the same if A's business had been operated as a sole 
proprietorship.
    (iii) Certain other taxes. Personal interest does not include 
interest--
    (A) Paid with respect to sales, excise and similar taxes that are 
incurred in connection with a trade or business or an investment 
activity;
    (B) Paid by an S corporation with respect to an underpayment of 
income tax from a year in which the S corporation was a C corporation or 
with respect to an underpayment of the taxes imposed by sections 1374 or 
1375, or similar provision of State law; or
    (C) Paid by a transferee under section 6901 (tax liability resulting 
from transferred assets), or a similar provision of State law, with 
respect to a C corporation's underpayment of income tax.
    (3) Cross references. See Sec. 1.163-8T for rules for determining 
the allocation of interest expense to various activities. See Sec. 
1.163-10T for rules concerning qualified residence interest.
    (c) Effective date--(1) In general. The provisions of this section 
are effective for taxable years beginning after December 31, 1986. In 
the case of any taxable year beginning in calendar years 1987 through 
1990, the amount of personal interest that is nondeductible under this 
section is limited to the applicable percentage of such amount.
    (2) Applicable percentages. The applicable percentage for taxable 
years beginning in 1987 through 1990 are as follows:

1987: 35 percent
1988: 60 percent
1989: 80 percent
1990: 90 percent

[T.D. 8168, 52 FR 48409, Dec. 22, 1987; 68 FR 13226, Mar. 19, 2003]



Sec. 1.163-10T  Qualified residence interest (temporary).

    (a) Table of contents. This paragraph (a) lists the major paragraphs 
that appear in this Sec. 1.163-10T.

(a) Table of contents.
(b) Treatment of qualified residence interest.
(c) Determination of qualified residence interest when secured debt does 
          not exceed the adjusted purchase price.
    (1) In general.
    (2) Examples.
(d) Determination of qualified residence interest when secured debt 
          exceeds adjusted purchase price--Simplified method.
    (1) In general.
    (2) Treatment of interest paid or accrued on secured debt that is 
not qualified residence interest.
    (3) Example.
(e) Determination of qualified residence interest when secured debt 
          exceeds adjusted purchase price--Exact method.
    (1) In general.
    (2) Determination of applicable debt limit.
    (3) Example.
    (4) Treatment of interest paid or accrued with respect to secured 
debt that is not qualified residence interest.
     (i) In general.
     (ii) Example.

[[Page 868]]

     (iii) Special rule of debt is allocated to more than one 
expenditure.
     (iv) Example.
(f) Special rules.
    (1) Special rules for personal property.
     (i) In general.
     (ii) Example.
    (2) Special rule for real property.
     (i) In general.
     (ii) Example.
(g) Selection of method.
(h) Average balance.
    (1) Average balance defined.
    (2) Average balance reported by lender.
    (3) Average balance computed on a daily basis.
     (i) In general.
     (ii) Example.
    (4) Average balance computed using the interest rate.
     (i) In general.
     (ii) Points and prepaid interest.
     (iii) Examples.
    (5) Average balance computed using average of beginning and ending 
balance.
     (i) In general.
     (ii) Example.
    (6) Highest principal balance.
    (7) Other methods provided by the Commissioner.
    (8) Anti-abuse rule.
(i) [Reserved]
(j) Determination of interest paid or accrued during the taxable year.
    (1) In general.
    (2) Special rules for cash-basis taxpayers.
     (i) Points deductible in year paid under section 461(g)(2).
     (ii) Points and other prepaid interest described in section 
461(g)(1).
    (3) Examples.
(k) Determination of adjusted purchase price and fair market value.
    (1) Adjusted purchase price.
     (i) In general.
     (ii) Adjusted purchase price of a qualified residence acquired 
incident to divorce.
     (iii) Examples.
    (2) Fair market value.
     (i) In general.
     (ii) Examples.
    (3) Allocation of adjusted purchase price and fair market value.
(l) [Reserved]
(m) Grandfathered amount.
    (1) Substitution for adjusted purchase price.
    (2) Determination of grandfathered amount.
     (i) In general.
     (ii) Special rule for lines of credit and certain other debt.
     (iii) Fair market value limitation.
     (iv) Examples.
    (3) Refinancing of grandfathered debt.
     (i) In general.
     (ii) Determination of grandfathered amount.
    (4) Limitation on terms of grandfathered debt.
     (i) In general.
     (ii) Special rule for nonamortizing debt.
     (iii) Example.
(n) Qualified indebtedness (secured debt used for medical and 
          educational purposes).
    (1) In general.
     (i) Treatment of qualified indebtedness.
     (ii) Determination of amount of qualified indebtedness.
     (iii) Determination of amount of qualified indebtedness for mixed-
use debt.
     (iv) Example.
     (v) Prevention of double counting in year of refinancing.
     (vi) Special rule for principal payments in excess of qualified 
expenses.
    (2) Debt used to pay for qualified medical or educational expenses.
     (i) In general.
     (ii) Special rule for refinancing.
     (iii) Other special rules.
     (iv) Examples.
    (3) Qualified medical expenses.
    (4) Qualified educational expenses.
(o) Secured debt.
    (1) In general.
    (2) Special rule for debt in certain States.
    (3) Time at which debt is treated as secured.
    (4) Partially secured debt.
     (i) In general.
     (ii) Example.
    (5) Election to treat debt as not secured by a qualified residence.
     (i) In general.
     (ii) Example.
     (iii) Allocation of debt secured by two qualified residences.
(p) Definition of qualified residence.
    (1) In general.
    (2) Principal residence.
    (3) Second residence.
     (i) In general.
     (ii) Definition of residence.
     (iii) Use as a residence.
     (iv) Election of second residence.
    (4) Allocations between residence and other property.
     (i) In general.
     (ii) Special rule for rental of residence.
     (iii) Examples.
    (5) Residence under construction.
     (i) In general.
     (ii) Example.
    (6) Special rule for the time-sharing arrangements.
(q) Special rules for tenant-stockholders in cooperative housing 
          corporations.
    (1) In general.
    (2) Special rule where stock may not be used to secure debt.

[[Page 869]]

    (3) Treatment of interest expense of the cooperative described in 
section 216(a)(2).
    (4) Special rule to prevent tax avoidance.
    (5) Other definitions.
(r) Effective date.

    (b) Treatment of qualified residence interest. Except as provided 
below, qualified residence interest is deductible under section 163(a). 
Qualified residence interest is not subject to limitation or otherwise 
taken into account under section 163(d) (limitation on investment 
interest), section 163(h)(1) (disallowance of deduction for personal 
interest), section 263A (capitalization and inclusion in inventory costs 
of certain expenses) or section 469 (limitations on losses from passive 
activities). Qualified residence interest is subject to the limitation 
imposed by section 263(g) (certain interest in the case of straddles), 
section 264(a) (2) and (4) (interest paid in connection with certain 
insurance), section 265(a)(2) (interest relating to tax-exempt income), 
section 266 (carrying charges), section 267(a)(2) (interest with respect 
to transactions between related taxpayers) section 465 (deductions 
limited to amount at risk), section 1277 (deferral of interest deduction 
allocable to accrued market discount), and section 1282 (deferral of 
interest deduction allocable to accrued discount).
    (c) Determination of qualified residence interest when secured debt 
does not exceed adjusted purchase price--(1) In general. If the sum of 
the average balances for the taxable year of all secured debts on a 
qualified residence does not exceed the adjusted purchase price 
(determined as of the end of the taxable year) of the qualified 
residence, all of the interest paid or accrued during the taxable year 
with respect to the secured debts is qualified residence interest. If 
the sum of the average balances for the taxable year of all secured 
debts exceeds the adjusted purchase price of the qualified residences 
(determined as of the end of the taxable year), the taxpayer must use 
either the simplified method (see paragraph (d) of this section) or the 
exact method (see paragraph (e) of this section) to determine the amount 
of interest that is qualified residence interest.
    (2) Examples.

    Example (1). T purchases a qualified residence in 1987 for $65,000. 
T pays $6,500 in cash and finances the remainder of the purchase with a 
mortgage of $58,500. In 1988, the average balance of the mortgage is 
$58,000. Because the average balance of the mortgage is less than the 
adjusted purchase price of the residence ($65,000), all of the interest 
paid or accrued during 1988 on the mortgage is qualified residence 
interest.
    Example (2). The facts are the same as in example (1), except that T 
incurs a second mortgage on January 1, 1988, with an initial principal 
balance of $2,000. The average balance of the second mortgage in 1988 is 
$1,900. Because the sum of the average balance of the first and second 
mortgages ($59,900) is less than the adjusted purchase price of the 
residence ($65,000), all of the interest paid or accrued during 1988 on 
both the first and second mortgages is qualified residence interest.
    Example (3). P borrows $50,000 on January 1, 1988 and secures the 
debt by a qualified residence. P pays the interest on the debt monthly, 
but makes no principal payments in 1988. There are no other debts 
secured by the residence during 1988. On December 31, 1988, the adjusted 
purchase price of the residence is $40,000. The average balance of the 
debt in 1988 is $50,000. Because the average balance of the debt exceeds 
the adjusted purchase price ($10,000), some of the interest on the debt 
is not qualified residence interest. The portion of the total interest 
that is qualified residence interest must be determined in accordance 
with the rules of paragraph (d) or paragraph (e) of this section.

    (d) Determination of qualified residence interest when secured debt 
exceeds adjusted purchase price--Simplified method--(1) In general. 
Under the simplified method, the amount of qualified residence interest 
for the taxable year is equal to the total interest paid or accrued 
during the taxable year with respect to all secured debts multiplied by 
a fraction (not in excess of one), the numerator of which is the 
adjusted purchase price (determined as of the end of the taxable year) 
of the qualified residence and the denominator of which is the sum of 
the average balances of all secured debts.
    (2) Treatment of interest paid or accrued on secured debt that is 
not qualified residence interest. Under the simplified method, the 
excess of the total interest paid or accrued during the taxable year 
with respect to all secured debts over the amount of qualified residence 
interest is personal interest.
    (3) Example.


[[Page 870]]


    Example. R's principal residence has an adjusted purchase price on 
December 31, 1988, of $105,000. R has two debts secured by the 
residence, with the following average balances and interest payments:

------------------------------------------------------------------------
       Debt            Date secured     Average balance      Interest
------------------------------------------------------------------------
        Debt 1           June 1983           $80,000          $8,000
        Debt 2            May 1987            40,000           4,800
                                       ---------------------------------
         Total      ..................       120,000          12,800
------------------------------------------------------------------------


The amount of qualified residence interest is determined under the 
simplified method by multiplying the total interest ($12,800) by a 
fraction (expressed as a decimal amount) equal to the adjusted purchase 
price ($105,000) of the residence divided by the combined average 
balances ($120,000). For 1988, this fraction is equal to 0.875 
($105,000/$120,000). Therefore, $11,200 ($12,800 x 0.875) of the total 
interest is qualified residence interest. The remaining $1,600 in 
interest ($12,800-$11,200) is personal interest, even if (under the 
rules of Sec. 1.163-8T) such remaining interest would be allocated to 
some other category of interest.

    (e) Determination of qualified residence interest when secured debt 
exceeds adjusted purchase price--Exact method--(1) In general. Under the 
exact method, the amount of qualified residence interest for the taxable 
year is determined on a debt-by-debt basis by computing the applicable 
debt limit for each secured debt and comparing each such applicable debt 
limit to the average balance of the corresponding debt. If, for the 
taxable year, the average balance of a secured debt does not exceed the 
applicable debt limit for that debt, all of the interest paid or accrued 
during the taxable year with respect to the debt is qualified residence 
interest. If the average balance of the secured debt exceeds the 
applicable debt limit for that debt, the amount of qualified residence 
interest with respect to the debt is determined by multiplying the 
interest paid or accrued with respect to the debt by a fraction, the 
numerator of which is the applicable debt limit for that debt and the 
denominator of which is the average balance of the debt.
    (2) Determination of applicable debt limit. For each secured debt, 
the applicable debt limit for the taxable year is equal to
    (i) The lesser of--
    (A) The fair market value of the qualified residence as of the date 
the debt is first secured, and
    (B) The adjusted purchase price of the qualified residence as of the 
end of the taxable year,
    (ii) Reduced by the average balance of each debt previously secured 
by the qualified residence.


For purposes of paragraph (e)(2)(ii) of this section, the average 
balance of a debt shall be treated as not exceeding the applicable debt 
limit of such debt. See paragraph (n)(1)(i) of this section for the rule 
that increases the adjusted purchase price in paragraph (e)(2)(i)(B) of 
this section by the amount of any qualified indebtedness (certain 
medical and educational debt). See paragraph (f) of this section for 
special rules relating to the determination of the fair market value of 
the qualified residence.
    (3) Example. (i) R's principal residence has an adjusted purchase 
price on December 31, 1988, of $105,000. R has two debts secured by the 
residence. The average balances and interest payments on each debt 
during 1988 and fair market value of the residence on the date each debt 
was secured are as follows:

------------------------------------------------------------------------
                                Fair market      Average
     Debt       Date secured       value         balance      Interest
------------------------------------------------------------------------
      Debt 1       June 1983       $100,000       $80,000        $8,000
      Debt 2        May 1987        140,000        40,000         4,800
                                             ---------------------------
       Total   ..............  .............      120,000        12,800
------------------------------------------------------------------------

    (ii) The amount of qualified residence interest for 1988 under the 
exact method is determined as follows. Because there are no debts 
previously secured by the residence, the applicable debt limit for Debt 
1 is $100,000 (the lesser of the adjusted purchase price as of the end 
of the taxable year and the fair market value of the residence at the 
time the debt was secured). Because

[[Page 871]]

the average balance of Debt 1 ($80,000) does not exceed its applicable 
debt limit ($100,000), all of the interest paid on the debt during 1988 
($8,000) is qualified residence interest.
    (iii) The applicable debt limit for Debt 2 is $25,000 ($105,000 (the 
lesser of $140,000 fair market value and $105,000 adjusted purchase 
price) reduced by $80,000 (the average balance of Debt 1)). Because the 
average balance of Debt 2 ($40,000) exceeds its applicable debt limit, 
the amount of qualified residence interest on Debt 2 is determined by 
multiplying the amount of interest paid on the debt during the year 
($4,800) by a fraction equal to its applicable debt limit divided by its 
average balance ($25,000/$40,000 = 0.625). Accordingly, $3,000 ($4,800 x 
0.625) of the interest paid in 1988 on Debt 2 is qualified residence 
interest. The character of the remaining $1,800 of interest paid on Debt 
2 is determined under the rules of paragraph (e)(4) of this section.
    (4) Treatment of interest paid or accrued with respect to secured 
debt that is not qualified residence interest--(i) In general. Under the 
exact method, the excess of the interest paid or accrued during the 
taxable year with respect to a secured debt over the amount of qualified 
residence interest with respect to the debt is allocated under the rules 
of Sec. 1.163-8T.
    (ii) Example. T borrows $20,000 and the entire proceeds of the debt 
are disbursed by the lender to T's broker to purchase securities held 
for investment. T secures the debt with T's principal residence. In 
1990, T pays $2,000 of interest on the debt. Assume that under the rules 
of paragraph (e) of this section, $1,500 of the interest is qualified 
residence interest. The remaining $500 in interest expense would be 
allocated under the rules of Sec. 1.163-8T. Section 1.163-8T generally 
allocates debt (and the associated interest expense) by tracing 
disbursements of the debt proceeds to specific expenditures. 
Accordingly, the $500 interest expense on the debt that is not qualified 
residence interest is investment interest subject to section 163(d).
    (iii) Special rule if debt is allocated to more than one 
expenditure. If--
    (A) The average balance of a secured debt exceeds the applicable 
debt limit for that debt, and
    (B) Under the rules of Sec. 1.163-8T, interest paid or accrued with 
respect to such debt is allocated to more than one expenditure,

the interest expense that is not qualified residence interest may be 
allocated among such expenditures, to the extent of such expenditures, 
in any manner selected by the taxpayer.
    (iv) Example. (i) C borrows $60,000 secured by a qualified 
residence. C uses (within the meaning of Sec. 1.163-8T) $20,000 of the 
proceeds in C's trade or business, $20,000 to purchase stock held for 
investment and $20,000 for personal purposes. In 1990, C pays $6,000 in 
interest on the debt and, under the rules of Sec. 1.163-8T, $2,000 in 
interest is allocable to trade or business expenses, $2,000 to 
investment expenses and $2,000 to personal expenses. Assume that under 
paragraph (e) of this section, $2,500 of the interest is qualified 
residence interest and $3,500 of the interest is not qualified residence 
interest.
    (ii) Under paragraph (e)(4)(iii) of this section, C may allocate up 
to $2,000 of the interest that is not qualified residence interest to 
any of the three categories of expenditures up to a total of $3,500 for 
all three categories. Therefore, for example, C may allocate $2,000 of 
such interest to C's trade or business and $1,500 of such interest to 
the purchase of stock.
    (f) Special rules--(1) Special rules for personal property--(i) In 
general. If a qualified residence is personal property under State law 
(e.g., a boat or motorized vehicle)--
    (A) For purposes of paragraphs (c)(1) and (d)(1) of this section, if 
the fair market value of the residence as of the date that any secured 
debt (outstanding during the taxable year) is first secured by the 
residence is less than the adjusted purchase price as of the end of the 
taxable year, the lowest such fair market value shall be substituted for 
the adjusted purchase price.
    (B) For purposes of paragraphs (e)(2)(i)(A) and (f)(1)(i)(A) of this 
section, the fair market value of the residence as of the date the debt 
is first secured by the residence shall not exceed

[[Page 872]]

the fair market value as of any date on which the taxpayer borrows any 
additional amount with respect to the debt.
    (ii) Example. D owns a recreational vehicle that is a qualified 
residence under paragraph (p)(4) of this section. The adjusted purchase 
price and fair market value of the recreational vehicle is $20,000 in 
1989. In 1989, D establishes a line of credit secured by the 
recreational vehicle. As of June 1, 1992, the fair market value of the 
vehicle has decreased to $10,000. On that day, D borrows an additional 
amount on the debt by using the line of credit. Although under 
paragraphs (e)(2)(i) and (f)(1)(i)(A) of this section, fair market value 
is determined at the time the debt is first secured, under paragraph 
(f)(1)(i)(B) of this section, the fair market value is the lesser of 
that amount or the fair market value on the most recent date that D 
borrows any additional amount with respect to the line of credit. 
Therefore, the fair market value with respect to the debt is $10,000.
    (2) Special rule for real property--(i) In general. For purposes of 
paragraph (e)(2)(i)(A) of this section, the fair market value of a 
qualified residence that is real property under State law is presumed 
irrebuttably to be not less than the adjusted purchase price of the 
residence as of the last day of the taxable year.
    (ii) Example. (i) C purchases a residence on August 11, 1987, for 
$50,000, incurring a first mortgage. The residence is real property 
under State law. During 1987, C makes $10,000 in home improvements. 
Accordingly, the adjusted purchase price of the residence as of December 
31, 1988, is $60,000. C incurs a second mortgage on May 19, 1988, as of 
which time the fair market value of the residence is $55,000.
    (ii) For purposes of determining the applicable debt limit for each 
debt, the fair market value of the residence is generally determined as 
of the time the debt is first secured. Accordingly, the fair market 
value would be $50,000 and $55,000 with respect to the first and second 
mortgage, respectively. Under the special rule of paragraph (f)(2)(i) of 
this section, however, the fair market value with respect to both debts 
in 1988 is $60,000, the adjusted purchase price on December 31, 1988.
    (g) Selection of method. For any taxable year, a taxpayer may use 
the simplified method (described in paragraph (d) of this section) or 
the exact method (described in paragraph (e) of this section) by 
completing the appropriate portion of Form 8598. A taxpayer with two 
qualified residences may use the simplified method for one residence and 
the exact method for the other residence.
    (h) Average balance--(1) Average balance defined. For purposes of 
this section, the term ``average balance'' means the amount determined 
under this paragraph (h). A taxpayer is not required to use the same 
method to determine the average balance of all secured debts during a 
taxable year or of any particular secured debt from one year to the 
next.
    (2) Average balance reported by lender. If a lender that is subject 
to section 6050H (returns relating to mortgage interest received in 
trade or business from individuals) reports the average balance of a 
secured debt on Form 1098, the taxpayer may use the average balance so 
reported.
    (3) Average balance computed on a daily basis--(i) In general. The 
average balance may be determined by--
    (A) Adding the outstanding balance of a debt on each day during the 
taxable year that the debt is secured by a qualified residence, and
    (B) Dividing the sum by the number of days during the taxable year 
that the residence is a qualified residence.
    (ii) Example. Taxpayer A incurs a debt of $10,000 on September 1, 
1989, securing the debt with A's principal residence. The residence is 
A's principal residence during the entire taxable year. A pays current 
interest on the debt monthly, but makes no principal payments. The debt 
is, therefore, outstanding for 122 days with a balance each day of 
$10,000. The residence is a qualified residence for 365 days. The 
average balance of the debt for 1989 is $3,342 (122 x $10,000/365).
    (4) Average balance computed using the interest rate--(i) In 
general. If all accrued interest on a secured debt is paid at least 
monthly, the average balance of the secured debt may be determined

[[Page 873]]

by dividing the interest paid or accrued during the taxable year while 
the debt is secured by a qualified residence by the annual interest rate 
on the debt. If the interest rate on a debt varies during the taxable 
year, the lowest annual interest rate that applies to the debt during 
the taxable year must be used for purposes of this paragraph (h)(4). If 
the residence securing the debt is a qualified residence for less than 
the entire taxable year, the average balance of any secured debt may be 
determined by dividing the average balance determined under the 
preceding sentence by the percentage of the taxable year that the debt 
is secured by a qualified residence.
    (ii) Points and prepaid interest. For purposes of paragraph 
(h)(4)(i) of this section, the amount of interest paid during the 
taxable year does not include any amount paid as points and includes 
prepaid interest only in the year accrued.
    (iii) Examples.

    Example (1). B has a line of credit secured by a qualified residence 
for the entire taxable year. The interest rate on the debt is 10 percent 
throughout the taxable year. The principal balance on the debt changes 
throughout the year. B pays the accrued interest on the debt monthly. B 
pays $2,500 in interest on the debt during the taxable year. The average 
balance of the debt ($25,000) may be computed by dividing the total 
interest paid by the interest rate ($25,000 = $2,500/0.10).
    Example (2). Assume the same facts as in example 1, except that the 
residence is a qualified residence, and the debt is outstanding, for 
only one-half of the taxable year and B pays only $1,250 in interest on 
the debt during the taxable year. The average balance of the debt may be 
computed by first dividing the total interest paid by the interest rate 
($12,500 = $1,250/0.10). Second, because the residence is not a 
qualified residence for the entire taxable year, the average balance 
must be determined by dividing this amount ($12,500) by the portion of 
the year that the residence is qualified (0.50). The average balance is 
therefore $25,000 ($12,500/0.50).

    (5) Average balance computed using average of beginning and ending 
balances--(i) In general. If--
    (A) A debt requires level payments at fixed equal intervals (e.g., 
monthly, quarterly) no less often than semi-annually during the taxable 
year,
    (B) The taxpayer prepays no more than one month's principal on the 
debt during the taxable year, and
    (C) No new amounts are borrowed on the debt during the taxable year,

the average balance of the debt may be determined by adding the 
principal balance as of the first day of the taxable year that the debt 
is secured by the qualified residence and the principal balance as of 
the last day of the taxable year that the debt is secured by the 
qualified residence and dividing the sum by 2. If the debt is secured by 
a qualified residence for less than the entire period during the taxable 
year that the residence is a qualified residence, the average balance 
may be determined by multiplying the average balance determined under 
the preceding sentence by a fraction, the numerator of which is the 
number of days during the taxable year that the debt is secured by the 
qualified residence and the denominator of which is the number of days 
during the taxable year that the residence is a qualified residence. For 
purposes of this paragraph (h)(5)(i), the determination of whether 
payments are level shall disregard the fact that the amount of the 
payments may be adjusted from time to time to take into account changes 
in the applicable interest rate.
    (ii) Example. C borrows $10,000 in 1988, securing the debt with a 
second mortgage on a principal residence. The terms of the loan require 
C to make equal monthly payments of principal and interest so as to 
amortize the entire loan balance over 20 years. The balance of the debt 
is $9,652 on January 1, 1990, and is $9,450 on December 31, 1990. The 
average balance of the debt during 1990 may be computed as follows:

Balance on first day of the year: $9,652
Balance on last day of the year: $9,450
[GRAPHIC] [TIFF OMITTED] TC14NO91.175

    (6) Highest principal balance. The average balance of a debt may be 
determined by taking the highest principal balance of the debt during 
the taxable year.
    (7) Other methods provided by the Commissioner. The average balance 
may be

[[Page 874]]

determined using any other method provided by the Commissioner by form, 
publication, revenue ruling, or revenue procedure. Such methods may 
include methods similar to (but with restrictions different from) those 
provided in paragraph (h) of this section.
    (8) Anti-abuse rule. If, as a result of the determination of the 
average balance of a debt using any of the methods specified in 
paragraphs (h) (4), (5), or (6) of this section, there is a significant 
overstatement of the amount of qualified residence interest and a 
principal purpose of the pattern of payments and borrowing on the debt 
is to cause the amount of such qualified residence interest to be 
overstated, the district director may redetermine the average balance 
using the method specified under paragraph (h)(3) of this section.
    (i) [Reserved]
    (j) Determination of interest paid or accrued during the taxable 
year--(1) In general. For purposes of determining the amount of 
qualified residence interest with respect to a secured debt, the amount 
of interest paid or accrued during the taxable year includes only 
interest paid or accrued while the debt is secured by a qualified 
residence.
    (2) Special rules for cash-basis taxpayers--(i) Points deductible in 
year paid under section 461(g)(2). If points described in section 
461(g)(2) (certain points paid in respect of debt incurred in connection 
with the purchase or improvement of a principal residence) are paid with 
respect to a debt, the amount of such points is qualified residence 
interest.
    (ii) Points and other prepaid interest described in section 
461(g)(1). The amount of points or other prepaid interest charged to 
capital account under section 461(g)(1) (prepaid interest) that is 
qualified residence interest shall be determined under the rules of 
paragraphs (c) through (e) of this section in the same manner as any 
other interest paid with respect to the debt in the taxable year to 
which such payments are allocable under section 461(g)(1).
    (3) Examples.

    Example (1). T designates a vacation home as a qualified residence 
as of October 1, 1987. The home is encumbered by a mortgage during the 
entire taxable year. For purposes of determining the amount of qualified 
residence interest for 1987, T may take into account the interest paid 
or accrued on the secured debt from October 1, 1987, through December 
31, 1987.
    Example (2). R purchases a principal residence on June 17, 1987. As 
part of the purchase price, R obtains a conventional 30-year mortgage, 
secured by the residence. At closing, R pays 2\1/2\ points on the 
mortgage and interest on the mortgage for the period June 17, 1987 
through June 30, 1987. The points are actually paid by R and are not 
merely withheld from the loan proceeds. R incurs no additional secured 
debt during 1987. Assuming that the points satisfy the requirements of 
section 461(g) (2), the entire amount of points and the interest paid at 
closing are qualified residence interest.
    Example (3). (i) On July 1, 1987, W borrows $120,000 to purchase a 
residence to use as a vacation home. W secures the debt with the 
residence. W pays 2 points, or $2,400. The debt has a term of 10 years 
and requires monthly payments of principal and interest. W is permitted 
to amortize the points at the rate of $20 per month over 120 months. W 
elects to treat the residence as a second residence. W has no other debt 
secured by the residence. The average balance of the debt in each 
taxable year is less than the adjusted purchase price of the residence. 
W sells the residence on June 30, 1990, and pays off the remaining 
balance of the debt.
    (ii) W is entitled to treat the following amounts of the points as 
interest paid on a debt secured by a qualified residence--

1987......................................  $120 = $20x6 months;
1988......................................  $240 = $20x12 months;
1989......................................  $120 = $20x6 months.
Total.....................................  $480

    All of the interest paid on the debt, including the allocable 
points, is qualified residence interest. Upon repaying the debt, the 
remaining $1,920 ($2,400-$480) in unamortized points is treated as 
interest paid in 1990 and, because the average balance of the secured 
debt in 1990 is less than the adjusted purchase price, is also qualified 
residence interest.

    (k) Determination of adjusted purchase price and fair market value--
(1) Adjusted purchase price--(i) In general. For purposes of this 
section, the adjusted purchase price of a qualified residence is equal 
to the taxpayer's basis in the residence as initially determined under 
section 1012 or other applicable sections of the Internal Revenue Code, 
increased by the cost of any improvements to the residence that have 
been added to the taxpayer's basis in the residence under section 
1016(a)(1). Any other adjustments to basis, including

[[Page 875]]

those required under section 1033(b) (involuntary conversions), and 
1034(e) (rollover of gain or sale of principal residence) are 
disregarded in determining the taxpayer's adjusted purchase price. If, 
for example, a taxpayer's second residence is rented for a portion of 
the year and its basis is reduced by depreciation allowed in connection 
with the rental use of the property, the amount of the taxpayer's 
adjusted purchase price in the residence is not reduced. See paragraph 
(m) of this section for a rule that treats the sum of the grandfathered 
amounts of all secured debts as the adjusted purchase price of the 
residence.
    (ii) Adjusted purchase price of a qualified residence acquired 
incident to divorce. [Reserved]
    (iii) Examples.

    Example (1). X purchases a residence for $120,000. X's basis, as 
determined under section 1012, is the cost of the property, or $120,000. 
Accordingly, the adjusted purchase price of the residence is initially 
$120,000.
    Example (2). Y owns a principal residence that has a basis of 
$30,000. Y sells the residence for $100,000 and purchases a new 
principal residence for $120,000. Under section 1034, Y does not 
recognize gain on the sale of the former residence. Under section 
1034(e), Y's basis in the new residence is reduced by the amount of gain 
not recognized. Therefore, under section 1034(e), Y's basis in the new 
residence is $50,000 ($120,000-$70,000). For purposes of section 163(h), 
however, the adjusted purchase price of the residence is not adjusted 
under section 1034(e). Therefore, the adjusted purchase price of the 
residence is initially $120,000.
    Example (3). Z acquires a residence by gift. The donor's basis in 
the residence was $30,000. Z's basis in the residence, determined under 
section 1015, is $30,000. Accordingly, the adjusted purchase price of 
the residence is initially $30,000.

    (2) Fair market value--(i) In general. For purposes of this section, 
the fair market value of a qualified residence on any date is the fair 
market value of the taxpayer's interest in the residence on such date. 
In addition, the fair market value determined under this paragraph 
(k)(2)(i) shall be determined by taking into account the cost of 
improvements to the residence reasonably expected to be made with the 
proceeds of the debt.
    (ii) Example. In 1988, the adjusted purchase price of P's second 
residence is $65,000 and the fair market value of the residence is 
$70,000. At that time, P incurs an additional debt of $10,000, the 
proceeds of which P reasonably expects to use to add two bedrooms to the 
residence. Because the fair market value is determined by taking into 
account the cost of improvements to the residence that are reasonably 
expected to be made with the proceeds of the debt, the fair market value 
of the residence with respect to the debt incurred in 1988 is $80,000 
($70,000+$10,000).
    (3) Allocation of adjusted purchase price and fair market value. If 
a property includes both a qualified residence and other property, the 
adjusted purchase price and the fair market value of such property must 
be allocated between the qualified residence and the other property. See 
paragraph (p)(4) of this section for rules governing such an allocation.
    (l) [Reserved]
    (m) Grandfathered amount--(1) Substitution for adjusted purchase 
price. If, for the taxable year, the sum of the grandfathered amounts, 
if any, of all secured debts exceeds the adjusted purchase price of the 
qualified residence, such sum may be treated as the adjusted purchase 
price of the residence under paragraphs (c), (d) and (e) of this 
section.
    (2) Determination of grandfathered amount--(i) In general. For any 
taxable year, the grandfathered amount of any secured debt that was 
incurred on or before August 16, 1986, and was secured by the residence 
continuously from August 16, 1986, through the end of the taxable year, 
is the average balance of the debt for the taxable year. A secured debt 
that was not incurred and secured on or before August 16, 1986, has no 
grandfathered amount.
    (ii) Special rule for lines of credit and certain other debt. If, 
with respect to a debt described in paragraph (m)(2)(i) of this section, 
a taxpayer has borrowed any additional amounts after August 16, 1986, 
the grandfathered amount of such debt is equal to the lesser of--
    (A) The average balance of the debt for the taxable year, or
    (B) The principal balance of the debt as of August 16, 1986, reduced 
(but not below zero) by all principal payments

[[Page 876]]

after August 16, 1986, and before the first day of the current taxable 
year.

For purposes of this paragraph (m)(2)(ii), a taxpayer shall not be 
considered to have borrowed any additional amount with respect to a debt 
merely because accrued interest is added to the principal balance of the 
debt, so long as such accrued interest is paid by the taxpayer no less 
often than quarterly.
    (iii) Fair market value limitation. The grandfathered amount of any 
debt for any taxable year may not exceed the fair market value of the 
residence on August 16, 1986, reduced by the principal balance on that 
day of all previously secured debt.
    (iv) Examples.

    Example (1). As of August 16, 1986, T has one debt secured by T's 
principal residence. The debt is a conventional self-amortizing mortgage 
and, on August 16, 1986, it has an outstanding principal balance of 
$75,000. In 1987, the average balance of the mortgage is $73,000. The 
adjusted purchase price of the residence as of the end of 1987 is 
$50,000. Because the mortgage was incurred and secured on or before 
August 16, 1986 and T has not borrowed any additional amounts with 
respect to the mortgage, the grandfathered amount is the average 
balance, $73,000. Because the grandfathered amount exceeds the adjusted 
purchase price ($50,000), T may treat the grandfathered amount as the 
adjusted purchase price in determining the amount of qualified residence 
interest.
    Example (2). (i) The facts are the same as in example (1), except 
that in May 1986, T also obtains a home equity line of credit that, on 
August 16, 1986, has a principal balance of $40,000. In November 1986, T 
borrows an additional $10,000 on the home equity line, increasing the 
balance to $50,000. In December 1986, T repays $5,000 of principal on 
the home equity line. The average balance of the home equity line in 
1987 is $45,000.
    (ii) Because T has borrowed additional amounts on the line of credit 
after August 16, 1986, the grandfathered amount for that debt must be 
determined under the rules of paragraph (m)(2)(ii) of this section. 
Accordingly, the grandfathered amount for the line of credit is equal to 
the lesser of $45,000, the average balance of the debt in 1987, and 
$35,000, the principal balance on August 16, 1986, reduced by all 
principal payments between August 17, 1986, and December 31, 1986 
($40,000-$5,000). The sum of the grandfathered amounts with respect to 
the residence is $108,000 ($73,000+$35,000). Because the sum of the 
grandfathered amounts exceeds the adjusted purchase price ($50,000), T 
may treat the sum as the adjusted purchase price in determining the 
qualified residence interest for 1987.

    (3) Refinancing of grandfathered debt--(i) In general. A debt 
incurred and secured on or before August 16, 1986, is refinanced if some 
or all of the outstanding balance of such a debt (the ``original debt'') 
is repaid out of the proceeds of a second debt secured by the same 
qualified residence (the ``replacement debt''). In the case of a 
refinancing, the replacement debt is treated as a debt incurred and 
secured on or before August 16, 1986, and the grandfathered amount of 
such debt is the amount (but not less than zero) determined pursuant to 
paragraph (m)(3)(ii) of this section.
    (ii) Determination of grandfathered amount--(A) Exact refinancing. 
If--
    (1) The entire proceeds of a replacement debt are used to refinance 
one or more original debts, and
    (2) The taxpayer has not borrowed any additional amounts after 
August 16, 1986, with respect to the original debt or debts,

the grandfathered amount of the replacement debt is the average balance 
of the replacement debt. For purposes of the preceding sentence, the 
fact that proceeds of a replacement debt are used to pay costs of 
obtaining the replacement debt (including points or other closing costs) 
shall be disregarded in determining whether the entire proceeds of the 
replacement debt have been used to refinance one or more original debts.
    (B) Refinancing other than exact refinancings--(1) Year of 
refinancing. In the taxable year in which an original debt is 
refinanced, the grandfathered amount of the original and replacement 
debts is equal to the lesser of--
    (i) The sum of the average balances of the original debt and the 
replacement debt, and
    (ii) The principal balance of the original debt as of August 16, 
1986, reduced by all principal payments on the original debt after 
August 16, 1986, and before the first day of the current taxable year.
    (2) In subsequent years. In any taxable year after the taxable year 
in which an

[[Page 877]]

original debt is refinanced, the grandfathered amount of the replacement 
debt is equal to the least of--
    (i) The average balance of the replacement debt for the taxable 
year,
    (ii) The amount of the replacement debt used to repay the principal 
balance of the original debt, reduced by all principal payments on the 
replacement debt after the date of the refinancing and before the first 
day of the current taxable year, or
    (iii) The principal balance of the original debt on August 16, 1986, 
reduced by all principal payments on the original debt after August 16, 
1986, and before the date of the refinancing, and further reduced by all 
principal payments on the replacement debt after the date of the 
refinancing and before the first day of the current taxable year.
    (C) Example. (i) Facts. On August 16, 1986, T has a single debt 
secured by a principal residence with a balance of $150,000. On July 1, 
1988, T refinances the debt, which still has a principal balance of 
$150,000, with a new secured debt. The principal balance of the 
replacement debt throughout 1988 and 1989 is $150,000. The adjusted 
purchase price of the residence is $100,000 throughout 1987, 1988 and 
1989. The average balance of the original debt was $150,000 in 1987 and 
$75,000 in 1988. The average balance of the replacement debt is $75,000 
in 1988 and $150,000 in 1989.
    (ii) Grandfathered amount in 1987. The original debt was incurred 
and secured on or before August 16, 1986 and T has not borrowed any 
additional amounts with respect to the debt. Therefore, its 
grandfathered amount in 1987 is its average balance ($150,000). This 
amount is treated as the adjusted purchase price for 1987 and all of the 
interest paid on the debt is qualified residence interest.
    (iii) Grandfathered amount in 1988. Because the replacement debt was 
used to refinance a debt incurred and secured on or before August 16, 
1986, the replacement debt is treated as a grandfathered debt. Because 
all of the proceeds of the replacement debt were used in the refinancing 
and because no amounts have been borrowed after August 16, 1986, on the 
original debt, the grandfathered amount for the original debt is its 
average balance ($75,000) and the grandfathered amount for the 
replacement debt is its average balance ($75,000). Since the sum of the 
grandfathered amounts ($150,000) exceeds the adjusted purchase price of 
the residence, the sum of the grandfathered amounts may be substituted 
for the adjusted purchase price for 1988 and all of the interest paid on 
the debt is qualified residence interest.
    (iv) Grandfathered amount in 1989. The grandfathered amount for the 
placement debt is its average balance ($150,000). This amount is treated 
as the adjusted purchase price for 1989 and all of the interest paid on 
the mortgage is qualified residence interest.
    (4) Limitation on term of grandfathered debt--(i) In general. An 
original debt or replacement debt shall not have any grandfathered 
amount in any taxable year that begins after the date, as determined on 
August 16, 1986, that the original debt was required to be repaid in 
full (the ``maturity date''). If a replacement debt is used to refinance 
more than one original debt, the maturity date is determined by 
reference to the original debt that, as of August 16, 1986, had the 
latest maturity date.
    (ii) Special rule for nonamortizing debt. If an original debt was 
actually incurred and secured on or before August 16, 1986, and if as of 
such date the terms of such debt did not require the amortization of its 
principal over its original term, the maturity date of the replacement 
debt is the earlier of the maturity date of the replacement debt or the 
date 30 years after the date the original debt is first refinanced.
    (iii) Example. C incurs a debt on May 10, 1986, the final payment of 
which is due May 1, 2006. C incurs a second debt on August 11, 1990, 
with a term of 20 years and uses the proceeds of the second debt to 
refinance the first debt. Because, under paragraph (m)(4)(i) of this 
section, a replacement debt will not have any grandfathered amount in 
any taxable year that begins after the maturity date of the original 
debt (May 1, 2006), the second debt has no grandfathered amount in any 
taxable year after 2006.
    (n) Qualified indebtedness (secured debt used for medical and 
educational purposes)--(1) In general--(i) Treatment of

[[Page 878]]

qualified indebtedness. The amount of any qualified indebtedness 
resulting from a secured debt may be added to the adjusted purchase 
price under paragraph (e)(2)(i)(B) of this section to determine the 
applicable debt limit for that secured debt and any other debt 
subsequently secured by the qualified residence.
    (ii) Determination of amount of qualified indebtedness. If, as of 
the end of the taxable year (or the last day in the taxable year that 
the debt is secured), at least 90 percent of the proceeds of a secured 
debt are used (within the meaning of paragraph (n)(2) of this section) 
to pay for qualified medical and educational expenses (within the 
meaning of paragraphs (n)(3) and (n)(4) of this section), the amount of 
qualified indebtedness resulting from that debt for the taxable year is 
equal to the average balance of such debt for the taxable year.
    (iii) Determination of amount of qualified indebtedness for mixed-
use debt. If, as of the end of the taxable year (or the last day in the 
taxable year that the debt is secured), more than ten percent of the 
proceeds of a secured debt are used to pay for expenses other than 
qualified medical and educational expenses, the amount of qualified 
indebtedness resulting from that debt for the taxable year shall equal 
the lesser of--
    (A) The average balance of the debt, or
    (B) The amount of the proceeds of the debt used to pay for qualified 
medical and educational expenses through the end of the taxable year, 
reduced by any principal payments on the debt before the first day of 
the current taxable year.
    (iv) Example. (i) C incurs a $10,000 debt on April 20, 1987, which 
is secured on that date by C's principal residence. C immediately uses 
(within the meaning of paragraph (n)(2) of this section) $4,000 of the 
proceeds of the debt to pay for a qualified medical expense. C makes no 
principal payments on the debt during 1987. During 1988 and 1989, C 
makes principal payments of $1,000 per year. The average balance of the 
debt during 1988 is $9,500 and the average balance during 1989 is 
$8,500.
    (ii) Under paragraph (n)(1)(iii) of this section, C determines the 
amount of qualified indebtedness for 1988 as follows:

Average balance.......................................  .......   $9,500
  Amount of debt used to pay for qualified medical       $4,000
   expenses...........................................
  Less payments of principal before 1988..............       $0
                                                       ---------
Net qualified expenses................................  .......   $4,000
 


The amount of qualified indebtedness for 1988 is, therefore, $4,000 
(lesser of $9,500 average balance or $4,000 net qualified expenses). 
This amount may be added to the adjusted purchase price of C's principal 
residence under paragraph (e)(2)(i)(B) of this section for purposes of 
computing the applicable debt limit for this debt and any other debt 
subsequently secured by the principal residence.
    (iii) C determines the amount of qualified indebtedness for 1989 as 
follows:

Average balance.......................................  .......   $8,500
  Amount of debt used to pay for qualified medical       $4,000
   expenses...........................................
  Less payments of principal before 1988..............   $1,000
                                                       ---------
Net qualified expenses................................  .......   $3,000
 


The amount of qualified indebtedness for 1989 is, therefore, $3,000 
(lesser of $8,500 average balance or $3,000 net qualified expenses).
    (v) Prevention of double counting in year of refinancing--(A) In 
general. A debt used to pay for qualified medical or educational 
expenses is refinanced if some or all of the outstanding balance of the 
debt (the ``original debt'') is repaid out of the proceeds of a second 
debt (the ``replacement debt''). If, in the year of a refinancing, the 
combined qualified indebtedness of the original debt and the replacement 
debt exceeds the combined qualified expenses of such debts, the amount 
of qualified indebtedness for each such debt shall be determined by 
multiplying the amount of qualified indebtedness for each such debt by a 
fraction, the numerator of which is the combined qualified expenses and 
the denominator of which is the combined qualified indebtedness.
    (B) Definitions. For purposes of paragraph (n)(1)(v)(A) of this 
section--
    (1) The term ``combined qualified indebtedness'' means the sum of 
the qualified indebtedness (determined without regard to paragraph 
(n)(1)(v) of

[[Page 879]]

this section) for the original debt and the replacement debt.
    (2) The term ``combined qualified expenses'' means the amount of the 
proceeds of the original debt used to pay for qualified medical and 
educational expenses through the end of the current taxable year, 
reduced by any principal payments on the debt before the first day of 
the current taxable year, and increased by the amount, if any, of the 
proceeds of the replacement debt used to pay such expenses through the 
end of the current taxable year other than as part of the refinancing.
    (C) Example. (i) On August 11, 1987, C incurs a $8,000 debt secured 
by a principal residence. C uses (within the meaning of paragraph 
(n)(2)(i) of this section) $5,000 of the proceeds of the debt to pay for 
qualified educational expenses. C makes no principal payments on the 
debt. On July 1, 1988, C incurs a new debt in the amount of $8,000 
secured by C's principal residence and uses all of the proceeds of the 
new debt to repay the original debt. Under paragraph (n)(2)(ii) of this 
section $5,000 of the new debt is treated as being used to pay for 
qualified educational expenses. C makes no principal payments (other 
than the refinancing) during 1987 or 1988 on either debt and pays all 
accrued interest monthly. The average balance of each debt in 1988 is 
$4,000.
    (ii) Under paragraph (n)(1)(iii) of this section, the amount of 
qualified indebtedness for 1988 with respect to the original debt is 
$4,000 (the lesser of its average balance ($4,000) and the amount of the 
debt used to pay for qualified medical and educational expenses 
($5,000)). Similarly, the amount of qualified indebtedness for 1988 with 
respect to the replacement debt is also $4,000. Both debts, however, are 
subject in 1988 to the limitation in paragraph (n)(1)(v)(A) of this 
section. The combined qualified indebtedness, determined without regard 
to the limitation, is $8,000 ($4,000 of qualified indebtedness from each 
debt). The combined qualified expenses are $5,000 ($5,000 from the 
original debt and $0 from the replacement debt). The amount of qualified 
indebtedness from each debt must, therefore, be reduced by a fraction, 
the numerator of which is $5,000 (the combined qualified expenses) and 
the denominator of which is $8,000 (the combined qualified 
indebtedness). After application of the limitation, the amount of 
qualified indebtedness for the original debt is $2,500 ($4,000 x x \5/
8\). Similarly, the amount of qualified indebtedness for the replacement 
debt is $2,500. Note that the total qualified indebtedness for both the 
original and the replacement debt is $5,000 ($2,500 + $2,500). 
Therefore, C is entitled to the same amount of qualified indebtedness as 
C would have been entitled to if C had not refinanced the debt.
    (vi) Special rule for principal payments in excess of qualified 
expenses. For purposes of paragraph (n)(1)(iii)(B), (n)(1)(v)(B)(2) and 
(n)(2)(ii) of this section, a principal payment is taken into account 
only to the extent that the payment, when added to all prior payments, 
does not exceed the amount used on or before the date of the payment to 
pay for qualified medical and educational expenses.
    (2) Debt used to pay for qualified medical or educational expenses--
(i) In general. For purposes of this section, the proceeds of a debt are 
used to pay for qualified medical or educational expenses to the extent 
that--
    (A) The taxpayer pays qualified medical or educational expenses 
within 90 days before or after the date that amounts are actually 
borrowed with respect to the debt, the proceeds of the debt are not 
directly allocable to another expense under Sec. 1.163-8T(c)(3) 
(allocation of debt; proceeds not disbursed to borrower) and the 
proceeds of any other debt are not allocable to the medical or 
educational expenses under Sec. 1.163-8T(c)(3), or
    (B) The proceeds of the debt are otherwise allocated to such 
expenditures under Sec. 1.163-8T.
    (ii) Special rule for refinancings. For purposes of this section, 
the proceeds of a debt are used to pay for qualified medical and 
educational expenses to the extent that the proceeds of the debt are 
allocated under Sec. 1.163-8T to the repayment of another debt (the 
``original debt''), but only to the extent of the amount of the original 
debt used

[[Page 880]]

to pay for qualified medical and educational expenses, reduced by any 
principal payments on such debt up to the time of the refinancing.
    (iii) Other special rules. The following special rules apply for 
purposes of this section.
    (A) Proceeds of a debt are used to pay for qualified medical or 
educational expenses as of the later of the taxable year in which such 
proceeds are borrowed or the taxable year in which such expenses are 
paid.
    (B) The amount of debt which may be treated as being used to pay for 
qualified medical or educational expenses may not exceed the amount of 
such expenses.
    (C) Proceeds of a debt may not be treated as being used to pay for 
qualified medical or educational expenses to the extent that:
    (1) The proceeds have been repaid as of the time the expense is 
paid;
    (2) The proceeds are actually borrowed before August 17, 1986; or
    (3) The medical or educational expenses are paid before August 17, 
1986.
    (iv) Examples--

    Example (1). A pays a $5,000 qualified educational expense from a 
checking account that A maintains at Bank 1 on November 9, 1987. On 
January 1, 1988, A incurs a $20,000 debt that is secured by A's 
residence and places the proceeds of the debt in a savings account that 
A also maintains at Bank 1. A pays another $5,000 qualified educations 
expense on March 15 from a checking account that A maintains at Bank 2. 
Under paragraph (n)(2) of this section, the debt proceeds are used to 
pay for both educational expenses, regardless of other deposits to, or 
expenditures from, the accounts, because both expenditures are made 
within 90 days before or after the debt was incurred.
    Example (2). B pays a $5,000 qualified educational expense from a 
checking account on November 1, 1987. On November 30, 1987, B incurs a 
debt secured by B's residence, and the lender disburses the debt 
proceeds directly to a person who sells B a new car. Although the 
educational expense is paid within 90 days of the date the debt is 
incurred, the proceeds of the debt are not used to pay for the 
educational expense because the proceeds are directly allocable to the 
purchase of the new car under Sec. 1.163-8T(c)(3).
    Example (3). On November 1, 1987, C borrows $5,000 from C's college. 
The proceeds of this debt are not disbursed to C, but rather are used to 
pay tuition fees for C's attendance at the college. On November 30, 
1987, C incurs a second debt and secures the debt by C's residence. 
Although the $5,000 educational expense is paid within 90 days before 
the second debt is incurred, the proceeds of the second debt are not 
used to pay for the educational expense, because the proceeds of the 
first debt are directly allocable to the educational expense under Sec. 
1.163-8T(c)(3).
    Example (4). On January 1, 1988, D incurs a $20,000 debt secured by 
a qualified residence. D places the proceeds of the debt in a separate 
account (i.e., the proceeds of the debt are the only deposit in the 
account). D makes payments of $5,000 each for qualified educational 
expenses on September 1, 1988, September 1, 1989, September 1, 1990, and 
September 1, 1991. Because the debt proceeds are allocated to 
educational expenses as of the date the expenses are paid, under the 
rules of Sec. 1.163-8T(c)(4), the following amounts of the debt 
proceeds are used to pay for qualified educational expenses as of the 
end of each year:


1988: $5,000
1989: $10,000
1990: $15,000
1991: $20,000

    Example (5). During 1987 E incurs a $10,000 debt secured by a 
principal residence. E uses (within the meaning of paragraph (n)(2)(i) 
of this section) all of the proceeds of the debt to pay for qualified 
educational expenses. On August 20, 1988, at which time the balance of 
the debt is $9,500, E incurs a new debt in the amount of $9,500 secured 
by E's principal residence and uses all of the proceeds of the new debt 
to repay the original debt. Under paragraph (n)(2)(ii) of this section, 
all of the proceeds of the new debt are used to pay for qualified 
educational expenses.

    (3) Qualified medical expenses. Qualified medical expenses are 
amounts that are paid for medical care (within the meaning of section 
213(d)(1) (A) and (B)) for the taxpayer, the taxpayer's spouse, or a 
dependent of the taxpayer (within the meaning of section 152), and that 
are not compensated for by insurance or otherwise.
    (4) Qualified educational expenses. Qualified educational expenses 
are amounts that are paid for tuition, fees, books, supplies and 
equipment required for enrollment, attendance or courses of instruction 
at an educational organization described in section 170(b) (1)(A)(ii) 
and for any reasonable living expenses while away from home while in 
attendance at such an institution, for the taxpayer, the taxpayer's 
spouse or a dependent of the taxpayer (within the meaning of section 
152) and that are not reimbursed by scholarship or otherwise.

[[Page 881]]

    (o) Secured debt--(1) In general. For purposes of this section, the 
term ``secured debt'' means a debt that is on the security of any 
instrument (such as a mortgage, deed of trust, or land contract)--
    (i) That makes the interest of the debtor in the qualified residence 
specific security for the payment of the debt,
    (ii) Under which, in the event of default, the residence could be 
subjected to the satisfaction of the debt with the same priority as a 
mortgage or deed of trust in the jurisdiction in which the property is 
situated, and
    (iii) That is recorded, where permitted, or is otherwise perfected 
in accordance with applicable State law.

A debt will not be considered to be secured by a qualified residence if 
it is secured solely by virtue of a lien upon the general assets of the 
taxpayer or by a security interest, such as a mechanic's lien or 
judgment lien, that attaches to the property without the consent of the 
debtor.
    (2) Special rule for debt in certain States. Debt will not fail to 
be treated as secured solely because, under an applicable State or local 
homestead law or other debtor protection law in effect on August 16, 
1986, the security interest is ineffective or the enforceability of the 
security interest is restricted.
    (3) Times at which debt is treated as secured. For purposes of this 
section, a debt is treated as secured as of the date on which each of 
the requirements of paragraph (o)(1) of this section are satisfied, 
regardless of when amounts are actually borrowed with respect to the 
debt. For purposes of this paragraph (o)(3), if the instrument is 
recorded within a commercially reasonable time after the security 
interest is granted, the instrument will be treated as recorded on the 
date that the security interest was granted.
    (4) Partially secured debt--(i) In general. If the security interest 
is limited to a prescribed maximum amount or portion of the residence, 
and the average balance of the debt exceeds such amount or the value of 
such portion, such excess shall not be treated as secured debt for 
purposes of this section.
    (ii) Example. T borrows $80,000 on January 1, 1991. T secures the 
debt with a principal residence. The security in the residence for the 
debt, however, is limited to $20,000. T pays $8,000 in interest on the 
debt in 1991 and the average balance of the debt in that year is 
$80,000. Because the average balance of the debt exceeds the maximum 
amount of the security interest, such excess is not treated as secured 
debt. Therefore, for purposes of applying the limitation on qualified 
residence interest, the average balance of the secured debt is $20,000 
(the maximum amount of the security interest) and the interest paid or 
accrued on the secured debt is $2,000 (the total interest paid on the 
debt multiplied by the ratio of the average balance of the secured debt 
($20,000) and the average balance of the total debt ($80,000)).
    (5) Election to treat debt as not secured by a qualified residence--
(i) In general. For purposes of this section, a taxpayer may elect to 
treat any debt that is secured by a qualified residence as not secured 
by the qualified residence. An election made under this paragraph shall 
be effective for the taxable year for which the election is made and for 
all subsequent taxable years unless revoked with the consent of the 
Commissioner.
    (ii) Example. T owns a principal residence with a fair market value 
of $75,000 and an adjusted purchase price of $40,000. In 1988, debt A, 
the proceeds of which were used to purchase the residence, has an 
average balance of $15,000. The proceeds of debt B, which is secured by 
a second mortgage on the property, are allocable to T's trade or 
business under Sec. 1.163-8T and has an average balance of $25,000. In 
1988, T incurs debt C, which is also secured by T's principal residence 
and which has an average balance in 1988 of $5,000. In the absence of an 
election to treat debt B as unsecured, the applicable debt limit for 
debt C in 1988 under paragraph (e) of this section would be zero dollars 
($40,000-$15,000-$25,000) and none of the interest paid on debt C would 
be qualified residence interest. If, however, T makes or has previously 
made an election pursuant to paragraph (o)(5)(i) of this section to 
treat debt B as not secured by the residence, the applicable debt limit 
for debt C would be $25,000 ($40,000-$15,000), and all of the

[[Page 882]]

interest paid on debt C during the taxable year would be qualified 
residence interest. Since the proceeds of debt B are allocable to T's 
trade or business under Sec. 1.163-8T, interest on debt B may be 
deductible under other sections of the Internal Revenue Code.
    (iii) Allocation of debt secured by two qualified residences. 
[Reserved]
    (p) Definition of qualified residence--(1) In general. The term 
``qualified residence'' means the taxpayer's principal residence (as 
defined in paragraph (p)(2) of this section), or the taxpayer's second 
residence (as defined in paragraph (p)(3) of this section).
    (2) Principal residence. The term ``principal residence'' means the 
taxpayer's principal residence within the meaning of section 1034. For 
purposes of this section, a taxpayer cannot have more than one principal 
residence at any one time.
    (3) Second residence--(i) In general. The term ``second residence'' 
means--
    (A) A residence within the meaning of paragraph (p)(3)(ii) of this 
section,
    (B) That the taxpayer uses as a residence within the meaning of 
paragraph (p)(3)(iii) of this section, and
    (C) That the taxpayer elects to treat as a second residence pursuant 
to paragraph (p)(3)(iv) of this section.

A taxpayer cannot have more than one second residence at any time.
    (ii) Definition of residence. Whether property is a residence shall 
be determined based on all the facts and circumstances, including the 
good faith of the taxpayer. A residence generally includes a house, 
condominium, mobile home, boat, or house trailer, that contains sleeping 
space and toilet and cooking facilities. A residence does not include 
personal property, such as furniture or a television, that, in 
accordance with the applicable local law, is not a fixture.
    (iii) Use as a residence. If a residence is rented at any time 
during the taxable year, it is considered to be used as a residence only 
if the taxpayer uses it during the taxable year as a residence within 
the meaning of section 280A(d). If a residence is not rented at any time 
during the taxable year, it shall be considered to be used as a 
residence. For purposes of the preceding sentence, a residence will be 
deemed to be rented during any period that the taxpayer holds the 
residence out for rental or resale or repairs or renovates the residence 
with the intention of holding it out for rental or resale.
    (iv) Election of second residence. A taxpayer may elect a different 
residence (other than the taxpayer's principal residence) to be the 
taxpayer's second residence for each taxable year. A taxpayer may not 
elect different residences as second residences at different times of 
the same taxable year except as provided below--
    (A) If the taxpayer acquires a new residence during the taxable 
year, the taxpayer may elect the new residence as a taxpayer's second 
residence as of the date acquired;
    (B) If property that was the taxpayer's principal residence during 
the taxable year ceases to qualify as the taxpayer's principal 
residence, the taxpayer may elect that property as the taxpayer's second 
residence as of the date that the property ceases to be the taxpayer's 
principal residence; or
    (C) If property that was the taxpayer's second residence is sold 
during the taxable year or becomes the taxpayer's principal residence, 
the taxpayer may elect a new second residence as of such day.
    (4) Allocations between residence and other property--(i) In 
general. For purposes of this section, the adjusted purchase price and 
fair market value of property must be allocated between the portion of 
the property that is a qualified residence and the portion that is not a 
qualified residence. Neither the average balance of the secured debt nor 
the interest paid or accrued on secured debt is so allocated. Property 
that is not used for residential purposes does not qualify as a 
residence. For example, if a portion of the property is used as an 
office in the taxpayer's trade or business, that portion of the property 
does not qualify as a residence.
    (ii) Special rule for rental of residence. If a taxpayer rents a 
portion of his or her principal or second residence to another person (a 
``tenant''), such portion may be treated as used by the taxpayer for 
residential purposes if, but only if--
    (A) Such rented portion is used by the tenant primarily for 
residential purposes,

[[Page 883]]

    (B) The rented portion is not a self-contained residential unit 
containing separate sleeping space and toilet and cooking facilities, 
and
    (C) The total number of tenants renting (directly or by sublease) 
the same or different portions of the residence at any time during the 
taxable year does not exceed two. For this purpose, if two persons (and 
the dependents, as defined by section 152, of either of them) share the 
same sleeping quarters, they shall be treated as a single tenant.
    (iii) Examples.

    Example (1). D, a dentist, uses a room in D's principal residence as 
an office which qualifies under section 280A(c)(1)(B) as a portion of 
the dwelling unit used exclusively on a regular basis as a place of 
business for meeting with patients in the normal course of D's trade or 
business. D's adjusted purchase price of the property is $65,000; 
$10,000 of which is allocable under paragraph (o)(4)(i) of this section 
to the room used as an office. For purposes of this section, D's 
residence does not include the room used as an office. The adjusted 
purchase price of the residence is, accordingly, $55,000. Similarly, the 
fair market value of D's residence must be allocated between the office 
and the remainder of the property.
    Example (2). J rents out the basement of property that is otherwise 
used as J's principal residence. The basement is a self-contained 
residential unit, with sleeping space and toilet and cooking facilities. 
The adjusted purchase price of the property is $100,000; $15,000 of 
which is allocable under paragraph (o)(4)(i) of this section to the 
basement. For purposes of this section, J's residence does not include 
the basement and the adjusted purchase price of the residence is 
$85,000. Similarly, the fair market value of the residence must be 
allocated between the basement unit and the remainder of the property.

    (5) Residence under construction--(i) In general. A taxpayer may 
treat a residence under construction as a qualified residence for a 
period of up to 24 months, but only if the residence becomes a qualified 
residence, without regard to this paragraph (p)(5)(i), as of the time 
that the residence is ready for occupancy.
    (ii) Example. X owns a residential lot suitable for the construction 
of a vacation home. On April 20, 1987, X obtains a mortgage secured by 
the lot and any property to be constructed on the lot. On August 9, 
1987, X begins construction of a residence on the lot. The residence is 
ready for occupancy on November 9, 1989. The residence is used as a 
residence within the meaning of paragraph (p)(3)(iii) of this section 
during 1989 and X elects to treat the residence as his second residence 
for the period November 9, 1989, through December 31, 1989. Since the 
residence under construction is a qualified residence as of the first 
day that the residence is ready for occupancy (November 9, 1987), X may 
treat the residence as his second residence under paragraph (p)(5)(i) of 
this section for up to 24 months of the period during which the 
residence is under construction, commencing on or after the date that 
construction is begun (August 9, 1987). If X treats the residence under 
construction as X's second residence beginning on August 9, 1987, the 
residence under construction would cease to qualify as a qualified 
residence under paragraph (p)(5)(i) on August 8, 1989. The residence's 
status as a qualified residence for future periods would be determined 
without regard to paragraph (p)(5)(i) of this section.
    (6) Special rule for time-sharing arrangements. Property that is 
otherwise a qualified residence will not fail to qualify as such solely 
because the taxpayer's interest in or right to use the property is 
restricted by an arrangement whereby two or more persons with interests 
in the property agree to exercise control over the property for 
different periods during the taxable year. For purposes of determining 
the use of a residence under paragraph (p)(3)(iii) of this section, a 
taxpayer will not be considered to have used or rented a residence 
during any period that the taxpayer does not have the right to use the 
property or to receive any benefits from the rental of the property.
    (q) Special rules for tenant-stockholders in cooperative housing 
corporations--(1) In general. For purposes of this section, a residence 
includes stock in a cooperative housing corporation owned by a tenant-
stockholder if the house or apartment which the tenant-stockholder is 
entitled to occupy by virtue of owning such stock is a residence within 
the meaning of paragraph (p)(3)(ii) of this section.

[[Page 884]]

    (2) Special rule where stock may not be used to secure debt. For 
purposes of this section, if stock described in paragraph (q)(1) of this 
section may not be used to secure debt because of restrictions under 
local or State law or because of restrictions in the cooperative 
agreement (other than restrictions the principal purpose of which is to 
permit the tenant-stockholder to treat unsecured debt as secured debt 
under this paragraph (q)(2)), debt may be treated as secured by such 
stock to the extent that the proceeds of the debt are allocated to the 
purchase of the stock under the rules of Sec. 1.163-8T. For purposes of 
this paragraph (q)(2), proceeds of debt incurred prior to January 1, 
1987, may be treated as allocated to the purchase of such stock to the 
extent that the tenant-stockholder has properly and consistently 
deducted interest expense on such debt as home mortgage interest 
attributable to such stock on Schedule A of Form 1040 in determining his 
taxable income for taxable years beginning before January 1, 1987. For 
purposes of this paragraph (q)(2), amended returns filed after December 
22, 1987, are disregarded.
    (3) Treatment of interest expense of the cooperative described in 
section 216(a)(2). For purposes of section 163(h) and Sec. 1.163-9T 
(disallowance of deduction for personal interest) and section 163(d) 
(limitation on investment interest), any amount allowable as a deduction 
to a tenant-stockholder under section 216(a)(2) shall be treated as 
interest paid or accrued by the tenant-stockholder. If a tenant-
stockholder's stock in a cooperative housing corporation is a qualified 
residence of the tenant-shareholder, any amount allowable as a deduction 
to the tenant-stockholder under section 216(a)(2) is qualified residence 
interest.
    (4) Special rule to prevent tax avoidance. If the amount treated as 
qualified residence interest under this section exceeds the amount which 
would be so treated if the tenant-stockholder were treated as directly 
owning his proportionate share of the assets and liabilities of the 
cooperative and one of the principal purposes of the cooperative 
arrangement is to permit the tenant-stockholder to increase the amount 
of qualified residence interest, the district director may determine 
that such excess is not qualified residence interest.
    (5) Other definitions. For purposes of this section, the terms 
``tenant-stockholder,'' ``cooperative housing corporation'' and 
``proportionate share'' shall have the meaning given by section 216 and 
the regulations thereunder.
    (r) Effective date. The provisions of this section are effective for 
taxable years beginning after December 31, 1986.

[T.D. 8168, 52 FR 48410, Dec. 22, 1987]



Sec. 1.163-12  Deduction of original issue discount on instrument held 
by related foreign person.

    (a) General rules--(1) Deferral of deduction. Except as provided in 
paragraph (b) of this section, section 163(e)(3) requires a taxpayer to 
use the cash method of accounting with respect to the deduction of 
original issue discount owed to a related foreign person. A deduction 
for an otherwise deductible portion of original issue discount with 
respect to a debt instrument will not be allowable as a deduction to the 
issuer until paid if, at the close of the issuer's taxable year in which 
such amount would otherwise be deductible, the person holding the debt 
instrument is a related foreign person. For purposes of this section, a 
related foreign person is any person that is not a United States person 
within the meaning of section 7701(a)(30), and that is related (within 
the meaning of section 267(b)) to the issuer at the close of the taxable 
year in which the amount incurred by the taxpayer would otherwise be 
deductible. Section 267(f) defines ``controlled group'' for purposes of 
section 267(b) without regard to the limitations of section 1563(b). An 
amount is treated as paid for purposes of this section if the amount is 
considered paid for purposes of section 1441 or section 1442 (including 
an amount taken into account pursuant to section 871(a)(1)(C), section 
881(a)(3), or section 884(f)). The rules of this paragraph (a) apply 
even if the original issue discount is not subject to United States tax, 
or is subject to a reduced rate of tax, pursuant to a provision of the 
Internal Revenue Code or a treaty obligation of the United States. For 
purposes

[[Page 885]]

of this section, original issue discount is an amount described in 
section 1273, whether from sources inside or outside the United States.
    (2) Change in method of accounting. A taxpayer that uses a method of 
accounting other than that required by the rules of this section must 
change its method of accounting to conform its method to the rules of 
this section. The taxpayer's change in method must be made pursuant to 
the rules of section 446(e), the regulations thereunder, and any 
applicable administrative procedures prescribed by the Commissioner. 
Because the rules of this section prescribe a method of accounting, 
these rules apply in the determination of a taxpayer's earnings and 
profits pursuant to Sec. 1.312-6(a).
    (b) Exceptions and special rules--(1) Effectively connected income. 
The provisions of section 267(a)(2) and the regulations thereunder, and 
not the provisions of paragraph (a) of this section, apply to an amount 
of original issue discount that is income of the related foreign person 
that is effectively connected with the conduct of a United States trade 
or business of such related foreign person. An amount described in this 
paragraph (b)(1) thus is allowable as a deduction as of the day on which 
the amount is includible in the gross income of the related foreign 
person as effectively connected income under sections 872(a)(2) or 
882(b) (or, if later, as of the day on which the deduction would be so 
allowable but for section 267(a)(2)). However, this paragraph (b)(1) 
does not apply if the related foreign person is exempt from United 
States income tax on the amount owed, or is subject to a reduced rate of 
tax, pursuant to a treaty obligation of the United States (such as under 
an article relating to the taxation of business profits).
    (2) Certain obligations issued by natural persons. This section does 
not apply to any debt instrument described in section 163(e)(4) 
(relating to obligations issued by natural persons before March 2, 1984, 
and to loans between natural persons).
    (3) Amounts owed to a foreign personal holding company, controlled 
foreign corporation, or passive foreign investment company--(i) Foreign 
personal holding companies. If an amount to which paragraph (a) of this 
section otherwise applies is owed to a related foreign person that is a 
foreign personal holding company within the meaning of section 552, then 
the amount is allowable as a deduction as of the day on which the amount 
is includible in the income of the foreign personal holding company. The 
day on which the amount is includible in income is determined with 
reference to the method of accounting under which the foreign personal 
holding company computes its taxable income and earnings and profits for 
purposes of sections 551 through 558. See section 551(c) and the 
regulations thereunder for the reporting requirements of the foreign 
personal holding company provisions (sections 551 through 558).
    (ii) Controlled foreign corporations. If an amount to which 
paragraph (a) of this section otherwise applies is owed to a related 
foreign person that is a controlled foreign corporation within the 
meaning of section 957, then the amount is allowable as a deduction as 
of the day on which the amount is includible in the income of the 
controlled foreign corporation. The day on which the amount is 
includible in income is determined with reference to the method of 
accounting under which the controlled foreign corporation computes its 
taxable income and earnings and profits for purposes of sections 951 
through 964. See section 6038 and the regulations thereunder for the 
reporting requirements of the controlled foreign corporation provisions 
(sections 951 through 964).
    (iii) Passive foreign investment companies. If an amount to which 
paragraph (a) of this section otherwise applies is owed to a related 
foreign person that is a passive foreign investment company within the 
meaning of section 1296, then the amount is allowable as a deduction as 
of the day on which amount is includible in the income of the passive 
foreign investment company. The day on which the amount is includible in 
income is determined with reference to the method of accounting under 
which the earnings and profits of the passive foreign investment company 
are computed for purposes of sections 1291 through 1297. See sections 
1291

[[Page 886]]

through 1297 and the regulations thereunder for the reporting 
requirements of the passive foreign investment company provisions. This 
exception shall apply, however, only if the person that owes the amount 
at issue has made and has in effect an election pursuant to section 1295 
with respect to the passive foreign investment company to which the 
amount at issue is owed.
    (c) Application of section 267. Except as limited in paragraph 
(b)(1) of this section, the provisions of section 267 and the 
regulations thereunder shall apply to any amount of original issue 
discount to which the provisions of this section do not apply.
    (d) Effective date. The rules of this section are effective with 
respect to all original issue discount on debt instruments issued after 
June 9, 1984.

[T.D. 8465, 58 FR 236, Jan. 5, 1993; 58 FR 8098, Feb. 11, 1993]



Sec. 1.163-13  Treatment of bond issuance premium.

    (a) General rule. If a debt instrument is issued with bond issuance 
premium, this section limits the amount of the issuer's interest 
deduction otherwise allowable under section 163(a). In general, the 
issuer determines its interest deduction by offsetting the interest 
allocable to an accrual period with the bond issuance premium allocable 
to that period. Bond issuance premium is allocable to an accrual period 
based on a constant yield. The use of a constant yield to amortize bond 
issuance premium is intended to generally conform the treatment of debt 
instruments having bond issuance premium with those having original 
issue discount. Unless otherwise provided, the terms used in this 
section have the same meaning as those terms in section 163(e), sections 
1271 through 1275, and the corresponding regulations. Moreover, unless 
otherwise provided, the provisions of this section apply in a manner 
consistent with those of section 163(e), sections 1271 through 1275, and 
the corresponding regulations. In addition, the anti-abuse rule in Sec. 
1.1275-2(g) applies for purposes of this section. For rules dealing with 
the treatment of bond premium by a holder, see Sec. Sec. 1.171-1 
through 1.171-5.
    (b) Exceptions. This section does not apply to--
    (1) A debt instrument described in section 1272(a)(6)(C) (regular 
interests in a REMIC, qualified mortgages held by a REMIC, and certain 
other debt instruments, or pools of debt instruments, with payments 
subject to acceleration); or
    (2) A debt instrument to which Sec. 1.1275-4 applies (relating to 
certain debt instruments that provide for contingent payments).
    (c) Bond issuance premium. Bond issuance premium is the excess, if 
any, of the issue price of a debt instrument over its stated redemption 
price at maturity. For purposes of this section, the issue price of a 
convertible bond (as defined in Sec. 1.171-1(e)(1)(iii)(C)) does not 
include an amount equal to the value of the conversion option (as 
determined under Sec. 1.171-1(e)(1)(iii)(A)).
    (d) Offsetting qualified stated interest with bond issuance 
premium--(1) In general. An issuer amortizes bond issuance premium by 
offsetting the qualified stated interest allocable to an accrual period 
with the bond issuance premium allocable to the accrual period. This 
offset occurs when the issuer takes the qualified stated interest into 
account under its regular method of accounting.
    (2) Qualified stated interest allocable to an accrual period. See 
Sec. 1.446-2(b) to determine the accrual period to which qualified 
stated interest is allocable and to determine the accrual of qualified 
stated interest within an accrual period.
    (3) Bond issuance premium allocable to an accrual period. The bond 
issuance premium allocable to an accrual period is determined under this 
paragraph (d)(3). Within an accrual period, the bond issuance premium 
allocable to the period accrues ratably.
    (i) Step one: Determine the debt instrument's yield to maturity. The 
yield to maturity of a debt instrument is determined under the rules of 
Sec. 1.1272-1(b)(1)(i).
    (ii) Step two: Determine the accrual periods. The accrual periods 
are determined under the rules of Sec. 1.1272-1(b)(1)(ii).
    (iii) Step three: Determine the bond issuance premium allocable to 
the accrual

[[Page 887]]

period. The bond issuance premium allocable to an accrual period is the 
excess of the qualified stated interest allocable to the accrual period 
over the product of the adjusted issue price at the beginning of the 
accrual period and the yield. In performing this calculation, the yield 
must be stated appropriately taking into account the length of the 
particular accrual period. Principles similar to those in Sec. 1.1272-
1(b)(4) apply in determining the bond issuance premium allocable to an 
accrual period.
    (4) Bond issuance premium in excess of qualified stated interest--
(i) Ordinary income. If the bond issuance premium allocable to an 
accrual period exceeds the qualified stated interest allocable to the 
accrual period, the excess is treated as ordinary income by the issuer 
for the accrual period. However, the amount treated as ordinary income 
is limited to the amount by which the issuer's total interest deductions 
on the debt instrument in prior accrual periods exceed the total amount 
treated by the issuer as ordinary income on the debt instrument in prior 
accrual periods.
    (ii) Carryforward. If the bond issuance premium allocable to an 
accrual period exceeds the sum of the qualified stated interest 
allocable to the accrual period and the amount treated as ordinary 
income for the accrual period under paragraph (d)(4)(i) of this section, 
the excess is carried forward to the next accrual period and is treated 
as bond issuance premium allocable to that period. If a carryforward 
exists on the date the debt instrument is retired, the carryforward is 
treated as ordinary income on that date.
    (e) Special rules--(1) Variable rate debt instruments. An issuer 
determines bond issuance premium on a variable rate debt instrument by 
reference to the stated redemption price at maturity of the equivalent 
fixed rate debt instrument constructed for the variable rate debt 
instrument. The issuer also allocates any bond issuance premium among 
the accrual periods by reference to the equivalent fixed rate debt 
instrument. The issuer constructs the equivalent fixed rate debt 
instrument, as of the issue date, by using the principles of Sec. 
1.1275-5(e).
    (2) Inflation-indexed debt instruments. An issuer determines bond 
issuance premium on an inflation-indexed debt instrument by assuming 
that there will be no inflation or deflation over the term of the 
instrument. The issuer also allocates any bond issuance premium among 
the accrual periods by assuming that there will be no inflation or 
deflation over the term of the instrument. The bond issuance premium 
allocable to an accrual period offsets qualified stated interest 
allocable to the period. Notwithstanding paragraph (d)(4) of this 
section, if the bond issuance premium allocable to an accrual period 
exceeds the qualified stated interest allocable to the period, the 
excess is treated as a deflation adjustment under Sec. 1.1275-
7(f)(1)(ii). See Sec. 1.1275-7 for other rules relating to inflation-
indexed debt instruments.
    (3) Certain debt instruments subject to contingencies--(i) In 
general. Except as provided in paragraph (e)(3)(ii) of this section, the 
rules of Sec. 1.1272-1(c) apply to determine a debt instrument's 
payment schedule for purposes of this section. For example, an issuer 
uses the payment schedule determined under Sec. 1.1272-1(c) to 
determine the amount, if any, of bond issuance premium on the debt 
instrument, the yield and maturity of the debt instrument, and the 
allocation of bond issuance premium to an accrual period.
    (ii) Mandatory sinking fund provision. Notwithstanding paragraph 
(e)(3)(i) of this section, if a debt instrument is subject to a 
mandatory sinking fund provision described in Sec. 1.1272-1(c)(3), the 
issuer must determine the payment schedule by assuming that a pro rata 
portion of the debt instrument will be called under the sinking fund 
provision.
    (4) Remote and incidental contingencies. For purposes of determining 
the amount of bond issuance premium and allocating bond issuance premium 
among accrual periods, if a bond provides for a contingency that is 
remote or incidental (within the meaning of Sec. 1.1275-2(h)), the 
issuer takes the contingency into account under the rules for remote and 
incidental contingencies in Sec. 1.1275-2(h).
    (f) Example. The following example illustrates the rules of this 
section:


[[Page 888]]


    Example-- (i) Facts. On February 1, 1999, X issues for $110,000 a 
debt instrument maturing on February 1, 2006, with a stated principal 
amount of $100,000, payable at maturity. The debt instrument provides 
for unconditional payments of interest of $10,000, payable on February 1 
of each year. X uses the calendar year as its taxable year, X uses the 
cash receipts and disbursements method of accounting, and X decides to 
use annual accrual periods ending on February 1 of each year. X's 
calculations assume a 30-day month and 360-day year.
    (ii) Amount of bond issuance premium. The issue price of the debt 
instrument is $110,000. Because the interest payments on the debt 
instrument are qualified stated interest, the stated redemption price at 
maturity of the debt instrument is $100,000. Therefore, the amount of 
bond issuance premium is $10,000 ($110,000-$100,000).
    (iii) Bond issuance premium allocable to the first accrual period. 
Based on the payment schedule and the issue price of the debt 
instrument, the yield of the debt instrument is 8.07 percent, compounded 
annually. (Although, for purposes of simplicity, the yield as stated is 
rounded to two decimal places, the computations do not reflect this 
rounding convention.) The bond issuance premium allocable to the accrual 
period ending on February 1, 2000, is the excess of the qualified stated 
interest allocable to the period ($10,000) over the product of the 
adjusted issue price at the beginning of the period ($110,000) and the 
yield (8.07 percent, compounded annually). Therefore, the bond issuance 
premium allocable to the accrual period is $1,118.17 ($10,000-
$8,881.83).
    (iv) Premium used to offset interest. Although X makes an interest 
payment of $10,000 on February 1, 2000, X only deducts interest of 
$8,881.83, the qualified stated interest allocable to the period 
($10,000) offset with the bond issuance premium allocable to the period 
($1,118.17).

    (g) Effective date. This section applies to debt instruments issued 
on or after March 2, 1998.
    (h) Accounting method changes--(1) Consent to change. An issuer 
required to change its method of accounting for bond issuance premium to 
comply with this section must secure the consent of the Commissioner in 
accordance with the requirements of Sec. 1.446-1(e). Paragraph (h)(2) 
of this section provides the Commissioner's automatic consent for 
certain changes.
    (2) Automatic consent. The Commissioner grants consent for an issuer 
to change its method of accounting for bond issuance premium on debt 
instruments issued on or after March 2, 1998. Because this change is 
made on a cut-off basis, no items of income or deduction are omitted or 
duplicated and, therefore, no adjustment under section 481 is allowed. 
The consent granted by this paragraph (h)(2) applies provided--
    (i) The change is made to comply with this section;
    (ii) The change is made for the first taxable year for which the 
issuer must account for a debt instrument under this section; and
    (iii) The issuer attaches to its federal income tax return for the 
taxable year containing the change a statement that it has changed its 
method of accounting under this section.

[T.D. 8746, 62 FR 68176, Dec. 31, 1997, as amended by T.D. 8838, 64 FR 
48547, Sept. 7, 1999]



Sec. 1.163(d)-1  Time and manner for making elections under the Omnibus 
Budget Reconciliation Act of 1993 and the Jobs and Growth Tax Relief 
Reconciliation Act of 2003.

    (a) Description. Section 163(d)(4)(B)(iii), as added by section 
13206(d) of the Omnibus Budget Reconciliation Act of 1993 (Pub. L. 103-
66, 107 Stat. 467), allows an electing taxpayer to take all or a portion 
of certain net capital gain attributable to dispositions of property 
held for investment into account as investment income. Section 
163(d)(4)(B), as amended by section 302(b) of the Jobs and Growth Tax 
Relief Reconciliation Act of 2003 (Pub. L. 108-27, 117 Stat. 762), 
allows an electing taxpayer to take all or a portion of qualified 
dividend income, as defined in section 1(h)(11)(B), into account as 
investment income. As a consequence, the net capital gain and qualified 
dividend income taken into account as investment income under these 
elections are not eligible to be taxed at the capital gains rates. An 
election may be made for net capital gain recognized by noncorporate 
taxpayers during any taxable year beginning after December 31, 1992. An 
election may be made for qualified dividend income received by 
noncorporate taxpayers during any taxable year beginning after December 
31, 2002, but before January 1, 2009.
    (b) Time and manner for making the elections. The elections for net 
capital gain and qualified dividend income

[[Page 889]]

must be made on or before the due date (including extensions) of the 
income tax return for the taxable year in which the net capital gain is 
recognized or the qualified dividend income is received. The elections 
are to be made on Form 4952, ``Investment Interest Expense Deduction,'' 
in accordance with the form and its instructions.
    (c) Revocability of elections. The elections described in this 
section are revocable with the consent of the Commissioner.
    (d) Effective date. The rules set forth in this section regarding 
the net capital gain election apply beginning December 12, 1996. The 
rules set forth in this section regarding the qualified dividend income 
election apply to any taxable year beginning after December 31, 2002, 
but before January 1, 2009.

[T.D. 9191, 70 FR 13100, Mar. 18, 2005]



Sec. 1.164-1  Deduction for taxes.

    (a) In general. Only the following taxes shall be allowed as a 
deduction under this section for the taxable year within which paid or 
accrued, according to the method of accounting used in computing taxable 
income:
    (1) State and local, and foreign, real property taxes.
    (2) State and local personal property taxes.
    (3) State and local, and foreign, income, war profits, and excess 
profits taxes.
    (4) State and local general sales taxes.
    (5) State and local taxes on the sale of gasoline, diesel fuel, and 
other motor fuels.

In addition, there shall be allowed as a deduction under this section 
State and local and foreign taxes not described in subparagraphs (1) 
through (5) of this paragraph which are paid or accrued within the 
taxable year in carrying on a trade or business or an activity described 
in section 212 (relating to expenses for production of income). For 
example, dealers or investors in securities and dealers or investors in 
real estate may deduct State stock transfer and real estate transfer 
taxes, respectively, under section 164, to the extent they are expenses 
incurred in carrying on a trade or business or an activity for the 
production of income. In general, taxes are deductible only by the 
person upon whom they are imposed. However, see Sec. 1.164-5 in the 
case of certain taxes paid by the consumer. Also, in the case of a 
qualified State individual income tax (as defined in section 6362 and 
the regulations thereunder) which is determined by reference to a 
percentage of the Federal income tax (pursuant to section 6362 (c)), an 
accrual method taxpayer shall use the cash receipts and disbursements 
method to compute the amount of his deduction therefor. Thus, the 
deduction under section 164 is in the amount actually paid with respect 
to the qualified tax, rather than the amount accrued with respect 
thereto, during the taxable year even though the taxpayer uses the 
accrual method of accounting for other purposes. In addition, see 
paragraph (f)(1) of Sec. 301.6361-1 of this chapter (Regulations on 
Procedure and Administration) with respect to rules relating to 
allocation and reallocation of amounts collected on account of the 
Federal income tax and qualified taxes.
    (b) Taxable years beginning before January 1, 1964. For taxable 
years beginning before January 1, 1964, except as otherwise provided in 
Sec. Sec. 1.164-2 through 1.164-8, inclusive, taxes imposed by the 
United States, any State, territory, possession of the United States, or 
a political subdivision of any of the foregoing, or by any foreign 
country, are deductible from gross income for the taxable year in which 
paid or accrued, according to the method of accounting used in computing 
taxable income. For this purpose, postage is not a tax and automobile 
license or registration fees are ordinarily taxes.
    (c) Cross references. For the definition of the term ``real property 
taxes'', see paragraph (d) of Sec. 1.164-3. For the definition of the 
term ``foreign taxes'', see paragraph (d) of Sec. 1.164-3. For the 
definition of the term ``general sales taxes'', see paragraph (f) of 
Sec. 1.164-3. For the treatment of gasoline, diesel fuel, and other 
motor fuel taxes, see Sec. 1.164-5. For apportionment of taxes on real 
property between seller and purchaser, see section 164(d) and Sec. 
1.164-6. For the general rule for taxable year of

[[Page 890]]

deduction, see section 461. For provisions disallowing any deduction for 
the tax paid at the source on interest from tax-free covenant bonds, see 
section 1451(f).

[T.D. 6780, 29 FR 18145, Dec. 22, 1964, as amended by T.D. 7577, 43 FR 
59357, Dec. 20, 1978]



Sec. 1.164-2  Deduction denied in case of certain taxes.

    This section and Sec. 1.275 describe certain taxes for which no 
deduction is allowed. In the case of taxable years beginning before 
January 1, 1964, the denial is provided for by section 164(b) (prior to 
being amended by section 207 of the Revenue Act of 1964 (78 Stat. 40)). 
In the case of taxable years beginning after December 31, 1963, the 
denial is governed by sections 164 and 275. No deduction is allowed for 
the following taxes:
    (a) Federal income taxes. Federal income taxes, including the taxes 
imposed by section 3101, relating to the tax on employees under the 
Federal Insurance Contributions Act (chapter 21 of the Code); sections 
3201 and 3211, relating to the taxes on railroad employees and railroad 
employee representatives; section 3402, relating to the tax withheld at 
source on wages; and by corresponding provisions of prior internal 
revenue laws.
    (b) Federal war profits and excess profits taxes. Federal war 
profits and excess profits taxes including those imposed by Title II of 
the Revenue Act of 1917 (39 Stat. 1000), Title III of the Revenue Act of 
1918 (40 Stat. 1088), Title III of the Revenue Act of 1921 (42 Stat. 
271), section 216 of the National Industrial Recovery Act (48 Stat. 
208), section 702 of the Revenue Act of 1934 (48 Stat. 770), Subchapter 
D, Chapter 1 of the Internal Revenue Code of 1939, and Subchapter E, 
Chapter 2 of the Internal Revenue Code of 1939.
    (c) Estate and gift taxes. Estate, inheritance, legacy, succession, 
and gift taxes.
    (d) Foreign income, war profits, and excess profits taxes. Income, 
war profits, and excess profits taxes imposed by the authority of any 
foreign country or possession of the United States, if the taxpayer 
chooses to take to any extent the benefits of section 901, relating to 
the credit for taxes of foreign countries and possessions of the United 
States.
    (e) Real property taxes. Taxes on real property, to the extent that 
section 164(d) and Sec. 1.164-6 require such taxes to be treated as 
imposed on another taxpayer.
    (f) Federal duties and excise taxes. Federal import or tariff 
duties, business, license, privilege, excise, and stamp taxes (not 
described in paragraphs (a), (b), (c), or (h) of this section, or Sec. 
1.164-4) paid or accrued within the taxable year. The fact that any such 
tax is not deductible as a tax under section 164 does not prevent (1) 
its deduction under section 162 or section 212, provided it represents 
an ordinary and necessary expense paid or incurred during the taxable 
year by a corporation or an individual in the conduct of any trade or 
business or, in the case of an individual for the production or 
collection of income, for the management, conservation, or maintenance 
of property held for the production of income, or in connection with the 
determination, collection, or refund of any tax, or (2) its being taken 
into account during the taxable year by a corporation or an individual 
as a part of the cost of acquiring or producing property in the trade or 
business or, in the case of an individual, as a part of the cost of 
property held for the production of income with respect to which it 
relates.
    (g) Taxes for local benefits. Except as provided in Sec. 1.164-4, 
taxes assessed against local benefits of a kind tending to increase the 
value of the property assessed.
    (h) Excise tax on real estate investment trusts. The excise tax 
imposed on certain real estate investment trusts by section 4981.

[T.D. 6780, 29 FR 18145, Dec 22, 1964, as amended by T.D. 7767, 46 FR 
11263, Feb. 6, 1981]



Sec. 1.164-3  Definitions and special rules.

    For purposes of section 164 and Sec. 1.164-1 to Sec. 1.164-8, 
inclusive--
    (a) State or local taxes. A State or local tax includes only a tax 
imposed by a State, a possession of the United States, or a political 
subdivision of any of the foregoing, or by the District of Columbia.
    (b) Real property taxes. The term ``real property taxes'' means 
taxes imposed

[[Page 891]]

on interests in real property and levied for the general public welfare, 
but it does not include taxes assessed against local benefits. See Sec. 
1.164-4.
    (c) Personal property taxes. The term ``personal property tax'' 
means an ad valorem tax which is imposed on an annual basis in respect 
of personal property. To qualify as a personal property tax, a tax must 
meet the following three tests:
    (1) The tax must be ad valorem--that is, substantially in proportion 
to the value of the personal property. A tax which is based on criteria 
other than value does not qualify as ad valorem. For example, a motor 
vehicle tax based on weight, model year, and horsepower, or any of these 
characteristics is not an ad valorem tax. However, a tax which is partly 
based on value and partly based on other criteria may qualify in part. 
For example, in the case of a motor vehicle tax of 1 percent of value 
plus 40 cents per hundredweight, the part of the tax equal to 1 percent 
of value qualifies as an ad valorem tax and the balance does not 
qualify.
    (2) The tax must be imposed on an annual basis, even if collected 
more frequently or less frequently.
    (3) The tax must be imposed in respect of personal property. A tax 
may be considered to be imposed in respect of personal property even if 
in form it is imposed on the exercise of a privilege. Thus, for taxable 
years beginning after December 31, 1963, State and local taxes on the 
registration or licensing of highway motor vehicles are not deductible 
as personal property taxes unless and to the extent that the tests 
prescribed in this subparagraph are met. For example, an annual ad 
valorem tax qualifies as a personal property tax although it is 
denominated a registration fee imposed for the privilege of registering 
motor vehicles or of using them on the highways.
    (d) Foreign taxes. The term ``foreign tax'' includes only a tax 
imposed by the authority of a foreign country. A tax-imposed by a 
political subdivision of a foreign country is considered to be imposed 
by the authority of that foreign country.
    (e) Sales tax. (1) The term ``sales tax'' means a tax imposed upon 
persons engaged in selling tangible personal property, or upon the 
consumers of such property, including persons selling gasoline or other 
motor vehicle fuels at wholesale or retail, which is a stated sum per 
unit of property sold or which is measured by the gross sales price or 
the gross receipts from the sale. The term also includes a tax imposed 
upon persons engaged in furnishing services which is measured by the 
gross receipts for furnishing such services.
    (2) In general, the term ``consumer'' means the ultimate user or 
purchaser; it does not include a purchaser such as a retailer, who 
acquires the property for resale.
    (f) General sales tax. A ``general sales tax'' is a sales tax which 
is imposed at one rate in respect of the sale at retail of a broad range 
of classes of items. No foreign sales tax is deductible under section 
164(a) and paragraph (a)(4) of Sec. 1.164-1. To qualify as a general 
sales tax, a tax must meet the following two tests:
    (1) The tax must be a tax in respect of sales at retail. This may 
include a tax imposed on persons engaged in selling property at retail 
or furnishing services at retail, for example, if the tax is measured by 
gross sales price or by gross receipts from sales or services. Rentals 
qualify as sales at retail if so treated under applicable State sales 
tax laws.
    (2) The tax must be general--that is, it must be imposed at one rate 
in respect of the retail sales of a broad range of classes of items. A 
sales tax is considered to be general although imposed on sales of 
various classes of items at more than one rate provided that one rate 
applies to the retail sales of a broad range of classes of items. The 
term ``items'' includes both commodities and services.
    (g) Special rules relating to general sales taxes. (1) A sales tax 
which is general is usually imposed at one rate in respect of the retail 
sales of all tangible personal property (with exceptions and additions). 
However, a sales tax which is selective--that is, a tax which applies at 
one rate with respect to retail sales of specified classes of items also 
qualifies as general if the specified classes represent a broad range of 
classes of items. A selective

[[Page 892]]

sales tax which does not apply at one rate to the retail sales of a 
broad range of classes of items is not general. For example, a tax which 
applies only to sales of alcoholic beverages, tobacco, admissions, 
luxury items, and a few other items is not general. Similarly, a tax 
imposed solely on services is not general. However, a selective sales 
tax may be deemed to be part of the general sales tax and hence may be 
deductible, even if imposed by a separate title, etc., of the State or 
local law, if imposed at the same rate as the general rate of tax (as 
defined in subparagraph (4) of this paragraph) which qualifies a tax in 
the taxing jurisdiction as a general sales tax. For example, if a State 
has a 5 percent general sales tax and a separate selective sales tax of 
5 percent on transient accommodations, the tax on transient 
accommodations is deductible.
    (2) A tax is imposed at one rate only if it is imposed at that rate 
on generally the same base for all items subject to tax. For example, a 
sales tax imposed at a 3 percent rate on 100 percent of the sales price 
of some classes of items and at a 3 percent rate on 50 percent of the 
sales price of other classes of items would not be imposed at one rate 
with respect to all such classes. However, a tax is considered to be 
imposed at one rate although it allows dollar exemptions, if the 
exemptions are designed to exclude all sales under a certain dollar 
amount. For example, a tax may be imposed at one rate although it 
applies to all sales of tangible personal property but applies only to 
sales amounting to more than 10 cents.
    (3) The fact that a sales tax exempts food, clothing, medical 
supplies, and motor vehicles, or any of them, shall not be taken into 
account in determining whether the tax applies to a broad range of 
classes of items. The fact that a sales tax applies to food, clothing, 
medical supplies, and motor vehicles, or any of them, at a rate which is 
lower than the general rate of tax (as defined in subparagraph (4) of 
this paragraph) is not taken into account in determining whether the tax 
is imposed at one rate on the retail sales of a broad range of classes 
of items. For purposes of this section, the term ``food'' means food for 
human consumption off the premises where sold, and the term ``medical 
supplies'' includes drugs, medicines, and medical devices.
    (4) Except in the case of a lower rate of tax applicable in respect 
of food, clothing, medical supplies, and motor vehicles, or any of them, 
no deduction is allowed for a general sales tax in respect of any item 
if the tax is imposed on such item at a rate other than the general rate 
of tax. The general rate of tax is the one rate which qualifies a tax in 
a taxing jurisdiction as a general sales tax because the tax is imposed 
at such one rate on a broad range of classes of items. There can be only 
one general rate of tax in any one taxing jurisdiction. However, a 
general sales tax imposed at a lower rate or rates on food, clothing, 
motor vehicles, and medical supplies, or any of them, may nonetheless be 
deductible with respect to such items. For example, a sales tax which is 
imposed at 1 percent with respect to food, imposed at 3 percent with 
respect to a broad range of classes of tangible personal property, and 
imposed at 4 percent with respect to transient accommodations would 
qualify as a general sales tax. Taxes paid at the 1 percent and the 3 
percent rates are deductible, but tax paid at the 4 percent rate is not 
deductible. The fact that a sales tax provides for the adjustment of the 
general rate of tax to reflect the sales tax rate in another taxing 
jurisdiction shall not be taken into account in determining whether the 
tax is imposed at one rate on the retail sales of a broad range of 
classes of items. Moreover, a general sales tax imposed at a lower rate 
with respect to an item in order to reflect the tax rate in another 
jurisdiction is also deductible at such lower rate. For example, State E 
imposes a general sales tax whose general rate is 3 percent. The State E 
sales tax law provides that in areas bordering on States with general 
sales taxes, selective sales taxes, or special excise taxes, the rate 
applied in the adjoining State will be used if such rate is under 3 
percent. State F imposes a 2 percent sales tax. The 2 percent sales tax 
paid by residents of State E in areas bordering on State F is 
deductible.

[[Page 893]]

    (h) Compensating use taxes. A compensating use tax in respect of any 
item is treated as a general sales tax. The term ``compensating use 
tax'' means, in respect of any item, a tax which is imposed on the use, 
storage, or consumption of such item and which is complementary to a 
general sales tax which is deductible with respect to sales of similar 
items.
    (i) Special rules relating to compensating use taxes. (1) In 
general, a use tax on an item is complementary to a general sales tax on 
similar items if the use tax is imposed on an item which was not subject 
to such general sales tax but which would have been subject to such 
general sales tax if the sale of the item had taken place within the 
jurisdiction imposing the use tax. For example, a tax imposed by State A 
on the use of a motor vehicle purchased in State B is complementary to 
the general sales tax of State A on similar items, if the latter tax 
applies to motor vehicles sold in State A.
    (2) Since a compensating use tax is treated as a general sales tax, 
it is subject to the rule of subparagraph (C) of section 164(b)(2) and 
paragraph (g)(4) of this section that no deduction is allowed for a 
general sales tax imposed in respect of an item at a rate other than the 
general rate of tax (except in the case of lower rates on the sale of 
food, clothing, medical supplies, and motor vehicles). The fact that a 
compensating use tax in respect of any item provides for an adjustment 
in the rate of the compensating use tax or the amount of such tax to be 
paid on account of a sales tax on such item imposed by another taxing 
jurisdiction is not taken into account in determining whether the 
compensating use tax is imposed in respect of the item at a rate other 
than the general rate of tax. For example, a compensating use tax 
imposed by State C on the use of an item purchased in State D is 
considered to be imposed at the general rate of tax even though the tax 
imposed by State C allows a credit for any sales tax paid on such item 
in State D, or the rate of such compensating use tax is adjusted to 
reflect the rate of sales tax imposed by State D.

[T.D. 6780, 29 FR 18146, Dec. 22, 1964]



Sec. 1.164-4  Taxes for local benefits.

    (a) So-called taxes for local benefits referred to in paragraph (g) 
of Sec. 1.164-2, more properly assessments, paid for local benefits 
such as street, sidewalk, and other like improvements, imposed because 
of and measured by some benefit inuring directly to the property against 
which the assessment is levied are not deductible as taxes. A tax is 
considered assessed against local benefits when the property subject to 
the tax is limited to property benefited. Special assessments are not 
deductible, even though an incidental benefit may inure to the public 
welfare. The real property taxes deductible are those levied for the 
general public welfare by the proper taxing authorities at a like rate 
against all property in the territory over which such authorities have 
jurisdiction. Assessments under the statutes of California relating to 
irrigation, and of Iowa relating to drainage, and under certain statutes 
of Tennessee relating to levees, are limited to property benefited, and 
if the assessments are so limited, the amounts paid thereunder are not 
deductible as taxes. For treatment of assessments for local benefits as 
adjustments to the basis of property, see section 1016(a)(1) and the 
regulations thereunder.
    (b)(1) Insofar as assessments against local benefits are made for 
the purpose of maintenance or repair or for the purpose of meeting 
interest charges with respect to such benefits, they are deductible. In 
such cases, the burden is on the taxpayer to show the allocation of the 
amounts assessed to the different purposes. If the allocation cannot be 
made, none of the amount so paid is deductible.
    (2) Taxes levied by a special taxing district which was in existence 
on December 31, 1963, for the purpose of retiring indebtedness existing 
on such date, are deductible, to the extent levied for such purpose, if 
(i) the district covers the whole of at least one county, (ii) if at 
least 1,000 persons are subject to the taxes levied by the district, and 
(iii) if the district levies its assessments annually at a uniform rate 
on the same

[[Page 894]]

assessed value of real property, including improvements, as is used for 
purposes of the real property tax generally.

[T.D. 6780, 29 FR 18147, Dec. 22, 1964]



Sec. 1.164-5  Certain retail sales taxes and gasoline taxes.

    For taxable years beginning before January 1, 1964, any amount 
representing a State or local sales tax paid by a consumer of services 
or tangible personal property is deductible by such consumer as a tax, 
provided it is separately stated and not paid in connection with his 
trade or business. For taxable years beginning after December 31, 1963, 
only the amount of any separately stated State and local general sales 
tax (as defined in paragraph (g) of Sec. 1.164-3) and tax on the sale 
of gasoline, diesel fuel or other motor fuel paid by the consumer (other 
than in connection with his trade or business) is deductible by the 
consumer as tax. The fact that, under the law imposing it, the incidence 
of such State or local tax does not fall on the consumer is immaterial. 
The requirement that the amount of tax must be separately stated will be 
deemed complied with where it clearly appears that at the time of sale 
to the consumer, the tax was added to the sales price and collected or 
charged as a separate item. It is not necessary, for the purpose of this 
section, that the consumer be furnished with a sales slip, bill, 
invoice, or other statement on which the tax is separately stated. For 
example, where the law imposing the State or local tax for which the 
taxpayer seeks a deduction contains a prohibition against the seller 
absorbing the tax, or a provision requiring a posted notice stating that 
the tax will be added to the quoted price, or a requirement that the tax 
be separately shown in advertisements or separately stated on all bills 
and invoices, it is presumed that the amount of the State or local tax 
was separately stated at the time paid by the consumer; except that such 
presumption shall have no application to a tax on the sale of gasoline, 
diesel fuel or other motor fuel imposed upon a wholesaler unless such 
provisions of law apply with respect to both the sale at wholesale and 
the sale at retail.

[T.D. 6780, 29 FR 18147, Dec. 22, 1964]



Sec. 1.164-6  Apportionment of taxes on real property between seller 
and purchaser.

    (a) Scope. Except as provided otherwise in section 164(f) and Sec. 
1.164-8, when real property is sold, section 164(d)(1) governs the 
deduction by the seller and the purchaser of current real property 
taxes. Section 164(d)(1) performs two functions: (1) It provides a 
method by which a portion of the taxes for the real property tax year in 
which the property is sold may be deducted by the seller and a portion 
by the purchaser; and (2) it limits the deduction of the seller and the 
purchaser to the portion of the taxes corresponding to the part of the 
real property tax year during which each was the owner of the property. 
These functions are accomplished by treating a portion of the taxes for 
the real property tax year in which the property is sold as imposed on 
the seller and a portion as imposed on the purchaser. To the extent that 
the taxes are treated as imposed on the seller and the purchaser, each 
shall be allowed a deduction, under section 164(a), in the taxable year 
such tax is paid or accrued, or treated as paid or accrued under section 
164(d)(2) (A) or (D) and this section. No deduction is allowed for taxes 
on real property to the extent that they are imposed on another 
taxpayer, or are treated as imposed on another taxpayer under section 
164(d). For the election to accrue real property taxes ratably see 
section 461(c) and the regulations thereunder.
    (b) Application of rule of apportionment. (1)(i) For purposes of the 
deduction provided by section 164(a), if real property is sold during 
any real property tax year, the portion of the real property tax 
properly allocable to that part of the real property tax year which ends 
on the day before the date of the sale shall be treated as a tax imposed 
on the seller, and the portion of such tax properly allocable to that 
part of such real property tax year which begins on the date of the sale 
shall be treated as a tax imposed on the purchased. For definition of 
``real property

[[Page 895]]

tax year'' see paragraph (c) of this section. This rule shall apply 
whether or not the seller and the purchaser apportion such tax. The rule 
of apportionment contained in section 164(d)(1) applies even though the 
same real property is sold more than once during the real property tax 
year. (See paragraph (d)(5) of this section for rule requiring inclusion 
in gross income of excess deductions.)
    (ii) Where the real property tax becomes a personal liability or a 
lien before the beginning of the real property tax year to which it 
relates and the real property is sold subsequent to the time the tax 
becomes a personal liability or a lien but prior to the beginning of the 
related real property tax year--
    (a) The seller may not deduct any amount for real property taxes for 
the related real property tax year, and
    (b) To the extent that he holds the property for such real property 
tax year, the purchaser may deduct the amount of such taxes for the 
taxable year they are paid (or amounts representing such taxes are paid 
to the seller, mortgagee, trustee or other person having an interest in 
the property as security) or accrued by him according to his method of 
accounting.
    (iii) Similarly, where the real property tax becomes a personal 
liability or a lien after the end of the real property tax year to which 
it relates and the real property is sold prior to the time the tax 
becomes a personal liability or a lien but after the end of the related 
real property tax year--
    (a) The purchaser may not deduct any amount for real property taxes 
for the related real property tax year, and
    (b) To the extent that he holds the property for such real property 
tax year, the seller may deduct the amount of such taxes for the taxable 
year they are paid (or amounts representing such taxes are paid to the 
purchaser, mortgagee, trustee, or other person having an interest in the 
property as security) or accrued by him according to his method of 
accounting.
    (iv) Where the real property is sold (or purchased) during the 
related real property tax year the real property taxes for such year are 
apportioned between the parties to such sale and may be deducted by such 
parties in accordance with the provisions of paragraph (d) of this 
section.
    (2) Section 164(d) does not apply to delinquent real property taxes 
for any real property tax year prior to the real property tax year in 
which the property is sold.
    (3) The provisions of this paragraph may be illustrated by the 
following examples:

    Example (1). The real property tax year in County R is April 1 to 
March 31. A, the owner on April 1, 1954, of real property located in 
County R sells the real property to B on June 30, 1954. B owns the real 
property from June 30, 1954, through March 31, 1955. The real property 
tax for the real property tax year April 1, 1954-March 31, 1955 is $365. 
For purposes of section 164(a), $90 (90/365x$365, April 1, 1954-June 29, 
1954) of the real property tax is treated as imposed on A, the seller, 
and $275 (275/365x $365, June 30, 1954-March 31, 1955) of such real 
property tax is treated as imposed on B, the purchaser.
    Example (2). In County S the real property tax year is the calendar 
year. The real property tax becomes a lien on June 1 and is payable on 
July 1 of the current real property tax year, but there is no personal 
liability for such tax. On April 30, 1955, C, the owner of real property 
in County S on January 1, 1955, sells the real property to D. On July 1, 
1955, D pays the 1955 real property tax. On August 31, 1955, D sells the 
same real property to E. C, D, and E use the cash receipts and 
disbursements method of accounting. Under the provisions of section 
164(d)(1), 119/365 (January 1-April 29, 1955) of the real property tax 
payable on July 1, 1955, for the 1955 real property tax year is treated 
as imposed on C, and, under the provisions of section 164(d)(2)(A), such 
portion is treated as having been paid by him on the date of sale. Under 
the provisions of section 164(d)(1), 123/365 (April 30-August 30, 1955) 
of the real property tax paid July 1, 1955, for the 1955 real property 
tax year is treated as imposed on D and may be deducted by him. Under 
the provisions of section 164(d)(1), 123/365 (August 31-December 31, 
1955) of the real property tax due and paid on July 1, 1955, for the 
1955 real property tax year is treated as imposed on E and, under the 
provisions of section 164(d)(2)(A) such portion is treated as having 
been paid by him on the date of sale.
    Example (3). In State X the real property tax year is the calendar 
year. The real property tax becomes a lien on November 1 of the 
preceding calendar year. On November 15, 1955, F sells real property in 
State X to G. G owns the real property through December 31, 1956. Under 
section 164(d)(1), the real property tax (which became a lien on 
November 1, 1954) for the 1955 real property tax year is apportioned 
between F and G. No part of the

[[Page 896]]

real property tax for the 1956 real property tax year may be deducted by 
F. The entire real property tax for the 1956 real property tax year may 
be deducted by G when paid or accrued, depending upon the method of 
accounting used by him. See subparagraph (6) of paragraph (d) and 
section 461(c) and the regulations thereunder.

    (c) Real property tax year. As used in section 164(d), the term 
``real property tax year'' refers to the period which, under the law 
imposing the tax, is regarded as the period to which the tax imposed 
relates. Where the State and one or more local governmental units each 
imposes a tax on real property, the real property tax year for each tax 
must be determined for purposes of applying the rule of apportionment of 
section 164(d)(1) to each tax. The time when the tax rate is determined, 
the time when the assessment is made, the time when the tax becomes a 
lien, or the time when the tax becomes due or delinquent does not 
necessarily determine the real property tax year. The real property tax 
year may or may not correspond to the fiscal year of the governmental 
unit imposing the tax. In each case the State or local law determines 
what constitutes the real property tax year. Although the seller and the 
purchaser may or may not make an allocation of real property taxes, the 
meaning of ``real property tax year'' in section 164(d) and the 
application of section 164(d) do not depend upon what real property 
taxes were allocated nor the method of allocation used by the parties.
    (d) Special rules--(1) Seller using cash receipts and disbursements 
method of accounting. Under the provisions of section 164(d), if the 
seller by reason of his method of accounting may not deduct any amount 
for taxes unless paid, and--
    (i) The purchaser (under the law imposing the real property tax) is 
liable for the real property tax for the real property tax year, or
    (ii) The seller (under the law imposing the real property tax) is 
liable for the real property tax for the real property tax year and the 
tax is not payable until after the date of sale,

then the portion of the tax treated under section 164(d)(1) as imposed 
upon the seller (whether or not actually paid by him in the taxable year 
in which the sale occurs) shall be considered as having been paid by him 
in such taxable year. Such portion may be deducted by him for the 
taxable year in which the sale occurs, or, if at a later time, for the 
taxable year (which would be proper under the taxpayer's method of 
accounting) in which the tax is actually paid, or an amount representing 
such tax is paid to the purchaser, mortgagee, trustee, or other person 
having an interest in the property as security.
    (2) Purchasers using the cash receipts and disbursements method of 
accounting. Under the provisions of section 164(d), if the purchaser by 
reason of his method of accounting may not deduct any amount for taxes 
unless paid and the seller (under the law imposing the real property 
tax) is liable for the real property tax for the real property tax year, 
the portion of the tax treated under section 164(d)(1) as imposed upon 
the purchaser (whether or not actually paid by him in the taxable year 
in which the sale occurs) shall be considered as having been paid by him 
in such taxable year. Such portion may be deducted by him for the 
taxable year in which the sale occurs, or, if at a later time, for the 
taxable year (which would be proper under the taxpayer's method of 
accounting) in which the tax is actually paid, or an amount representing 
such tax is paid to the seller, mortgagee, trustee, or other person 
having an interest in the property as security.
    (3) Persons considered liable for tax. Where the tax is not a 
liability of any person, the person who holds the property at the time 
the tax becomes a lien on the property shall be considered liable for 
the tax. As to a particular sale, in determining:
    (i) Whether the other party to the sale is liable for the tax or,
    (ii) The person who holds the property at the time the tax becomes a 
lien on the property (where the tax is not a liability of any person),

prior or subsequent sales of the property during the real property tax 
year shall be disregarded.
    (4) Examples. The provisions of subparagraphs (1), (2), and (3) of 
this paragraph may be illustrated as follows:


[[Page 897]]


    Example (1). In County X the real property tax year is the calendar 
year. The real property tax is a personal liability of the owner of the 
real property on June 30 of the current real property tax year, but is 
not payable until February 28 of the following real property tax year. 
A, the owner of real property in County X on January 1, 1955, uses the 
cash receipts and disbursements method of accounting. On May 30, 1955, A 
sells the real property to B, who also uses the cash receipts and 
disbursements method of accounting. B retains ownership of the real 
property for the balance of the 1955 calendar year. Under the provisions 
of section 164(d)(1), 149/365 (January 1-May 29, 1955) of the real 
property tax payable on February 28, 1956, for the 1955 real property 
tax year is treated as imposed on A, the seller, and under the 
provisions of section 164(d)(2)(A) such portion is treated as having 
been paid by him on the date of sale and may be deducted by him for his 
taxable year in which the sale occurs (whether or not such portion is 
actually paid by him in that year) or for his taxable year in which the 
tax is actually paid or an amount representing such tax is paid. Under 
the provisions of section 164(d)(1), 216/365 (May 30-December 31, 1955) 
of the real property tax payable on February 28, 1956, for the 1955 real 
property tax year is treated as imposed on B, the purchaser, and may be 
deducted by him for his taxable year in which the tax is actually paid, 
or an amount representing such tax is paid.
    Example (2). In County Y, the real property tax year is the calendar 
year. The real property tax becomes a lien on January 1, 1955, and is 
payable on April 30, 1955. There is no personal liability for the real 
property tax imposed by County Y. On April 30, 1955, C, the owner of 
real property in County Y on January 1, 1955, pays the real property tax 
for the 1955 real property tax year. On May 1, 1955, C sells the real 
property to D. On September 1, 1955, D sells the real property to E. C, 
D, and E use the cash receipts and disbursements method of accounting. 
Under the provisions of section 164(d)(1), 120/365 (January 1-April 30, 
1955) of the real property tax is treated as imposed upon C and may be 
deducted by him for his taxable year in which the tax is actually paid. 
Under section 164(d)(1), 123/365 (May 1- August 31, 1955) of the real 
property tax is treated as imposed upon D and, under the provisions of 
section 164(d)(2)(A), is treated as having been paid by him on May 1, 
1955, and may be deducted by D for his taxable year in which the sale 
from C to him occurs (whether or not such portion is actually paid by 
him in that year), or for his taxable year in which an amount 
representing such tax is paid. Since, according to paragraph (d)(3) of 
this section, the prior sale by C to D is disregarded, under the 
provisions of section 164(d)(1), 122/365 (September 1-December 31, 1955) 
of the real property tax is treated as imposed on E and, under the 
provisions of section 164(d)(2)(A), is treated as having been paid by 
him on September 1, 1955, and may be deducted by E for his taxable year 
in which the sale from D to him occurs (whether or not such portion is 
actually paid by him in that year), or for his taxable year in which an 
amount representing such tax is paid.
    Example (3). In County X the real property tax year is the calendar 
year and the real property taxes are assessed and become a lien on June 
30 of the current real property tax year, but are not payable until 
September 1 of that year. There is no personal liability for the real 
property tax imposed by County X. A, the owner on January 1, 1955, of 
real property in County X, uses the cash receipts and disbursements 
method of accounting. On July 15, 1955, A sells the real property to B. 
Under the provisions of section 164(d)(1), 195/365 (January 1-July 14, 
1955) of the real property tax payable on September 1, 1955, for the 
1955 real property tax year is treated as imposed on A, and may be 
deducted by him for his taxable year in which the sale occurs (whether 
or not such portion is actually paid by him in that year) or for his 
taxable year in which the tax is actually paid or an amount representing 
such tax is paid. Under the provisions of section 164(d)(1), 170/365 
(July 15-December 31, 1955) of the real property tax is treated as 
imposed on B and may be deducted by him for his taxable year in which 
the sale occurs (whether or not such portion is actually paid by him in 
that year), or for his taxable year in which the tax is actually paid or 
an amount representing such tax is paid.

    (5) Treatment of excess deduction. If, for a taxable year prior to 
the taxable year of sale of real property, a taxpayer has deducted an 
amount for real property tax in excess of the portion of such real 
property tax treated as imposed on him under the provisions of section 
164(d), the excess of the amount deducted over the portion treated as 
imposed on him shall be included in his gross income for the taxable 
year of the sale, subject to the provisions of section 111, relating to 
the recovery of bad debts, prior taxes, and delinquency amounts. The 
provisions of this subparagraph may be illustrated as follows:

    Example (1). In Borough Y the real property tax is due and payable 
on November 30 for the succeeding calendar year, which is also the real 
property tax year. On November 30, 1954, taxpayer A, who reports his 
income on a calendar year under the cash receipts and disbursements 
method of accounting, pays

[[Page 898]]

the real property tax on real property owned by him in Borough Y for the 
1955 real property tax year. On June 30, 1955, A sells the real 
property. Under the provisions of section 164(d), only 180/365 (January 
1-June 29, 1955) of the real property tax for the 1955 real property tax 
year is treated as imposed on A, and the excess of the amount of real 
property tax for 1955 deducted by A, on his 1954 income tax return, over 
the 180/365 portion of such tax treated as imposed on him under section 
164(d), must be included in gross income in A's 1955 income tax return, 
subject to the provisions of section 111.
    Example (2). In County Z the real property tax year is the calendar 
year. The real property tax becomes a personal liability of the owner of 
real property on January 1 of the current real property tax year, and is 
payable on July 1 of the current real property tax year. On May 1, 1955, 
A, the owner of real property in County Z on January 1, 1955, sells the 
real property to B. On November 1, 1955, B sells the same real property 
to C. B uses the cash receipts and disbursements method of accounting 
and reports his income on the basis of a fiscal year ending July 31. B, 
on July 1, 1955, pays the entire real property tax for the real property 
tax year ending December 31, 1955. Under the provisions of section 
164(d), only 184/365 (May 1-October 31, 1955) of the real property tax 
for the 1955 real property tax year is treated as imposed on B, and the 
excess of the amount of real property tax for 1955 deducted by B on his 
income tax return for the fiscal year ending July 31, 1955, over the 
184/365 portion of such tax treated as imposed on him under section 
164(d), must be included in gross income in B's income tax return for 
his fiscal year ending July 31, 1956, subject to the provisions of 
section 111.

    (6) Persons using an accrual method of accounting. Where real 
property is sold and the seller or the purchaser computes his taxable 
income (for the taxable year during which the sale occurs) on an accrual 
method of accounting then, if the seller or the purchaser has not made 
the election provided in section 461(c) (relating to the accrual of real 
property taxes), the portion of any real property tax which is treated 
as imposed on him and which may not be deducted by him for any taxable 
year by reason of his method of accounting shall be treated as having 
accrued on the date of sale. The provisions of this subparagraph may be 
illustrated as follows:

    Example. In County X the real property tax becomes a lien on 
property and is assessed on November 30 for the current calendar year, 
which is also the real property tax year. There is no personal liability 
for the real property tax imposed by County X. A owns, on January 1, 
1955, real property in County X. A uses an accrual method of accounting 
and has not made any election under section 461(c) to accrue ratably 
real property taxes. A sells real property on June 30, 1955. By reason 
of A's method of accounting, he could not deduct any part of the real 
property tax for 1955 on the real property since he sold the real 
property prior to November 30, 1955, the accrual date. Under section 
164(d)(1), 180/365 (January 1-June 29, 1955) of the real property tax 
for the 1955 real property tax year is treated as imposed on A, and 
under section 164(d)(2)(D) that portion is treated as having accrued on 
June 30, 1955, and may be deducted by A for his taxable year in which 
such date falls. B, the purchaser from A, who uses an accrual method of 
accounting, has likewise not made an election under section 461(c) to 
accrue real property taxes ratably. Under section 164(d)(1), 185/365 of 
the real property taxes may be accrued by B on November 30, 1955, and 
deducted for his taxable year in which such date falls.

    (7) Cross references. For determination of amount realized on a sale 
of real property, see section 1001(b) and the regulations thereunder. 
For determination of basis of real property acquired by purchase, see 
section 1012 and the regulations thereunder.
    (8) Effective dates. Section 164(d) applies to taxable years ending 
after December 31, 1953, but only in the case of sales made after 
December 31, 1953. However, section 164(d) does not apply to any real 
property tax to the extent that such tax was allowable as a deduction 
under the Internal Revenue Code of 1939 to the seller for any taxable 
year which ended before January 1, 1954.



Sec. 1.164-7  Taxes of shareholder paid by corporation.

    Banks and other corporations paying taxes assessed against their 
shareholders on account of their ownership of the shares of stock issued 
by such corporations without reimbursement from such shareholders may 
deduct the amount of taxes so paid. In such cases no deduction shall be 
allowed to the shareholders for such taxes. The amount so paid should 
not be included in the gross income of the shareholder.

[[Page 899]]



Sec. 1.164-8  Payments for municipal services in atomic energy 
communities.

    (a) General. For taxable years beginning after December 31, 1957, 
amounts paid or accrued by any owner of real property within any 
community (as defined in section 21b of the Atomic Energy Community Act 
of 1955 (42 U.S.C. 2304)) to compensate the Atomic Energy Commission for 
municipal-type services (or any agent or contractor authorized by the 
Atomic Energy Commission to charge for such services) shall be treated 
as State real property taxes paid or accrued for purposes of section 
164. Such amounts shall be deductible as taxes to the extent provided in 
section 164, Sec. Sec. 1.164-1 through 1.164-7, and this section. See 
paragraph (b) of this section for definition of the term ``Atomic Energy 
Commission''; paragraph (c) of this section for the definition of the 
term ``municipal-type services''; and paragraph (d) of this section for 
the definition of the term ``owner''.
    (b) Atomic Energy Commission. For purposes of paragraph (a) of this 
section, the term ``Atomic Energy Commission'' shall mean--
    (1) The Atomic Energy Commission, and
    (2) Any other agency of the United States Government to which the 
duties and responsibilities of providing municipal-type services are 
delegated under the authority of section 101 of the Atomic Energy 
Community Act of 1955 (42 U.S.C. 2313).
    (c) Municipal-type services. For purposes of paragraph (a) of this 
section, the term ``municipal-type services'' includes services usually 
rendered by a municipality and usually paid for by taxes. Examples of 
municipal-type services are police protection, fire protection, public 
recreational facilities, public libraries, public schools, public 
health, public welfare, and the maintenance of roads and streets. The 
term shall include sewage and refuse disposal which are maintained out 
of revenues derived from a general charge for municipal-type services; 
however, the term shall not include sewage and refuse disposal if a 
separate charge for such services is made. Charges assessed against 
local benefits of a kind tending to increase the value of the property 
assessed are not charges for municipal-type services. See section 
164(c)(1) and Sec. 1.164-4.
    (d) Owner. For purposes of paragraph (a) of this section, the term 
``owner'' includes a person who holds the real property under a 
leasehold of 40 or more years from the Atomic Energy Commission (or any 
agency of the United States Government to which the duties and 
responsibilities of leasing real property are delegated under section 
101 of the Atomic Energy Community Act of 1955), and a person who has 
entered into a contract to purchase under section 61 of the Atomic 
Energy Community Act of 1955 (42 U.S.C. 2361). An assignee (either 
immediate or more remote) of a lessee referred to in the preceding 
sentence will also qualify as an owner for purposes of paragraph (a) of 
this section.
    (e) Nonapplication of section 164(d). Section 164(d) and Sec. 
1.164-6, relating to apportionment of taxes on real property between 
seller and purchaser, do not apply to a sale by the United States or any 
of its agencies of real property to which section 164(f) and this 
section apply. Thus, amounts paid or accrued which qualify under 
paragraph (a) of this section will continue to be deductible as taxes to 
the extent provided in this section, even in the taxable year in which 
the owner actually purchases the real property from the United States or 
any of its agencies. However, the provisions of section 164(d) and Sec. 
1.164-6 shall apply to a sale of real property to which section 164(f) 
and this section apply, if the seller is other than the United States or 
any of its agencies.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6789, 29 FR 
18147, Dec. 22, 1964]



Sec. 1.165-1  Losses.

    (a) Allowance of deduction. Section 165(a) provides that, in 
computing taxable income under section 63, any loss actually sustained 
during the taxable year and not made good by insurance or some other 
form of compensation shall be allowed as a deduction subject to any 
provision of the internal revenue laws which prohibits or limits the 
amount of the deduction. This deduction for losses sustained shall be 
taken in accordance with section 165 and the

[[Page 900]]

regulations thereunder. For the disallowance of deductions for worthless 
securities issued by a political party, see Sec. 1.271-1.
    (b) Nature of loss allowable. To be allowable as a deduction under 
section 165(a), a loss must be evidenced by closed and completed 
transactions, fixed by identifiable events, and, except as otherwise 
provided in section 165(h) and Sec. 1.165-11, relating to disaster 
losses, actually sustained during the taxable year. Only a bona fide 
loss is allowable. Substance and not mere form shall govern in 
determining a deductible loss.
    (c) Amount deductible. (1) The amount of loss allowable as a 
deduction under section 165(a) shall not exceed the amount prescribed by 
Sec. 1.1011-1 as the adjusted basis for determining the loss from the 
sale or other disposition of the property involved. In the case of each 
such deduction claimed, therefore, the basis of the property must be 
properly adjusted as prescribed by Sec. 1.1011-1 for such items as 
expenditures, receipts, or losses, properly chargeable to capital 
account, and for such items as depreciation, obsolescence, amortization, 
and depletion, in order to determine the amount of loss allowable as a 
deduction. To determine the allowable loss in the case of property 
acquired before March 1, 1913, see also paragraph (b) of Sec. 1.1053-1.
    (2) The amount of loss recognized upon the sale or exchange of 
property shall be determined for purposes of section 165(a) in 
accordance with Sec. 1.1002-1.
    (3) A loss from the sale or exchange of a capital asset shall be 
allowed as a deduction under section 165(a) but only to the extent 
allowed in section 1211 (relating to limitation on capital losses) and 
section 1212 (relating to capital loss carrybacks and carryovers), and 
in the regulations under those sections.
    (4) In determining the amount of loss actually sustained for 
purposes of section 165(a), proper adjustment shall be made for any 
salvage value and for any insurance or other compensation received.
    (d) Year of deduction. (1) A loss shall be allowed as a deduction 
under section 165(a) only for the taxable year in which the loss is 
sustained. For this purpose, a loss shall be treated as sustained during 
the taxable year in which the loss occurs as evidenced by closed and 
completed transactions and as fixed by identifiable events occurring in 
such taxable year. For provisions relating to situations where a loss 
attributable to a disaster will be treated as sustained in the taxable 
year immediately preceding the taxable year in which the disaster 
actually occurred, see section 165(h) and Sec. 1.165-11.
    (2)(i) If a casualty or other event occurs which may result in a 
loss and, in the year of such casualty or event, there exists a claim 
for reimbursement with respect to which there is a reasonable prospect 
of recovery, no portion of the loss with respect to which reimbursement 
may be received is sustained, for purposes of section 165, until it can 
be ascertained with reasonable certainty whether or not such 
reimbursement will be received. Whether a reasonable prospect of 
recovery exists with respect to a claim for reimbursement of a loss is a 
question of fact to be determined upon an examination of all facts and 
circumstances. Whether or not such reimbursement will be received may be 
ascertained with reasonable certainty, for example, by a settlement of 
the claim, by an adjudication of the claim, or by an abandonment of the 
claim. When a taxpayer claims that the taxable year in which a loss is 
sustained is fixed by his abandonment of the claim for reimbursement, he 
must be able to produce objective evidence of his having abandoned the 
claim, such as the execution of a release.
    (ii) If in the year of the casualty or other event a portion of the 
loss is not covered by a claim for reimbursement with respect to which 
there is a reasonable prospect of recovery, then such portion of the 
loss is sustained during the taxable year in which the casualty or other 
event occurs. For example, if property having an adjusted basis of 
$10,000 is completely destroyed by fire in 1961, and if the taxpayer's 
only claim for reimbursement consists of an insurance claim for $8,000 
which is settled in 1962, the taxpayer sustains a loss of

[[Page 901]]

$2,000 in 1961. However, if the taxpayer's automobile is completely 
destroyed in 1961 as a result of the negligence of another person and 
there exists a reasonable prospect of recovery on a claim for the full 
value of the automobile against such person, the taxpayer does not 
sustain any loss until the taxable year in which the claim is 
adjudicated or otherwise settled. If the automobile had an adjusted 
basis of $5,000 and the taxpayer secures a judgment of $4,000 in 1962, 
$1,000 is deductible for the taxable year 1962. If in 1963 it becomes 
reasonably certain that only $3,500 can ever be collected on such 
judgment, $500 is deductible for the taxable year 1963.
    (iii) If the taxpayer deducted a loss in accordance with the 
provisions of this paragraph and in a subsequent taxable year receives 
reimbursement for such loss, he does not recompute the tax for the 
taxable year in which the deduction was taken but includes the amount of 
such reimbursement in his gross income for the taxable year in which 
received, subject to the provisions of section 111, relating to recovery 
of amounts previously deducted.
    (3) Any loss arising from theft shall be treated as sustained during 
the taxable year in which the taxpayer discovers the loss (see Sec. 
1.165-8, relating to theft losses). However, if in the year of discovery 
there exists a claim for reimbursement with respect to which there is a 
reasonable prospect of recovery, no portion of the loss with respect to 
which reimbursement may be received is sustained, for purposes of 
section 165, until the taxable year in which it can be ascertained with 
reasonable certainty whether or not such reimbursement will be received.
    (4) The rules of this paragraph are applicable with respect to a 
casualty or other event which may result in a loss and which occurs 
after January 16, 1960. If the casualty or other event occurs on or 
before such date, a taxpayer may treat any loss resulting therefrom in 
accordance with the rules then applicable, or, if he so desires, in 
accordance with the provisions of this paragraph; but no provision of 
this paragraph shall be construed to permit a deduction of the same loss 
or any part thereof in more than one taxable year or to extend the 
period of limitations within which a claim for credit or refund may be 
filed under section 6511.
    (e) Limitation on losses of individuals. In the case of an 
individual, the deduction for losses granted by section 165(a) shall, 
subject to the provisions of section 165(c) and paragraph (a) of this 
section, be limited to:
    (1) Losses incurred in a trade or business;
    (2) Losses incurred in any transaction entered into for profit, 
though not connected with a trade or business; and
    (3) Losses of property not connected with a trade or business and 
not incurred in any transaction entered into for profit, if such losses 
arise from fire, storm, shipwreck, or other causalty, or from theft, and 
if the loss involved has not been allowed for estate tax purposes in the 
estate tax return. For additional provisions pertaining to the allowance 
of casualty and theft losses, see Sec. Sec. 1.165-7 and 1.165-8, 
respectively.

For special rules relating to an election by a taxpayer to deduct 
disaster losses in the taxable year immediately preceding the taxable 
year in which the disaster occurred, see section 165(h) and Sec. 1.165-
11.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6735, 29 FR 
6493, May 19, 1964; T.D. 6996, 34 FR 835, Jan. 18, 1969; T.D. 7301, 39 
FR 963, Jan. 4, 1974; T.D. 7522, 42 FR 63411, Dec. 16, 1977]



Sec. 1.165-2  Obsolescence of nondepreciable property.

    (a) Allowance of deduction. A loss incurred in a business or in a 
transaction entered into for profit and arising from the sudden 
termination of the usefulness in such business or transaction of any 
nondepreciable property, in a case where such business or transaction is 
discontinued or where such property is permanently discarded from use 
therein, shall be allowed as a deduction under section 165(a) for the 
taxable year in which the loss is actually sustained. For this purpose, 
the taxable year in which the loss is sustained is not necessarily the 
taxable year in which the overt act of abandonment, or the loss of title 
to the property, occurs.
    (b) Exceptions. This section does not apply to losses sustained upon 
the sale

[[Page 902]]

or exchange of property, losses sustained upon the obsolescence or 
worthlessness of depreciable property, casualty losses, or losses 
reflected in inventories required to be taken under section 471. The 
limitations contained in sections 1211 and 1212 upon losses from the 
sale or exchange of capital assets do not apply to losses allowable 
under this section.
    (c) Cross references. For the allowance under section 165(a) of 
losses arising from the permanent withdrawal of depreciable property 
from use in the trade or business or in the production of income, see 
Sec. 1.167(a)-8. For provisions respecting the obsolescence of 
depreciable property, see Sec. 1.167(a)-9. For the allowance of 
casualty losses, see Sec. 1.165-7.



Sec. 1.165-3  Demolition of buildings.

    (a) Intent to demolish formed at time of purchase. (1) Except as 
provided in subparagraph (2) of this paragraph, the following rule shall 
apply when, in the course of a trade or business or in a transaction 
entered into for profit, real property is purchased with the intention 
of demolishing either immediately or subsequently the buildings situated 
thereon: No deduction shall be allowed under section 165(a) on account 
of the demolition of the old buildings even though any demolition 
originally planned is subsequently deferred or abandoned. The entire 
basis of the property so purchased shall, notwithstanding the provisions 
of Sec. 1.167(a)-5, be allocated to the land only. Such basis shall be 
increased by the net cost of demolition or decreased by the net proceeds 
from demolition.
    (2)(i) If the property is purchased with the intention of 
demolishing the buildings and the buildings are used in a trade or 
business or held for the production of income before their demolition, a 
portion of the basis of the property may be allocated to such buildings 
and depreciated over the period during which they are so used or held. 
The fact that the taxpayer intends to demolish the buildings shall be 
taken into account in making the apportionment of basis between the land 
and buildings under Sec. 1.167(a)-5. In any event, the portion of the 
purchase price which may be allocated to the buildings shall not exceed 
the present value of the right to receive rentals from the buildings 
over the period of their intended use. The present value of such right 
shall be determined at the time that the buildings are first used in the 
trade or business or first held for the production of income. If the 
taxpayer does not rent the buildings, but uses them in his own trade or 
business or in the production of his income, the present value of such 
right shall be determined by reference to the rentals which could be 
realized during such period of intended use. The fact that the taxpayer 
intends to rent or use the buildings for a limited period before their 
demolition shall also be taken into account in computing the useful life 
in accordance with paragraph (b) of Sec. 1.167(a)-1.
    (ii) Any portion of the purchase price which is allocated to the 
buildings in accordance with this subparagraph shall not be included in 
the basis of the land computed under subparagraph (1) of this paragraph, 
and any portion of the basis of the buildings which has not been 
recovered through depreciation or otherwise at the time of the 
demolition of the buildings is allowable as a deduction under section 
165.
    (iii) The application of this subparagraph may be illustrated by the 
following example:

    Example. In January 1958, A purchased land and a building for 
$60,000 with the intention of demolishing the building. In the following 
April, A concludes that he will be unable to commence the construction 
of a proposed new building for a period of more than 3 years. 
Accordingly, on June 1, 1958, he leased the building for a period of 3 
years at an annual rental of $1,200. A intends to demolish the building 
upon expiration of the lease. A may allocate a portion of the $60,000 
basis of the property to the building to be depreciated over the 3-year 
period. That portion is equal to the present value of the right to 
receive $3,600 (3 times $1,200). Assuming that the present value of that 
right determined as of June 1, 1958, is $2,850, A may allocate that 
amount to the building and, if A files his return on the basis of a 
taxable year ending May 31, 1959, A may take a depreciation deduction 
with respect to such building of $950 for such taxable year. The basis 
of the land to A as determined under subparagraph (1) of this paragraph 
is reduced by $2,850. If on June 1, 1960, A ceases to rent the building 
and demolishes it, the balance of the

[[Page 903]]

undepreciated portion allocated to the buildings, $950, may be deducted 
from gross income under section 165.

    (3) The basis of any building acquired in replacement of the old 
buildings shall not include any part of the basis of the property 
originally purchased even though such part was, at the time of purchase, 
allocated to the buildings to be demolished for purposes of determining 
allowable depreciation for the period before demolition.
    (b) Intent to demolish formed subsequent to the time of acquisition. 
(1) Except as provided in subparagraph (2) of this paragraph, the loss 
incurred in a trade or business or in a transaction entered into for 
profit and arising from a demolition of old buildings shall be allowed 
as a deduction under section 165(a) if the demolition occurs as a result 
of a plan formed subsequent to the acquisition of the buildings 
demolished. The amount of the loss shall be the adjusted basis of the 
buildings demolished increased by the net cost of demolition or 
decreased by the net proceeds from demolition. See paragraph (c) of 
Sec. 1.165-1 relating to amount deductible under section 165. The basis 
of any building acquired in replacement of the old buildings shall not 
include any part of the basis of the property demolished.
    (2) If a lessor or lessee of real property demolishes the buildings 
situated thereon pursuant to a lease or an agreement which resulted in a 
lease, under which either the lessor was required or the lessee was 
required or permitted to demolish such buildings, no deduction shall be 
allowed to the lessor under section 165(a) on account of the demolition 
of the old buildings. However, the adjusted basis of the demolished 
buildings, increased by the net cost of demolition or decreased by the 
net proceeds from demolition, shall be considered as a part of the cost 
of the lease to be amortized over the remaining term thereof.
    (c) Evidence of intention. (1) Whether real property has been 
purchased with the intention of demolishing the buildings thereon or 
whether the demolition of the buildings occurs as a result of a plan 
formed subsequent to their acquisition is a question of fact, and the 
answer depends upon an examination of all the surrounding facts and 
circumstances. The answer to the question does not depend solely upon 
the statements of the taxpayer at the time he acquired the property or 
demolished the buildings, but such statements, if made, are relevant and 
will be considered. Certain other relevant facts and circumstances that 
exist in some cases and the inferences that might reasonably be drawn 
from them are described in subparagraphs (2) and (3) of this paragraph. 
The question as to the taxpayer's intention is not answered by any 
inference that is drawn from any one fact or circumstance but can be 
answered only by a consideration of all relevant facts and circumstances 
and the reasonable inferences to be drawn therefrom.
    (2) An intention at the time of acquisition to demolish may be 
suggested by:
    (i) A short delay between the date of acquisition and the date of 
demolition;
    (ii) Evidence of prohibitive remodeling costs determined at the time 
of acquisition;
    (iii) Existence of municipal regulations at the time of acquisition 
which would prohibit the continued use of the buildings for profit 
purposes;
    (iv) Unsuitability of the buildings for the taxpayer's trade or 
business at the time of acquisition; or
    (v) Inability at the time of acquisition to realize a reasonable 
income from the buildings.
    (3) The fact that the demolition occurred pursuant to a plan formed 
subsequent to the acquisition of the property may be suggested by:
    (i) Substantial improvement of the buildings immediately after their 
acquisition;
    (ii) Prolonged use of the buildings for business purposes after 
their acquisition;
    (iii) Suitability of the buildings for investment purposes at the 
time of acquisition;
    (iv) Substantial change in economic or business conditions after the 
date of acquisition;
    (v) Loss of useful value occurring after the date of acquisition;
    (vi) Substantial damage to the buildings occurring after their 
acquisition;

[[Page 904]]

    (vii) Discovery of latent structural defects in the buildings after 
their acquisition;
    (viii) Decline in the taxpayer's business after the date of 
acquisition;
    (ix) Condemnation of the property by municipal authorities after the 
date of acquisition; or
    (x) Inability after acquisition to obtain building material 
necessary for the improvement of the property.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 74474, 41 FR 
55710, Dec. 22, 1976]



Sec. 1.165-4  Decline in value of stock.

    (a) Deduction disallowed. No deduction shall be allowed under 
section 165(a) solely on account of a decline in the value of stock 
owned by the taxpayer when the decline is due to a fluctuation in the 
market price of the stock or to other similar cause. A mere shrinkage in 
the value of stock owned by the taxpayer, even though extensive, does 
not give rise to a deduction under section 165(a) if the stock has any 
recognizable value on the date claimed as the date of loss. No loss for 
a decline in the value of stock owned by the taxpayer shall be allowed 
as a deduction under section 165(a) except insofar as the loss is 
recognized under Sec. 1.1002-1 upon the sale or exchange of the stock 
and except as otherwise provided in Sec. 1.165-5 with respect to stock 
which becomes worthless during the taxable year.
    (b) Stock owned by banks. (1) In the regulation of banks and certain 
other corporations, Federal and State authorities may require that stock 
owned by such organizations be charged off as worthless or written down 
to a nominal value. If, in any such case, this requirement is premised 
upon the worthlessness of the stock, the charging off or writing down 
will be considered prima facie evidence of worthlessness for purposes of 
section 165(a); but, if the charging off or writing down is due to a 
fluctuation in the market price of the stock or if no reasonable attempt 
to determine the worthlessness of the stock has been made, then no 
deduction shall be allowed under section 165(a) for the amount so 
charged off or written down.
    (2) This paragraph shall not be construed, however, to permit a 
deduction under section 165(a) unless the stock owned by the bank or 
other corporation actually becomes worthless in the taxable year. Such a 
taxpayer owning stock which becomes worthless during the taxable year is 
not precluded from deducting the loss under section 165(a) merely 
because, in obedience to the specific orders or general policy of such 
supervisory authorities, the value of the stock is written down to a 
nominal amount instead of being charged off completely.
    (c) Application to inventories. This section does not apply to a 
decline in the value of corporate stock reflected in inventories 
required to be taken by a dealer in securities under section 471. See 
Sec. 1.471-5.
    (d) Definition. As used in this section, the term ``stock'' means a 
share of stock in a corporation or a right to subscribe for, or to 
receive, a share of stock in a corporation.



Sec. 1.165-5  Worthless securities.

    (a) Definition of security. As used in section 165(g) and this 
section, the term ``security'' means:
    (1) A share of stock in a corporation;
    (2) A right to subscribe for, or to receive, a share of stock in a 
corporation; or
    (3) A bond, debenture, note, or certificate, or other evidence of 
indebtedness to pay a fixed or determinable sum of money, which has been 
issued with interest coupons or in registered form by a domestic or 
foreign corporation or by any government or political subdivision 
thereof.
    (b) Ordinary loss. If any security which is not a capital asset 
becomes wholly worthless during the taxable year, the loss resulting 
therefrom may be deducted under section 165(a) as an ordinary loss.
    (c) Capital loss. If any security which is a capital asset becomes 
wholly worthless at any time during the taxable year, the loss resulting 
therefrom may be deducted under section 165(a) but only as though it 
were a loss from a sale or exchange, on the last day of the taxable 
year, of a capital asset. See section 165(g)(1). The amount so allowed 
as a deduction shall be subject to the limitations upon capital losses 
described in paragraph (c)(3) of Sec. 1.165-1.

[[Page 905]]

    (d) Loss on worthless securities of an affiliated corporation--(1) 
Deductible as an ordinary loss. If a taxpayer which is a domestic 
corporation owns any security of a domestic or foreign corporation which 
is affiliated with the taxpayer within the meaning of subparagraph (2) 
of this paragraph and such security becomes wholly worthless during the 
taxable year, the loss resulting therefrom may be deducted under section 
165(a) as an ordinary loss in accordance with paragraph (b) of this 
section. The fact that the security is in fact a capital asset of the 
taxpayer is immaterial for this purpose, since section 165(g)(3) 
provides that such security shall be treated as though it were not a 
capital asset for the purposes of section 165(g)(1). A debt which 
becomes wholly worthless during the taxable year shall be as an ordinary 
loss in accordance with the provisions of this subparagraph, to the 
extent that such debt is a security within the meaning of paragraph 
(a)(3) of this section.
    (2) Affiliated corporation defined. For purposes of this paragraph, 
a corporation shall be treated as affiliated with the taxpayer owning 
the security if--
    (i)(a) In the case of a taxable year beginning on or after January 
1, 1970, the taxpayer owns directly--
    (1) Stock possessing at least 80 percent of the voting power of all 
classes of such corporation's stock, and
    (2) At least 80 percent of each class of such corporation's 
nonvoting stock excluding for purposes of this subdivision (i)(a) 
nonvoting stock which is limited and preferred as to dividends (see 
section 1504(a)), or
    (b) In the case of a taxable year beginning before January 1, 1970, 
the taxpayer owns directly at least 95 percent of each class of the 
stock of such corporation;
    (ii) None of the stock of such corporation was acquired by the 
taxpayer solely for the purpose of converting a capital loss sustained 
by reason of the worthlessness of any such stock into an ordinary loss 
under section 165(g)(3), and
    (iii) More than 90 percent of the aggregate of the gross receipts of 
such corporation for all the taxable years during which it has been in 
existence has been from sources other than royalties, rents (except 
rents derived from rental of properties to employees of such corporation 
in the ordinary course of its operating business), dividends, interest 
(except interest received on the deferred purchase price of operating 
assets sold), annuities, and gains from sales or exchanges of stocks and 
securities. For this purpose, the term ``gross receipts'' means total 
receipts determined without any deduction for cost of goods sold, and 
gross receipts from sales or exchanges of stocks and securities shall be 
taken into account only to the extent of gains from such sales or 
exchanges.
    (e) Bonds issued by an insolvent corporation. A bond of an insolvent 
corporation secured only by a mortgage from which nothing is realized 
for the bondholders on foreclosure shall be regarded as having become 
worthless not later than the year of the foreclosure sale, and no 
deduction in respect of the loss shall be allowed under section 165(a) 
in computing a bondholder's taxable income for a subsequent year. See 
also paragraph (d) of Sec. 1.165-1.
    (f) Decline in market value. A taxpayer possessing a security to 
which this section relates shall not be allowed any deduction under 
section 165(a) on account of mere market fluctuation in the value of 
such security. See also Sec. 1.165-4.
    (g) Application to inventories. This section does not apply to any 
loss upon the worthlessness of any security reflected in inventories 
required to be taken by a dealer in securities under section 471. See 
Sec. 1.471-5.
    (h) Special rules for banks. For special rules applicable under this 
section to worthless securities of a bank, including securities issued 
by an affiliated bank, see Sec. 1.582-1.
    (i) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example (1). (i) X Corporation, a domestic manufacturing corporation 
which makes its return on the basis of the calendar year, owns 100 
percent of each class of the stock of Y Corporation; and, in addition, 
19 percent of the common stock (the only class of stock) of Z 
Corporation, which it acquired in 1948. Y Corporation, a domestic 
manufacturing corporation which makes its return on the basis of the 
calendar year, owns 81 percent of the

[[Page 906]]

common stock of Z Corporation, which it acquired in 1946. It is 
established that the stock of Z Corporation, which has from its 
inception derived all of its gross receipts from manufacturing 
operations, became worthless during 1971.
    (ii) Since the stock of Z Corporation which is owned by X 
Corporation is a capital asset and since X Corporation does not directly 
own at least 80 percent of the stock of Z Corporation, any loss 
sustained by X Corporation upon the worthlessness of such stock shall be 
deducted under section 165(g)(1) and paragraph (c) of this section as a 
loss from a sale or exchange on December 31, 1971, of a capital asset. 
The loss so sustained by X Corporation shall be considered a long-term 
capital loss under the provisions of section 1222(4), since the stock 
was held by that corporation for more than 6 months.
    (iii) Since Z Corporation is considered to be affiliated with Y 
Corporation under the provisions of paragraph (d)(2) of this section, 
any loss sustained by Y Corporation upon the worthlessness of the stock 
of Z Corporation shall be deducted in 1971 under section 165(g)(3) and 
paragraph (d)(1) of this section as an ordinary loss.
    Example (2). (i) On January 1, 1971, X Corporation, a domestic 
manufacturing corporation which makes its return on the basis of the 
calendar year, owns 60 percent of each class of the stock of Y 
Corporation, a foreign corporation, which it acquired in 1950. Y 
Corporation has, from the date of its incorporation, derived all of its 
gross receipts from manufacturing operations. It is established that the 
stock of Y Corporation became worthless on June 30, 1971. On August 1, 
1971, X Corporation acquires the balance of the stock of Y Corporation 
for the purpose of obtaining the benefit of section 165(g)(3) with 
respect to the loss it has sustained on the worthlessness of the stock 
of Y Corporation.
    (ii) Since the stock of Y Corporation which is owned by X 
Corporation is a capital asset and since Y Corporation is not to be 
treated as affiliated with X Corporation under the provisions of 
paragraph (d)(2) of this section, notwithstanding the fact that, at the 
close of 1971, X Corporation owns 100 percent of each class of stock of 
Y Corporation, any loss sustained by X Corporation upon the 
worthlessness of such stock shall be deducted under the provisions of 
section 165(g)(1) and paragraph (c) of this section as a loss from a 
sale or exchange on December 31, 1971, of a capital asset.
    Example (3). (i) X Corporation, a domestic manufacturing corporation 
which makes its return on the basis of the calendar year, owns 80 
percent of each class of the stock of Y Corporation, which from its 
inception has derived all of its gross receipts from manufacturing 
operations. As one of its capital assets, X Corporation owns $100,000 in 
registered bonds issued by Y Corporation payable at maturity on December 
31, 1974. It is established that these bonds became worthless during 
1971.
    (ii) Since Y Corporation is considered to be affiliated with X 
Corporation under the provisions of paragraph (d)(2) of this section, 
any loss sustained by X Corporation upon the worthlessness of these 
bonds may be deducted in 1971 under section 165(g)(3) and paragraph 
(d)(1) of this section as an ordinary loss. The loss may not be deducted 
under section 166 as a bad debt. See section 166(e).

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7224, 37 FR 25928, Dec. 6, 1972]



Sec. 1.165-6  Farming losses.

    (a) Allowance of losses. (1) Except as otherwise provided in this 
section, any loss incurred in the operation of a farm as a trade or 
business shall be allowed as a deduction under section 165(a) or as a 
net operating loss deduction in accordance with the provisions of 
section 172. See Sec. 1.172-1.
    (2) If the taxpayer owns and operates a farm for profit in addition 
to being engaged in another trade or business, but sustains a loss from 
the operation of the farming business, then the amount of loss sustained 
in the operation of the farm may be deducted from gross income, if any, 
from all other sources.
    (3) Loss incurred in the operation of a farm for recreation or 
pleasure shall not be allowed as a deduction from gross income. See 
Sec. 1.162-12.
    (b) Loss from shrinkage. If, in the course of the business of 
farming, farm products are held for a favorable market, no deduction 
shall be allowed under section 165(a) in respect of such products merely 
because of shrinkage in weight, decline in value, or deterioration in 
storage.
    (c) Loss of prospective crop. The total loss by frost, storm, flood, 
or fire of a prospective crop being grown in the business of farming 
shall not be allowed as a deduction under section 165(a).
    (d) Loss of livestock--(1) Raised stock. A taxpayer engaged in the 
business of raising and selling livestock, such as cattle, sheep, or 
horses, may not deduct as a loss under section 165(a) the value of 
animals that perish from

[[Page 907]]

among those which were raised on the farm.
    (2) Purchased stock. The loss sustained upon the death by disease, 
exposure, or injury of any livestock purchased and used in the trade or 
business of farming shall be allowed as a deduction under section 
165(a). See, also, paragraph (e) of this section.
    (e) Loss due to compliance with orders of governmental authority. 
The loss sustained upon the destruction by order of the United States, a 
State, or any other governmental authority, of any livestock, or other 
property, purchased and used in the trade or business of farming shall 
be allowed as a deduction under section 165(a).
    (f) Amount deductible--(1) Expenses of operation. The cost of any 
feed, pasture, or care which is allowed under section 162 as an expense 
of operating a farm for profit shall not be included as a part of the 
cost of livestock for purposes of determining the amount of loss 
deductible under section 165(a) and this section. For the deduction of 
farming expenses, see Sec. 1.162-12.
    (2) Losses reflected in inventories. If inventories are taken into 
account in determining the income from the trade or business of farming, 
no deduction shall be allowed under this section for losses sustained 
during the taxable year upon livestock or other products, whether 
purchased for resale or produced on the farm, to the extent such losses 
are reflected in the inventory on hand at the close of the taxable year. 
Nothing in this section shall be construed to disallow the deduction of 
any loss reflected in the inventories of the taxpayer. For provisions 
relating to inventories of farmers, see section 471 and the regulations 
thereunder.
    (3) Other limitations. For other provisions relating to the amount 
deductible under this section, see paragraph (c) of Sec. 1.165-1, 
relating to the amount deductible under section 165(a); Sec. 1.165-7, 
relating to casualty losses; and Sec. 1.1231-1, relating to gains and 
losses from the sale or exchange of certain property used in the trade 
or business.
    (g) Other provisions applicable to farmers. For other provisions 
relating to farmers, see Sec. 1.61-4, relating to gross income of 
farmers; paragraph (b) of Sec. 1.167(a)-6, relating to depreciation in 
the case of farmers; and Sec. 1.175-1, relating to soil and water 
conservation expenditures.



Sec. 1.165-7  Casualty losses.

    (a) In general--(1) Allowance of deduction. Except as otherwise 
provided in paragraphs (b)(4) and (c) of this section, any loss arising 
from fire, storm, shipwreck, or other casualty is allowable as a 
deduction under section 165(a) for the taxable year in which the loss is 
sustained. However, see Sec. 1.165-6, relating to farming losses, and 
Sec. 1.165-11, relating to an election by a taxpayer to deduct disaster 
losses in the taxable year immediately preceding the taxable year in 
which the disaster occurred. The manner of determining the amount of a 
casualty loss allowable as a deduction in computing taxable income under 
section 63 is the same whether the loss has been incurred in a trade or 
business or in any transaction entered into for profit, or whether it 
has been a loss of property not connected with a trade or business and 
not incurred in any transaction entered into for profit. The amount of a 
casualty loss shall be determined in accordance with paragraph (b) of 
this section. For other rules relating to the treatment of deductible 
casualty losses, see Sec. 1.1231-1, relating to the involuntary 
conversion of property.
    (2) Method of valuation. (i) In determining the amount of loss 
deductible under this section, the fair market value of the property 
immediately before and immediately after the casualty shall generally be 
ascertained by competent appraisal. This appraisal must recognize the 
effects of any general market decline affecting undamaged as well as 
damaged property which may occur simultaneously with the casualty, in 
order that any deduction under this section shall be limited to the 
actual loss resulting from damage to the property.
    (ii) The cost of repairs to the property damaged is acceptable as 
evidence of the loss of value if the taxpayer shows that (a) the repairs 
are necessary to restore the property to its condition immediately 
before the casualty, (b) the amount spent for such repairs is not 
excessive, (c) the repairs do

[[Page 908]]

not care for more than the damage suffered, and (d) the value of the 
property after the repairs does not as a result of the repairs exceed 
the value of the property immediately before the casualty.
    (3) Damage to automobiles. An automobile owned by the taxpayer, 
whether used for business purposes or maintained for recreation or 
pleasure, may be the subject of a casualty loss, including those losses 
specifically referred to in subparagraph (1) of this paragraph. In 
addition, a casualty loss occurs when an automobile owned by the 
taxpayer is damaged and when:
    (i) The damage results from the faulty driving of the taxpayer or 
other person operating the automobile but is not due to the willful act 
or willful negligence of the taxpayer or of one acting in his behalf or
    (ii) The damage results from the faulty driving of the operator of 
the vehicle with which the automobile of the taxpayer collides.
    (4) Application to inventories. This section does not apply to a 
casualty loss reflected in the inventories of the taxpayer. For 
provisions relating to inventories, see section 471 and the regulations 
thereunder.
    (5) Property converted from personal use. In the case of property 
which originally was not used in the trade or business or for income-
producing purposes and which is thereafter converted to either of such 
uses, the fair market value of the property on the date of conversion, 
if less than the adjusted basis of the property at such time, shall be 
used, after making proper adjustments in respect of basis, as the basis 
for determining the amount of loss under paragraph (b)(1) of this 
section. See paragraph (b) of Sec. 1.165-9, and Sec. 1.167(g)-1.
    (6) Theft losses. A loss which arises from theft is not considered a 
casualty loss for purposes of this section. See Sec. 1.165-8, relating 
to theft losses.
    (b) Amount deductible--(1) General rule. In the case of any casualty 
loss whether or not incurred in a trade or business or in any 
transaction entered into for profit, the amount of loss to be taken into 
account for purposes of section 165(a) shall be the lesser of either--
    (i) The amount which is equal to the fair market value of the 
property immediately before the casualty reduced by the fair market 
value of the property immediately after the casualty; or
    (ii) The amount of the adjusted basis prescribed in Sec. 1.1011-1 
for determining the loss from the sale or other disposition of the 
property involved.

However, if property used in a trade or business or held for the 
production of income is totally destroyed by casualty, and if the fair 
market value of such property immediately before the casualty is less 
than the adjusted basis of such property, the amount of the adjusted 
basis of such property shall be treated as the amount of the loss for 
purposes of section 165(a).
    (2) Aggregation of property for computing loss. (i) A loss incurred 
in a trade or business or in any transaction entered into for profit 
shall be determined under subparagraph (1) of this paragraph by 
reference to the single, identifiable property damaged or destroyed. 
Thus, for example, in determining the fair market value of the property 
before and after the casualty in a case where damage by casualty has 
occurred to a building and ornamental or fruit trees used in a trade or 
business, the decrease in value shall be measured by taking the building 
and trees into account separately, and not together as an integral part 
of the realty, and separate losses shall be determined for such building 
and trees.
    (ii) In determining a casualty loss involving real property and 
improvements thereon not used in a trade or business or in any 
transaction entered into for profit, the improvements (such as buildings 
and ornamental trees and shrubbery) to the property damaged or destroyed 
shall be considered an integral part of the property, for purposes of 
subparagraph (1) of this paragraph, and no separate basis need be 
apportioned to such improvements.
    (3) Examples. The application of this paragraph may be illustrated 
by the following examples:

    Example (1). In 1956 B purchases for $3,600 an automobile which he 
uses for nonbusiness purposes. In 1959 the automobile is damaged

[[Page 909]]

in an accidental collision with another automobile. The fair market 
value of B's automobile is $2,000 immediately before the collision and 
$1,500 immediately after the collision. B receives insurance proceeds of 
$300 to cover the loss. The amount of the deduction allowable under 
section 165(a) for the taxable year 1959 is $200, computed as follows:

Value of automobile immediately before casualty...............    $2,000
Less: Value of automobile immediately after casualty..........     1,500
                                                               ---------
Value of property actually destroyed..........................       500
                                                               =========
Loss to be taken into account for purposes of section 165(a):        500
 Lesser amount of property actually destroyed ($500) or
 adjusted basis of property ($3,600)..........................
Less: Insurance received......................................       300
                                                               ---------
Deduction allowable...........................................       200
 

    Example (2). In 1958 A purchases land containing an office building 
for the lump sum of $90,000. The purchase price is allocated between the 
land ($18,000) and the building ($72,000) for purposes of determining 
basis. After the purchase A planted trees and ornamental shrubs on the 
grounds surrounding the building. In 1961 the land, building, trees, and 
shrubs are damaged by hurricane. At the time of the casualty the 
adjusted basis of the land is $18,000 and the adjusted basis of the 
building is $66,000. At that time the trees and shrubs have an adjusted 
basis of $1,200. The fair market value of the land and building 
immediately before the casualty is $18,000 and $70,000, respectively, 
and immediately after the casualty is $18,000 and $52,000, respectively. 
The fair market value of the trees and shrubs immediately before the 
casualty is $2,000 and immediately after the casualty is $400. In 1961 
insurance of $5,000 is received to cover the loss to the building. A has 
no other gains or losses in 1961 subject to section 1231 and Sec. 
1.1231-1. The amount of the deduction allowable under section 165(a) 
with respect to the building for the taxable year 1961 is $13,000, 
computed as follows:

Value of property immediately before casualty.................   $70,000
Less: Value of property immediately after casualty............    52,000
                                                               ---------
Value of property actually destroyed..........................    18,000
                                                               =========
Less: Insurance received......................................     5,000
Loss to be taken into account for purposes of section 165(a):     18,000
 Lesser amount of property actually destroyed ($18,000) or
 adjusted basis of property ($66,000).........................
Less: Insurance received......................................     5,000
                                                               ---------
Deduction allowable...........................................    13,000
 


The amount of the deduction allowable under section 165(a) with respect 
to the trees and shrubs for the taxable year 1961 is $1,200, computed as 
follows:

Value of property immediately before casualty.................    $2,000
Less: Value of property immediately after casualty............      $400
                                                               ---------
Value of property actually destroyed..........................     1,600
                                                               =========
Loss to be taken into account for purposes of section 165(a):      1,200
 Lesser amount of property actually destroyed ($1,600) or
 adjusted basis of property ($1,200)..........................
 

    Example (3). Assume the same facts as in example (2) except that A 
purchases land containing a house instead of an office building. The 
house is used as his private residence. Since the property is used for 
personal purposes, no allocation of the purchase price is necessary for 
the land and house. Likewise, no individual determination of the fair 
market values of the land, house, trees, and shrubs is necessary. The 
amount of the deduction allowable under section 165(a) with respect to 
the land, house, trees, and shrubs for the taxable year 1961 is $14,600, 
computed as follows:

Value of property immediately before casualty.................   $90,000
Less: Value of property immediately after casualty............    70,400
                                                               ---------
Value of property actually destroyed..........................    19,600
                                                               =========
Loss to be taken into account for purposes of section 165(a):     19,600
 Lesser amount of property actually destroyed ($19,600) or
 adjusted basis of property ($91,200).........................
Less: Insurance received......................................     5,000
                                                               ---------
Deduction allowable...........................................    14,600
 


    (4) Limitation on certain losses sustained by individuals after 
December 31, 1963. (i) Pursuant to section 165(c)(3), the deduction 
allowable under section 165(a) in respect of a loss sustained--
    (a) After December 31, 1963, in a taxable year ending after such 
date,
    (b) In respect of property not used in a trade or business or for 
income producing purposes, and
    (c) From a single casualty

shall be limited to that portion of the loss which is in excess of $100. 
The nondeductibility of the first $100 of loss applies to a loss 
sustained after December 31, 1963, without regard to when the casualty 
occurred. Thus, if property not used in a trade or business or for 
income producing purposes is damaged or destroyed by a casualty which 
occurred prior to January 1, 1964, and loss resulting therefrom is 
sustained after December 31, 1963, the $100 limitation applies.
    (ii) The $100 limitation applies separately in respect of each 
casualty and applies to the entire loss sustained from each casualty. 
Thus, if as a result of a particular casualty occurring in 1964, a 
taxpayer sustains in 1964 a loss

[[Page 910]]

of $40 and in 1965 a loss of $250, no deduction is allowable for the 
loss sustained in 1964 and the loss sustained in 1965 must be reduced by 
$60 ($100-$40). The determination of whether damage to, or destruction 
of, property resulted from a single casualty or from two or more 
separate casualties will be made upon the basis of the particular facts 
of each case. However, events which are closely related in origin 
generally give rise to a single casualty. For example, if a storm 
damages a taxpayer's residence and his automobile parked in his 
driveway, any loss sustained results from a single casualty. Similarly, 
if a hurricane causes high waves, all wind and flood damage to a 
taxpayer's property caused by the hurricane and the waves results from a 
single casualty.
    (iii) Except as otherwise provided in this subdivision, the $100 
limitation applies separately to each individual taxpayer who sustains a 
loss even though the property damaged or destroyed is owned by two or 
more individuals. Thus, if a house occupied by two sisters and jointly 
owned by them is damaged or destroyed, the $100 limitation applies 
separately to each sister in respect of any loss sustained by her. 
However, for purposes of applying the $100 limitation, a husband and 
wife who file a joint return for the first taxable year in which the 
loss is allowable as a deduction are treated as one individual taxpayer. 
Accordingly, if property jointly owned by a husband and wife, or 
property separately owned by the husband or by the wife, is damaged or 
destroyed by a single casualty in 1964, and a loss is sustained in that 
year by either or both the husband or wife, only one $100 limitation 
applies if a joint return is filed for 1964. If, however, the husband 
and wife file separate returns for 1964, the $100 limitation applies 
separately in respect of any loss sustained by the husband and in 
respect of any loss sustained by the wife. Where losses from a single 
casualty are sustained in two or more separate tax years, the husband 
and wife shall, for purposes of applying the $100 limitation to such 
losses, be treated as one individual for all such years if they file a 
joint return for the first year in which a loss is sustained from the 
casualty; they shall be treated as separate individuals for all such 
years if they file separate returns for the first such year. If a joint 
return is filed in the first loss year but separate returns are filed in 
a subsequent year, any unused portion of the $100 limitation shall be 
allocated equally between the husband and wife in the latter year.
    (iv) If a loss is sustained in respect of property used partially 
for business and partially for nonbusiness purposes, the $100 limitation 
applies only to that portion of the loss properly attributable to the 
nonbusiness use. For example, if a taxpayer sustains a $1,000 loss in 
respect of an automobile which he uses 60 percent for business and 40 
percent for nonbusiness, the loss is allocated 60 percent to business 
use and 40 percent to nonbusiness use. The $100 limitation applies to 
the portion of the loss allocable to the nonbusiness loss.
    (c) Loss sustained by an estate. A casualty loss of property not 
connected with a trade or business and not incurred in any transaction 
entered into for profit which is sustained during the settlement of an 
estate shall be allowed as a deduction under sections 165(a) and 641(b) 
in computing the taxable income of the estate if the loss has not been 
allowed under section 2054 in computing the taxable estate of the 
decedent and if the statement has been filed in accordance with Sec. 
1.642(g)-1. See section 165(c)(3).
    (d) Loss treated as though attributable to a trade or business. For 
the rule treating a casualty loss not connected with a trade or business 
as though it were a deduction attributable to a trade or business for 
purposes of computing a net operating loss, see paragraph (a)(3)(iii) of 
Sec. 1.172-3.
    (e) Effective date. The rules of this section are applicable to any 
taxable year beginning after January 16, 1960. If, for any taxable year 
beginning on or before such date, a taxpayer computed the amount of any 
casualty loss in accordance with the rules then applicable, such 
taxpayer is not required to change the amount of the casualty loss 
allowable for any such prior taxable year. On the other hand, the 
taxpayer may, if he so desires, amend his income tax return for such 
year to compute the amount of a casualty loss in accordance with the 
provisions of this

[[Page 911]]

section, but no provision in this section shall be construed as 
extending the period of limitations within which a claim for credit or 
refund may be filed under section 6511.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6712, 29 FR 
3652, Mar. 24, 1964; T.D. 6786, 29 FR 18501, Dec. 29, 1964; T.D. 7522, 
42 FR 63411, Dec. 16, 1977]



Sec. 1.165-8  Theft losses.

    (a) Allowance of deduction. (1) Except as otherwise provided in 
paragraphs (b) and (c) of this section, any loss arising from theft is 
allowable as a deduction under section 165(a) for the taxable year in 
which the loss is sustained. See section 165(c)(3).
    (2) A loss arising from theft shall be treated under section 165(a) 
as sustained during the taxable year in which the taxpayer discovers the 
loss. See section 165(e). Thus, a theft loss is not deductible under 
section 165(a) for the taxable year in which the theft actually occurs 
unless that is also the year in which the taxpayer discovers the loss. 
However, if in the year of discovery there exists a claim for 
reimbursement with respect to which there is a reasonable prospect of 
recovery, see paragraph (d) of Sec. 1.165-1.
    (3) The same theft loss shall not be taken into account both in 
computing a tax under chapter 1, relating to the income tax, or chapter 
2, relating to additional income taxes, of the Internal Revenue Code of 
1939 and in computing the income tax under the Internal Revenue Code of 
1954. See section 7852(c), relating to items not to be twice deducted 
from income.
    (b) Loss sustained by an estate. A theft loss of property not 
connected with a trade or business and not incurred in any transaction 
entered into for profit which is discovered during the settlement of an 
estate, even though the theft actually occurred during a taxable year of 
the decedent, shall be allowed as a deduction under sections 165(a) and 
641(b) in computing the taxable income of the estate if the loss has not 
been allowed under section 2054 in computing the taxable estate of the 
decedent and if the statement has been filed in accordance with Sec. 
1.642(g)-1. See section 165(c)(3). For purposes of determining the year 
of deduction, see paragraph (a)(2) of this section.
    (c) Amount deductible. The amount deductible under this section in 
respect of a theft loss shall be determined consistently with the manner 
prescribed in Sec. 1.165-7 for determining the amount of casualty loss 
allowable as a deduction under section 165(a). In applying the 
provisions of paragraph (b) of Sec. 1.165-7 for this purpose, the fair 
market value of the property immediately after the theft shall be 
considered to be zero. In the case of a loss sustained after December 
31, 1963, in a taxable year ending after such date, in respect of 
property not used in a trade or business or for income producing 
purposes, the amount deductible shall be limited to that portion of the 
loss which is in excess of $100. For rules applicable in applying the 
$100 limitation, see paragraph (b)(4) of Sec. 1.165-7. For other rules 
relating to the treatment of deductible theft losses, see Sec. 1.1231-
1, relating to the involuntary conversion of property.
    (d) Definition. For purposes of this section the term ``theft'' 
shall be deemed to include, but shall not necessarily be limited to, 
larceny, embezzlement, and robbery.
    (e) Application to inventories. This section does not apply to a 
theft loss reflected in the inventories of the taxpayer. For provisions 
relating to inventories, see section 471 and the regulations thereunder.
    (f) Example. The application of this section may be illustrated by 
the following example:

    Example. In 1955 B, who makes her return on the basis of the 
calendar year, purchases for personal use a diamond brooch costing 
$4,000. On November 30, 1961, at which time it has a fair market value 
of $3,500, the brooch is stolen; but B does not discover the loss until 
January 1962. The brooch was fully insured against theft. A controversy 
develops with the insurance company over its liability in respect of the 
loss. However, in 1962, B has a reasonable prospect of recovery of the 
fair market value of the brooch from the insurance company. The 
controversy is settled in March 1963, at which time B receives $2,000 in 
insurance proceeds to cover the loss from theft. No deduction for the 
loss is allowable for 1961 or 1962; but the amount of the deduction 
allowable under section 165(a) for the taxable year 1963 is $1,500, 
computed as follows:

Value of property immediately before theft....................    $3,500

[[Page 912]]

 
Less: Value of property immediately after the theft...........         0
                                                               ---------
 
Balance.......................................................     3,500
                                                               =========
 
Loss to be taken into account for purposes of section 165(a):     $3,500
 ($3,500 but not to exceed adjusted basis of $4,000 at time of
 theft).......................................................
Less: Insurance received in 1963..............................     2,000
                                                               ---------
 
Deduction allowable for 1963..................................     1,500
 


[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6786, 29 FR 
18502, Dec. 29, 1964]



Sec. 1.165-9  Sale of residential property.

    (a) Losses not allowed. A loss sustained on the sale of residential 
property purchased or constructed by the taxpayer for use as his 
personal residence and so used by him up to the time of the sale is not 
deductible under section 165(a).
    (b) Property converted from personal use. (1) If property purchased 
or constructed by the taxpayer for use as his personal residence is, 
prior to its sale, rented or otherwise appropriated to income-producing 
purposes and is used for such purposes up to the time of its sale, a 
loss sustained on the sale of the property shall be allowed as a 
deduction under section 165(a).
    (2) The loss allowed under this paragraph upon the sale of the 
property shall be the excess of the adjusted basis prescribed in Sec. 
1.1011-1 for determining loss over the amount realized from the sale. 
For this purpose, the adjusted basis for determining loss shall be the 
lesser of either of the following amounts, adjusted as prescribed in 
Sec. 1.1011-1 for the period subsequent to the conversion of the 
property to income-producing purposes:
    (i) The fair market value of the property at the time of conversion, 
or
    (ii) The adjusted basis for loss, at the time of conversion, 
determined under Sec. 1.1011-1 but without reference to the fair market 
value.
    (3) For rules relating to casualty losses of property converted from 
personal use, see paragraph (a)(5) of Sec. 1.165-7. To determine the 
basis for depreciation in the case of such property, see Sec. 1.167(g)-
1. For limitations on the loss from the sale of a capital asset, see 
paragraph (c)(3) of Sec. 1.165-1.
    (c) Examples. The application of paragraph (b) of this section may 
be illustrated by the following examples:

    Example (1). Residential property is purchased by the taxpayer in 
1943 for use as his personal residence at a cost of $25,000, of which 
$15,000 is allocable to the building. The taxpayer uses the property as 
his personal residence until January 1, 1952, at which time its fair 
market value is $22,000, of which $12,000 is allocable to the building. 
The taxpayer rents the property from January 1, 1952, until January 1, 
1955, at which time it is sold for $16,000. On January 1, 1952, the 
building has an estimated useful life of 20 years. It is assumed that 
the building has no estimated salvage value and that there are no 
adjustments in respect of basis other than depreciation, which is 
computed on the straight-line method. The loss to be taken into account 
for purposes of section 165(a) for the taxable year 1955 is $4,200, 
computed as follows:

Basis of property at time of conversion for purposes of this     $22,000
 section (that is, the lesser of $25,000 cost or $22,000 fair
 market value)................................................
Less: Depreciation allowable from January 1, 1952, to January      1,800
 1, 1955 (3 years at 5 percent based on $12,000, the value of
 the building at time of conversion, as prescribed by Sec.
 1.167(g)-1)..................................................
                                                               ---------
 
Adjusted basis prescribed in Sec.  1.1011-1 for determining      20,200
 loss on sale of the property.................................
Less: Amount realized on sale.................................    16,000
                                                               ---------
 
Loss to be taken into account for purposes of section 165(a)..     4,200
 


In this example the value of the building at the time of conversion is 
used as the basis for computing depreciation. See example (2) of this 
paragraph wherein the adjusted basis of the building is required to be 
used for such purpose.
    Example (2). Residential property is purchased by the taxpayer in 
1940 for use as his personal residence at a cost of $23,000, of which 
$10,000 is allocable to the building. The taxpayer uses the property as 
his personal residence until January 1, 1953, at which time its fair 
market value is $20,000, of which $12,000 is allocable to the building. 
The taxpayer rents the property from January 1, 1953, until January 1, 
1957, at which time it is sold for $17,000. On January 1, 1953, the 
building has an estimated useful life of 20 years. It is assumed that 
the building has no estimated salvage value and that there are no 
adjustments in respect of basis other than depreciation, which is 
computed on the straight-line method. The loss to be taken into account 
for purposes of section 165(a) for the taxable year 1957 is $1,000, 
computed as follows:

[[Page 913]]



Basis of property at time of conversion for purposes of this     $20,000
 section (that is, the lesser of $23,000 cost or $20,000 fair
 market value)................................................
Less: Depreciation allowable from January 1, 1953, to January      2,000
 1, 1957 (4 years at 5 percent based on $10,000, the cost of
 the building, as prescribed by Sec.  1.167(g)-1.............
                                                               ---------
 
Adjusted basis prescribed in Sec.  1.1011-1 for determining     $18,000
 loss on sale of the property.................................
Less: Amount realized on sale.................................    17,000
                                                               ---------
 
Loss to be taken into account for purposes of section 165(a)..     1,000
 


[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6712, 29 FR 
3652, Mar. 24, 1964]



Sec. 1.165-10  Wagering losses.

    Losses sustained during the taxable year on wagering transactions 
shall be allowed as a deduction but only to the extent of the gains 
during the taxable year from such transactions. In the case of a husband 
and wife making a joint return for the taxable year, the combined losses 
of the spouses from wagering transactions shall be allowed to the extent 
of the combined gains of the spouses from wagering transactions.



Sec. 1.165-11  Election in respect of losses attributable to a disaster.

    (a) In general. Section 165(h) provides that a taxpayer who has 
sustained a disaster loss which is allowable as a deduction under 
section 165(a) may, under certain circumstances, elect to deduct such 
loss for the taxable year immediately preceding the taxable year in 
which the disaster actually occurred.
    (b) Loss subject to election. The election provided by section 
165(h) and paragraph (a) of this section applies only to a loss:
    (1) Arising from a disaster resulting in a determination referred to 
in subparagraph (2) of this paragraph and occurring--
    (i) After December 31, 1971, or
    (ii) After December 31, 1961, and before January 1, 1972, and during 
the period following the close of a particular taxable year of the 
taxpayer and on or before the due date for filing the income tax return 
for that taxable year (determined without regard to any extension of 
time granted the taxpayer for filing such return);
    (2) Occurring in an area subsequently determined by the President of 
the United States to warrant assistance by the Federal Government under 
the Disaster Relief Act of 1974; and
    (3) Constituting a loss otherwise allowable as a deduction for the 
year in which the loss occurred under section 165(a) and the provisions 
of Sec. Sec. 1.165-1 through 1.165-10 which are applicable to such 
losses.
    (c) Amount of loss to which election applies. The amount of the loss 
to which section 165(h) and this section apply shall be the amount of 
the loss sustained during the period specified in paragraph (b)(1) of 
this section computed in accordance with the provisions of section 165 
and those provisions of Sec. Sec. 1.165-1 through 1.165-10 which are 
applicable to such losses. However, for purposes of making such 
computation, the period specified in paragraph (b)(1) of this section 
shall be deemed to be a taxable year.
    (d) Scope and effect of election. An election made pursuant to 
section 165(h) and this section in respect of a loss arising from a 
particular disaster shall apply to the entire loss sustained by the 
taxpayer from such disaster during the period specified in paragraph 
(b)(1) of this section in the area specified in paragraph (b)(2) of this 
section. If such an election is made, the disaster to which the election 
relates will be deemed to have occurred in the taxable year immediately 
preceding the taxable year in which the disaster actually occurred, and 
the loss to which the election applies will be deemed to have been 
sustained in such preceding taxable year.
    (e) Time and manner of making election. An election to claim a 
deduction with respect to a disaster loss described in paragraph (b) of 
this section for the taxable year immediately preceding the taxable year 
in which the disaster actually occurred must be made by filing a return, 
an amended return, or a claim for refund clearly showing that the 
election provided by section 165(h) has been made. In general, the 
return or claim should specify the date or dates of the disaster which 
gave rise to the loss, and the city,

[[Page 914]]

town, county, and State in which the property which was damaged or 
destroyed was located at the time of the disaster. An election in 
respect of a loss arising from a particular disaster occurring after 
December 31, 1971, must be made on or before the later of (1) the due 
date for filing the income tax return (determined without regard to any 
extension of time granted the taxpayer for filing such return) for the 
taxable year in which the disaster actually occurred, or (2) the due 
date of filing the income tax return (determined with regard to any 
extension of time granted the taxpayer for filing such return) for the 
taxable year immediately preceding the taxable year in which the 
disaster actually occurred. Such election shall be irrevocable after the 
later of (1) 90 days after the date on which the election was made, or 
(2) March 6, 1973. No revocation of such election shall be effective 
unless the amount of any credit or refund which resulted from such 
election is paid to the Internal Revenue Service within the revocation 
period described in the preceding sentence. However, in the case of a 
revocation made before receipt by the taxpayer of a refund claimed 
pursuant to such election, the revocation shall be effective if the 
refund is repaid within 30 calendar days after such receipt. An election 
in respect of a loss arising from a particular disaster occurring after 
December 31, 1961, and before January 1, 1972, must be made on or before 
the later of (1) the 15th day of the third month following the month in 
which falls the date prescribed for the filing of the income tax return 
(determined without regard to any extension of time granted the taxpayer 
for filing such return) for the taxable year immediately preceding the 
taxable year in which the disaster actually occurred, or (2) the due 
date for filing the income tax return (determined with regard to any 
extension of time granted the taxpayer for filing such return) for the 
taxable year immediately preceding the taxable year in which the 
disaster actually occurred. Such election shall be irrevocable after the 
date by which it must be made.

[T.D. 6735, 29 FR 6493, May 19, 1964, as amended by T.D. 7224, 37 FR 
25928, Dec. 6, 1972; T.D. 7522, 42 FR 63411, Dec. 16, 1977]



Sec. 1.165-12  Denial of deduction for losses on registration-required 
obligations not in registered form.

    (a) In general. Except as provided in paragraph (c) of this section, 
nothing in section 165(a) and the regulations thereunder, or in any 
other provision of law, shall be construed to provide a deduction for 
any loss sustained on any registration-required obligation held after 
December 31, 1982, unless the obligation is in registered form or the 
issuance of the obligation was subject to tax under section 4701. The 
term ``registration-required obligation'' has the meaning given to that 
term in section 163(f)(2), except that clause (iv) of subparagraph (A) 
thereof shall not apply. Therefore, although an obligation that is not 
in registered form is described in Sec. 1.163-5(c)(1), the holder of 
such an obligation shall not be allowed a deduction for any loss 
sustained on such obligation unless paragraph (c) of this section 
applies. The term ``holder'' means the person that would be denied a 
loss deduction under section 165(j)(1) or denied capital gain treatment 
under section 1287(a). For purposes of this section, the term United 
States means the United States and its possessions within the meaning of 
Sec. 1.163-5(c)(2)(iv).
    (b) Registered form--(1) Obligations issued after September 21, 
1984. With respect to any obligation originally issued after September 
21, 1984, the term ``registered form'' has the meaning given that term 
in section 103(j)(3) and the regulations thereunder. Therefore, an 
obligation that would otherwise be in registered form is not considered 
to be in registered form if it can be transferred at that time or at any 
time until its maturity by any means not described in Sec. 5f.103-1(c). 
An obligation that, as of a particular time, is not considered to be in 
registered form because it can be transferred by any means not described 
in Sec. 5f.103-1(c) is considered to be in registered form at all times 
during the period beginning with a later time and ending with the 
maturity of the obligation in which

[[Page 915]]

the obligation can be transferred only by a means described in Sec. 
5f.103-1(c).
    (2) Obligations issued after December 31, 1982 and on or before 
September 21, 1984. With respect to any obligation originally issued 
after December 31, 1982 and on or before September 21, 1984 or an 
obligation originally issued after September 21, 1984 pursuant to the 
exercise of a warrant or the conversion of a convertible obligation, 
which warrant or obligation (including conversion privilege) was issued 
after December 31, 1982 and on or before September 21, 1984, that 
obligation will be considered in registered form if it satisfied Sec. 
5f.163-1 or the proposed regulations provided in Sec. 1.163-5(c) and 
published in the Federal Register on September 2, 1983 (48 FR 39953).
    (c) Registration-required obligations not in registered form which 
are not subject to section 165(j)(1). Notwithstanding the fact that an 
obligation is a registration-required obligation that is not in 
registered form, the holder will not be subject to section 165(j)(1) if 
the holder meets the conditions of any one of the following 
subparagraphs (1), (2), (3), or (4) of this paragraph (c).
    (1) Persons permitted to hold in connection with the conduct of a 
trade or business. (i) The holder is an underwriter, broker, dealer, 
bank, or other financial institution (defined in paragraph (c)(1)(iv)) 
that holds such obligation in connection with its trade or business 
conducted outside the United States; or the holder is a broker-dealer 
(registered under Federal or State law or exempted from registration by 
the provisions of such law because it is a bank) that holds such 
obligation for sale to customers in the ordinary course of its trade or 
business.
    (ii) The holder must offer to sell, sell and deliver the obligation 
in bearer form only outside of the United States except that a holder 
that is a registered broker-dealer as described in paragraph (c)(1)(i) 
of this section may offer to sell and sell the obligation in bearer form 
inside the United States to a financial institution as defined in 
paragraph (c)(1)(iv) of this section for its own account or for the 
account of another financial institution or of an exempt organization as 
defined in section 501(c)(3).
    (iii) The holder may deliver an obligation in bearer form that is 
offered or sold inside the United States only if the holder delivers it 
to a financial institution that is purchasing for its own account, or 
for the account of another financial institution or of an exempt 
organization, and the financial institution or organization that 
purchases the obligation for its own account or for whose account the 
obligation is purchased represents that it will comply with the 
requirements of section 165(j)(3) (A), (B), or (C). Absent actual 
knowledge that the representation is false, the holder may rely on a 
written statement provided by the financial institution or exempt 
organization, including a statement that is delivered in electronic 
form. The holder may deliver a registration-required obligation in 
bearer form that is offered and sold outside the United States to a 
person other than a financial institution only if the holder has 
evidence in its records that such person is not a U.S. citizen or 
resident and does not have actual knowledge that such evidence is false. 
Such evidence may include a written statement by that person, including 
a statement that is delivered electronically. For purposes of this 
paragraph (c), the term deliver includes a transfer of an obligation 
evidenced by a book entry including a book entry notation by a clearing 
organization evidencing transfer of the obligation from one member of 
the organization to another member. For purposes of this paragraph (c), 
the term deliver does not include a transfer of an obligation to the 
issuer or its agent for cancellation or extinguishment. The record-
retention provisions in Sec. 1.1441-1(e)(4)(iii) shall apply to any 
statement that a holder receives pursuant to this paragraph (c)(1)(iii).
    (iv) For purposes of paragraph (c) of this section, the term 
``financial institution'' means a person which itself is, or more than 
50 percent of the total combined voting power of all classes of whose 
stock entitled to vote is owned by a person which is--
    (A) Engaged in the conduct of a banking, financing, or similar 
business within the meaning of section 954(c)(3)(B) as in effect before 
the Tax

[[Page 916]]

Reform Act of 1986, and the regulations thereunder;
    (B) Engaged in business as a broker or dealer in securities;
    (C) An insurance company;
    (D) A person that provides pensions or other similar benefits to 
retired employees;
    (E) Primarily engaged in the business of rendering investment 
advice;
    (F) A regulated investment company or other mutual fund; or
    (G) A finance corporation a substantial part of the business of 
which consists of making loans (including the acquisition of obligations 
under a lease which is entered into primarily as a financing 
transaction), acquiring accounts receivable, notes or installment 
obligations arising out of the sale of tangible personal property or the 
performing of services, or servicing debt obligations.
    (2) Persons permitted to hold obligations for their own investment 
account. The holder is a financial institution holding the obligation 
for its own investment account that satisfies the conditions set forth 
in subdivisions (i), (ii), (iii), and (iv) of his paragraph (c) (2).
    (i) The holder reports on its Federal income tax return for the 
taxable year any interest payments received (including original issue 
discount includable in gross income for such taxable year) with respect 
to such obligation and gain or loss on the sale or other disposition of 
such obligation;
    (ii) The holder indicates on its Federal income tax return that 
income, gain or loss described in paragraph (c)(2)(i) is attributable to 
registration-required obligations held in bearer form for its own 
account;
    (iii) The holder of a bearer obligation that resells the obligation 
inside the United States resells the obligation only to another 
financial institution for its own account or for the account of another 
financial institution or exempt organization; and
    (iv) The holder delivers such obligation in bearer form to any other 
person in accordance with paragraph (c)(1) (ii) and (iii) of this 
section.
    (3) Persons permitted to hold through financial institutions. The 
holder is any person that purchases and holds a registration-required 
obligation in bearer form through a financial institution with which the 
holder maintains a customer, custodial or nominee relationship and such 
institution agrees to satisfy, and does in fact satisfy, the conditions 
set forth in subdivisions (i), (ii), (iii), (iv) and (v) of this 
paragraph (c)(3).
    (i) The financial institution makes a return of information to the 
Internal Revenue Service with respect to any interest payments received. 
The financial institution must report original issue discount includable 
in the holder's gross income for the taxable year on any obligation so 
held, but only if the obligation appears in an Internal Revenue Service 
publication of obligations issued at an original issue discount and only 
in an amount determined in accordance with information contained in that 
publication. An information return for any interest payment shall be 
made on a Form 1099 for the calendar year. It shall indicate the 
aggregate amount of the payment received, the name, address and taxpayer 
identification number of the holder, and such other information as is 
required by the form. No return of information is required under this 
subdivision if the financial institution reports payments under section 
6041 or 6049.
    (ii) The financial institution makes a return of information on Form 
1099B with respect to any disposition by the holder of such obligation. 
The return shall show the name, address, and taxpayer identification 
number of the holder of the obligation, Committee on Uniform Security 
Information Procedures (CUSIP), gross proceeds, sale date, and such 
other information as may be required by the form. No return of 
information is required under this subdivision if such financial 
institution reports with respect to the disposition under section 6045.
    (iii) In the case of a bearer obligation offered for resale or 
resold in the United States, the financial institution may resell the 
obligation only to another financial institution for its own account or 
for the account of an exempt organization.
    (iv) The financial institution covenants with the holder that the 
financial institution will deliver the obligation in bearer form in 
accordance with

[[Page 917]]

the requirements set forth in paragraph (c)(1) (ii) and (iii).
    (v) The financial institution delivers the obligation in bearer form 
in accordance with paragraph (c)(1) (ii) and (iv) as if the financial 
institution delivering the obligation were the holder referred to in 
such paragraph.
    (4) Conversion of obligations into registered form. The holder is 
not a person described in paragraph (c) (1), (2), or (3) of this 
section, and within thirty days of the date when the seller or other 
transferor is reasonably able to make the bearer obligation available to 
the holder, the holder surrenders the obligation to a transfer agent or 
the issuer for conversion of the obligation into registered form. If 
such obligation is not registered within such 30 day period, the holder 
shall be subject to sections 165(j) and 1287(a).
    (d) Effective date. These regulations apply generally to obligations 
issued after January 20, 1987. However, a taxpayer may choose to apply 
the rules of Sec. 1.165-12 with respect to an obligation issued after 
December 31, 1982 and on or before January 20, 1987, which obligation is 
held after January 20, 1987.

[T.D. 8110, 51 FR 45459, Dec. 19, 1986, as amended by T.D. 8734, 62 FR 
53416, Oct. 14, 1997]



Sec. 1.165-13T  Questions and answers relating to the treatment of losses 

on certain straddle transactions entered into before the effective date of 
the Economic Recovery Tax Act of 1981, under section 108 of the Tax Reform 
Act of 1984 (temporary).

    The following questions and answers concern the treatment of losses 
on certain straddle transactions entered into before the effective date 
of the Economic Recovery Tax Act of 1981, under the Tax Reform Act of 
1984 (98 Stat. 494).
    Q-1  What is the scope of section 108 of the Tax Reform Act of 1984 
(Act)?
    A-1  Section 108 of the Act provides that in the case of any 
disposition of one or more positions, which were entered into before 
1982 and form part of a straddle, and to which the provisions of Title V 
of The Economic Recovery Act of 1981 (ERTA) do not apply, any loss from 
such disposition shall be allowed for the taxable year of the 
disposition if such position is part of a transaction entered into for 
profit. For purposes of section 108 of the Act, the term ``straddle'' 
has the meaning given to such term by section 1092(c) of the Internal 
Revenue Code of 1954 as in effect on the day after the date of enactment 
of ERTA; including a straddle all the positions of which are regulated 
futures contracts (as defined in Q&A-6 of this section). Straddles in 
certain listed stock options were not covered by ERTA and are not 
affected by this provision.
    Q-2  What transactions are considered entered into for profit?
    A-2  A transaction is considered entered into for profit if the 
transaction is entered into for profit within the meaning of section 
165(c)(2) of the Code. In this respect, section 108 of the Act restates 
existing law applicable to stradddle transactions. All the circumstances 
surrounding the transaction, including the magnitude and timing for 
entry into, and disposition of, the positions comprising the transaction 
are relevant in making the determination whether a transaction is 
considered entered into for profit. Moreover, in order for section 108 
of the Act to apply, the transaction must have sufficient substance to 
be recognized for Federal income tax purposes. Thus, for example, since 
a ``sham'' transaction would not be recognized for tax purposes, section 
108 of the Act would not apply to such a transaction.
    Q-3  If a loss is disallowed in a taxable year (year 1) because the 
transaction was not entered into for profit, is the entire gain from the 
straddle occurring in a later taxable year taxed?
    A-3  No. Under section 108(c) of the Act the taxpayer is allowed to 
offset the gain in the subsequent taxable year by the amount of loss 
(including expenses) disallowed in year 1.
    Q-4  In what manner does the for-profit test of Q&A-2 apply to 
losses from straddle transactions sustained by commodities dealers and 
persons regularly engaged in investing in regulated futures contracts?
    A-4  In general, for a loss to be allowable with respect to 
positions that form part of a straddle, the for-profit test of Q&A-2 
must be satisfied. However, certain positions (see Q&A-6) held

[[Page 918]]

by a commodities dealer or person regularly engaged in investing in 
regulated futures contracts are rebuttably presumed to be part of a 
transaction entered into for profit. Thus, the for profit test is 
applied to commodities dealers and persons regularly engaged in 
investing in regulated futures contracts in light of the factors 
relating to the applicability and rebuttal of the profit presumption, 
including, for example, the nature and extent of the taxpayer's trading 
activities.
    Q-5  Under what circumstances is the presumption considered 
rebutted?
    A-5  All the facts and circumstances of each case are to be 
considered in determining if the presumption is rebutted. The following 
factors are significant in making this determination: (1) The level of 
transaction costs; (2) the extent to which the transaction results from 
trading patterns different from the taxpayer's regular patterns; and (3) 
the extent of straddle transactions having tax results disproportionate 
to economic consequences. Factors other than the ones described above 
may be taken into account in making the determination. Moreover, a 
determination is not to be made solely on the basis of the number of 
factors indicating that the presumption is rebutted.
    Q-6  Does a commodities dealer or person regularly engaged in 
investing in regulated futures contracts qualify for the profit 
presumption for all transactions?
    A-6  No. The presumption is only applicable to regulated futures 
contract transactions in property that is the subject of the person's 
regular trading activity. For example, a commodities dealer who 
regularly trades only in agricultural futures will not qualify for the 
presumption for a silver futures straddle transaction. For purposes of 
this section, the term ``regulated futures contracts'' has the meaning 
given to such term by section 1256(b) of the Code as in effect before 
the enactment of the Tax Reform Act of 1984.
    Q-7  Who qualifies as a commodities dealer or as a person regularly 
engaged in investing in regulated futures contracts for purposes of the 
profit presumption?
    A-7  For purposes of this section, the term ``commodities dealer'' 
has the meaning given to such term by section 1402(i)(2)(B) of the Code. 
Section 1402(i)(2)(B) defines a commodities dealer as a person who is 
actively engaged in trading section 1256 contracts (which includes 
regulated futures contracts as defined in Q&A-6) and is registered with 
a domestic board of trade which is designated as a contract market by 
the Commodity Futures Trading Commission. To determine if a person is 
regularly engaged in investing in regulated futures contracts all the 
facts and circumstances should be considered including, but not limited 
to, the following factors: (1) Regularity of trading at all times 
throughout the year; (2) the level of transaction costs; (3) substantial 
volume and economic consequences of trading at all times throughout the 
year; (4) percentage of time dedicated to commodity trading activities 
as compared to other activities; and (5) the person's knowledge of the 
regulated futures contract market.
    Q-8  If a commodities dealer or a person regularly engaged in 
investing in regulated futures contracts participates in a syndicate, as 
defined in section 1256(e)(3)(B) of the Code, does the rebuttable 
presumption of ``entered into for profit'' apply to the transactions 
entered into through the syndicate?
    A-8  No. A participant in a syndicate does not qualify for the 
rebuttable presumption of ``entered into for profit'' with respect to 
transactions entered into by or for the syndicate. A syndicate is 
defined in section 1256(e)(3)(B) of the Code as any partnership or other 
entity (other than a corporation which is not an S corporation) if more 
than 35 percent of the losses of such entity during the taxable year are 
allocable to limited partners or limited entrepreneurs (within the 
meaning of section 464(e)(2)).
    Q-9  Will the Service continue to make the closed and completed 
transaction argument set forth in Rev. Rul. 77-185, 1977-1 C.B. 48, with 
respect to transactions covered by section 108 of the Act?
    A-9  No. The closed and completed transaction argument will not be 
made

[[Page 919]]

regarding transactions subject to section 108 of the Act. In general, 
losses in such transactions will be allowed for the taxable year of 
disposition if the transaction is not viewed as a sham and satisfies the 
``entered into for profit'' test described in Q&A-2. Nevertheless, for 
certain positions covered by section 108 of the Act, various Code 
sections may apply without regard to whether such position constitutes a 
straddle to disallow or limit the loss otherwise allowable in the year 
of the disposition. For example, dispositions of certain positions held 
by a partnership which resulted in a loss to a partner may be limited or 
disallowed under section 465 of 704(d).

[T.D. 7968, 49 FR 33445, Aug. 23, 1984]



Sec. 1.166-1  Bad debts.

    (a) Allowance of deduction. Section 166 provides that, in computing 
taxable income under section 63, a deduction shall be allowed in respect 
of bad debts owed to the taxpayer. For this purpose, bad debts shall, 
subject to the provisions of section 166 and the regulations thereunder, 
be taken into account either as--
    (1) A deduction in respect of debts which become worthless in whole 
or in part; or as
    (2) A deduction for a reasonable addition to a reserve for bad 
debts.
    (b) Manner of selecting method. (1) A taxpayer filing a return of 
income for the first taxable year for which he is entitled to a bad debt 
deduction may select either of the two methods prescribed by paragraph 
(a) of this section for treating bad debts, but such selection is 
subject to the approval of the district director upon examination of the 
return. If the method so selected is approved, it shall be used in 
returns for all subsequent taxable years unless the Commissioner grants 
permission to use the other method. A statement of facts substantiating 
any deduction claimed under section 166 on account of bad debts shall 
accompany each return of income.
    (2) Taxpayers who have properly selected one of the two methods for 
treating bad debts under provisions of prior law corresponding to 
section 166 shall continue to use that method for all subsequent taxable 
years unless the Commissioner grants permission to use the other method.
    (3)(i) For taxable years beginning after December 31, 1959, 
application for permission to change the method of treating bad debts 
shall be made in accordance with section 446(e) and paragraph (e)(3) of 
Sec. 1.446-1.
    (ii) For taxable years beginning before January 1, 1960, application 
for permission to change the method of treating bad debts shall be made 
at least 30 days before the close of the taxable year for which the 
change is effective.
    (4) Nothwithstanding paragraphs (b) (1), (2), and (3) of this 
section, a dealer in property currently employing the accrual method of 
accounting and currently maintaining a reserve for bad debts under 
section 166(c) (which may have included guaranteed debt obligations 
described in section 166(f)(1)(A)) may establish a reserve for section 
166(f)(1)(A) guaranteed debt obligations for a taxable year ending after 
October 21, 1965 under section 166(f) and Sec. 1.166-10 by filing on or 
before April 17, 1986 an amended return indicating that such a reserve 
has been established. The establishment of such a reserve will not be 
considered a change in method of accounting for purposes of section 
446(e). However, an election by a taxpayer to establish a reserve for 
bad debts under section 166(c) shall be treated as a change in method of 
accounting. See also Sec. 1.166-4, relating to reserve for bad debts, 
and Sec. 1.166-10, relating to reserve for guaranteed debt obligations.
    (c) Bona fide debt required. Only a bona fide debt qualifies for 
purposes of section 166. A bona fide debt is a debt which arises from a 
debtor-creditor relationship based upon a valid and enforceable 
obligation to pay a fixed or determinable sum of money. A debt arising 
out of the receivables of an accrual method taxpayer is deemed to be an 
enforceable obligation for purposes of the preceding sentence to the 
extent that the income such debt represents have been included in the 
return of income for the year for which the deduction as a bad debt is 
claimed or for a prior taxable year. For example, a debt arising out of 
gambling receivables that are unenforceable under state or

[[Page 920]]

local law, which an accrual method taxpayer includes in income under 
section 61, is an enforceable obligation for purposes of this pargarph. 
A gift or contribution to capital shall not be considered a debt for 
purposes of section 166. The fact that a bad debt its not due at the 
time of deduction shall not of itself prevent is allowance under section 
166. For the disallowance of deductions for bad debts owed by a 
political party, see Sec. 1.271-1.
    (d) Amount deductible--(1) General rule. Except in the case of a 
deduction for a reasonable addition to a reserve for bad debts, the 
basis for determining the amount of deduction under section 166 in 
respect of a bad debt shall be the same as the adjusted basis prescribed 
by Sec. 1.1011-1 for determining the loss from the sale or other 
disposition of property. To determine the allowable deduction in the 
case of obligations acquired before March 1, 1913, see also paragraph 
(b) of Sec. 1.1053-1.
    (2) Specific cases. Subject to any provision of section 166 and the 
regulations thereunder which provides to the contrary, the following 
amounts are deductible as bad debts:
    (i) Notes or accounts receivable. (a) If, in computing taxable 
income, a taxpayer values his notes or accounts receivable at their fair 
market value when received, the amount deductible as a bad debt under 
section 166 in respect of such receivables shall be limited to such fair 
market value even though it is less than their face value.
    (b) A purchaser of accounts receivable which become worthless during 
the taxable year shall be entitled under section 166 to a deduction 
which is based upon the price he paid for such receivables but not upon 
their face value.
    (ii) Bankruptcy claim. Only the difference between the amount 
received in distribution of the assets of a bankrupt and the amount of 
the claim may be deducted under section 166 as a bad debt.
    (iii) Claim against decedent's estate. The excess of the amount of 
the claim over the amount received by a creditor of a decedent in 
distribution of the assets of the decedent's estate may be considered a 
worthless debt under section 166.
    (e) Prior inclusion in income required. Worthless debts arising from 
unpaid wages, salaries, fees, rents, and similar items of taxable income 
shall not be allowed as a deduction under section 166 unless the income 
such items represent has been included in the return of income for the 
year for which the deduction as a bad debt is claimed or for a prior 
taxable year.
    (f) Recovery of bad debts. Any amount attributable to the recovery 
during the taxable year of a bad debt, or of a part of a bad debt, which 
was allowed as a deduction from gross income in a prior taxable year 
shall be included in gross income for the taxable year of recovery, 
except to the extent that the recovery is excluded from gross income 
under the provisions of Sec. 1.111-1, relating to the recovery of 
certain items previously deducted or credited. This paragraph shall not 
apply, however, to a bad debt which was previously charged against a 
reserve by a taxpayer on the reserve method of treating bad debts.
    (g) Worthless securities. (1) Section 166 and the regulations 
thereunder do not apply to a debt which is evidenced by a bond, 
debenture, note, or certificate, or other evidence of indebtedness, 
issued by a corporation or by a government or political subdivision 
thereof, with interest coupons or in registered form. See section 
166(e). For provisions allowing the deduction of a loss resulting from 
the worthlessness of such a debt, see Sec. 1.165-5.
    (2) The provisions of subparagraph (1) of this paragraph do not 
apply to any loss sustained by a bank and resulting from the 
worthlessness of a security described in section 165(g)(2)(C). See 
paragraph (a) of Sec. 1.582-1.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6996, 34 FR 
835, Jan. 18, 1969; T.D. 7902, 48 FR 33260, July 21, 1983; T.D. 8071, 51 
FR 2479, Jan. 17, 1986]



Sec. 1.166-2  Evidence of worthlessness.

    (a) General rule. In determining whether a debt is worthless in 
whole or in part the district director will consider all pertinent 
evidence, including the value of the collateral, if any, securing the 
debt and the financial condition of the debtor.

[[Page 921]]

    (b) Legal action not required. Where the surrounding circumstances 
indicate that a debt is worthless and uncollectible and that legal 
action to enforce payment would in all probability not result in the 
satisfaction of execution on a judgment, a showing of these facts will 
be sufficient evidence of the worthlessness of the debt for purposes of 
the deduction under section 166.
    (c) Bankruptcy--(1) General rule. Bankruptcy is generally an 
indication of the worthlessness of at least a part of an unsecured and 
unpreferred debt.
    (2) Year of deduction. In bankruptcy cases a debt may become 
worthless before settlement in some instances; and in others, only when 
a settlement in bankruptcy has been reached. In either case, the mere 
fact that bankruptcy proceedings instituted against the debtor are 
terminated in a later year, thereby confirming the conclusion that the 
debt is worthless, shall not authorize the shifting of the deduction 
under section 166 to such later year.
    (d) Banks and other regulated corporations--(1) Worthlessness 
presumed in year of charge-off. If a bank or other corporation which is 
subject to supervision by Federal authorities, or by State authorities 
maintaining substantially equivalent standards, charges off a debt in 
whole or in part, either--
    (i) In obedience to the specific orders of such authorities, or
    (ii) In accordance with established policies of such authorities, 
and, upon their first audit of the bank or other corporation subsequent 
to the charge-off, such authorities confirm in writing that the charge-
off would have been subject to such specific orders if the audit had 
been made on the date of the charge-off,

then the debt shall, to the extent charged off during the taxable year, 
be conclusively presumed to have become worthless, or worthless only in 
part, as the case may be, during such taxable year. But no such debt 
shall be so conclusively presumed to be worthless, or worthless only in 
part, as the case may be, if the amount so charged off is not claimed as 
a deduction by the taxpayer at the time of filing the return for the 
taxable year in which the charge-off takes place.
    (2) Evidence of worthlessness in later taxable year. If such a bank 
or other corporation does not claim a deduction for such a totally or 
partially worthless debt in its return for the taxable year in which the 
charge-off takes place, but claims the deduction for a later taxable 
year, then the charge-off in the prior taxable year shall be deemed to 
have been involuntary and the deduction under section 166 shall be 
allowed for the taxable year for which claimed, provided that the 
taxpayer produces sufficient evidence to show that--
    (i) The debt became wholly worthless in the later taxable year, or 
became recoverable only in part subsequent to the taxable year of the 
involuntary charge-off, as the case may be; and,
    (ii) To the extent that the deduction claimed in the later taxable 
year for a debt partially worthless was not involuntarily charged off in 
prior taxable years, it was charged off in the later taxable year.
    (3) Conformity election--(i) Eligibility for election. In lieu of 
applying paragraphs (d)(1) and (2) of this section, a bank (as defined 
in paragraph (d)(4)(i) of this section) that is subject to supervision 
by Federal authorities, or by state authorities maintaining 
substantially equivalent standards, may elect under this paragraph 
(d)(3) to use a method of accounting that establishes a conclusive 
presumption of worthlessness for debts, provided that the bank meets the 
express determination requirement of paragraph (d)(3)(iii)(D) of this 
section for the taxable year of the election.
    (ii) Conclusive presumption--(A) In general. If a bank satisfies the 
express determination requirement of paragraph (d)(3)(iii)(D) of this 
section and elects to use the method of accounting under this paragraph 
(d)(3)--
    (1) Debts charged off, in whole or in part, for regulatory purposes 
during a taxable year are conclusively presumed to have become 
worthless, or worthless only in part, as the case may be, during that 
year, but only if the charge-off results from a specific order of the 
bank's supervisory authority or corresponds to the bank's classification 
of the debt, in whole or in part, as a loss asset, as

[[Page 922]]

described in paragraph (d)(3)(ii)(C) of this section; and
    (2) A bad debt deduction for a debt that is subject to regulatory 
loss classification standards is allowed for a taxable year only to the 
extent that the debt is conclusively presumed to have become worthless 
under paragraph (d)(3)(ii)(A)(1) of this section during that year.
    (B) Charge-off should have been made in earlier year. The conclusive 
presumption that a debt is worthless in the year that it is charged off 
for regulatory purposes applies even if the bank's supervisory authority 
determines in a subsequent year that the charge-off should have been 
made in an earlier year. A pattern of charge-offs in the wrong year, 
however, may result in revocation of the bank's election by the 
Commissioner pursuant to paragraph (d)(3)(iv)(D) of this section.
    (C) Loss asset defined. A debt is classified as a loss asset by a 
bank if the bank assigns the debt to a class that corresponds to a loss 
asset classification under the standards set forth in the ``Uniform 
Agreement on the Classification of Assets and Securities Held by Banks'' 
(See Attachment to Comptroller of the Currency Banking Circular No. 127, 
Rev. 4-26-91, Comptroller of the Currency, Communications Department, 
Washington, DC 20219) or similar guidance issued by the Office of the 
Comptroller of the Currency, the Federal Deposit Insurance Corporation, 
the Board of Governors of the Federal Reserve, or the Farm Credit 
Administration; or for institutions under the supervision of the Office 
of Thrift Supervision, 12 CFR 563.160(b)(3).
    (iii) Election--(A) In general. An election under this paragraph 
(d)(3) is to be made on bank-by-bank basis and constitutes either the 
adoption of or a change in method of accounting, depending on the 
particular bank's facts. A change in method of accounting that results 
from the making of an election under this paragraph (d)(3) has the 
effects described in paragraph (d)(3)(iii)(B) of this section.
    (B) Effect of change in method of accounting. A change in method of 
accounting resulting from an election under this paragraph (d)(3) does 
not require or permit an adjustment under section 481(a). Under this 
cut-off approach--
    (1) There is no change in the Sec. 1.1011-1 adjusted basis of the 
bank's existing debts (as determined under the bank's former method of 
accounting for bad debts) as a result of the change in method of 
accounting;
    (2) With respect to debts that are subject to regulatory loss 
classification standards and are held by the bank at the beginning of 
the year of change (to the extent that they have not been charged off 
for regulatory purposes), and with respect to debts subject to 
regulatory loss classification standards that are originated or acquired 
subsequent to the beginning of the year of change, bad debt deductions 
in the year of change and thereafter are determined under the method of 
accounting for bad debts prescribed by this paragraph (d)(3);
    (3) With respect to debts that are not subject to regulatory loss 
classification standards or that have been totally charged off prior to 
the year of change, bad debt deductions are determined under the general 
rules of section 166; and
    (4) If there was any partial charge-off of a debt in a prechange 
year, any portion of which was not claimed as a deduction, the deduction 
reflecting that partial charge-off must be taken in the first year in 
which there is any further charge-off of the debt for regulatory 
purposes.
    (C) Procedures--(1) In general. A new bank adopts the method of 
accounting under this paragraph (d)(3) for any taxable year ending on or 
after December 31, 1991 (and for all subsequent taxable years) when it 
adopts its overall method of accounting for bad debts, by attaching a 
statement to this effect to its income tax return for that year. Any 
other bank makes an election for any taxable year ending on or after 
December 31, 1991 (and for all subsequent taxable years) by filing a 
completed Form 3115 (Application for Change in Accounting Method) in 
accordance with the rules of paragraph (d)(3)(iii)(C)(2) or (3) of this 
section. The statement or Form 3115 must include the name, address, and 
taxpayer identification number of the electing bank and contain a 
declaration that

[[Page 923]]

the express determination requirement of paragraph (d)(3)(iii)(D) of 
this section is satisfied for the taxable year of the election. When a 
Form 3115 is used, the declaration must be made in the space provided on 
the form for ``Other changes in method of accounting.'' The words 
``ELECTION UNDER Sec. 1.166-2(d)(3)'' must be typed or legibly printed 
at the top of the statement or page 1 of the Form 3115.
    (2) First election. The first time a bank makes this election, the 
statement or Form 3115 must be attached to the bank's timely filed 
return (taking into account extensions of time to file) for the first 
taxable year covered by the election. The consent of the Commissioner to 
make a change in method of accounting under this paragraph (d)(3) is 
granted, pursuant to section 446(e), to any bank that makes the election 
in accordance with this paragraph (d)(3)(iii)(C), provided the bank has 
not made a prior election under this paragraph (d)(3).
    (3) Subsequent elections. The advance consent of the Commissioner is 
required to make any election under this paragraph (d)(3) after a 
previous election has been revoked pursuant to paragraph (d)(3)(iv) of 
this section. This consent must be requested under the procedures, 
terms, and conditions prescribed under the authority of section 446(e) 
and Sec. 1.446-1(e) for requesting a change in method of accounting.
    (D) Express determination requirement. In connection with its most 
recent examination involving the bank's loan review process, the bank's 
supervisory authority must have made an express determination (in 
accordance with any applicable administrative procedure prescribed 
hereunder) that the bank maintains and applies loan loss classification 
standards that are consistent with the regulatory standards of that 
supervisory authority. For purposes of this paragraph (d)(3)(iii)(D), 
the supervisory authority of a bank is the appropriate Federal banking 
agency for the bank, as that term is defined in 12 U.S.C. 1813(q), or, 
in the case of an institution in the Farm Credit System, the Farm Credit 
Administration.
    (E) Transition period election. For taxable years ending before 
completion of the first examination of the bank by its supervisory 
authority (as defined in paragraph (d)(3)(iii)(D) of this section) that 
is after October 1, 1992, and that involves the bank's loan review 
process, the statement or Form 3115 filed by the bank must include a 
declaration that the bank maintains and applies loan loss classification 
standards that are consistent with the regulatory standards of that 
supervisory authority. A bank that makes this declaration is deemed to 
satisfy the express determination requirement of paragraph 
(d)(3)(iii)(D) of this section for those years, even though an express 
determination has not yet been made.
    (iv) Revocation of Election--(A) In general. Revocation of an 
election under this paragraph (d)(3) constitutes a change in method of 
accounting that has the effects described in paragraph (d)(3)(iv)(B) of 
this section. If an election under this paragraph (d)(3) has been 
revoked, a bank may make a subsequent election only under the provisions 
of paragraph (d)(3)(iii)(C)(3) of this section.
    (B) Effect of change in method of accounting. A change in method of 
accounting resulting from revocation of an election under this paragraph 
(d)(3) does not require or permit an adjustment under section 481(a). 
Under this cut-off approach--
    (1) There is no change in the Sec. 1.1011-1 adjusted basis of the 
bank's existing debts (as determined under this paragraph (d)(3) method 
or any other former method of accounting used by the bank with respect 
to its bad debts) as a result of the change in method of accounting; and
    (2) Bad debt deductions in the year of change and thereafter with 
respect to all debts held by the bank, whether in existence at the 
beginning of the year of change or subsequently originated or acquired, 
are determined under the new method of accounting.
    (C) Automatic revocation--(1) In general--A bank's election under 
this paragraph (d)(3) is revoked automatically if, in connection with 
any examination involving the bank's loan review process by the bank's 
supervisory authority as defined in paragraph (d)(3)(iii)(D) of this 
section, the bank does not obtain the express determination required by 
that paragraph.

[[Page 924]]

    (2) Year of revocation. If a bank makes the conformity election 
under the transition rules of paragraph (d)(3)(iii)(E) of this section 
and does not obtain the express determination in connection with the 
first examination involving the bank's loan review process that is after 
October 1, 1992, the election is revoked as of the beginning of the 
taxable year of the election or, if later, the earliest taxable year for 
which tax may be assessed. In other cases in which a bank does not 
obtain an express determination in connection with an examination of its 
loan review process, the election is revoked as of the beginning of the 
taxable year that includes the date as of which the supervisory 
authority conducts the examination even if the examination is completed 
in the following taxable year.
    (3) Consent granted. Under the Commissioner's authority in section 
446(e) and Sec. 1.446-1(e), the bank is directed to and is granted 
consent to change from this paragraph (3)(1) method as of the year of 
revocation (year of change) prescribed by paragraph (d)(3)(iv)(C)(2) of 
this section.
    (4) Requirements. A bank changing its method of accounting under the 
automatic revocation rules of this paragraph (d)(3)(iv)(C) must attach a 
completed Form 3115 to its income tax return for the year of revocation 
prescribed by paragraph (d)(3)(iv)(C)(2) of this section. The words 
``REVOCATION OF Sec. 1.166-2(d)(3) ELECTION'' must be typed or legibly 
printed at the top of page 1 of the Form 3115. If the year of revocation 
is a year for which the bank has already filed its income tax return, 
the bank must file an amended return for that year reflecting its change 
in method of accounting and must attach the completed Form 3115 to that 
amended return. The bank also must file amended returns reflecting the 
new method of accounting for all subsequent taxable years for which 
returns have been filed and tax may be assessed.
    (D) Revocation by Commissioner. An election under this paragraph 
(d)(3) may be revoked by the Commissioner as of the beginning of any 
taxable year for which a bank fails to follow the method of accounting 
prescribed by this paragraph. In addition, the Commissioner may revoke 
an election as of the beginning of any taxable year for which the 
Commissioner determines that a bank has taken charge-offs and deductions 
that, under all facts and circumstances existing at the time, were 
substantially in excess of those warranted by the exercise of reasonable 
business judgment in applying the regulatory standards of the bank's 
supervisory authority as defined in paragraph (d)(3)(III)(D) of this 
section.
    (E) Voluntary revocation. A bank may apply for revocation of its 
election made under this paragraph (d)(3) by timely filing a completed 
Form 3115 for the appropriate year and obtaining the consent of the 
Commissioner in accordance with section 446(e) and Sec. 1.446-1(e) 
(including any applicable administrative procedures prescribed 
thereunder). The words ``REVOCATION OF Sec. 1.166-2(d)(3) ELECTION'' 
must be typed or legibly printed at the top of page 1 of the Form 3115. 
If any bank has had its election automatically revoked pursuant to 
paragraph (d)(3)(iv)(C) of this section and has not changed its method 
of accounting in accordance with the requirements of that paragraph, the 
Commissioner will require that any voluntary change in method of 
accounting under this paragraph (d)(3)(iv)(E) be implemented 
retroactively pursuant to the same amended return terms and conditions 
as are prescribed by paragraph (d)(3)(iv)(C) of this section.
    (4) Definitions. For purposes of this paragraph (d)--
    (i) Bank. The term bank has the meaning assigned to it by section 
581. The term bank also includes any corporation that would be a bank 
within the meaning of section 581 except for the fact that it is a 
foreign corporation, but this paragraph (d) applies only with respect to 
loans the interest on which is effectively connected with the conduct of 
a banking business within the United States. In addition, the term bank 
includes a Farm Credit System institution that is subject to supervision 
by the Farm Credit Administration.
    (ii) Charge-off. For banks regulated by the Office of Thrift 
Supervision, the term charge-off includes the establishment of specific 
allowances for loan

[[Page 925]]

losses in the amount of 100 percent of the portion of the debt 
classified as loss.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7254, 38 FR 2418, Jan. 26, 1973; T.D. 8396, 57 FR 6294, 
Feb. 24, 1992; T.D. 8441, 57 FR 45569, Oct. 2, 1992; T.D. 8492, 58 FR 
53658, Oct. 18, 1993]



Sec. 1.166-3  Partial or total worthlessness.

    (a) Partial worthlessness--(1) Applicable to specific debts only. A 
deduction under section 166(a)(2) on account of partially worthless 
debts shall be allowed with respect to specific debts only.
    (2) Charge-off required. (i) If, from all the surrounding and 
attending circumstances, the district director is satisfied that a debt 
is partially worthless, the amount which has become worthless shall be 
allowed as a deduction under section 166(a)(2) but only to the extent 
charged off during the taxable year.
    (ii) If a taxpayer claims a deduction for a part of a debt for the 
taxable year within which that part of the debt is charged off and the 
deduction is disallowed for that taxable year, then, in a case where the 
debt becomes partially worthless after the close of that taxable year, a 
deduction under section 166(a)(2) shall be allowed for a subsequent 
taxable year but not in excess of the amount charged off in the prior 
taxable year plus any amount charged off in the subsequent taxable year. 
In such instance, the charge-off in the prior taxable year shall, if 
consistently maintained as such, be sufficient to that extent to meet 
the charge-off requirement of section 166(a)(2) with respect to the 
subsequent taxable year.
    (iii) Before a taxpayer may deduct a debt in part, he must be able 
to demonstrate to the satisfaction of the district director the amount 
thereof which is worthless and the part thereof which has been charged 
off.
    (3) Significantly modified debt--(i) Deemed charge-off. If a 
significant modification of a debt instrument (within the meaning of 
Sec. 1.1001-3) during a taxable year results in the recognition of gain 
by a taxpayer under Sec. 1.1001-1(a), and if the requirements of 
paragraph (a)(3)(ii) of this section are met, there is a deemed charge-
off of the debt during that taxable year in the amount specified in 
paragraph (a)(3)(iii) of this section.
    (ii) Requirements for deemed charge-off. A debt is deemed to have 
been charged off only if--
    (A) The taxpayer (or, in the case of a debt that constitutes 
transferred basis property within the meaning of section 7701(a)(43), a 
transferor taxpayer) has claimed a deduction for partial worthlessness 
of the debt in any prior taxable year; and
    (B) Each prior charge-off and deduction for partial worthlessness 
satisfied the requirements of paragraphs (a) (1) and (2) of this 
section.
    (iii) Amount of deemed charge-off. The amount of the deemed charge-
off, if any, is the amount by which the tax basis of the debt exceeds 
the greater of the fair market value of the debt or the amount of the 
debt recorded on the taxpayer's books and records reduced as appropriate 
for a specific allowance for loan losses. The amount of the deemed 
charge-off, however, may not exceed the amount of recognized gain 
described in paragraph (a)(3)(i) of this section.
    (iv) Effective date. This paragraph (a)(3) applies to significant 
modifications of debt instruments occurring on or after September 23, 
1996.
    (b) Total worthlessness. If a debt becomes wholly worthless during 
the taxable year, the amount thereof which has not been allowed as a 
deduction from gross income for any prior taxable year shall be allowed 
as a deduction for the current taxable year.

[T.D. 6500, 25 FR 11402, Nov. 29, 1960, as amended by T.D. 8763, 63 FR 
4396, Jan. 29, 1998]



Sec. 1.166-4  Reserve for bad debts.

    (a) Allowance of deduction. A taxpayer who has established the 
reserve method of treating bad debts and has maintained proper reserve 
accounts for bad debts or who, in accordance with paragraph (b) of Sec. 
1.166-1, adopts the reserve method of treating bad debts may deduct from 
gross income a reasonable addition to a reserve for bad debts in lieu of 
deducting specific bad debt items. This paragraph applies both to bad 
debts owed to the taxpayer and to

[[Page 926]]

bad debts arising out of section 166(f)(1)(A) guaranteed debt 
obligations. If a reserve is maintained for bad debts arising out of 
section 166(f)(1)(A) guaranteed debt obligations, then a separate 
reserve must also be maintained for all other debt obligations of the 
taxpayer in the same trade or business, if any. A taxpayer may not 
maintain a reserve for bad debts arising out of section 166(f)(1)(A) 
guaranteed debt obligations if with respect to direct debt obligations 
in the same trade or business the taxpayer takes deductions when the 
debts become worthless in whole or in part rather than maintaining a 
reserve for such obligations. See Sec. 1.166-10 for rules concerning 
section 166(f)(1)(A) guaranteed debt obligations.
    (b) Reasonableness of addition to reserve--(1) Relevant factors. 
What constitutes a reasonable addition to a reserve for bad debts shall 
be determined in the light of the facts existing at the close of the 
taxable year of the proposed addition. The reasonableness of the 
addition will vary as between classes of business and with conditions of 
business prosperity. It will depend primarily upon the total amount of 
debts outstanding as of the close of the taxable year, including those 
arising currently as well as those arising in prior taxable years, and 
the total amount of the existing reserve.
    (2) Correction of errors in prior estimates. In the event that 
subsequent realizations upon outstanding debts prove to be more or less 
than estimated at the time of the creation of the existing reserve, the 
amount of the excess or inadequacy in the existing reserve shall be 
reflected in the determination of the reasonable addition necessary in 
the current taxable year.
    (c) Statement required. A taxpayer using the reserve method shall 
file with his return a statement showing--
    (1) The volume of his charge sales or other business transactions 
for the taxable year and the percentage of the reserve to such amount;
    (2) The total amount of notes and accounts receivable at the 
beginning and close of the taxable year;
    (3) The amount of the debts which have become wholly or partially 
worthless and have been charged against the reserve account; and
    (4) The computation of the addition to the reserve for bad debts.
    (d) Special rules applicable to financial institutions. (1) For 
special rules for the addition to the bad debt reserves of certain 
banks, see Sec. Sec. 1.585-1 through 1.585-3.
    (2) For special rules for the addition to the bad debt reserves of 
small business investment companies and business development 
corporations, see Sec. Sec. 1.586-1 and 1.586-2.
    (3) For special rules for the addition to the bad debts reserves of 
certain mutual savings banks, domestic building and loan associations, 
and cooperative banks, see Sec. Sec. 1.593-1 through 1.593-11.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6728, 29 FR 
5855, May 5, 1964; T.D. 7444, 41 FR 53481, Dec. 7, 1976; T.D. 8071, 51 
FR 2479, Jan. 17, 1986]



Sec. 1.166-5  Nonbusiness debts.

    (a) Allowance of deduction as capital loss. (1) The loss resulting 
from any nonbusiness debt's becoming partially or wholly worthless 
within the taxable year shall not be allowed as a deduction under either 
section 166(a) or section 166(c) in determining the taxable income of a 
taxpayer other than a corporation. See section 166(d)(1)(A).
    (2) If, in the case of a taxpayer other than a corporation, a 
nonbusiness debt becomes wholly worthless within the taxable year, the 
loss resulting therefrom shall be treated as a loss from the sale or 
exchange, during the taxable year, of a capital asset held for not more 
than 1 year (6 months for taxable years beginning before 1977; 9 months 
for taxable years beginning in 1977). Such a loss is subject to the 
limitations provided in section 1211, relating to the limitation on 
capital losses, and section 1212, relating to the capital loss 
carryover, and in the regulations under those sections. A loss on a 
nonbusiness debt shall be treated as sustained only if and when the debt 
has become totally worthless, and no deduction shall be allowed for a 
nonbusiness debt which is recoverable in part during the taxable year.
    (b) Nonbusiness debt defined. For purposes of section 166 and this 
section, a

[[Page 927]]

nonbusiness debt is any debt other than--
    (1) A debt which is created, or acquired, in the course of a trade 
or business of the taxpayer, determined without regard to the 
relationship of the debt to a trade or business of the taxpayer at the 
time when the debt becomes worthless; or
    (2) A debt the loss from the worthlessness of which is incurred in 
the taxpayer's trade or business.

The question whether a debt is a nonbusiness debt is a question of fact 
in each particular case. The determination of whether the loss on a 
debt's becoming worthless has been incurred in a trade or business of 
the taxpayer shall, for this purpose, be made in substantially the same 
manner for determining whether a loss has been incurred in a trade or 
business for purposes of section 165(c)(1). For purposes of subparagraph 
(2) of this paragraph, the character of the debt is to be determined by 
the relation which the loss resulting from the debt's becoming worthless 
bears to the trade or business of the taxpayer. If that relation is a 
proximate one in the conduct of the trade or business in which the 
taxpayer is engaged at the time the debt becomes worthless, the debt 
comes within the exception provided by that subparagraph. The use to 
which the borrowed funds are put by the debtor is of no consequence in 
making a determination under this paragraph. For purposes of section 166 
and this section, a nonbusiness debt does not include a debt described 
in section 165(g)(2)(C). See Sec. 1.165-5, relating to losses on 
worthless securities.
    (c) Guaranty of obligations. For provisions treating a loss 
sustained by a guarantor of obligations as a loss resulting from the 
worthlessness of a debt, see Sec. Sec. 1.166-8 and 1.166-9.
    (d) Examples. The application of this section may be illustrated by 
the following examples involving a case where A, an individual who is 
engaged in the grocery business and who makes his return on the basis of 
the calendar year, extends credit to B in 1955 on an open account:

    Example (1). In 1956 A sells the business but retains the claim 
against B. The claim becomes worthless in A's hands in 1957. A's loss is 
not controlled by the nonbusiness debt provisions, since the original 
consideration has been advanced by A in his trade or business.
    Example (2). In 1956 A sells the business to C but sells the claim 
against B to the taxpayer, D. The claim becomes worthless in D's hands 
in 1957. During 1956 and 1957, D is not engaged in any trade or 
business. D's loss is controlled by the nonbusiness debt provisions even 
though the original consideration has been advanced by A in his trade or 
business, since the debt has not been created or acquired in connection 
with a trade or business of D and since in 1957 D is not engaged in a 
trade or business incident to the conduct of which a loss from the 
worthlessness of such claim is a proximate result.
    Example (3). In 1956 A dies, leaving the business, including the 
accounts receivable, to his son, C, the taxpayer. The claim against B 
becomes worthless in C's hands in 1957. C's loss is not controlled by 
the nonbusiness debt provisions. While C does not advance any 
consideration for the claim, or create or acquire it in connection with 
his trade or business, the loss is sustained as a proximate incident to 
the conduct of the trade or business in which he is engaged at the time 
the debt becomes worthless.
    Example (4). In 1956 A dies, leaving the business to his son, C, but 
leaving the claim against B to his son, D, the taxpayer. The claim 
against B becomes worthless in D's hands in 1957. During 1956 and 1957, 
D is not engaged in any trade or business. D's loss is controlled by the 
nonbusiness debt provisions even though the original consideration has 
been advanced by A in his trade or business, since the debt has not been 
created or acquired in connection with a trade or business of D and 
since in 1957 D is not engaged in a trade or business incident to the 
conduct of which a loss from the worthlessness of such claim is a 
proximate result.
    Example (5). In 1956 A dies; and, while his executor, C, is carrying 
on the business, the claim against B becomes worthless in 1957. The loss 
sustained by A's estate is not controlled by the nonbusiness debt 
provisions. While C does not advance any consideration for the claim on 
behalf of the estate, or create or acquire it in connection with a trade 
or business in which the estate is engaged, the loss is sustained as a 
proximate incident to the conduct of the trade or business in which the 
estate is engaged at the time the debt becomes worthless.
    Example (6). In 1956, A, in liquidating the business, attempts to 
collect the claim against B but finds that it has become worthless. A's 
loss is not controlled by the nonbusiness debt provisions, since the 
original consideration has been advanced by A in

[[Page 928]]

his trade or business and since a loss incurred in liquidating a trade 
or business is a proximate incident to the conduct thereof.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 7657, 44 FR 
68464, Nov. 29, 1979; T.D. 7728, 45 FR 72650, Nov. 3, 1980]



Sec. 1.166-6  Sale of mortgaged or pledged property.

    (a) Deficiency deductible as bad debt--(1) Principal amount. If 
mortgaged or pledged property is lawfully sold (whether to the creditor 
or another purchaser) for less than the amount of the debt, and the 
portion of the indebtedness remaining unsatisfied after the sale is 
wholly or partially uncollectible, the mortgagee or pledgee may deduct 
such amount under section 166(a) (to the extent that it constitutes 
capital or represents an item the income from which has been returned by 
him) as a bad debt for the taxable year in which it becomes wholly 
worthless or is charged off as partially worthless. See Sec. 1.166-3.
    (2) Accrued interest. Accrued interest may be included as part of 
the deduction allowable under this paragraph, but only if it has 
previously been returned as income.
    (b) Realization of gain or loss--(1) Determination of amount. If, in 
the case of a sale described in paragraph (a) of this section, the 
creditor buys in the mortgaged or pledged property, loss or gain is also 
realized, measured by the difference between the amount of those 
obligations of the debtor which are applied to the purchase or bid price 
of the property (to the extent that such obligations constitute capital 
or represent an item the income from which has been returned by the 
creditor) and the fair market value of the property.
    (2) Fair market value defined. The fair market value of the property 
for this purpose shall, in the absence of clear and convincing proof to 
the contrary, be presumed to be the amount for which it is bid in by the 
taxpayer.
    (c) Basis of property purchased. If the creditor subsequently sells 
the property so acquired, the basis for determining gain or loss upon 
the subsequent sale is the fair market value of the property at the date 
of its acquisition by the creditor.
    (d) Special rules applicable to certain banking organizations. For 
special rules relating to the treatment of mortgaged or pledged property 
by certain mutual savings banks, domestic building and loan 
associations, and cooperative banks, see section 595 and the regulations 
thereunder.
    (e) Special rules applicable to certain reacquisitions of real 
property. Notwithstanding this section, special rules apply for taxable 
years beginning after September 2, 1964 (and for certain taxable years 
beginning after December 31, 1957), to the gain or loss on certain 
reacquisitions of real property, to indebtedness remaining unsatisfied 
as a result of such reacquisitions, and to the basis of the reacquired 
real property. See Sec. Sec. 1.1038-1 through 1.1038-3.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6814, 30 FR 
4472, Apr. 7, 1965, T.D. 6916, 32 FR 5923, Apr. 13, 1967]



Sec. 1.166-7  Worthless bonds issued by an individual.

    (a) Allowance of deduction. A bond or other similar obligation 
issued by an individual, if it becomes worthless in whole or in part, is 
subject to the bad debt provisions of section 166. The loss from the 
worthlessness of any such bond or obligation is deductible in accordance 
with section 166(a), unless such bond or obligation is a nonbusiness 
debt as defined in section 166(d)(2). If the bond or obligation is a 
nonbusiness debt, it is subject to section 166(d) and Sec. 1.166-5.
    (b) Decline in market value. A taxpayer possessing debts evidenced 
by bonds or other similar obligations issued by an individual shall not 
be allowed any deduction under section 166 on account of mere market 
fluctuation in the value of such obligations.
    (c) Worthless bonds issued by corporation. For provisions allowing 
the deduction under section 165(a) of the loss sustained upon the 
worthlessness of any bond or similar obligation issued by a corporation 
or a government, see Sec. 1.165-5.
    (d) Application to inventories. This section does not apply to any 
loss upon the worthlessness of any bond or similar obligation reflected 
in inventories required to be taken by a dealer in securities under 
section 471. See Sec. 1.471-5.

[[Page 929]]



Sec. 1.166-8  Losses of guarantors, endorsers, and indemnitors incurred 
on agreements made before January 1, 1976.

    (a) Noncorporate obligations--(1) Deductible as bad debt. A payment 
during the taxable year by a taxpayer other than a corporation in 
discharge of part or all of his obligation as a guarantor, endorser, or 
indemnitor of an obligation issued by a person other than a corporation 
shall, for purposes of section 166 and the regulations thereunder, be 
treated as a debt's becoming worthless within the taxable year, if--
    (i) The proceeds of the obligation so issued have been used in the 
trade or business of the borrower, and
    (ii) The borrower's obligation to the person to whom the taxpayer's 
payment is made is worthless at the time of payment except for the 
existence of the guaranty, endorsement, or indemnity, whether or not 
such obligation has in fact become worthless within the taxable year in 
which payment is made.
    (2) Nonbusiness debt rule not applicable. If a payment is treated as 
a loss in accordance with the provisions of subparagraph (1) of this 
paragraph, section 166(d), relating to the special rule for losses 
sustained on the worthlessness of a nonbusiness debt, shall not apply. 
Accordingly, in each instance the loss shall be deducted under section 
166(a)(1) as a wholly worthless debt even though there has been a 
discharge of only a part of the taxpayer's obligation. Thus, if the 
taxpayer makes a payment during the taxable year in discharge of only 
part of his obligation as a guarantor, endorser, or indemnitor, he may 
treat such payment under section 166(a)(1) as a debt's becoming wholly 
worthless within the taxable year, provided that he can establish that 
such part of the borrower's obligation to the person to whom the 
taxpayer's payment is made is worthless at the time of payment and the 
conditions of subparagraph (1) of this paragraph have otherwise been 
satisfied.
    (3) Other applicable provisions. Other provisions of the internal 
revenue laws relating to bad debts, such as section 111, relating to the 
recovery of bad debts, shall be deemed to apply to any payment which, 
under the provisions of this paragraph, is treated as a bad debt. If the 
requirements of section 166(f) are not met, any loss sustained by a 
guarantor, endorser, or indemnitor upon the worthlessness of the 
debtor's obligation shall be treated under the provisions of law 
applicable thereto. See, for example, paragraph (b) of this section.
    (b) Corporate obligations. The loss sustained during the taxable 
year by a taxpayer other than a corporation in discharge of all of his 
obligation as a guarantor of an obligation issued by a corporation shall 
be treated, in accordance with section 166(d) and the regulations 
thereunder, as a loss sustained on the worthlessness of a nonbusiness 
debt if the debt created in the guarantor's favor as a result of the 
payment does not come within the exceptions prescribed by section 
166(d)(2) (A) or (B). See paragraph (a)(2) of Sec. 1.166-5.
    (c) Examples. The application of this section may be illustrated by 
the following examples:

    Example (1). During 1955, A, an individual who makes his return on 
the basis of the calendar year, guarantees payment of an obligation of 
B, an individual, to the X Bank, the proceeds of the obligation being 
used in B's business. B defaults on his obligation in 1956. A makes 
payment to the X Bank during 1957 in discharge of his entire obligation 
as a guarantor, the obligation of B to the X Bank being wholly 
worthless. For his taxable year 1957, A is entitled to a deduction under 
section 166(a)(1) as a result of his payment during that year.
    Example (2). During 1955, A, an individual who makes his return on 
the basis of the calendar year, guarantees payment of an obligation of 
B, an individual, to the X Bank, the proceeds of the obligation being 
used in B's business. In 1956, B pays a part of his obligation to the X 
Bank but defaults on the remaining part. In 1957, A makes payment to the 
X Bank, in discharge of part of his obligation as a guarantor, of the 
remaining unpaid part of B's obligation to the bank, such part of B's 
obligation then being worthless. For his taxable year 1957, A is 
entitled to a deduction under section 166(a) (1) as a result of his 
payment of the remaining unpaid part of B's obligation.
    Example (3). During 1955, A, an individual who makes his return on 
the basis of the calendar year, guarantees payment of an obligation of 
B, an individual, to the X Bank, the proceeds of the obligation being 
used for B's personal use. B defaults on his obligation in 1956. A makes 
payment to the X Bank during

[[Page 930]]

1957 in discharge of his entire obligation as a guarantor, the 
obligation of B to X Bank being wholly worthless. A may not apply the 
benefit of section 166(f) to his loss, since the proceeds of B's 
obligation have not been used in B's trade or business.
    Example (4). During 1955, A, an individual who makes his return on 
the basis of the calendar year, guarantees payment of an obligation of Y 
Corporation to the X Bank, the proceeds of the obligation being used in 
Y Corporation's business. Y Corporation defaults on its obligation in 
1956. A makes payment to the X Bank during 1957 in discharge of his 
entire obligation as a guarantor, the obligation of Y Corporation to the 
X Bank being wholly worthless. At no time during 1955 or 1957 is A 
engaged in a trade or business. For his taxable year 1957, A is entitled 
to deduct a capital loss in accordance with the provisions of section 
166(d) and paragraph (a) (2) of Sec. 1.166-5. He may not apply the 
benefit of section 166(f) to his loss, since his payment is in discharge 
of an obligation issued by a corporation.

    (d) Effective date. This section applies only to losses, regardless 
of the taxable year in which incurred, on agreements made before January 
1, 1976.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 7657, 44 FR 
68464, Nov. 29, 1979]



Sec. 1.166-9  Losses of guarantors, endorsers, and indemnitors incurred, 
on agreements made after December 31, 1975, in taxable years beginning 
after such date.

    (a) Payment treated as worthless business debt. This paragraph 
applies to taxpayers who, after December 31, 1975, enter into an 
agreement in the course of their trade or business to act as (or in a 
manner essentially equivalent to) a guarantor, endorser, or indemnitor 
of (or other secondary obligor upon) a debt obligation. Subject to the 
provisions of paragraphs (c), (d), and (e) of this section, a payment of 
principal or interest made during a taxable year beginning after 
December 31, 1975, by the taxpayer in discharge of part or all of the 
taxpayer's obligation as a guarantor, endorser, or idemnitor is treated 
as a business debt becoming worthless in the taxable year in which the 
payment is made or in the taxable year described in paragraph (e)(2) of 
this section. Neither section 163 (relating to interest) nor section 165 
(relating to losses) shall apply with respect to such a payment.
    (b) Payment treated as worthless nonbusiness debt. This paragraph 
applies to taxpayers (other than corporations) who, after December 31, 
1975, enter into a transaction for profit, but not in the course of 
their trade or business, to act as (or in a manner essentially 
equivalent to) a guarantor, endorser, or indemnitor of (or other 
secondary obligor upon) a debt obligation. Subject to the provisions of 
paragraphs (c), (d), and (e) of this section, a payment of principal or 
interest made during a taxable year beginning after December 31, 1975, 
by the taxpayer in discharge of part or all of the taxpayer's obligation 
as a guarantor, endorser, or indemnitor is treated as a worthless 
nonbusiness debt in the taxable year in which the payment is made or in 
the taxable year described in paragraph (e)(2) of this section. Neither 
section 163 nor section 165 shall apply with respect to such a payment.
    (c) Obligations issued by corporations. No treatment as a worthless 
debt is allowed with respect to a payment made by the taxpayer in 
discharge of part or all of the taxpayer's obligation as a guarantor, 
endorser, or indemnitor of an obligation issued by a corporation if, on 
the basis of the facts and circumstances at the time the obligation was 
entered into, the payment constitutes a contribution to capital by a 
shareholder. The rule of this paragraph (c) applies to payments whenever 
made (see paragraph (f) of this section).
    (d) Certain payments treated as worthless debts. A payment in 
discharge of part or all of taxpayer's agreement to act as guarantor, 
endorser, or indemnitor of an obligation is to be treated as a worthless 
debt only if--
    (1) The agreement was entered into in the course of the taxpayer's 
trade or business or a transaction for profit;
    (2) There was an enforceable legal duty upon the taxpayer to make 
the payment (except that legal action need not have been brought against 
the taxpayer); and
    (3) The agreement was entered into before the obligation became 
worthless (or partially worthless in the case of an agreement entered 
into in the course of the taxpayer's trade or business). See Sec. Sec. 
1.166-2 and 1.166-3 for rules on worthless and partially worthless 
debts. For

[[Page 931]]

purposes of this paragraph (d)(3), an agreement is considered as entered 
into before the obligation became worthless (or partially worthless) if 
there was a reasonable expectation on the part of the taxpayer at the 
time the agreement was entered into that the taxpayer would not be 
called upon to pay the debt (subject to such agreement) without full 
reimbursement from the issuer of the obligation.
    (e) Special rules--(1) Reasonable consideration required. Treatment 
as a worthless debt of a payment made by a taxpayer in discharge of part 
or all of the taxpayer's agreement to act as a guarantor, endorser, or 
indemnitor of an obligation is allowed only if the taxpayer demonstrates 
that reasonable consideration was received for entering into the 
agreement. For purposes of this paragraph (e)(1), reasonable 
consideration is not limited to direct consideration in the form of cash 
or property. Thus, where a taxpayer can demonstrate that the agreement 
was given without direct consideration in the form of cash or property 
but in accordance with normal business practice or for a good faith 
business purpose, worthless debt treatment is allowed with respect to a 
payment in discharge of part or all of the agreement if the conditions 
of this section are met. However, consideration received from a 
taxpayer's spouse or any individual listed in section 152(a) must be 
direct consideration in the form of cash or property.
    (2) Right of subrogation. With respect to a payment made by a 
taxpayer in discharge of part or all of the taxpayer's agreement to act 
as a guarantor, endorser, or indemnitor where the agreement provides for 
a right of subrogation or other similar right against the issuer, 
treatment as a worthless debt is not allowed until the taxable year in 
which the right of subrogation or other similar right becomes totally 
worthless (or partially worthless in the case of an agreement which 
arose in the course of the taxpayer's trade or business).
    (3) Other applicable provisions. Unless inconsistent with this 
section, other Internal Revenue laws concerning worthless debts, such as 
section 111 relating to the recovery of bad debts, apply to any payment 
which, under the provisions of this section, is treated as giving rise 
to a worthless debt.
    (4) Taxpayer defined. For purposes of this section, except as 
otherwise provided, the term ``taxpayer'' means any taxpayer and 
includes individuals, corporations, partnerships, trusts and estates.
    (f) Effective date. This section applies to losses incurred on 
agreements made after December 31, 1975, in taxable years beginning 
after such date. However, paragraph (c) of this section also applies to 
payments, regardless of the taxable year in which made, under agreements 
made before January 1, 1976.

[T.D. 7657, 44 FR 68465, Nov. 29, 1979, as amended by T.D. 7920, 48 FR 
50712, Nov. 3, 1983]



Sec. 1.166-10  Reserve for guaranteed debt obligations.

    (a) Definitions. The following provisions apply for purposes of this 
section and section 166(f):
    (1) Dealer in property. A dealer in property is a person who 
regularly sells property in the ordinary course of the person's trade or 
business.
    (2) Guaranteed debt obligation. A guaranteed debt obligation is a 
legal duty of one person as a guarantor, endorser or indemnitor of a 
second person to pay a third person. It does not include duties based 
solely on moral or good public relations considerations that are not 
legally binding. A guaranteed debt obligation typically arises where a 
seller receives in payment for property or services the debt obligation 
of a purchaser and sells that obligation to a third party with recourse. 
However, a guaranteed debt obligation also may arise out of a sale in 
respect of which there is no direct debtor-creditor relationship between 
the debtor purchaser and the seller. For example, it arises where a 
purchaser borrows money from a third party to make payment to the seller 
and the seller guarantees the payment of the purchaser's debt. 
Generally, debt obligations which are sold without recourse do not 
result in any obligation of the seller as a guarantor, endorser, or 
indemnitor. However, there are certain without-recourse transactions 
which may give rise to a

[[Page 932]]

seller's liability as a guarantor or indemnitor. For example, such a 
liability may arise where a holder of a debt obligation holds money or 
other property of a seller which the holder may apply, without seeking 
permission of the seller, against any uncollectible debt obligations 
transferred to the holder by the seller without recourse, or where the 
seller is under a legal obligation to reacquire the real or tangible 
personal property from the holder of the debt obligation who repossessed 
property in satisfaction of the debt obligations.
    (3) Real or tangible personal property. Real or tangible personal 
property generally does not include other forms of property, such as 
securities. However, if the sale of other property is related to the 
sale of actual real or tangible personal property, the other property 
will be considered to be real or tangible personal property. In order 
for the sale of other property to be related, it must be--
    (i) Incidental to the sale of the actual real or tangible personal 
property; and
    (ii) Made under an agreement, entered into at the same time as the 
sale of actual real or tangible personal property, between the dealer in 
that property and the customer with respect to that property.

The other property may be charged for as a part of, or in addition to, 
the sales price of the actual real or tangible personal property. If the 
value of the other property is not greater than 20 percent of the total 
sales price, including the value of all related services other than 
financing services, the sale of the other property is related to the 
sale of actual real or tangible personal property.
    (4) Related services. In the case of a sale of both property and 
services a determination must be made as to whether the services are 
related to the property. Related services include only those services 
which are--
    (i) Incidental to the sale of the real or tangible personal 
property; and
    (ii) To be performed under an agreement, entered into at the same 
time as the sale of the property, between the dealer in property and the 
customer with respect to the property.

Delivery, financing installation. maintenance, repair, or instructional 
services generally qualify as related services. The services may be 
charged for as a part of, or in addition to, the sales price of the 
property. Where the value of all services other than financing services 
is not greater than 20 percent of the total of the sales price of the 
property, including the value of all the services other than financing 
services, all of the services are considered to be incidental to the 
sale of the property. Where the value of the services is greater than 20 
percent, the determination as to whether a service is a related service 
in a particular case is to be made on the basis of all relevant facts 
and circumstances.
    (5) Examples. The following examples apply to paragraph (a)(4) of 
this section:

    Example (1). A. a dealer in television sets sells a television set 
to B, his customer. If at the time of the sale A, for a separate charge 
which is added to the sales price of the set and which is not greater 
than 20 percent of the total sales price, provides a 3-year service 
contract on only that television set, the service contract is a related 
service agreement. However, if A does not sell the service contract to B 
contemporaneously with the sale of the television set, as would be the 
case if the service agreement were entered into after the sale of the 
set were completed, or if the service contract includes services for a 
television set in addition to the one then sold by A to B, the service 
contract is not an agreement for a related service.
    Example (2). C, an automobile dealer, at the time of the sale by C 
of an automobile to D, agrees to made available to D driving 
instructions furnished by the M driving school, the cost of which is 
included in the sale price of the automobile and is not greater than 20 
percent of the total sales price. C also agrees to pay M for the driving 
instructions furnished to D. Since C's agreement with D to make 
available driving instructions is incidental to the sale of the 
automobile, is made contemporaneously with the sale, and is charged for 
as part of the sales price of the automobile, it is an agreement for a 
related service. In contrast, however, because M's agreement with C is 
not an agreement between the dealer in property and the customer, M's 
agreement with C to provide driving instructions to C's customers is not 
an agreement for a related service.


[[Page 933]]


    (b) Incorporation of section 166(c) rules. A reserve for section 
166(f)(1)(A) guaranteed debt obligations must be established and 
maintained under the rules applicable to the reserve for bad debts under 
section 166(c) (with the exception of the statement requirement under 
Sec. 1.166-4 (c)). For example, the rules in Sec. 1.166-4(b), relating 
to what constitutes a reasonable addition to a reserve for bad debts and 
to correction of errors in prior estimates, apply to a reserve for 
section 166(f)(1)(A) guaranteed debt obligations as well.
    (c) Special requirements. Any reserve for section 166(f)(1)(A) 
guaranteed debt obligations must be established and maintained 
separately from any reserve for other debt obligations. In addition, a 
taxpayer who charges off direct debts when they become worthless in 
whole or in part rather than maintaining a reserve for such obligations 
may not maintain a reserve for section 166(f)(1)(A) guaranteed debt 
obligations in the same trade or business.
    (d) Requirement of statement. A taxpayer who uses the reserve method 
of treating section 166(f)(1)(A) guaranteed debt obligations must attach 
to his return for each taxable year, returns for which are filed after 
April 17, 1986, and for each trade or business for which the reserve is 
maintained a statement showing--
    (1) The total amount of these obligations at the beginning of the 
taxable year;
    (2) The total amount of these obligations incurred during the 
taxable year;
    (3) The amount of the initial balance of the suspense account, if 
any, established with respect to these obligations;
    (4) The balance of the suspense account, if any, at the beginning of 
the taxable year,
    (5) The adjustment, if any, to that account;
    (6) The adjusted balance, if any, at the close of the taxable year;
    (7) The reconciliation of the beginning and closing balances of the 
reserve for these obligations and the computation of the addition to the 
reserve; and
    (8) The taxable year for which the reserve for these obligations was 
established.
    (e) Computation of opening balance--(1) In general. The opening 
balance of a reserve for section 166(f)(1)(A) guaranteed debt 
obligations established for the first taxable year for which a taxpayer 
maintains such a reserve shall be determined as if the taxpayer had 
maintained such a reserve for the taxable years preceding that taxable 
year. The amount of the opening balance may be determined under the 
following formula:
[GRAPHIC] [TIFF OMITTED] TC14NO91.176

where--

OB = the opening balance at the beginning of the first taxable year
CG = the amount of these obligations at the close of the last preceding 
taxable year
SG = the sum of the amounts of these obligations at the close of the 
five preceding taxable years
SNL the sum of the amounts of net losses arising from these obligations 
for the five preceding taxable years

    (2) Example. The following example applies to paragraph (e)(1) of 
this section.

    Example. For 1977, A, a dealer in automobiles who uses the calendar 
year as the taxable year, adopts in accordance with this section the 
reserve method of treating section 166(f)(1)(A) guaranteed debt 
obligations. A's first year in business as an automobile dealer is 1973. 
For 1972, 1973, 1974, 1975, and 1976, A's records disclose the following 
information with respect to these obligations:

----------------------------------------------------------------------------------------------------------------
                                                              Obligations     Gross
                                                              outstanding  losses from   Recoveries   Net losses
                            Year                              at close of     these      from these   from these
                                                                  year     obligations  obligations  obligations
----------------------------------------------------------------------------------------------------------------
1972........................................................           $0           $0           $0           $0
1973........................................................      780,000        9,700        1,000        8,700
1974........................................................      795,000        8,900        1,050        7,850
1975........................................................      850,000        8,850          850        8,000
1976........................................................      820,000        8,300        1,400        7,900
                                                             ---------------------------------------------------
  Total.....................................................    3,245,000       36,750        4,300       32,450
----------------------------------------------------------------------------------------------------------------


[[Page 934]]

    The opening balance for 1977 of A's reserve for these obligations is 
$8,200, determined as follows:
[GRAPHIC] [TIFF OMITTED] TC14NO91.177

    (3) More appropriate balance. A taxpayer may select a balance other 
than the one produced under paragraph (e)(1) of this section if it is 
more appropriate, based upon the taxpayer's actual experience, and in 
the event the taxpayer's return is examined, if the balance is approved 
by the district director.
    (4) No losses in the five preceding taxable years. If a taxpayer is 
in the taxpayer's first taxable year of a particular trade or business, 
or if the taxpayer has no losses arising from section 166(f)(1)(A) 
guaranteed debt obligations in a particular trade or business for any 
other reason in the five preceding taxable years, then the taxpayer's 
opening balance is zero for that particular trade or business.
    (5) Where reserve method was used before October 22, 1965. If for a 
taxable year ending before October 22, 1965, the taxpayer maintained a 
reserve for bad debts under section 166(c) which included guaranteed 
debt obligations described in section 166(f)(1)(A), and if the taxpayer 
is allowed a deduction referred to in paragraph (g)(2) of this section 
on account of those obligations, the amount of the opening balance of 
the reserve for section 166(f)(1)(A) guaranteed debt obligations for the 
taxpayer's first taxable year ending after October 21, 1965, shall be an 
amount equal to that portion of the section 166(c) reserve at the close 
of the last taxable year which is attributable to those debt 
obligations. The amount of the balance of the section 166(c) reserve for 
the taxable year shall be reduced by the amount of the opening balance 
of the reserve for those guaranteed debt obligations.
    (f) Suspense account--(1) Zero opening balance cases. No suspense 
account shall be maintained if the opening balance of the reserve for 
section 166(f)(1)(A) guaranteed debt obligations under section 166(f)(3) 
is zero
    (2) Example. The following example applies to section 166(f)(4)(B), 
relating to adjustments to the suspense account:

    Example. In 1977, A, an individual who operates an appliance store 
and uses the calendar year as the taxable year, adopts the reserve 
method of treating section 166(f)(1)(A) guaranteed debt obligations. The 
initial balance of A's suspense account is $8,200. At the close of 1977, 
1978, 1979, and 1980, the balance of A's reserve for these obligations 
is $8,400, $8,250, $8,150, and $8,175, respectively, after making the 
addition to the reserve for each year. The adjustments under section 
166(f)(4)(B) to the suspense account at the close of each of the years 
involved are as follows:

(1) Taxable year............       1977       1978       1979       1980
------------------------------------------------------------------------
(2) Closing reserve account      $8,400     $8,250     $8,150     $8,175
 balance....................
(3) Opening suspense account      8,200      8,200      8,200      8,150
 balance....................
(4) Line (2) less line (3)..        200         50        (50         25
(5) Adjustment to suspense            0          0        (50         25
 account balance............
(6) Closing suspense account      8,200      8,200      8,150      8,175
 balance (line 3 plus line
 5).........................
------------------------------------------------------------------------

    (g) Effective date--(1) In general. This section is generally 
effective for taxable years ending after October 21, 1965.
    (2) Transitional rule. Section 2(b) of the Act of November 2, 1966 
(Pub. L. 89-722, 80 Stat. 1151) allows additions to section 166(c) bad 
debt reserves in earlier taxable years on account of section 
166(f)(1)(A) guaranteed debt obligations to be deducted for those 
earlier taxable years. Paragraphs (c), (d), (e), and (f) of this section 
do not apply in determining whether a deduction is allowed under section 
2(b) of the Act. See Rev. Rul. 68-313 (1968-1C.B. 75) for rules relating 
to that deduction.

[T.D. 8071, 51 FR 2479, Jan. 17, 1986; 51 FR 9787, Mar. 21, 1986]



Sec. 1.167(a)-1  Depreciation in general.

    (a) Reasonable allowance. Section 167(a) provides that a reasonable 
allowance for the exhaustion, wear and tear, and obsolescence of 
property used in the trade or business or of property held by the 
taxpayer for the production of income shall be allowed as a depreciation 
deduction. The allowance is

[[Page 935]]

that amount which should be set aside for the taxable year in accordance 
with a reasonably consistent plan (not necessarily at a uniform rate), 
so that the aggregate of the amounts set aside, plus the salvage value, 
will, at the end of the estimated useful life of the depreciable 
property, equal the cost or other basis of the property as provided in 
section 167(g) and Sec. 1.167(g)-1. An asset shall not be depreciated 
below a reasonable salvage value under any method of computing 
depreciation. However, see section 167(f) and Sec. 1.167(f)-1 for rules 
which permit a reduction in the amount of salvage value to be taken into 
account for certain personal property acquired after October 16, 1962. 
See also paragraph (c) of this section for definition of salvage. The 
allowance shall not reflect amounts representing a mere reduction in 
market value. See section 179 and Sec. 1.179-1 for a further 
description of the term ``reasonable allowance.''
    (b) Useful life. For the purpose of section 167 the estimated useful 
life of an asset is not necessarily the useful life inherent in the 
asset but is the period over which the asset may reasonably be expected 
to be useful to the taxpayer in his trade or business or in the 
production of his income. This period shall be determined by reference 
to his experience with similar property taking into account present 
conditions and probable future developments. Some of the factors to be 
considered in determining this period are (1) wear and tear and decay or 
decline from natural causes, (2) the normal progress of the art, 
economic changes, inventions, and current developments within the 
industry and the taxpayer's trade or business, (3) the climatic and 
other local conditions peculiar to the taxpayer's trade or business, and 
(4) the taxpayer's policy as to repairs, renewals, and replacements. 
Salvage value is not a factor for the purpose of determining useful 
life. If the taxpayer's experience is inadequate, the general experience 
in the industry may be used until such time as the taxpayer's own 
experience forms an adequate basis for making the determination. The 
estimated remaining useful life may be subject to modification by reason 
of conditions known to exist at the end of the taxable year and shall be 
redetermined when necessary regardless of the method of computing 
depreciation. However, estimated remaining useful life shall be 
redetermined only when the change in the useful life is significant and 
there is a clear and convincing basis for the redetermination. For rules 
covering agreements with respect to useful life, see section 167(d) and 
Sec. 1.167(d)-1. If a taxpayer claims an investment credit with respect 
to an asset for a taxable year preceding the taxable year in which the 
asset is considered as placed in service under Sec. 1.167(a)-10(b) or 
Sec. 1.167(a)-11(e), the useful life of the asset under this paragraph 
shall be the same useful life assigned to the asset under Sec. 1.46-
3(e).
    (c) Salvage. (1) Salvage value is the amount (determined at the time 
of acquisition) which is estimated will be realizable upon sale or other 
disposition of an asset when it is no longer useful in the taxpayer's 
trade or business or in the production of his income and is to be 
retired from service by the taxpayer. Salvage value shall not be changed 
at any time after the determination made at the time of acquisition 
merely because of changes in price levels. However, if there is a 
redetermination of useful life under the rules of paragraph (b) of this 
section, salvage value may be redetermined based upon facts known at the 
time of such redetermination of useful life. Salvage, when reduced by 
the cost of removal, is referred to as net salvage. The time at which an 
asset is retired from service may vary according to the policy of the 
taxpayer. If the taxpayer's policy is to dispose of assets which are 
still in good operating condition, the salvage value may represent a 
relatively large proportion of the original basis of the asset. However, 
if the taxpayer customarily uses an asset until its inherent useful life 
has been substantially exhausted, salvage value may represent no more 
than junk value. Salvage value must be taken into account in determining 
the depreciation deduction either by a reduction of the amount subject 
to depreciation or by a reduction in the rate of depreciation,

[[Page 936]]

but in no event shall an asset (or an account) be depreciated below a 
reasonable salvage value. See, however, paragraph (a) of Sec. 1.167(b)-
2 for the treatment of salvage under the declining balance method, and 
Sec. 1.179-1 for the treatment of salvage in computing the additional 
first-year depreciation allowance. The taxpayer may use either salvage 
or net salvage in determining depreciation allowances but such practice 
must be consistently followed and the treatment of the costs of removal 
must be consistent with the practice adopted. For specific treatment of 
salvage value, see Sec. Sec. 1.167(b)-1, 1.167(b)-2, and 1.167(b)-3. 
When an asset is retired or disposed of, appropriate adjustments shall 
be made in the asset and depreciation reserve accounts. For example, the 
amount of the salvage adjusted for the costs of removal may be credited 
to the depreciation reserve.
    (2) For taxable years beginning after December 31, 1961, and ending 
after October 16, 1962, see section 167(f) and Sec. 1.167(f)-1 for 
rules applicable to the reduction of salvage value taken into account 
for certain personal property acquired after October 16, 1962.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6712, 29 FR 
3653, Mar. 24, 1964; T.D. 7203, 37 FR 17133, Aug. 25, 1972]



Sec. 1.167(a)-2  Tangible property.

    The depreciation allowance in the case of tangible property applies 
only to that part of the property which is subject to wear and tear, to 
decay or decline from natural causes, to exhaustion, and to 
obsolescence. The allowance does not apply to inventories or stock in 
trade, or to land apart from the improvements or physical development 
added to it. The allowance does not apply to natural resources which are 
subject to the allowance for depletion provided in section 611. No 
deduction for depreciation shall be allowed on automobiles or other 
vehicles used solely for pleasure, on a building used by the taxpayer 
solely as his residence, or on furniture or furnishings therein, 
personal effects, or clothing; but properties and costumes used 
exclusively in a business, such as a theatrical business, may be 
depreciated.



Sec. 1.167(a)-3  Intangibles.

    (a) In general. If an intangible asset is known from experience or 
other factors to be of use in the business or in the production of 
income for only a limited period, the length of which can be estimated 
with reasonable accuracy, such an intangible asset may be the subject of 
a depreciation allowance. Examples are patents and copyrights. An 
intangible asset, the useful life of which is not limited, is not 
subject to the allowance for depreciation. No allowance will be 
permitted merely because, in the unsupported opinion of the taxpayer, 
the intangible asset has a limited useful life. No deduction for 
depreciation is allowable with respect to goodwill. For rules with 
respect to organizational expenditures, see section 248 and the 
regulations thereunder. For rules with respect to trademark and trade 
name expenditures, see section 177 and the regulations thereunder. See 
sections 197 and 167(f) and, to the extent applicable, Sec. Sec. 1.197-
2 and 1.167(a)-14 for amortization of goodwill and certain other 
intangibles acquired after August 10, 1993, or after July 25, 1991, if a 
valid retroactive election under Sec. 1.197-1T has been made.
    (b) Safe harbor amortization for certain intangible assets--(1) 
Useful life. Solely for purposes of determining the depreciation 
allowance referred to in paragraph (a) of this section, a taxpayer may 
treat an intangible asset as having a useful life equal to 15 years 
unless--
    (i) An amortization period or useful life for the intangible asset 
is specifically prescribed or prohibited by the Internal Revenue Code, 
the regulations thereunder (other than by this paragraph (b)), or other 
published guidance in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2) of this chapter);
    (ii) The intangible asset is described in Sec. 1.263(a)-4(c) 
(relating to intangibles acquired from another person) or Sec. 
1.263(a)-4(d)(2) (relating to created financial interests);
    (iii) The intangible asset has a useful life the length of which can 
be estimated with reasonable accuracy; or
    (iv) The intangible asset is described in Sec. 1.263(a)-4(d)(8) 
(relating to certain benefits arising from the provision, production, or 
improvement of real

[[Page 937]]

property), in which case the taxpayer may treat the intangible asset as 
having a useful life equal to 25 years solely for purposes of 
determining the depreciation allowance referred to in paragraph (a) of 
this section.
    (2) Applicability to acquisitions of a trade or business, changes in 
the capital structure of a business entity, and certain other 
transactions. The safe harbor useful life provided by paragraph (b)(1) 
of this section does not apply to an amount required to be capitalized 
by Sec. 1.263(a)-5 (relating to amounts paid to facilitate an 
acquisition of a trade or business, a change in the capital structure of 
a business entity, and certain other transactions).
    (3) Depreciation method. A taxpayer that determines its depreciation 
allowance for an intangible asset using the 15-year useful life 
prescribed by paragraph (b)(1) of this section (or the 25-year useful 
life in the case of an intangible asset described in Sec. 1.263(a)-
4(d)(8)) must determine the allowance by amortizing the basis of the 
intangible asset (as determined under section 167(c) and without regard 
to salvage value) ratably over the useful life beginning on the first 
day of the month in which the intangible asset is placed in service by 
the taxpayer. The intangible asset is not eligible for amortization in 
the month of disposition.
    (4) Effective date. This paragraph (b) applies to intangible assets 
created on or after December 31, 2003.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as 
amended by T.D. 8867, 65 FR 3825, Jan. 25, 2000; T.D. 9107, 69 FR 444, 
Jan. 5, 2004]



Sec. 1.167(a)-4  Leased property.

    Capital expenditures made by a lessee for the erection of buildings 
or the construction of other permanent improvements on leased property 
are recoverable through allowances for depreciation or amortization. If 
the useful life of such improvements in the hands of the taxpayer is 
equal to or shorter than the remaining period of the lease, the 
allowances shall take the form of depreciation under section 167. See 
Sec. Sec. 1.167(b)-0, 1.167(b)-1, 1.167(b)-2, 1.167(b)-3, and 1.167(b)-
4 for methods of computing such depreciation allowances. If, on the 
other hand, the estimated useful life of such property in the hands of 
the taxpayer, determined without regard to the terms of the lease, would 
be longer than the remaining period of such lease, the allowances shall 
take the form of annual deductions from gross income in an amount equal 
to the unrecovered cost of such capital expenditures divided by the 
number of years remaining of the term of the lease. Such deductions 
shall be in lieu of allowances for depreciation. See section 162 and the 
regulations thereunder. See section 178 and the regulations thereunder 
for rules governing the effect to be given renewal options in 
determining whether the useful life of the improvement exceeds the 
remaining term of the lease where a lessee begins improvements on leased 
property after July 28, 1958, other than improvements which on such date 
and at all times thereafter, the lessee was under a binding legal 
obligation to make. Capital expenditures made by a lessor for the 
erection of buildings or other improvements shall, if subject to 
depreciation allowances, be recovered by him over the estimated life of 
the improvements without regard to the period of the lease.

[T.D. 6520, 25 FR 13692, Dec. 24, 1960]



Sec. 1.167(a)-5  Apportionment of basis.

    In the case of the acquisition on or after March 1, 1913, of a 
combination of depreciable and nondepreciable property for a lump sum, 
as for example, buildings and land, the basis for depreciation cannot 
exceed an amount which bears the same proportion to the lump sum as the 
value of the depreciable property at the time of acquisition bears to 
the value of the entire property at that time. In the case of property 
which is subject to both the allowance for depreciation and 
amortization, depreciation is allowable only with respect to the portion 
of the depreciable property which is not subject to the allowance for 
amortization and may be taken concurrently with the allowance for 
amortization. After the close of the amortization period or after 
amortization deductions have been discontinued with respect to any such 
property, the unrecovered cost or other basis of the depreciable portion 
of such property

[[Page 938]]

will be subject to depreciation. For adjustments to basis, see section 
1016 and other applicable provisions of law. For the adjustment to the 
basis of a structure in the case of a donation of a qualified 
conservation contribution under section 170(h), see Sec. 1.170A-
14(h)(3)(iii).

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as 
amended by T.D. 8069, 51 FR 1498, Jan. 14, 1986]



Sec. 1.167(a)-5T  Application of section 1060 to section 167 (temporary).

    In the case of an acquisition of a combination of depreciable and 
nondepreciable property for a lump sum in an applicable asset 
acquisition to which section 1060 applies, the basis for depreciation of 
the depreciable property cannot exceed the amount of consideration 
allocated to that property under section 1060 and Sec. 1.1060-1T.

[T.D. 8215, 53 FR 27043, July 18, 1988]



Sec. 1.167(a)-6  Depreciation in special cases.

    (a) Depreciation of patents or copyrights. The cost or other basis 
of a patent or copyright shall be depreciated over its remaining useful 
life. Its cost to the patentee includes the various Government fees, 
cost of drawings, models, attorneys' fees, and similar expenditures. For 
rules applicable to research and experimental expenditures, see sections 
174 and 1016 and the regulations thereunder. If a patent or copyright 
becomes valueless in any year before its expiration the unrecovered cost 
or other basis may be deducted in that year. See Sec. 1.167(a)-14(c)(4) 
for depreciation of a separately acquired interest in a patent or 
copyright described in section 167(f)(2) acquired after January 25, 
2000. See Sec. 1.197-2 for amortization of interests in patents and 
copyrights that constitute amortizable section 197 intangibles.
    (b) Depreciation in case of farmers. A reasonable allowance for 
depreciation may be claimed on farm buildings (except a dwelling 
occupied by the owner), farm machinery, and other physical property but 
not including land. Livestock acquired for work, breeding, or dairy 
purposes may be depreciated unless included in an inventory used to 
determine profits in accordance with section 61 and the regulations 
thereunder. Such depreciation should be determined with reference to the 
cost or other basis, salvage value, and the estimated useful life of the 
livestock. See also section 162 and the regulations thereunder relating 
to trade or business expenses, section 165 and the regulations 
thereunder relating to losses of farmers, and section 175 and the 
regulations thereunder relating to soil or water conservation 
expenditures.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as 
amended by T.D. 8867, 65 FR 3825, Jan. 25, 2000]



Sec. 1.167(a)-7  Accounting for depreciable property.

    (a) Depreciable property may be accounted for by treating each 
individual item as an account, or by combining two or more assets in a 
single account. Assets may be grouped in an account in a variety of 
ways. For example, assets similar in kind with approximately the same 
useful lives may be grouped together. Such an account is commonly known 
as a group account. Another appropriate grouping might consist of assets 
segregated according to use without regard to useful life, for example, 
machinery and equipment, furniture and fixtures, or transportation 
equipment. Such an account is commonly known as a classified account. A 
broader grouping, where assets are included in the same account 
regardless of their character or useful lives, is commonly referred to 
as a composite account. For example, all the assets used in a business 
may be included in a single account. Group, classified, or composite 
accounts may be further broken down on the basis of location, dates of 
acquisition, cost, character, use, etc.
    (b) When group, classified, or composite accounts are used with 
average useful lives and a normal retirement occurs, the full cost or 
other basis of the asset retired, unadjusted for depreciation or 
salvage, shall be removed from the asset account and shall be charged to 
the depreciation reserve. Amounts representing salvage ordinarily are 
credited to the depreciation reserve. Where an asset is disposed of for 
reasons other than normal retirement, the full cost or other basis of 
the asset shall be removed from the asset

[[Page 939]]

account, and the depreciation reserve shall be charged with the 
depreciation applicable to the retired asset. For rules with respect to 
losses on normal retirements, see Sec. 1.167 (a)-8.
    (c) A taxpayer may establish as many accounts for depreciable 
property as he desires. Depreciation allowances shall be computed 
separately for each account. Such depreciation preferably should be 
recorded in a depreciation reserve account; however, in appropriate 
cases it may be recorded directly in the asset account. Where 
depreciation reserves are maintained, a separate reserve account shall 
be maintained for each asset account. The regular books of account or 
permanent auxiliary records shall show for each account the basis of the 
property, including adjustments necessary to conform to the requirements 
of section 1016 and other provisions of law relating to adjustments to 
basis, and the depreciation allowances for tax purposes. In the event 
that reserves for book purposes do not correspond with reserves 
maintained for tax purposes, permanent auxiliary records shall be 
maintained with the regular books of accounts reconciling the 
differences in depreciation for tax and book purposes because of 
different methods of depreciation, bases, rates, salvage, or other 
factors. Depreciation schedules filed with the income tax return shall 
show the accumulated reserves computed in accordance with the allowances 
for income tax purposes.
    (d) In classified or composite accounts, the average useful life and 
rate shall be redetermined whenever additions, retirements, or 
replacements substantially alter the relative proportion of types of 
assets in the accounts. See example (2) in paragraph (b) of Sec. 
1.167(b)-1 for method of determining the depreciation rate for a 
classified or composite account.



Sec. 1.167(a)-8  Retirements.

    (a) Gains and losses on retirements. For the purposes of this 
section the term ``retirement'' means the permanent withdrawal of 
depreciable property from use in the trade or business or in the 
production of income. The withdrawal may be made in one of several ways. 
For example, the withdrawal may be made by selling or exchanging the 
asset, or by actual abandonment. In addition, the asset may be withdrawn 
from such productive use without disposition as, for example, by being 
placed in a supplies or scrap account. The tax consequences of a 
retirement depend upon the form of the transaction, the reason therefor, 
the timing of the retirement, the estimated useful life used in 
computing depreciation, and whether the asset is accounted for in a 
separate or multiple asset account. Upon the retirement of assets, the 
rules in this section apply in determining whether gain or loss will be 
recognized, the amount of such gain or loss, and the basis for 
determining gain or loss:
    (1) Where an asset is retired by sale at arm's length, recognition 
of gain or loss will be subject to the provisions of sections 1002, 
1231, and other applicable provisions of law.
    (2) Where an asset is retired by exchange, the recognition of gain 
or loss will be subject to the provisions of sections 1002, 1031, 1231, 
and other applicable provisions of law.
    (3) Where an asset is permanently retired from use in the trade or 
business or in the production of income but is not disposed of by the 
taxpayer or physically abandoned (as, for example, when the asset is 
transferred to a supplies or scrap account), gain will not be 
recognized. In such a case loss will be recognized measured by the 
excess of the adjusted basis of the asset at the time of retirement over 
the estimated salvage value or over the fair market value at the time of 
such retirement if greater, but only if--
    (i) The retirement is an abnormal retirement, or
    (ii) The retirement is a normal retirement from a single asset 
account (but see paragraph (d) of this section for special rule for item 
accounts), or
    (iii) The retirement is a normal retirement from a multiple asset 
account in which the depreciation rate was based on the maximum expected 
life of the longest lived asset contained in the account.
    (4) Where an asset is retired by actual physical abandonment (as, 
for example, in the case of a building condemned as unfit for further 
occupancy

[[Page 940]]

or other use), loss will be recognized measured by the amount of the 
adjusted basis of the asset abandoned at the time of such abandonment. 
In order to qualify for the recognition of loss from physical 
abandonment, the intent of the taxpayer must be irrevocably to discard 
the asset so that it will neither be used again by him nor retrieved by 
him for sale, exchange, or other disposition.

Experience with assets which have attained an exceptional or unusual age 
shall, with respect to similar assets, be disregarded in determining the 
maximum expected useful life of the longest lived asset in a multiple 
asset account. For example, if a manufacturer establishes a proper 
multiple asset account for 50 assets which are expected to have an 
average life of 30 years but which will remain useful to him for varying 
periods between 20 and 40 years, the maximum expected useful life will 
be 40 years, even though an occasional asset of this kind may last 60 
years.
    (b) Definition of normal and abnormal retirements. For the purpose 
of this section the determination of whether a retirement is normal or 
abnormal shall be made in the light of all the facts and circumstances. 
In general, a retirement shall be considered a normal retirement unless 
the taxpayer can show that the withdrawal of the asset was due to a 
cause not contemplated in setting the applicable depreciation rate. For 
example, a retirement is considered normal if made within the range of 
years taken into consideration in fixing the depreciation rate and if 
the asset has reached a condition at which, in the normal course of 
events, the taxpayer customarily retires similar assets from use in his 
business. On the other hand, a retirement may be abnormal if the asset 
is withdrawn at an earlier time or under other circumstances, as, for 
example, when the asset has been damaged by casualty or has lost its 
usefulness suddenly as the result of extraordinary obsolescence.
    (c) Basis of assets retired. The basis of an asset at the time of 
retirement for computing gain or loss shall be its adjusted basis for 
determining gain or loss upon a sale or other disposition as determined 
in accordance with the provisions of section 1011 and the following 
rules:
    (1) In the case of a normal retirement of an asset from a multiple 
asset account where the depreciation rate is based on average expected 
useful life, the term ``adjusted basis'' means the salvage value 
estimated in determining the depreciation deduction in accordance with 
the provisions in paragraph (c) of Sec. 1.167(a)-1.
    (2) In the case of a normal retirement of an asset from a multiple 
asset account on which the depreciation rate was based on the maximum 
expected life of the longest lived asset in the account, the adjustment 
for depreciation allowed or allowable shall be made at the rate which 
would have been proper if the asset had been depreciated in a single 
asset account (under the method of depreciation used for the multiple 
asset account) using a rate based upon the maximum expected useful life 
of that asset, and
    (3) In the case of an abnormal retirement from a multiple asset 
account the adjustment for depreciation allowed or allowable shall be 
made at the rate which would have been proper had the asset been 
depreciated in a single asset account (under the method of depreciation 
used for the multiple asset account) and using a rate based upon either 
the average expected useful life or the maximum expected useful life of 
the asset, depending upon the method of determining the rate of 
depreciation used in connection with the multiple asset account.
    (d) Special rule for item accounts. (1) As indicated in paragraph 
(a)(3)(ii) and (iii) of this section, a loss is recognized upon the 
normal retirement of an asset from a single asset account but a loss on 
the normal retirement of an asset in a multiple asset account is not 
allowable where the depreciation rate is based upon the average useful 
life of the assets in the account. Where a taxpayer with more than one 
depreciable asset chooses to set up a separate account for each such 
asset and the depreciation rate is based on the average useful life of 
such assets (so that he uses the same life for each account), the 
question arises whether his depreciation deductions in substance are the 
equivalent of those which would result

[[Page 941]]

from the use of multiple asset accounts and, therefore, he should be 
subject to the rules governing losses on retirements of assets from 
multiple asset accounts. Where a taxpayer has only a few depreciable 
assets which he chooses to account for in single asset accounts, 
particularly where such assets cover a relatively narrow range of lives, 
it cannot be said in the usual case that the allowance of losses on 
retirements from such accounts clearly will distort income. This results 
from the fact that where a taxpayer has only a few depreciable assets it 
is usually not possible clearly to determine that the depreciation rate 
is based upon the average useful life of such assets. Accordingly, it 
cannot be said that the taxpayer is in effect clearly operating with a 
multiple asset account using an average life rate so that losses should 
not be allowed on normal retirements. Therefore, losses normally will be 
allowed upon retirement of assets from single asset accounts where the 
taxpayer has only a few depreciable assets. On the other hand, when a 
taxpayer who has only a few depreciable assets chooses to account for 
them in single asset accounts, using for each account a depreciation 
rate based on the average useful life of such assets, and the assets 
cover a wide range of lives, the likelihood that income will be 
distorted is greater than where the group of assets covers a relatively 
narrow range of lives. In those cases where the allowance of losses 
would distort income, the rules with respect to the allowance of losses 
on normal retirement shall be applied to such assets in the same manner 
as though the assets had been accounted for in multiple asset accounts 
using a rate based upon average expected useful life.
    (2) Where a taxpayer has a large number of depreciable assets and 
depreciation is based on the average useful life of such assets, then, 
whether such assets are similar or dissimilar and regardless of whether 
they are accounted for in individual asset accounts or multiple asset 
accounts the allowance of losses on the normal retirement of such assets 
would distort income. Such distortion would result from the fact that 
the use of average useful life (and, accordingly, average rate) assumes 
that while some assets normally will be retired before the expiration of 
the average life, others normally will be retired after expiration of 
the average life. Accordingly, if instead of accounting for a large 
number of similar or dissimilar depreciable assets in multiple asset 
accounts, the taxpayer chooses to account separately for such assets, 
using a rate based upon the average life of such assets, the rules with 
respect to the allowances of losses on normal retirements will be 
applied to such assets in the same manner as though the assets were 
accounted for in multiple asset accounts using a rate based upon average 
expected useful life.
    (3) Where a taxpayer who does not have a large number of depreciable 
assets (and who therefore is not subject to subparagraph (2) of this 
paragraph) chooses to set up a separate account for each such asset, and 
has sought to compute an average life for such assets on which to base 
his depreciation deductions (so that he uses the same life for each 
account), the allowance of losses on normal retirements from such 
accounts may in some situations substantially distort income. Such 
distortion would result from the fact that the use of average useful 
life (and, accordingly, average rate) assumes that while some assets 
normally will be retired before expiration of the average life, others 
normally will be retired after expiration of the average life. 
Accordingly, where a taxpayer chooses to account separately for such 
assets instead of accounting for them in multiple asset accounts, and 
the result is to substantially distort his income, the rules with 
respect to the allowance of losses on normal retirements shall be 
applied to such assets in the same manner as though the assets had been 
accounted for in multiple asset accounts using a rate based upon average 
expected useful life.
    (4) Whenever a taxpayer is treated under this paragraph as though 
his assets were accounted for in a multiple asset account using an 
average life rate, and, therefore, he is denied a loss on retirements, 
the unrecovered cost less salvage of each asset which was accounted for 
separately may be amortized in accordance with the regulation

[[Page 942]]

stated in paragraph (e)(1)(ii) of this section.
    (e) Accounting treatment of asset retirements. (1) In the case of a 
normal retirement where under the foregoing rules no loss is recognized 
and where the asset is retired without disposition or abandonment, (i) 
if the asset was contained in a multiple asset account, the full cost of 
such asset, reduced by estimated salvage, shall be charged to the 
depreciation reserve, or (ii) if the asset was accounted for separately, 
the unrecovered cost or other basis, less salvage, of the asset may be 
amortized through annual deductions from gross income in amounts equal 
to the unrecovered cost or other basis of such asset, divided by the 
average expected useful life (not the remaining useful life) applicable 
to the asset at the time of retirement. For example, if an asset is 
retired after six years of use and at the time of retirement 
depreciation was being claimed on the basis of an average expected 
useful life of ten years, the unrecovered cost or other basis less 
salvage would be amortized through equal annual deductions over a period 
of ten years from the time of retirement.
    (2) Where multiple asset accounts are used and acquisitions and 
retirements are numerous, if a taxpayer, in order to avoid unnecessarily 
detailed accounting for individual retirements, consistently follows the 
practice of charging the reserve with the full cost or other basis of 
assets retired and of crediting it with all receipts from salvage, the 
practice may be continued so long as, in the opinion of the 
Commissioner, it clearly reflects income. Conversely, where the taxpayer 
customarily follows a practice of reporting all receipts from salvage as 
ordinary taxable income such practice may be continued so long as, in 
the opinion of the Commissioner, it clearly reflects income.
    (f) Cross reference. For special rules in connection with the 
retirement of the last assets of a given year's acquisitions under the 
declining balance method, see example (2) in paragraph (b) of Sec. 
1.167 (b)-2.



Sec. 1.167(a)-9  Obsolescence.

    The depreciation allowance includes an allowance for normal 
obsolescence which should be taken into account to the extent that the 
expected useful life of property will be shortened by reason thereof. 
Obsolescence may render an asset economically useless to the taxpayer 
regardless of its physical condition. Obsolescence is attributable to 
many causes, including technological improvements and reasonably 
foreseeable economic changes. Among these causes are normal progress of 
the arts and sciences, supersession or inadequacy brought about by 
developments in the industry, products, methods, markets, sources of 
supply, and other like changes, and legislative or regulatory action. In 
any case in which the taxpayer shows that the estimated useful life 
previously used should be shortened by reason of obsolescence greater 
than had been assumed in computing such estimated useful life, a change 
to a new and shorter estimated useful life computed in accordance with 
such showing will be permitted. No such change will be permitted merely 
because in the unsupported opinion of the taxpayer the property may 
become obsolete. For rules governing the allowance of a loss when the 
usefulness of depreciable property is suddenly terminated, see Sec. 
1.167(a)-8. If the estimated useful life and the depreciation rates have 
been the subject of a previous agreement, see section 167(d) and Sec. 
1.167(d)-1.



Sec. 1.167(a)-10  When depreciation deduction is allowable.

    (a) A taxpayer should deduct the proper depreciation allowance each 
year and may not increase his depreciation allowances in later years by 
reason of his failure to deduct any depreciation allowance or of his 
action in deducting an allowance plainly inadequate under the known 
facts in prior years. The inadequacy of the depreciation allowance for 
property in prior years shall be determined on the basis of the 
allowable method of depreciation used by the taxpayer for such property 
or under the straight line method if no allowance has ever been claimed 
for such property. The preceding sentence shall not be construed as 
precluding application of any method provided in section 167(b) if 
taxpayer's failure to claim any allowance

[[Page 943]]

for depreciation was due solely to erroneously treating as a deductible 
expense an item properly chargeable to capital account. For rules 
relating to adjustments to basis, see section 1016 and the regulations 
thereunder.
    (b) The period for depreciation of an asset shall begin when the 
asset is placed in service and shall end when the asset is retired from 
service. A proportionate part of one year's depreciation is allowable 
for that part of the first and last year during which the asset was in 
service. However, in the case of a multiple asset account, the amount of 
depreciation may be determined by using what is commonly described as an 
``averaging convention'', that is, by using an assumed timing of 
additions and retirements. For example, it might be assumed that all 
additions and retirements to the asset account occur uniformly 
throughout the taxable year, in which case depreciation is computed on 
the average of the beginning and ending balances of the asset account 
for the taxable year. See example (3) under paragraph (b) of Sec. 
1.167(b)-1. Among still other averaging conventions which may be used is 
the one under which it is assumed that all additions and retirements 
during the first half of a given year were made on the first day of that 
year and that all additions and retirements during the second half of 
the year were made on the first day of the following year. Thus, a full 
year's depreciation would be taken on additions in the first half of the 
year and no depreciation would be taken on additions in the second half. 
Moreover, under this convention, no depreciation would be taken on 
retirements in the first half of the year and a full year's depreciation 
would be taken on the retirements in the second half. An averaging 
convention, if used, must be consistently followed as to the account or 
accounts for which it is adopted, and must be applied to both additions 
and retirements. In any year in which an averaging convention 
substantially distorts the depreciation allowance for the taxable year, 
it may not be used.



Sec. 1.167(a)-11  Depreciation based on class lives and asset 
depreciation ranges for property placed in service after December 
31, 1970.

    (a) In general--(1) Summary. This section provides an asset 
depreciation range and class life system for determining the reasonable 
allowance for depreciation of designated classes of assets placed in 
service after December 31, 1970. The system is designed to minimize 
disputes between taxpayers and the Internal Revenue Service as to the 
useful life of property, and as to salvage value, repairs, and other 
matters. The system is optional with the taxpayer. The taxpayer has an 
annual election. Generally, an election for a taxable year must apply to 
all additions of eligible property during the taxable year of election, 
but does not apply to additions of eligible property in any other 
taxable year. The taxpayer's election, made with the return for the 
taxable year, may not be revoked or modified for any property included 
in the election. Generally, the taxpayer must establish vintage accounts 
for all eligible property included in the election, must determine the 
allowance for depreciation of such property in the taxable year of 
election, and in subsequent taxable years, on the basis of the asset 
depreciation period selected and must apply the first-year convention 
specified in the election to determine the allowance for depreciation of 
such property. This section also contains special provisions for the 
treatment of salvage value, retirements, and the costs of the repair, 
maintenance, rehabilitation or improvement of property. In general, a 
taxpayer may not apply any provision of this section unless he makes an 
election and thereby consents to, and agrees to apply, all the 
provisions of this section. A taxpayer who elects to apply this section 
does, however, have certain options as to the application of specified 
provisions of this section. A taxpayer may elect to apply this section 
for a taxable year only if for such taxable year he complies with the 
requirements of paragraph (f)(4) of this section.
    (2) Definitions. For the meaning of certain terms used in this 
section, see paragraphs (b)(2) (``eligible property''),

[[Page 944]]

(b)(3) (``vintage account'' and ``vintage''), (b)(4) (``asset 
depreciation range'', ``asset guideline class'', ``asset guideline 
period'', and ``asset depreciation period''), (b)(5)(iii)(c) (``used 
property''), (b)(6)(i) (``public utility property''), (c)(1)(iv) 
(``original use''), (c)(1)(v) (``unadjusted basis'' and ``adjusted 
basis''), (c)(2)(ii) (``modified half-year convention''), (c)(2)(iii) 
(``half-year convention''), (d)(1)(i) (``gross salvage value''), 
(d)(1)(ii) (``salvage value''), (d)(2)(iii) (``repair allowance'', 
``repair allowance percentage'', and ``repair allowance property''), 
(d)(2)(vi) (``excluded addition''), (d)(2)(vii) (``property 
improvement''), (d)(3)(ii) (``ordinary retirement'' and ``extraordinary 
retirement''), (d)(3)(vi) (``special basis vintage account''), and 
(e)(1) (``first placed in service'') of this section.
    (b) Reasonable allowance using asset depreciation ranges--(1) In 
general. The allowance for depreciation of eligible property (as defined 
in subparagraph (2) of this paragraph) to which the taxpayer elects to 
apply this section shall be determined as provided in paragraph (c) of 
this section and shall constitute the reasonable allowance for 
depreciation of such property under section 167(a).
    (2) Definition of eligible property. For purposes of this section, 
the term ``eligible property'' means tangible property which is subject 
to the allowance for depreciation provided by section 167(a) but only 
if--
    (i) An asset guideline class and asset guideline period are in 
effect for such property for the taxable year of election (see 
subparagraph (4) of this paragraph);
    (ii) The property is first placed in service (as described in 
paragraph (e) (1) of this section) by the taxpayer after December 31, 
1970 (but see subparagraph (7) of this paragraph for special rule where 
there is a mere change in the form of conducting a trade or business); 
and
    (iii) The property is either--
    (a) Section 1245 property as defined in section 1245(a) (3), or
    (b) Section 1250 property as defined in section 1250(c).

See, however, subparagraph (6) of this paragraph for special rule for 
certain public utility property as defined in section 167(l)(3)(A). 
Property which meets the requirements of this subparagraph is eligible 
property even if depreciation with respect to such property, determined 
in accordance with this section, is allocated to or otherwise required 
to be reflected in the cost of a capitalized item. The term ``eligible 
property'' includes any property which meets the requirements of this 
subparagraph, whether such property is new property, ``used property'' 
(as described in subparagraph (5)(iii)(c) of this paragraph), a 
``property improvement'' (as described in paragraph (d)(2)(vii) of this 
section), or an ``excluded addition'' (as described in paragraph 
(d)(2)(vi) of this section). For the treatment of expenditures for the 
repair, maintenance, rehabilitation or improvement of certain property, 
see paragraph (d) (2) of this section.
    (3) Requirement of vintage accounts--(i) In general. For purposes of 
this section, a ``vintage account'' is a closed-end depreciation account 
containing eligible property to which the taxpayer elects to apply this 
section, first placed in service by the taxpayer during the taxable year 
of election. The ``vintage'' of an account refers to the taxable year 
during which the eligible property in the account is first placed in 
service by the taxpayer. Such an account will consist of an asset, or a 
group of assets, within a single asset guideline class established 
pursuant to subparagraph (4) of this paragraph and may contain only 
eligible property. Each item of eligible property to which the taxpayer 
elects to apply this section, first placed in service by the taxpayer 
during the taxable year of election (determined without regard to a 
convention described in paragraph (c)(2) of this section) shall be 
placed in a vintage account of the taxable year of election. For rule 
regarding ``special basis vintage accounts'' for certain property 
improvements, see paragraph (d)(2)(viii) and (3)(vi) of this section. 
Any number of vintage accounts of a taxable year may be established. 
More than one account of the same vintage may be established for 
different assets of the same asset guideline class. See paragraph 
(d)(3)(xi) of this section for special rule for

[[Page 945]]

treatment of certain multiple asset and item accounts.
    (ii) Special rule. Section 1245 property may not be placed in a 
vintage account with section 1250 property. Property the original use of 
which does not commence with the taxpayer may not be placed in a vintage 
account with property the original use of which commences with the 
taxpayer. Property described in section 167(f)(2) may not be placed in a 
vintage account with property not described in section 167(f)(2). 
Property described in section 179(d)(1) for which the taxpayer elects 
the allowance for the first taxable year in accordance with section 
179(c) may not be placed in a vintage account with property not 
described in section 179(d)(1) or for which the taxpayer does not elect 
such allowance for the first taxable year. For special rule for property 
acquired in a transaction to which section 381(a) applies, see paragraph 
(e)(3)(i) of this section. For additional rules with respect to 
accounting for eligible property, see paragraph (e) of this section.
    (4) Asset depreciation ranges and periods--(i) Selection of asset 
depreciation period. The taxpayers books and records must specify for 
each vintage account of the taxable year of election--
    (a) In the case of vintage account for property in an asset 
guideline class for which no asset depreciation range is in effect for 
the taxable year, the asset depreciation period (which shall be equal to 
the asset guideline period for the assets in such account), or
    (b) In the case of a vintage account for property in an asset 
guideline class for which an asset depreciation range is in effect for 
the taxable year, the asset depreciation period selected by the taxpayer 
from the asset depreciation range for the assets in such account.

Unless otherwise expressly provided in the establishment thereof, for 
purposes of this section, the term ``asset guideline class'' means a 
category of assets (including ``subsidiary assets'') for which a 
separate asset guideline period is in effect for the taxable year as 
provided in subdivision (ii) of this subparagraph. The ``asset 
depreciation range'' is a period of years which extends from 80 percent 
of the asset guideline period to 120 percent of such period, determined 
in each case by rounding any fractional part of a year to the nearer of 
the nearest whole or half year. Except as provided in paragraph 
(e)(3)(iv) of this section, in the case of an asset guideline class for 
which an asset depreciation range is in effect, any period within the 
asset depreciation range for the assets in a vintage account which is a 
whole number of years or a whole number of years plus a half year, may 
be selected. The term ``asset depreciation period'' means the period 
selected from the asset depreciation range, or if no asset depreciation 
range is in effect for the class, the asset guideline period. The 
``asset guideline period'' is established in accordance with subdivision 
(ii) of this subparagraph and is the class life under section 167(m). 
See Revenue Procedure 72-10 for special rules for section 1250 property 
and property predominately used outside the United States. In general, 
an asset guideline period, but no asset depreciation range, is in effect 
for such property.
    (ii) Establishment of asset guideline classes and periods. The asset 
guideline classes and the asset guideline periods, and the asset 
depreciation ranges determined from such periods, in effect for taxable 
years ending before the effective date of the first supplemental asset 
guideline classes, asset guideline periods, and asset depreciation 
ranges, established pursuant to this section are set forth in Revenue 
Procedure 72-10. Asset guideline classes and periods, and asset 
depreciation ranges, will from time to time be established, 
supplemented, and revised with express reference to this section, and 
will be published in the Internal Revenue Bulletin. The asset guideline 
classes, the asset guideline periods, and the asset depreciation ranges 
determined from such periods in effect as of the last day of a taxable 
year of election shall apply to all vintage accounts of such taxable 
year, except that neither the asset guideline period nor the lower limit 
of the asset depreciation range for any such account shall be longer 
than the asset guideline period or the lower limit of the asset 
depreciation range, as the case may be, for such account in effect as of 
the first day of the taxable

[[Page 946]]

year (or as of such later time in such year as an asset guideline class 
first established during such year becomes effective). Generally, the 
reasonable allowance for depreciation of property for any taxable year 
in a vintage account shall not be changed to reflect any supplement or 
revision of the asset guideline classes or periods, and asset 
depreciation ranges, for the taxable year in which the account is 
established, which occurs after the end of such taxable year. However, 
if expressly provided in such a supplement or revision, the taxpayer 
may, at his option in the manner specified therein, apply the revised or 
supplemented asset guideline classes or periods and asset depreciation 
ranges to such property for such taxable year and succeeding taxable 
years.
    (iii) Applicable guideline classes and periods in special 
situations. (a) An electric or gas utility which would in accordance 
with Revenue Procedure 64-21 be entitled to use a composite guideline 
class basis for applying Revenue Procedure 62-21 may, solely with 
respect to property for which an asset depreciation range is in effect 
for the taxable year, elect to apply this section on the basis of a 
composite asset guideline class and asset guideline period determined by 
applying the provisions of Revenue Procedure 64-21 to such property. The 
asset depreciation range for such a composite asset guideline class 
shall be determined by reference to the composite asset guideline period 
at the beginning of the first taxable year to which the taxpayer elects 
to apply this section and shall not be changed until such time as major 
variations in the asset mix or the asset guideline classes or periods 
justify some other composite asset guideline period. Except as provided 
in paragraph (d)(2)(iii) of this section with respect to buildings and 
other structures, for the purposes of this section, all property in the 
composite asset guideline class shall be treated as included in a single 
asset guideline class. If the taxpayer elects to apply this subdivision, 
the election shall be made on the tax return filed for the first taxable 
year for which the taxpayer elects to apply this section. An election to 
apply this subdivision for any taxable year shall apply to all 
succeeding taxable years to which the taxpayer elects to apply this 
section, except to the extent the election to apply this subdivision is 
with the consent of the Commissioner terminated with respect to a 
succeeding taxable year and all taxable years thereafter.
    (b) For purposes of this section, property shall be included in the 
asset guideline class for the activity in which the property is 
primarily used. See paragraph (e)(3)(iii) of this section for rule for 
leased property. Property shall be classified according to primary use 
even though the activity in which such property is primarily used is 
insubstantial in relation to all the taxpayer's activities. No change in 
the classification of property shall be made because of a change in 
primary use after the end of the taxable year in which property is first 
placed in service, including a change in use which results in section 
1250 property becoming section 1245 property.
    (c) An incorrect classification or characterization by the taxpayer 
of property for the purposes of this section (such as under (b) of this 
subdivision or under subparagraph (2) or (3) (ii) of this paragraph) 
shall not cause or permit a revocation of the election to apply this 
section for the taxable year in which such property was first placed in 
service. The classification or characterization of such property shall 
be corrected. All adjustments necessary to the correction shall be made, 
including adjustments of unadjusted basis, adjusted basis, salvage 
value, the reserve for depreciation of all vintage accounts affected, 
and the amount of depreciation allowable for all taxable years for which 
the period for assessment of tax prescribed in section 6501 has not 
expired. If because of incorrect classification or characterization 
property included in an election to apply this section was not placed in 
a vintage account and no asset depreciation period was selected for the 
property or the property was placed in a vintage account but an asset 
depreciation period was selected from an incorrect asset depreciation 
range, the taxpayer shall place the property in a vintage

[[Page 947]]

account and select an asset depreciation period for the account from the 
correct asset depreciation range.
    (d) Generally, except as provided in subparagraph (5)(v)(a) of this 
paragraph, a taxpayer may not compute depreciation for eligible property 
first placed in service during the taxable year under a method of 
depreciation not described in section 167(b) (1), (2), or (3). (If the 
taxpayer computes depreciation with respect to such property under 
section 167(k), or amortizes such property, the property must be 
excluded from the election to apply this section.) (See subparagraph 
(5)(v)(b) of this paragraph.) However, if the taxpayer establishes to 
the satisfaction of the Commissioner that a method of depreciation not 
described in section 167(b) (1), (2), (3), or (k) was adopted for 
property in the asset guideline class on the basis of a good faith 
mistake as to the proper asset guideline class for the property, then, 
unless the requirements of subparagraph (5)(v)(a) of this paragraph are 
met, the taxpayer must terminate (as of the beginning of the taxable 
year) such method of depreciation with respect to all eligible property 
in the asset guideline class which was first placed in service during 
the taxable year. In such event, the taxpayer's election to apply this 
section shall include eligible property in the asset guideline class 
without regard to subparagraph (5)(v)(a) of this paragraph. The 
provisions of (c) of this subdivision shall apply to the correction in 
the classification of the property.
    (e) If the provisions of section 167(j) apply to require a change in 
the method of depreciation with respect to an item of section 1250 
property in a multiple asset vintage account, the asset shall be removed 
from the account and placed in a separate item vintage account. The 
unadjusted basis of the asset shall be removed from the unadjusted basis 
of the vintage account as of the first day of the taxable year in which 
the change in method of depreciation is required and the depreciation 
reserve established for the account shall be reduced by the depreciation 
allowable for the property computed in the manner prescribed in 
paragraph (c)(1)(v)(b) of this section for determination of the adjusted 
basis of property. See paragraph (d)(3)(vii)(e) of this section for 
treatment of salvage value when property is removed from a vintage 
account.
    (iv) Examples. The principles of this subparagraph may be 
illustrated by the following examples:

    Example (1). Corporation X purchases a bulldozer for the use in its 
construction business. The bulldozer is first placed in service in 1972. 
Since the bulldozer is tangible property for which an asset guideline 
class and period have been established, the bulldozer is eligible 
property. The bulldozer is in asset guideline class 15.1 of Revenue 
Procedure 72-10, and the asset depreciation range is 4-6 years.
    Example (2). In 1972, corporation Y first places in service a 
factory building. Since the factory building is tangible property for 
which an asset guideline class and period have been established, it is 
eligible property. The factory building is in asset guideline class 
65.11 of Revenue Procedure 72-10. Since no asset depreciation range is 
in effect for the asset guideline class, the asset depreciation period 
is the asset guideline period of 45 years. (See subparagraph (5)(vi) of 
this paragraph for election to exclude certain section 1250 property 
during transition period.)
    Example (3). In January of 1971, corporation Y, a calendar year 
taxpayer, pays or incurs $2,000 for the rehabilitation and improvement 
of machine A which was first placed in service in 1969. On January 1, 
1971, corporation Y first placed in service machines B and C, each with 
an unadjusted basis of $10,000. Machines B and C are eligible property. 
Machine A would be eligible property but for the fact it was first 
placed in service prior to January 1, 1971 (that is, machine A is 
eligible property determined without regard to subparagraph (2)(ii) of 
this paragraph). Corporation Y elects to apply this section for the 
taxable year, and adopts the modified half-year convention described in 
paragraph (c)(2)(ii) of this section, but does not elect to apply the 
asset guideline class repair allowance described in paragraph 
(d)(2)(iii) of this section. Machines A, B, and C are in asset guideline 
class 24.4 under Revenue Procedure 72-10 for which the asset 
depreciation range is 8 to 12 years. The $2,000 expended on machine A 
substantially increases its capacity and is a capital expenditure under 
sections 162 and 263. The $2,000 is a property improvement (as defined 
in paragraph (d)(2)(vii)(b) of this section) which is eligible property. 
However, corporation Y by mistake treats the property improvement of 
$2,000 as a deductible repair. Also by mistake, corporation Y includes 
machine B in asset guideline class 24.3 under Revenue Procedure 72-10 
for which the asset depreciation range is 5 to 7 years. Corporation Y 
establishes vintage accounts

[[Page 948]]

for 1971, and computes depreciation for 1971 and 1972 as follows:

------------------------------------------------------------------------
                                                  Dec. 31,     Dec. 31,
                                                    1972,        1972,
                                                 reserve for   adjusted
                                                depreciation     basis
------------------------------------------------------------------------
Vintage account for machine B, with an asset         $4,000       $6,000
 depreciation period of 5 years and an
 unadjusted basis of $10,000 for which
 corporation Y adopts the straight line method
Vintage account for machine C, with an asset          2,500        7,500
 depreciation period of 8 years and an
 unadjusted basis of $10,000 for which
 corporation Y adopts the straight line method
------------------------------------------------------------------------


After audit in 1973 of corporation Y's taxable years 1971 and 1972, it 
is determined that the $2,000 paid in 1971 for the rehabilitation and 
improvement of machine A is a capital expenditure and that machine B is 
in asset guideline class 24.4. The incorrect classification is 
corrected. Corporation Y places machine B and the property improvement 
in a vintage account of 1971 and on its tax return filed for 1973 
selects an asset depreciation period of 8 years for that account. Giving 
effect to the correction in classification of the property in accordance 
with subdivision (iii) (c) of this subparagraph, at the end of 1972 the 
unadjusted basis, reserve for depreciation, and adjusted basis of the 
vintage account for machine B and the property improvement with respect 
to machine A are $12,000, $3,000, and $9,000, respectively. Corporation 
Y's deduction of the $2,000 property improvement in 1971 as a repair 
expense under section 162 is disallowed. For 1971 and 1972 depreciation 
deductions are disallowed in the amount of $500 each year (that is, $750 
excess annual depreciation on machine B minus $250 annual depreciation 
on the property improvement).
    Example (4). (a) In 1971, Corporation X, a calendar year taxpayer, 
first places in service machines A through M, all of which are eligible 
property. All the machines except machine A are in asset guideline class 
24.3 under Revenue Procedure 72-10. Machine A is in asset guideline 
class 24.4 under Revenue Procedure 72-10. Machine B has an unadjusted 
basis equal to 80 percent of the total unadjusted basis of machines B 
through M. By good faith mistake as to proper classification, 
corporation X includes both machine A and machine B in asset guideline 
class 24.4. Corporation X consistently uses the machine hour method of 
depreciation on all property in asset guideline class 24.4, and for 1971 
computes depreciation for machines A and B under that method. 
Corporation X elects to apply this section for 1971 on the assumption 
that the election includes machines C through M which are in asset 
guideline class 24.3. In 1973, upon audit of corporation X's taxable 
years 1971 and 1972, it is determined that machine B is included in 
asset guideline class 24.3 and that since for 1971 corporation X 
computed depreciation on machine B under the machine hour method, in 
accordance with subparagraph (5)(v)(a) of this paragraph, all property 
in asset guideline class 24.3 (machines B through M) is excluded from 
corporation X's election to apply this section for 1971. Although 
corporation X has consistently used the machine hour method for asset 
guideline class 24.4, corporation X has not in the past used the machine 
hour method for machines of the type and function of machines C through 
M which are in asset guideline class 24.3. Both machine A and machine B 
are used in connection with the manufacture of wood products. There is 
reasonable basis for corporation X having assumed that machine B is in 
asset guideline class 24.4 along with machine A to which it is similar. 
Corporation X establishes to the satisfaction of the Commissioner that 
it used the machine hour method for machine B on the basis of a good 
faith mistake as to the proper classification of the machine. 
Corporation X may, at its option (see subparagraph (5)(v) of this 
paragraph), terminate the machine hour method of depreciation for 
machine B as of the beginning of 1971, and in that event corporation X's 
election to apply this section for 1971 will apply to machines B through 
M without regard to subparagraph (5)(v)(a) of this paragraph. The 
adjustments provided in subdivision (iii)(c) of this subparagraph will 
be made as a result of the correction in classification of property. If 
corporation X does not terminate the machine hour method with respect to 
machine B, machines B through M must be excluded from the election to 
apply this section (see subparagraph (5)(v) of this paragraph).
    (b) The facts are the same as in (a) of this example except that 
machine B has an unadjusted basis equal to only 65 percent of the total 
unadjusted basis of machines B through M.
    In this case, corporation X must either terminate the machine hour 
method of depreciation with respect to asset B (since the provisions of 
subparagraph (5)(v) of this paragraph do not permit the exclusion of the 
property from the election to apply this section) or otherwise comply 
with the provisions of subparagraph (5)(v) of this paragraph. (See 
paragraph (c)(1)(iv) for limitation on methods which may be adopted for 
property included in the election to apply this section.)

    (5) Requirements of election--(i) In general. Except as otherwise 
provided in paragraph (d)(2) of this section dealing

[[Page 949]]

with expenditures for the repair, maintenance, rehabilitation or 
improvement of certain property, no provision of this section shall 
apply to any property other than eligible property to which the taxpayer 
elects in accordance with this section, to apply this section. For the 
time and manner of election, and certain conditions to an election, see 
paragraph (f) of this section. Except as otherwise provided in 
subparagraph (4)(iii) of this paragraph, subdivision (v) of this 
subparagraph and in subparagraph (6)(iii) of this paragraph, a 
taxpayer's election to apply this section may not be revoked or modified 
after the last day prescribed for filing the election. Thus, for 
example, after such day, a taxpayer may not cease to apply this section 
to property included in the election, establish different vintage 
accounts for the taxable year of election, select a different period 
from the asset depreciation range for any such account, or adopt a 
different first-year convention for any such account.
    (ii) Property required to be included in election. Except as 
otherwise provided in subdivision (iii) of this subparagraph dealing 
with certain ``used property'', in subdivision (iv) of this subparagraph 
dealing with ``section 38 property'', in subdivision (v) of this 
subparagraph dealing with property subject to special depreciation or 
amortization, in subdivision (vi) of this subparagraph dealing with 
certain section 1250 property, in subdivision (vii) of this subparagraph 
dealing with certain subsidiary assets, and in paragraph (e)(3) (i) and 
(iv) of this section dealing with transactions to which section 381(a) 
applies, if the taxpayer elects to apply this section to any eligible 
property first placed in service by the taxpayer during the taxable year 
of election, the election shall apply to all such eligible property, 
whether placed in service in a trade or business or held for production 
of income.
    (iii) Special 10 percent used property rule. (a) If (1) the 
unadjusted basis of eligible used section 1245 property (as defined in 
(c) of this subdivision) first placed in service by the taxpayer during 
the taxable year of election, for which no specific used property asset 
guideline class (as defined in (c) of this subdivision) is in effect for 
the taxable year, exceeds (2) 10 percent of the unadjusted basis of all 
eligible section 1245 property first placed in service during the 
taxable year of election, the taxpayer may exclude all (but not less 
than all) the property described in (a)(1) of this subdivision from the 
election to apply this section.
    (b) If (1) the unadjusted basis of eligible used section 1250 
property first placed in service by the taxpayer during the taxable year 
of election, for which no specific used property asset guideline class 
is in effect for the taxable year, exceeds (2) 10 percent of the 
unadjusted basis of all eligible section 1250 property first placed in 
service during the taxable year of election, the taxpayer may exclude 
all (but not less than all) the property described in (b)(1) of this 
subdivision from the election to apply this section.
    (c) For the purposes of this section, the term ``used property'' 
means property the original use of which does not commence with the 
taxpayer. Solely for the purpose of determining whether the 10 percent 
rule of this subdivision is satisfied, (1) eligible used property first 
placed in service during the taxable year and excluded from the election 
to apply this section pursuant to subdivision (v)(a) of this 
subparagraph and (2) eligible property acquired during the taxable year 
in a transaction to which section 381(a) applies, shall all be treated 
as used property regardless of whether such property would be treated as 
new property under section 167(c) and the regulations thereunder. The 
term ``specific used property asset guideline class'' means a class 
established in accordance with subparagraph (4) of this paragraph solely 
for used property primarily used in connection with the activity to 
which the class relates.
    (iv) Property subject to investment tax credit. The taxpayer may 
exclude from an election to apply this section all, or less than all, 
units of eligible property first placed in service during the taxable 
year which is--
    (a) ``Section 38 property'' as defined in section 48(a) which meets 
the requirements of section 49 and which is not property described in 
section 50, or

[[Page 950]]

    (b) Property to which section 47(a)(5)(B) applies which would be 
section 38 property but for section 49 and which is placed in service to 
replace section 38 property (other than property described in section 
50) disposed of prior to August 15, 1971.
    (v) Property subject to special method of depreciation or 
authorization. (a) In the case of eligible property first placed in 
service in a taxable year of election (and not otherwise properly 
excluded from an election to apply this section) the taxpayer may not 
compute depreciation for any of such property in the asset guideline 
class under a method not described in section 167(b) (1), (2), (3), or 
(k) unless he (1) computes depreciation under a method or methods not so 
described for eligible property first placed in service in the taxable 
year in the asset guideline class with an unadjusted basis at least 
equal to 75 percent of the unadjusted basis of all eligible property 
first placed in service in the taxable year in the asset guideline class 
and (2) agrees to continue to depreciate such property under such method 
or methods until the consent of the Commissioner is obtained to a change 
in method. The consent of the Commissioner must be obtained by filing 
Form 3115 with the Commissioner of Internal Revenue, Washington, D.C. 
20224, within the first 180 days of the taxable year for which the 
change is desired. If for the taxable year of election the taxpayer 
computes depreciation under any method not described in section 167(b) 
(1), (2), (3), or (k) for any eligible property (other than property 
otherwise properly excluded from an election to apply this section) 
first placed in service during the taxable year, an election to apply 
this section for the taxable year shall not include such property or any 
other eligible property in the same asset guideline class as such 
property. With respect to a taxable year beginning before January 1, 
1973, if the taxpayer has adopted a method of depreciation which is not 
permitted under this subdivision, the taxpayer may under this section 
adopt a method of depreciation permitted under this subdivision or 
otherwise comply with the provisions of this subdivision.
    (b) An election to apply this section shall not include eligible 
property for which, for the taxable year of election, the taxpayer 
computes depreciation under section 167(k), or computes amortization 
under section 169, 184, 185, 187, 188, or paragraph (b) of Sec. 1.162-
11. If the taxpayer has elected to apply this section to eligible 
property described in section 167(k), 169, 184, 185, or 187 and the 
taxpayer thereafter computes depreciation or amortization for such 
property for any taxable year in accordance with section 167(k), 169, 
184, 185, or 187, then the election to apply this section to such 
property shall terminate as of the beginning of the taxable year for 
which depreciation or amortization is computed under such section. 
Application of this section to the property for any period prior to the 
termination date will not be affected by the termination. The unadjusted 
basis of the property shall be removed as of the termination date from 
the unadjusted basis of the vintage account. The depreciation reserve 
established for the account shall be reduced by the depreciation 
allowable for the property, computed in the manner prescribed in 
paragraph (c)(1)(v)(b) of this section for determination of the adjusted 
basis of the property. See paragraph (d)(3)(vii)(e) of this section for 
treatment of salvage value when property is removed from a vintage 
account.
    (vi) Certain section 1250 property. (a) The taxpayer may exclude 
from an election to apply this section all, or less than all, items of 
eligible section 1250 property first placed in service during the 
taxable year of election provided that--
    (1) The item is first placed in service before the earlier of the 
effective date of the first supplemental asset guideline class including 
such property established in accordance with subparagraph (4)(ii) of 
this paragraph, or January 1, 1974, and
    (2) The taxpayer establishes that a useful life shorter than the 
asset guideline period in effect on January 1, 1971, for such item of 
property is justified for such taxable year.

A useful life shorter than the asset guideline period in effect on 
January 1, 1971, will be considered justified only if

[[Page 951]]

such life is justified in accordance with the provisions of Revenue 
Procedure 62-21 (including all modifications, amendments or supplements 
thereto as of January 1, 1971), determined without application of the 
minimal adjustment rule in section 4, part II, of Revenue Procedure 65-
13. If an item of section 1250 property is excluded from an election to 
apply this section pursuant to this subdivision, any elevator or 
escalator which is a part of such item shall also be excluded from the 
election.
    (b) If the taxpayer excludes an item of section 1250 property from 
an election to apply this section in accordance with this subdivision, 
the useful life justified under Revenue Procedure 62-21 in accordance 
with this subdivision for the taxable year of exclusion will be treated 
as justified for such item of section 1250 property for the taxable year 
of the exclusion and all subsequent taxable years.
    (vii) Subsidiary assets. The taxpayer may exclude from an election 
to apply this section all (but not less than all) subsidiary assets 
first placed in service during the taxable year of election in an asset 
guideline class, provided that--
    (a) The unadjusted basis of eligible subsidiary assets first placed 
in service during the taxable year in the class is as much as 3 percent 
of the unadjusted basis of all eligible property first placed in service 
during the taxable year in the class, and
    (b) Such subsidiary assets are first placed in service by the 
taxpayer before the earlier of (1) the effective date of the first 
supplemental asset guideline class including such subsidiary assets 
established in accordance with subparagraph (4)(ii) of this paragraph, 
or (2) January 1, 1974.

For purposes of this subdivision the term ``subsidiary assets'' includes 
jigs, dies, molds, returnable containers, glassware, silverware, textile 
mill cam assemblies, and other equipment included in group 1, class 5, 
of Revenue Procedure 62-21. which is usually and property accounted for 
separately from other property and under a method of depreciation not 
expressed in terms of years.
    (6) Special rule for certain public utility property--(i) 
Requirement of normalization in certain cases. Under section 167(1), in 
the case of public utility property (as defined in section 
167(1)(3)(A)), if the taxpayer--
    (a) Is entitled to use a method of depreciation other than a 
``subsection (1) method'' of depreciation (as defined in section 
167(1)(3)(F)) only if it uses the ``normalization method of accounting'' 
(as defined in section 167(1)(3)(G)) with respect to such property, or
    (b) Is entitled for the taxable year to use only a ``subsection (1) 
method'' of depreciation, such property shall be eligible property (as 
defined in subparagraph (2) of this paragraph) only if the taxpayer 
normalizes the tax deferral resulting from the election to apply this 
section.
    (ii) Normalization. The taxpayer will be considered to normalize the 
tax deferral resulting from the election to apply this section only if 
it computes its tax expense for purposes of establishing its cost of 
service for ratemaking purposes and for reflecting operating results in 
its regulated books of account using a period for depreciation no less 
than the lesser of--
    (a) 100 percent of the asset guideline period in effect in 
accordance with subparagraph (4)(ii) of this paragraph for the first 
taxable year to which this section applies, or
    (b) The period for computing its depreciation expense for ratemaking 
purposes and for reflecting operating results in its regulated books of 
account, and makes adjustments to a reserve to reflect the deferral of 
taxes resulting from the election to apply this section. A determination 
whether the taxpayer is considered to normalize (within the meaning of 
the preceding sentence) the tax deferral resulting from the election to 
apply this section shall be made in a manner consistent with the 
principles for determining whether a taxpayer is using the 
``normalization method of accounting'' (within the meaning of section 
167(1)(3)(G)). [Removed] See Sec. 1.167(1)-1(h).
    (iii) Failure to normalize. If a taxpayer, which has elected to 
apply this section to any eligible public utility property and is 
required under subdivision (i) of this subparagraph to normalize the tax 
deferral resulting from the election to apply this section to

[[Page 952]]

such property, fails to normalize such tax deferral, the election to 
apply this section to such property shall terminate as of the beginning 
of the taxable year for which the taxpayer fails to normalize such tax 
deferral. Application of this section to such property for any period 
prior to the termination date will not be affected by the termination. 
The unadjusted basis of the property shall be removed as of the 
termination date from the unadjusted basis of the vintage account. The 
depreciation reserve established for the account shall be reduced by the 
depreciation allowable for the property, computed in the manner 
prescribed in paragraph (c)(1)(v)(b) of this section for determination 
of the adjusted basis of the property. See paragraph (d)(3)(vii)(e) of 
this section for treatment of salvage value when property is removed 
from a vintage account.
    (iv) Examples. The principles of this subparagraph may be 
illustrated by the following examples:

    Example (1). Corporation A is a gas pipeline company, subject to the 
jurisdiction of the Federal Power Commission, which is entitled under 
section 167(1) to use a method of depreciation other than a ``subsection 
(1) method'' of depreciation (as defined in section 167(1) (3) (F)) only 
if it uses the ``normalization method of accounting'' (as defined in 
section 167(1)(3)(G)). Corporation A elects to apply this section for 
1972 with respect to all eligible property. In 1972, corporation A 
places in service eligible property with an unadjusted basis of $2 
million. One hundred percent of the asset guideline period for such 
property is 22 years and the asset depreciation range is from 17.5 years 
to 26.5 years. The taxpayer uses the double declining balance method of 
depreciation, selects an asset depreciation period of 17.5 years and 
applies the half-year convention (described in paragraph (c)(2)(iii) of 
this section). The depreciation allowable under this section with 
respect to such property in 1972 is $114,285. The taxpayer will be 
considered to normalize the tax deferral resulting from the election to 
apply this section and to use the ``normalization method of accounting'' 
(within the meaning of section 167(1)(3)(G)) if it computes its tax 
expense for purposes of determining its cost of service for rate making 
purposes and for reflecting operating results in its regulated books of 
account using a ``subsection (1) method'' of depreciation, such as the 
straight line method, determined by using a depreciation period of 22 
years (that is, 100 percent of the asset guideline period). A 
depreciation allowance computed in this manner is $45,454. The 
difference in the amount determined under this section ($114,285) and 
the amount used in computing its tax expense for purposes of estimating 
its cost of service for rate making purposes and for reflecting 
operating results in its regulated books of account ($45,454) is 
$68,831. Assuming a tax rate of 48 percent, the deferral of taxes 
resulting from an election to apply this section and using a different 
method of depreciation for tax purposes from that used for establishing 
its cost of service for rate making purposes and for reflecting 
operating results in its regulated books of account is 48 percent of 
$68,831, or $33,039, which amount should be added to a reserve to 
reflect the deferral of taxes resulting from the election to apply this 
section and from the use of a different method of depreciation in 
computing the allowance for depreciation under section 167 from that 
used in computing its depreciation expense for purposes of establishing 
its cost of service for rate making purposes and for reflecting 
operating results in its regulated books of account.
    Example (2). Corporation B, a telephone company subject to the 
jurisdiction of the Federal Communications Commission used a ``flow-
through method of accounting'' (as defined in section 167(1)(3)(H)) for 
its ``July 1969 accounting period'' (as defined in section 167(1)(3)(I)) 
with respect to all of its pre-1970 public utility property and did not 
make an election under section 167(1)(4)(A). Thus, corporation B is 
entitled under section 167(1) to use a method of depreciation other than 
a ``subsection (1) method'' with respect to certain property without 
using the ``normalization method of accounting.'' In 1972, corporation B 
makes an election to apply this section with respect to all eligible 
property. Corporation B is not required to normalize the tax deferral 
resulting from the election to apply this section in the case of 
property for which it is not required to use the ``normalization method 
of accounting'' under section 167(1).
    Example (3). Assume the same facts as in example (2) except that 
corporation B made a timely election under section 167(1)(4)(A) that 
section 167(1)(2)(C) not apply with respect to property which increases 
the productive or operational capacity of the taxpayer. Corporation B 
must normalize the tax deferral resulting from the election to apply 
this section with respect to such property.

    (7) Mere change in form of conducting a trade or business. Property 
which was first placed in service by the transferor before January 1, 
1971, shall not be eligible property if such property is first placed in 
service by the transferee after December 31, 1970, by reason of a mere 
change in the form of conducting

[[Page 953]]

a trade or business in which such property is used. A mere change in the 
form of conducting a trade or business in which such property is used 
will be considered to have occurred if--
    (i) The transferor (or in a case where the transferor is a 
partnership, estate, trust, or corporation, the partners, beneficiaries, 
or shareholders) of such property retains a substantial interest in such 
trade or business, or
    (ii) The basis of such property in the hands of the transferee is 
determined in whole or in part by reference to the basis of such 
property in the hands of the transferor.

For purposes of this subparagraph, a transferor (or in a case where the 
transferor is a partnership, estate, trust, or corporation, the 
partners, beneficiaries, or shareholders) shall be considered as having 
retained a substantial interest in the trade or business only if, after 
the change in form, his (or their) interest in such trade or business is 
substantial in relation to the total interest of all persons in such 
trade or business. This subparagraph shall apply to property first 
placed in service prior to January 1, 1971, held for the production of 
income (within the meaning of section 167(a)(2)) as well as to property 
used in a trade or business. The principles of this subdivision may be 
illustrated by the following examples:

    Example (1). Corporation X and corporation Y are includible 
corporations in an affiliated group as defined in section 1504(a). In 
1971 corporation X sells property to corporation Y for cash. The 
property would meet the requirements of subparagraph (2) of this 
paragraph for eligible property except that it was first placed in 
service by corporation X in 1970. After the transfer, the property is 
first placed in service by corporation Y in 1971. The property is not 
eligible property because of the mere change in the form of conducting a 
trade or business.
    Example (2). In 1971, in a transaction to which section 351 applies, 
taxpayer B transfers to corporation W property which would meet the 
requirements of subparagraph (2) of this paragraph for eligible property 
except that the property was first placed in service by B in 1969. 
Corporation W first places the property in service in 1971. The property 
is not eligible property because of the mere change in the form of 
conducting a trade or business.

    (c) Manner of determining allowance--(1) In general--(i) Computation 
of allowance. (a) The allowance for depreciation of property in a 
vintage account shall be determined in the manner specified in this 
paragraph by using the method of depreciation adopted by the taxpayer 
for the account and a rate based upon the asset depreciation period for 
the account. (For limitations on methods of depreciation permitted with 
respect to property, see section 167 (c) and (j) and subdivision (iv) of 
this subparagraph.) In applying the method of depreciation adopted by 
the taxpayer, the annual allowance for depreciation of a vintage account 
shall be determined without adjustment for the salvage value of the 
property in such account except that no account may be depreciated below 
the reasonable salvage value of the account. (For rules regarding 
estimation and treatment of salvage value, see paragraph (d)(1) and (3) 
(vii) and (viii) of this section.) Regardless of the method of 
depreciation adopted by the taxpayer, the depreciation allowable for a 
taxable year with respect to a vintage account may not exceed the amount 
by which (as of the beginning of the taxable year) the unadjusted basis 
of the account exceeds (1) the reserve for depreciation established for 
the account plus (2) the salvage value of the account. The unadjusted 
basis of a vintage account is defined in subdivision (v) of this 
subparagraph. The adjustments to the depreciation reserve are described 
in subdivision (ii) of this subparagraph.
    (b) The annual allowance for depreciation of a vintage account using 
the straight line method of depreciation shall be determined by dividing 
the unadjusted basis of the vintage account (without reduction for 
salvage value) by the number of years in the asset depreciation period 
selected for the account. See subdivision (iii)(b) of this subparagraph 
for the manner of computing the depreciation allowance following a 
change from the declining balance method or the sum of the years-digits 
method to the straight line method.

[[Page 954]]

    (c) In the case of the sum of the years-digits method, the annual 
allowance for depreciation of a vintage account shall be computed by 
multiplying the unadjusted basis of the vintage account (without 
reduction for salvage value) by a fraction, the numerator of which 
changes each year to a number which corresponds to the years remaining 
in the asset depreciation period for the account (including the year for 
which the allowance is being computed) and the denominator of which is 
the sum of all the year's digits corresponding to the asset depreciation 
period for the account. See subdivision (iii)(c) of this subparagraph 
for the manner of computing the depreciation allowance following a 
change from the declining balance method to the sum of the years-digits 
method.
    (d) The annual allowance for depreciation of a vintage account using 
a declining balance method is determined by applying a uniform rate to 
the excess of the unadjusted basis of the vintage account over the 
depreciation reserve established for that account. The rate under the 
declining balance method may not exceed twice the straight line rate 
based upon the asset depreciation period for the vintage account.
    (e) The allowance for depreciation under this paragraph shall 
constitute the amount of depreciation allowable under section 167. See 
section 179 for additional first-year allowance for certain property.
    (ii) Establishment of depreciation reserve. The taxpayer must 
establish a depreciation reserve for each vintage account. The amount of 
the reserve for a guideline class must be stated on each income tax 
return on which depreciation with respect to such class is determined 
under this section. The depreciation reserve for a vintage account 
consists of the accumulated depreciation allowable under this section 
with respect to the vintage account, increased by the adjustments for 
ordinary retirements prescribed by paragraph (d)(3)(iii) of this 
section, by the adjustments for reduction of the salvage value of a 
vintage account prescribed by paragraph (d)(3)(vii)(d) of this section, 
and by the adjustments for transfers to supplies or scrap prescribed by 
paragraph (d)(3)(viii)(b) of this section, and decreased by the 
adjustments for extraordinary retirements and certain special 
retirements as prescribed by paragraph (d)(3) (iv) and (v) of this 
section, by the adjustments for the amount of the reserve in excess of 
the unadjusted basis of a vintage account prescribed by paragraph 
(d)(3)(ix)(a) of this section, and by the adjustments for property 
removed from a vintage account prescribed by paragraphs (b)(4)(iii)(e), 
(5)(v)(b) and (6)(iii) of this section. The adjustments to the 
depreciation reserve for ordinary retirements during the taxable year 
shall be made as of the beginning of the taxable year. The adjustments 
to the depreciation reserve for extraordinary retirements shall be made 
as of the date the retirement is treated as having occurred in 
accordance with the first-year convention (described in subparagraph (2) 
of this paragraph) adopted by the taxpayer for the vintage account. The 
adjustment to the depreciation reserve for reduction of salvage value 
and for transfers to supplies or scrap shall, in the case of an ordinary 
retirement, be made as of the beginning of the taxable year, and in the 
case of an extraordinary retirement the adjustment for reduction of 
salvage value shall be made as of the date the retirement is treated as 
having occurred in accordance with the first-year convention (described 
in subparagraph (2) of this paragraph) adopted by the taxpayer for the 
vintage account. The adjustment to the depreciation reserve for property 
removed from a vintage account in accordance with paragraph 
(b)(4)(iii)(e), (5)(v)(b) and (6)(iii) of this section shall be made as 
of the beginning of the taxable year. The depreciation reserve of a 
vintage account may not be decreased below zero.
    (iii) Consent to change in method of depreciation. (a) During the 
asset depreciation period for a vintage account, the taxpayer is 
permitted to change under this section from a declining balance method 
of depreciation to the sum of the years-digits method of depreciation 
and from a declining balance method of depreciation or the sum of the 
years-digits method of depreciation to the straight line method of 
depreciation with respect to such account. Except as provided in section 
167(j)(2)(1),

[[Page 955]]

and paragraph (e)(3)(i) of this section, no other changes in the method 
of depreciation adopted for a vintage account will be permitted. The 
provisions of Sec. 1.167(e)-1 shall not apply to any change in 
depreciation method permitted under this section. The change in method 
applies to all property in the vintage account and must be adhered to 
for the entire taxable year of the change.
    (b) When a change is made to the straight line method of 
depreciation, the annual allowance for depreciation of the vintage 
account shall be determined by dividing the adjusted basis of the 
vintage account (without reduction for salvage value) by the number of 
years remaining (at the time as of which the change is made) in the 
asset depreciation period selected for the account. However, the 
depreciation allowable for any taxable year following a change to the 
straight line method may not exceed an amount determined by dividing the 
unadjusted basis of the vintage account (without reduction for salvage 
value) by the number of years in the asset depreciation period selected 
for the account.
    (c) When a change is made from the declining balance method of 
depreciation to the sum of the years-digits method of depreciation, the 
annual allowance for depreciation of a vintage account shall be 
determined by multiplying the adjusted basis of the account (without 
reduction for salvage value) at the time as of which the change is made 
by a fraction, the numerator of which changes each year to a number 
which corresponds to the number of years remaining in the asset 
depreciation period selected for the account (including the year for 
which the allowance is being computed), and the denominator of which is 
the sum of all the year's digits corresponding to the number of years 
remaining in the asset depreciation period at the time as of which the 
change is made.
    (d) The number of years remaining in the asset depreciation period 
selected for an account is equal to the asset depreciation period less 
the number of years of depreciation previously allowed. For this 
purpose, regardless of the first year convention adopted by the 
taxpayer, it will be assumed that depreciation was allowed for one-half 
of a year in the first year.
    (e) The taxpayer shall furnish a statement setting forth the vintage 
accounts for which the change is made with the income tax return filed 
for the taxable year of the change.
    (f) The principles of this subdivision may be illustrated by the 
following examples:

    Example (1). A, a calendar year taxpayer, places new section 1245 
property in service in a trade or business as follows:

------------------------------------------------------------------------
                                                   Unadjusted  Estimated
             Asset              Placed in service     basis     salvage
------------------------------------------------------------------------
X.............................  Mar. 15, 1971....       $400        $20
Y.............................  June 13, 1971....        500         50
Z.............................  July 30, 1971....        100          0
------------------------------------------------------------------------


The property is eligible property and is properly included in a single 
vintage account. The asset depreciation range for such property is 5 to 
7 years and the taxpayer selects an asset depreciation period of 5\1/2\ 
years and adopts the 200-percent declining balance method of 
depreciation. The taxpayer adopts the half-year convention described in 
subparagraph (2)(iii) of this paragraph. After 3 years, A changes from 
the 200-percent declining balance method to the straight line method of 
depreciation. Depreciation allowances would be as follows:

----------------------------------------------------------------------------------------------------------------
                                    Unadjusted
              Year                     basis           Rate        Depreciation       Reserve     Adjusted basis
----------------------------------------------------------------------------------------------------------------
1971............................          $1,000         0.18182         $181.82         $181.82         $818.18
1972............................           1,000          .36363          297.52          479.34          520.66
1973............................           1,000          .36363          189.33          668.67          331.33
1974............................           1,000      \1\ .33333          110.44          779.11          220.89
1975............................           1,000          .33333          110.44          889.56          110.44
1976............................           1,000          .33333       \2\ 40.44          930.00           70.00
----------------------------------------------------------------------------------------------------------------
\1\ Rate applied to adjusted basis of the account (without reduction by salvage) at the time as of which the
  change is made to the straight line method.
\2\ The allowable depreciation is limited by estimated salvage.


[[Page 956]]

    Example (2). The facts are the same as in example (1) except that A 
elects to use the modified half-year convention described in 
subparagraph (2)(ii) of this paragraph. The depreciation allowances 
would be as follows:

----------------------------------------------------------------------------------------------------------------
                                    Unadjusted
              Year                     basis           Rate        Depreciation       Reserve     Adjusted basis
----------------------------------------------------------------------------------------------------------------
1971............................          $1,000     \1\ 0.36363         $327.27         $327.27         $672.73
1972............................           1,000          .36363          244.63          571.90          428.10
1973............................           1,000          .36363          155.67          727.57          272.43
1974............................           1,000          .33333           90.81          818.38          181.62
1975............................           1,000          .33333           90.81          909.19           90.81
1976............................           1,000          .33333       \2\ 20.81          930.00           70.00
----------------------------------------------------------------------------------------------------------------
\1\ Rate applied to $900, the amount of assets placed in service during the first half of the taxable year.
\2\ The allowable depreciation is limited by estimated salvage.

    Example (3). The facts are the same as in example (1) except that A 
adopted the sum of the years-digits method of depreciation and does not 
change to the straight line method of depreciation. The depreciation 
allowances would be as follows:

----------------------------------------------------------------------------------------------------------------
                                    Unadjusted
              Year                     basis           Rate        Depreciation       Reserve     Adjusted basis
----------------------------------------------------------------------------------------------------------------
1971............................          $1,000     \1\ 2.75/18         $152.78         $152.78         $847.22
1972............................           1,000            5/18          277.78          430.56          569.44
1973............................           1,000            4/18          222.22          652.78          347.22
1974............................           1,000            3/18          166.67          819.45          180.55
1975............................           1,000            2/18      \2\ 110.55          930.00           70.00
1976............................           1,000            1/18            0.00          930.00           70.00
1977............................           1,000         0.25/18            0.00          930.00           70.00
----------------------------------------------------------------------------------------------------------------
\1\ Rate is equal to one-half of 5.5/18. The denominator is equal to 5.5+4.5+3.5+2.5+1.5+0.5.
\2\ The allowable depreciation is limited by estimated salvage.

    Example (4). The facts are the same as in example (3) except that A 
elects to use the modified half-year convention described in 
subparagraph (2) (ii) of this paragraph. The depreciation allowances 
would be as follows:

----------------------------------------------------------------------------------------------------------------
                                    Unadjusted
              Year                     basis           Rate        Depreciation       Reserve     Adjusted basis
----------------------------------------------------------------------------------------------------------------
1971............................          $1,000      \1\ 5.5/18         $275.00         $275.00         $725.00
1972............................           1,000            5/18          277.78          552.78          447.22
1973............................           1,000            4/18          222.22          775.00          225.00
1974............................           1,000            3/18      \2\ 155.00          930.00           70.00
1975............................           1,000            2/18            0.00          930.00           70.00
1976............................           1,000            1/18            0.00          930.00           70.00
1977............................           1,000         0.25/18            0.00          930.00           70.00
----------------------------------------------------------------------------------------------------------------
\1\ Rate applied to $900, the amount of assets placed in service during the first half of the taxable year.
\2\ The allowable depreciation is limited by estimated salvage.

    Example (5). The facts are the same as in example (2) except that 
after 2 years A changes from the 200-percent declining balance method to 
the sum of the years-digits method of depreciation. The depreciation 
allowances would be as follows:

----------------------------------------------------------------------------------------------------------------
                                    Unadjusted
              Year                     basis           Rate        Depreciation       Reserve     Adjusted basis
----------------------------------------------------------------------------------------------------------------
1971............................          $1,000         0.36363         $327.27         $327.27         $672.73
1972............................           1,000          .36363          244.63          571.90          428.10
1973............................           1,000            4/10          171.24          743.14          256.86
1974............................           1,000            3/10          128.43          871.57          128.43
1975............................           1,000            2/10       \1\ 58.43          930.00           70.00
1976............................           1,000            1/10            0.00          930.00           70.00
----------------------------------------------------------------------------------------------------------------
\1\ The allowable depreciation is limited by estimated salvage.


[[Page 957]]

    (iv) Limitation on methods. (a) The same method of depreciation must 
be adopted for all property in a single vintage account. Generally, the 
method of depreciation which may be adopted is subject to the 
limitations contained in section 167 (c), (j) and (l).
    (b) Except as otherwise provided in section 167(j) with respect to 
certain eligible section 1250 property--
    (1) In the case of a vintage account for which the taxpayer has 
selected an asset depreciation period of 3 years or more and which only 
contains property the original use of which commences with the taxpayer, 
any method of depreciation described in section 167(b) (1), (2), or (3) 
may be adopted, but if the vintage account contains property the 
original use of which does not commence with the taxpayer, or if the 
asset depreciation period for the account is less than 3 years, a method 
of depreciation described in section 167(b) (2) or (3) may not be 
adopted for the account, and
    (2) The declining balance method using a rate not in excess of 150 
percent of the straight line rate based upon the asset depreciation 
period for the vintage account may be adopted for the account even if 
the original use of the property does not commence with the taxpayer 
provided the asset depreciation period for the account is at least 3 
years.
    (c) The term ``original use'' means the first use to which the 
property is put, whether or not such use corresponds to the use of such 
property by the taxpayer. (See Sec. 1.167(c)-1).
    (v) Unadjusted and adjusted basis. (a) For purposes of this section, 
the unadjusted basis of an asset (including an ``excluded addition'' and 
a ``property improvement'' as described, respectively, in paragraph 
(d)(2) (vi) and (vii) of this section) is its cost or other basis 
without any adjustment for depreciation or amortization (other than 
depreciation under section 179) but with other adjustments required 
under section 1016 or other applicable provisions of law. The unadjusted 
basis of a vintage account is the total of the unadjusted bases of all 
the assets in the account. The unadjusted basis of a ``special basis 
vintage account'' as described in paragraph (d)(3)(vi) of this section 
is the amount of the property improvement determined in paragraph 
(d)(2)(vii)(a) of this section.
    (b) The adjusted basis of a vintage account is the amount by which 
the unadjusted basis of the account exceeds the reserve for depreciation 
for the account. The adjusted basis of an asset in a vintage account is 
the amount by which the unadjusted basis of the asset exceeds the amount 
of depreciation allowable for the asset under this section computed by 
using the method of depreciation and the rate applicable to the account. 
For purposes of this subdivision, the depreciation allowable for an 
asset shall include, to the extent identifiable, the amount of proceeds 
previously added to the depreciation reserve in accordance with 
paragraph (d)(3)(iii) of this section upon the retirement of any portion 
of such asset. (See paragraph (d)(3)(vi) of this section for election 
under certain circumstances to allocate adjusted basis of an amount of 
property improvement determined under paragraph (d)(2)(vii)(a) of this 
section.)
    (2) Conventions applied to additions and retirements--(i) In 
general. The allowance for depreciation of a vintage account (whether an 
item account or a multiple asset account) shall be determined by 
applying one of the conventions described in subdivisions (ii) and (iii) 
of this subparagraph. (For the manner of applying a convention in the 
case of taxable years beginning before and ending after December 31, 
1970, see subparagraph (3) of this paragraph.) The same convention must 
be adopted for all vintage accounts of a taxable year, but the same 
convention need not be adopted for the vintage accounts of another 
taxable year. An election to apply this section must specify the 
convention adopted. (See paragraph (f) of this section for information 
required in making the election.) The convention adopted by the taxpayer 
is a method of accounting for purposes of section 446, but the consent 
of the Commissioner will be deemed granted to make an annual adoption of 
either of the conventions described in subdivisions (ii) and (iii) of 
this subparagraph.
    (ii) Modified half-year convention. The depreciation allowance for a 
vintage account for which the taxpayer adopts

[[Page 958]]

the ``modified half-year convention'' shall be determined by treating: 
(a) All property in such account which is placed in service during the 
first half of the taxable year as placed in service on the first day of 
the taxable year; and (b) all property in such account which is placed 
in service during the second half of the taxable year as placed in 
service on the first day of the succeeding taxable year. The 
depreciation allowance for a vintage account for a taxable year in which 
there is an extraordinary retirement (as defined in paragraph (d) (3) 
(ii) of this section) of property first placed in service during the 
first half of the taxable year is determined by treating all such 
retirements from such account during the first half of the taxable year 
as occurring on the first day of the taxable year and all such 
retirements from such account during the second half of the taxable year 
as occurring on the first day of the second half of the taxable year. 
The depreciation allowance for a vintage account for a taxable year in 
which there is an extraordinary retirement (as defined in paragraph 
(d)(3)(ii) of this section) of property first placed in service during 
the second half of the taxable year is determined by treating all such 
retirements from such account during the first half of the taxable year 
as occurring on the first day of the second half of the taxable year and 
all such retirements in the second half of the taxable year as occurring 
on the first day of the succeeding taxable year.
    (iii) Half-year convention. The depreciation allowance for a vintage 
account for which the taxpayer adopts the ``half-year convention'' shall 
be determined by treating all property in the account as placed in 
service on the first day of the second half of the taxable year and by 
treating all extraordinary retirements (as defined in paragraph 
(d)(3)(ii) of this section) from the account as occurring on the first 
day of the second half of the taxable year.
    (iv) Rules of application. (a) The first-year convention adopted for 
a vintage account must be consistently applied to all additions to and 
all extraordinary retirements from such account. See paragraph (d)(3) 
(ii) and (iii) of this section for definition and treatment of ordinary 
retirements.
    (b) If the actual number of months in a taxable year is other than 
12 full calendar months, depreciation is allowed only for such actual 
number of months and the term ``taxable year'', for purposes of this 
subparagraph, shall mean only such number of months. In such event, the 
first half of such taxable year shall be deemed to expire at the close 
of the last day of a calendar month which is the closest such last day 
to the middle of such taxable year and the second half of such taxable 
year shall be deemed to begin the day after the expiration of the first 
half of such taxable year. If a taxable year consists of a period which 
includes only 1 calendar month, the first half of the taxable year shall 
be deemed to expire on the first day which is nearest to the midpoint of 
the month, and the second half of the taxable year shall begin the day 
after the expiration of the first half of the month.
    (c) For purposes of this subparagraph, for property placed in 
service after November 14, 1979, other than depreciable property 
described in paragraph (c)(2)(iv)(e) of this section, the taxable year 
of the person placing such property in service does not include any 
month before the month in which the person begins engaging in a trade or 
business or holding depreciable property for the production of income.
    (d) For purposes of paragraph (c)(2) (iv)(c) of this section--
    (1) For property placed in service after February 21, 1981, an 
employee is not considered engaged in a trade or business by virtue of 
employment.
    (2) If a person engages in a small amount of trade or business 
activity after February 21, 1981, for the purpose of obtaining a 
disproportionately large depreciation deduction for assets for the 
taxable year in which they are placed in service, and placing those 
assets in service represents a substantial increase in the person's 
level of business activity, then for purposes of depreciating those 
assets the person will not be treated as beginning a trade or business 
until the increased amount of business activity begins. For property 
held for the production of income, the

[[Page 959]]

principle of the preceding sentence applies.
    (3) A person may elect to apply the rules of Sec. 1.167(a)-11 
(c)(2)(iv)(d) as set forth in T.D. 7763 (``(d) rules in T.D. 7763''). 
This election shall be made by reflecting it under paragraph (f)(4) of 
this section in the books and records. If necessary, amended returns 
shall be filed.
    (4) If an averaging convention was adopted in reliance on or in 
anticipation of the (d) rules in T.D. 7763, that convention may be 
changed without regard to paragraph (f)(3) of this section. Similarly, 
if an election is made under paragraph (c)(2)(iv)(d)(3) of this section 
to apply to the (d) rules in T.D. 7763, the averaging convention adopted 
for the taxable years for which the election is made may be changed. The 
change shall be made by filing a timely amended return for the taxable 
year for which the convention was adopted. Notwithstanding the three 
preceding sentences, if an averaging convention was adopted in reliance 
on or in anticipation of the (d) rules in T.D. 7763, and if an election 
is made to apply those rules, the averaging convention adopted cannot be 
changed except as provided in paragraph (f) of this section.
    (e) The rules in paragraph (c)(2)(iv)(c) of this section do not 
apply to depreciable property placed in service after November 14, 1979, 
and the rules in paragraph (c)(2)(iv)(d) of this section do not apply to 
depreciable property placed in service after February 21, 1981, with 
respect to which substantial expenditures were paid or incurred prior to 
November 15, 1979. For purposes of the preceding sentence, expenditures 
will not be considered substantial unless they exceed the lesser of 30 
percent of the final cost of the property or $10 million. Expenditures 
that are not includible in the basis of the depreciable property will be 
considered expenditures with respect to property if they are directly 
related to a specific project involving such property. For purposes of 
determining whether expenditures were paid or incurred prior to November 
15, 1979, expenditures made by a person (transferor) other than the 
person placing the property in service (transferee) will be taken into 
account only if the basis of the property in the hands of the transferee 
is determined in whole or in part by reference to the basis in the hands 
of the transferor. The principle of the preceding sentence also applies 
if there are multiple transfers.
    (v) Mass assets. In the case of mass assets, if extraordinary 
retirements of such assets in a guideline class during the first half of 
the taxable year are allocated to a particular vintage year for which 
the taxpayer applied the modified half-year convention, then that 
portion of the mass assets so allocated which bears the same ratio to 
the total number of mass assets so allocated as the mass assets in the 
same vintage and assets guideline class placed in service during the 
first half of that vintage year bear to the total mass assets in the 
same vintage and asset guideline class shall be treated as retired on 
the first day of the taxable year. The remaining mass assets which are 
subject to extraordinary retirement during the first half of the taxable 
year and which are allocated to that vintage year and assets guideline 
class shall be treated as retired on the first days of the second half 
of the taxable year. If extraordinary retirements of mass assets in a 
guideline class occur in the second half of the taxable year and are 
allocated to a particular vintage year for which the taxpayer applied 
the modified half-year convention, then that portion of the mass assets 
so allocated which bears the same ratio to the total number of mass 
assets so allocated as the mass assets in the same vintage and asset 
guideline class first placed in service during the first half of that 
vintage year bear to the total mass assets in the same vintage and asset 
guideline class shall be treated as retired on the first day of the 
second half of the taxable year. The remaining mass assets which are 
subject to extraordinary retirements during the second half of the 
taxable year and which are allocated to that same vintage and asset 
guideline class shall be treated as retired on the first day of the 
succeeding taxable year. If the taxpayer has applied the half-year 
convention for the vintage year to which the extraordinary retirements 
are allocated, the mass assets shall be treated as retired on the first

[[Page 960]]

day of the second half of the taxable year.
    (3) Taxable years beginning before and ending after December 31, 
1970. In the case of a taxable year which begins before January 1, 1971, 
and ends after December 31, 1970, property first placed in service after 
December 31, 1970, but treated as first placed in service before January 
1, 1971, by application of a convention described in subparagraph (2) of 
this paragraph shall be treated as provided in this subparagraph. The 
depreciation allowed (or allowable) for the taxable year shall consist 
of the depreciation allowed (or allowable) for the period before January 
1, 1971, determined without regard to this section plus the amount 
allowable for the period after December 31, 1970, determined under this 
section. However, neither the modified half-year convention described in 
subparagraph (2)(ii) of this paragraph, nor the half-year convention 
described in subparagraph (2)(iii) of this paragraph may for any such 
taxable year be applied with respect to property placed in service after 
December 31, 1970, to allow depreciation for any period prior to January 
1, 1971, unless such convention is consistent with the convention 
applied by the taxpayer with respect to property placed in service in 
such taxable year prior to January 1, 1971.
    (4) Examples. The principles of this paragraph may be illustrated by 
the following examples:

    Example (1). Taxpayer A, a calendar year taxpayer, places new 
property in service in a trade or business as follows:

------------------------------------------------------------------------
                                                              Unadjusted
                Asset                    Placed in service       basis
------------------------------------------------------------------------
W...................................  Apr. 1, 1971..........     $5,000
X...................................  June 30, 1971.........      8,000
Y...................................  July 15, 1971.........     12,000
------------------------------------------------------------------------


Taxpayer A adopts the modified half-year convention described in 
subparagraph (2) (ii) of this paragraph. Assets W, X, and Y are placed 
in a multiple asset account for which the asset depreciation range is 8 
to 12 years. A selects 8 years, the minimum asset depreciation period 
with respect to such assets, and adopts the declining balance method of 
depreciation using a rate twice the straight line rate (computed without 
reduction for salvage). The annual rate under this method using a period 
of 8 years is 25 percent. The depreciation allowance for assets W and X 
for 1971 is $3,250, a full year's depreciation under the modified half-
year convention (that is, basis of $13,000 (unreduced by salvage) 
multiplied by 25 percent). The depreciation allowance for asset Y for 
1971 is zero under the modified half-year convention.
    Example (2). The facts are the same as in example (1), except that 
the taxpayer adopts the half-year convention described in subparagraph 
(2) (iii) of this paragraph. The depreciation allowance with respect to 
asset Y is $1,500 (that is the basis of $12,000 multiplied by 25 
percent, then multiplied by \1/2\). Assets W and X are also entitled to 
a depreciation allowance for only a half year. Thus, the depreciation 
allowance for assets W and X for 1971 is $1,625 (that is, \1/2\ of the 
$3,250 allowance computed in example (1)).
    Example (3). Asset Z is placed in service by a calendar year 
taxpayer on December 1, 1971. The taxpayer places asset Z in an item 
account and adopts the sum of the years-digits method and the half year 
convention described in subparagraph (2) (iii) of this paragraph. The 
asset depreciation range for such asset is 4 to 6 years and the taxpayer 
selects an asset depreciation period of 5 years. The depreciation 
allowance for asset Z in 1971 is $10,000 (that is, basis of $60,000 
(unreduced by salvage) multiplied by \5/15\, the appropriate fraction 
using the sum of the years-digits method then multiplied by \1/2\, since 
only one half year's depreciation is allowable under the convention).
    Example (4). A is a calendar year taxpayer. All taxpayer A's assets 
are placed in service in the first half of 1971. If the taxpayer selects 
the modified half-year convention described in subparagraph (2) (ii) of 
this paragraph, a full year's depreciation is allowable for all assets.
    Example (5). (i) The taxpayer during his taxable year which begins 
April 1, 1970, and ends March 31, 1971, places new property in service 
in a trade or business as follows:

------------------------------------------------------------------------
                                                              Unadjusted
                Asset                    Placed in service       basis
------------------------------------------------------------------------
A...................................  Apr. 30, 1970.........    $10,000
B...................................  Dec. 15, 1970.........     10,000
C...................................  Jan. 1, 1971..........     10,000
------------------------------------------------------------------------


The taxpayer adopted a convention under Sec. 1.167(a)-10(b) with 
respect to assets placed in service prior to January 1, 1971, which 
treats assets placed in service during the first half of the year as 
placed in service on the first day of such year and assets placed in 
service in the second half of the year as placed in service on the first 
day of the following year. If the taxpayer selects the half-year 
convention described in subparagraph (2) (iii) of this paragraph, one 
year's depreciation is allowable on asset A determined without regard to 
this section. No depreciation is allowable for asset B. No depreciation 
is allowable for asset C for the period prior

[[Page 961]]

to January 1, 1971. One-fourth year's depreciation is allowable on asset 
C determined under this section.
    (ii) The facts are the same as in (i) of this example except that 
the taxpayer adopts the modified half-year convention described in 
subparagraph (2) (ii) of this paragraph for 1971. No depreciation is 
allowable for assets B and C which were placed in service in the second 
half of the taxable year.
    Example (6). The taxpayer during his taxable year which begins 
August 1, 1970, and ends July 31, 1971, places new property in service 
in a trade or business as follows:

------------------------------------------------------------------------
                  Asset                          Placed in service
------------------------------------------------------------------------
  A......................................  Aug. 1, 1970.
  B......................................  Jan. 15, 1971.
  C......................................  June 30, 1971.
------------------------------------------------------------------------


The taxpayer adopted a convention under Sec. 1.167(a)-10(b) with 
respect to assets placed in service prior to January 1, 1971, which 
treats all assets as placed in service at the mid-point of the taxable 
year. If the taxpayer selects the half-year convention described in 
subparagraph (2) (iii) of this paragraph, one-half year's depreciation 
is allowable for asset A determined without regard to this section. One-
half year's depreciation is allowable for assets B and C determined 
under this section.
    Example (7). X, a calendar year corporation, is incorporated on July 
1, 1978, and begins engaging in a trade or business in September 1979. X 
purchases asset A and places it in service on November 20, 1979. 
Substantial expenditures were not paid or incurred by X with respect to 
asset A prior to November 15, 1979. For purposes of applying the 
conventions under this section to determine depreciation for asset A, 
the 1979 taxable year is treated as consisting of 4 months. The first 
half of the taxable year ends on October 31, 1979, and the second half 
begins on November 1, 1979. X adopts the half-year convention. Asset A 
is treated as placed in service on November 1, 1979.
    Example (8). On January 20, 1982, A, B, and C enter an agreement to 
form partnership P for the purpose of purchasing and leasing a ship to a 
third party, Z. P uses the calendar year as its taxable year. On 
December 15, 1982, P acquires the ship and leases it to Z. For purposes 
of applying the conventions, P begins its leasing business in December 
1982, and its taxable year begins on December 1, 1982. Assuming that P 
elects to apply this section and adopts the modified half-year 
convention, P depreciates the ship placed in service in 1982 for the 1-
month period beginning December 1, 1982, and ending December 31, 1982.
    Example (9). A and B form partnership P on December 15, 1981, to 
conduct a business of leasing small aircraft. P uses the calendar year 
as its taxable year. On January 15, 1982, P acquires and places in 
service a $25,000 aircraft. P begins engaging in business with only one 
aircraft for the purpose of obtaining a disproportionately large 
depreciation deduction for aircraft that P plans to acquire at the end 
of the year. On December 10, 1982, P acquires and places in service 4 
aircraft, the total purchase price of which is $250,000. For purposes of 
applying the conventions to the aircraft acquired in December, P begins 
its leasing business in December 1982, and P's taxable year begins 
December 1, 1982, and ends December 31, 1982. Assuming that P elects to 
apply this section and adopts the modified half-year convention, P 
depreciates the aircraft placed in service in December 1982, for the 1-
month period beginning December 1, 1982, and ending December 31, 1982. P 
depreciates the aircraft placed in service in January 1982, for the 12-
month period beginning January 1, 1982, and ending December 31, 1982.

    (d) Special rules for salvage, repairs and retirements--(1) Salvage 
value--(i) Definition of gross salvage value. ``Gross salvage'' value is 
the amount which is estimated will be realized upon a sale or other 
disposition of the property in the vintage account when it is no longer 
useful in the taxpayer's trade or business or in the production of his 
income and is to be retired from service, without reduction for the cost 
of removal, dismantling, demolition or similar operations. If a taxpayer 
customarily sells or otherwise disposes of property at a time when such 
property is still in good operating condition, the gross salvage value 
of such property is the amount expected to be realized upon such sale or 
disposition, and under certain circumstances, as where such property is 
customarily sold at a time when it is still relatively new, the gross 
salvage value may constitute a relatively large proportion of the 
unadjusted basis of such property.
    (ii) Definition of salvage value. ``Salvage value'' means gross 
salvage value less the amount, if any, by which the gross salvage value 
is reduced by application of section 167(f). Generally, as provided in 
section 167(f), a taxpayer may reduce the amount of gross salvage value 
of a vintage account by an amount which does not exceed 10 percent of 
the unadjusted basis of the personal property (as defined in section 
167(f)(2)) in the account. See paragraph (b)(3)(ii) of this section for 
requirement

[[Page 962]]

of separate vintage accounts for personal property described in section 
167(f)(2).
    (iii) Estimation of salvage value. The salvage value of each vintage 
account of the taxable year shall be estimated by the taxpayer at the 
time the election to apply this section is made, upon the basis of all 
the facts and circumstances existing at the close of the taxable year in 
which the account is established. The taxpayer shall specify the amount, 
if any, by which gross salvage value taken into account is reduced by 
application of section 167(f). See paragraph (f)(2) of this section for 
requirement that the election specify the estimated salvage value for 
each vintage account of the taxable year of election. The salvage value 
estimated by the taxpayer will not be redetermined merely as a result of 
fluctuations in price levels or as a result of other facts and 
circumstances occurring after the close of the taxable year of election. 
Salvage value for a vintage account need not be established or increased 
as a result of a property improvement as described in subparagraph (2) 
(vii) of this paragraph. The taxpayer shall maintain records reasonably 
sufficient to determine facts and circumstances taken into account in 
estimating salvage value.
    (iv) Salvage as limitation on depreciation. In no case may a vintage 
account be depreciated below a reasonable salvage value after taking 
into account any reduction in gross salvage value permitted by section 
167(f).
    (v) Limitation on adjustment of reasonable salvage value. The 
salvage value established by the taxpayer for a vintage account will not 
be redetermined if it is reasonable. Since the determination of salvage 
value is a matter of estimation, minimal adjustments will not be made. 
The salvage value established by the taxpayer will be deemed to be 
reasonable unless there is sufficient basis in the facts and 
circumstances existing at the close of the taxable year in which the 
account is established for a determination of an amount of salvage value 
for the account which exceeds the salvage value established by the 
taxpayer for the account by an amount greater than 10 percent of the 
unadjusted basis of the account at the close of the taxable year in 
which the account is established. If the salvage value established by 
the taxpayer for the account is not within the 10 percent range, or if 
the taxpayer follows the practice of understating his estimates of gross 
salvage value to take advantage of this subdivision, and if there is a 
determination of an amount of salvage value for the account which 
exceeds the salvage value established by the taxpayer for the account, 
an adjustment will be made by increasing the salvage value established 
by the taxpayer for the account by an amount equal to the difference 
between the salvage value as determined and the salvage value 
established by the taxpayer for the account. For the purposes of this 
subdivision, a determination of salvage value shall include all 
determinations at all levels of audit and appellate proceedings, and as 
well as all final determinations within the meaning of section 1313(a) 
(1). This subdivision shall apply to each such determination. (See 
example (3) of subdivision (vi) of this subparagraph.)
    (vi) Examples. The principles of this subparagraph may be 
illustrated by the following examples in which it is assumed that the 
taxpayer has not followed a practice of understating his estimates of 
gross salvage value:

    Example (1). Taxpayer B elects to apply this section to assets Y and 
Z, which are placed in a multiple asset vintage account of 1971 for 
which the taxpayer selects an asset depreciation period of 8 years. The 
unadjusted basis of asset Y is $50,000 and the unadjusted basis of asset 
Z is $30,000. B estimates a gross salvage value of $55,000. The property 
qualifies under section 167(f) (2) and B reduces the amount of salvage 
taken into account by $8,000 (that is, 10 percent of $80,000 under 
section 167(f)). Thus, B establishes a salvage value of $47,000 for the 
account. Assume that there is not sufficient basis for determining a 
salvage value for the account greater than $52,000 (that is, $60,000 
minus the $8,000 reduction under section 167(f)). Since the salvage 
value of $47,000 established by B for the account is within the 10 
percent range, it is reasonable. Salvage value for the account will not 
be redetermined.
    Example (2). The facts are the same as in example (1) except that B 
estimates a gross salvage value of $50,000 and establishes a salvage 
value of $42,000 for the account (that is,

[[Page 963]]

$50,000 minus the $8,000 reduction under section 167(f)). There is 
sufficient basis for determining an amount of salvage value greater than 
$50,000 (that is, $58,000 minus the $8,000 reduction under section 
167(f)). The salvage value of $42,000 established by B for the account 
can be redetermined without regard to the limitation in subdivision (v) 
of this subparagraph, since it is not within the 10 percent range. Upon 
audit of B's tax return for a taxable year for which the redetermination 
would affect the amount of depreciation allowable for the account, 
salvage value is determined to be $52,000 after taking into account the 
reduction under section 167(f). Salvage value for the account will be 
adjusted to $52,000.
    Example (3). The facts are the same as in example (1) except that 
upon audit of B's tax return for a taxable year the examining officer 
determines the salvage value to be $58,000 (that is, $66,000 minus the 
$8,000 reduction under section 167(f)), and proposes to adjust salvage 
value for the vintage account to $58,000 which will result in 
disallowing an amount of depreciation for the taxable year. B does not 
agree with the finding of the examining officer. After receipt of a 
``30-day letter'', B waives a district conference and initiates 
proceedings before the Appellate Division. In consideration of the case 
by the Appellate Division it is concluded that there is not sufficient 
basis for determining an amount of salvage value for the account in 
excess of $55,000 (that is $63,000 minus the $8,000 reduction under 
section 167(f)). Since the salvage of $47,000 established by B for the 
account is within the 10 percent range, it is reasonable. Salvage value 
for the account will not be redetermined.
    Example (4). Taxpayer C elects to apply this section to factory 
building X which is placed in an item vintage account of 1971. The 
unadjusted basis of factory building X is $90,000. C estimates a gross 
salvage value for the account of $10,000. The property does not qualify 
under section 167(f)(2). C establishes a salvage value of $10,000 for 
the account. Assume that there is not sufficient basis for determining a 
salvage value for the account greater than $18,000. Since the salvage 
value of $10,000 established by B for the account is within the 10 
percent range, it is reasonable. Salvage value for the account will not 
be redetermined.

    (2) Treatment of repairs--(i) In general. (a) Sections 162, 212, and 
263 provide general rules for the treatment of certain expenditures for 
the repair, maintenance, rehabilitation or improvement of property. In 
general, under those sections, expenditures which substantially prolong 
the life of an asset, or are made to increase its value or adapt it to a 
different use are capital expenditures. If an expenditure is treated as 
a capital expenditure under section 162, 212, or 263, it is subject to 
the allowance for depreciation. On the other hand, in general, 
expenditures which do not substantially prolong the life of an asset or 
materially increase its value or adapt it for a substantially different 
use may be deducted as an expense in the taxable year in which paid or 
incurred. Expenditures, or a series of expenditures, may have 
characteristics both of deductible expenses and capital expenditures. 
Other expenditures may have the characteristics of capital expenditures, 
as in the case of an ``excluded addition'' (as defined in subdivision 
(vi) of this subparagraph). This subparagraph provides a simplified 
procedure for determining whether expenditures with respect to certain 
property are to be treated as deductible expenses or capital 
expenditures.
    (b) [Reserved]
    (ii) Election of repair allowance. In the case of an asset guideline 
class which consists of ``repair allowance property'' as defined in 
subdivision (iii) of this subparagraph, subject to the provisions of 
subdivision (v) of this subparagraph, the taxpayer may elect to apply 
the asset guideline class repair allowance described in subdivision 
(iii) of this subparagraph for any taxable year ending after December 
31, 1970, for which the taxpayer elects to apply this section.
    (iii) Repair allowance for an asset guideline class. For a taxable 
year for which the taxpayer elects to apply this section, the ``repair 
allowance'' for an asset guideline class which consists of ``repair 
allowance property'' is an amount equal to--
    (a) The average of (1) the unadjusted basis of all ``repair 
allowance property'' in the asset guideline class at the beginning of 
the taxable year, less in the case of such property in a vintage account 
the unadjusted basis of all such property retired in an ordinary 
retirement (as described in subparagraph (3)(ii) of this paragraph) in 
prior taxable years, and (2) the unadjusted basis of all ``repair 
allowance property'' in the asset guideline class at the end of the 
taxable year, less in the case of such property in a vintage account the 
unadjusted basis of all such property

[[Page 964]]

retired in an ordinary retirement (including ordinary retirements during 
the taxable year), multiplied by--
    (b) The repair allowance percentage in effect for the asset 
guideline class for the taxable year.

In applying the assets guideline class repair allowance to buildings 
which are section 1250 property, for the purpose of this subparagraph 
each building shall be treated as in a separate asset guideline class. 
If two or more buildings are in the same asset guideline class 
determined without regard to the preceding sentence and are operated as 
an integrated unit (as evidenced by their actual operation, management, 
financing and accounting), they shall be treated as a single building 
for this purpose. The ``repair allowance percentages'' in effect for 
taxable years ending before the effective date of the first supplemental 
repair allowance percentages established pursuant to this section are 
set forth in Revenue Procedure 72-10. Repair allowance percentages will 
from time to time be established, supplemented and revised with express 
reference to this section. These repair allowance percentages will be 
published in the Internal Revenue Bulletin. The repair allowance 
percentages in effect on the last day of the taxable year shall apply 
for the taxable year, except that the repair allowance percentage for a 
particular taxable year shall not be less than the repair allowance 
percentage in effect on the first day of such taxable year (or as of 
such later time in such year as a repair allowance percentage first 
established during such year becomes effective). Generally, the repair 
allowance percentages for a taxable year shall not be changed to reflect 
any supplement or revision of the repair allowance percentages after the 
end of such taxable year. However, if expressly provided in such a 
supplement or revision of the repair allowance percentages, the taxpayer 
may, at his option in the manner specified therein, apply the revised or 
supplemented repair allowance percentages for such taxable year and 
succeeding taxable years. For the purposes of this section, ``repair 
allowance property'' means eligible property determined without regard 
to paragraph (b)(2)(ii) of this section (that is, without regard to 
whether such property was first placed in service by the taxpayer before 
or after December 31, 1970) in an asset guideline class for which a 
repair allowance percentage is in effect for the taxable year. The 
determination whether property is repair allowance property shall be 
made without regard to whether such property is excluded, under 
paragraph (b)(5) of this section, from an election to apply this 
section. Property in an asset guideline class for which the taxpayer 
elects to apply the asset guideline class repair allowance described in 
this subdivision, which results from expenditures in the taxable year of 
election for the repair, maintenance, rehabilitation, or improvement of 
property in an asset guideline class shall not be ``repair allowance 
property'' for such taxable year but shall be for each succeeding 
taxable year provided such property is a property improvement as 
described in subdivision (vii) (a) of this subparagraph and is in an 
asset guideline class for which a repair allowance percentage is in 
effect for such succeeding taxable year.
    (iv) Application of asset guideline class repair allowance. In 
accordance with the principles of sections 162, 212, and 263, if the 
taxpayer pays or incurs any expenditures during the taxable year for the 
repair, maintenance, rehabilitation or improvement of eligible property 
(determined without regard to paragraph (b)(2)(ii) of this section), the 
taxpayer must either--
    (a) If such property is repair allowance property and if the 
taxpayer elects to apply the repair allowance for the asset guideline 
class, treat an amount of all such expenditures in such taxable year 
with respect to all such property in the asset guideline class which 
does not exceed in total the repair allowance for that asset guideline 
class as deductible repairs, and treat the excess of all such 
expenditures with respect to all such property in the asset guideline 
class in the manner described for a property improvement in subdivision 
(viii) of this subparagraph, or
    (b) If such property is not repair allowance property or if the 
taxpayer does not elect to apply the repair allowance for the asset 
guideline class,

[[Page 965]]

treat each of such expenditures in such taxable year with respect to all 
such property in the asset guideline class as either a capital 
expenditure or as a deductible repair in accordance with the principles 
of sections 162, 212, and 263 (without regard to (a) of this 
subdivision), and treat the expenditures which are required to be 
capitalized under sections 162, 212, and 263 (without regard to (a) of 
this subdivision) in the manner described for a property improvement in 
subdivision (viii) of this subparagraph.

For the purposes of (a) of this subdivision, expenditures for the 
repair, maintenance, rehabilitation or improvement of property do not 
include expenditures for an excluded addition or for which a deduction 
is allowed under section 167(k). (See subdivision (viii) of this 
subparagraph for treatment of an excluded addition.) The taxpayer shall 
elect each taxable year whether to apply the repair allowance and treat 
expenditures under (a) of this subdivision, or to treat expenditures 
under (b) of this subdivision. The treatment of expenditures under this 
subdivision for a taxable year for all asset guideline classes shall be 
specified in the books and records of the taxpayer for the taxable year. 
The taxpayer may treat expenditures under (a) of this subdivision with 
respect to property in one asset guideline class and treat expenditures 
under (b) of this subdivision with respect to property in some other 
asset guideline class. In addition, the taxpayer may treat expenditures 
with respect to property in an asset guideline class under (a) of this 
subdivision in one taxable year, and treat expenditures with respect to 
property in that asset guideline class under (b) of this subdivision in 
another taxable year.
    (v) Special rules for repair allowance. (a) The asset guideline 
class repair allowance described in subdivision (iii) of this 
subparagraph shall apply only to expenditures for the repair, 
maintenance, rehabilitation or improvement of repair allowance property 
(as described in subdivision (iii) of this subparagraph). The taxpayer 
may apply the asset guideline class repair allowance for the taxable 
year only if he maintains books and records reasonably sufficient to 
determine:
    (1) The amount of expenditures paid or incurred during the taxable 
year for the repair, maintenance, rehabilitation or improvement of 
repair allowance property in the asset guideline class, and
    (2) The expenditures (and the amount thereof) with respect to such 
property which are for excluded additions (such as whether the 
expenditure is for an additional identifiable unit of property, or 
substantially increases the productivity or capacity of an existing 
identifiable unit of property or adapts it for a substantially different 
use).

In general, such books and records shall be sufficient to identify the 
amount and nature of expenditures with respect to specific items of 
repair allowance property or groups of similar properties in the same 
asset guideline class. However, in the case of such expenditures with 
respect to property, part of which is in one asset guideline class and 
part in another, or part of which is repair allowance property and part 
of which is not, and in comparable circumstances involving property in 
the same asset guideline class, to the extent books and records are not 
maintained identifying such expenditures with specific items of property 
or groups of similar properties and it is not practicable to do so, the 
total amount of such expenditures which is not specifically identified 
may be allocated by any reasonable method consistently applied. In any 
case, the cost of repair, maintenance, rehabilitation or improvement of 
property performed by production personnel may be allocated by any 
reasonable method consistently applied and if performed incidental to 
production and not substantial in amount, no allocation to repair, 
maintenance, rehabilitation or improvement need be made. The types of 
expenditures for which specific identification would ordinarily be made 
include: Substantial expenditures such as for major parts or major 
structural materials for which a work order is or would customarily be 
written; expenditures for work performed by an outside contractor; or 
expenditures under a specific down time program. Types of expenditures 
for which specific identification would ordinarily be impractical 
include: General maintenance

[[Page 966]]

costs of machinery, equipment, and plant in the case of a taxpayer 
having assets in more than one class (or different types of assets in 
the same class) which are located together and generally maintained by 
the same work crew; small supplies which are used with respect to 
various classes or types of property; labor costs of personnel who work 
on property in different classes, or different types of property in the 
same class, if the work is performed on a routine, as needed, basis and 
the only identification of the property repaired is by the personnel. 
Factors which will be taken into account in determining the 
reasonableness of the taxpayer's allocation of expenditures include 
prior experience of the taxpayer; relative bases of the assets in the 
guideline class; types of assets involved; and relationship to 
specifically identified expenditures.
    (b) If for the taxable year the taxpayer elects to deduct under 
section 263(e) expenditures with respect to repair allowance property 
consisting of railroad rolling stock (other than a locomotive) in a 
particular asset guideline class, the taxpayer may not, for such taxable 
year, use the asset guideline class repair allowance described in 
subdivision (iii) of this subparagraph for any property in such asset 
guideline class.
    (c)(1) If the taxpayer repairs, rehabilitates or improves property 
for sale or resale to customers, the asset guideline class repair 
allowance described in subdivision (iii) of this subparagraph shall not 
apply to expenditures for the repair, maintenance, rehabilitation or 
improvement of such property, or (2) if a taxpayer follows the practice 
of acquiring for his own use property (in need of repair, rehabilitation 
or improvement to be suitable for the use intended by the taxpayer) and 
of making expenditures to repair, rehabilitate or improve such property 
in order to take advantage of this subparagraph, the asset guideline 
class repair allowance described in subdivision (iii) of this 
subparagraph shall not apply to such expenditures. In either event, such 
property shall not be ``repair allowance property'' as described in 
subdivision (iii) of this subparagraph.
    (vi) Definition of excluded addition. The term ``excluded addition'' 
means--
    (a) An expenditure which substantially increases the productivity of 
an existing identifiable unit of property over its productivity when 
first acquired by the taxpayer;
    (b) An expenditure which substantially increases the capacity of an 
existing identifiable unit of property over its capacity when first 
acquired by the taxpayer;
    (c) An expenditure which modifies an existing identifiable unit of 
property for a substantially different use;
    (d) An expenditure for an identifiable unit of property if (1) such 
expenditure is for an additional identifiable unit of property or (2) 
such expenditure (other than an expenditure described in (e) of this 
subdivision) is for replacement of an identifiable unit of property 
which was retired;
    (e) An expenditure for replacement of a part in or a component or 
portion of an existing identifiable unit of property (whether or not 
such part, component or portion is also an identifiable unit of 
property) if such part, component or portion is for replacement of a 
part, component or portion which was retired in a retirement upon which 
gain or loss is recognized (or would be recognized but for a special 
nonrecognition provision of the Code or Sec. 1.1502-13).
    (f) In the case of a building or other structure (in addition to 
(b), (c), (d), and (e) of this subdivision which also apply to such 
property), an expenditure for additional cubic or linear space; and
    (g) In the case of those units of property of pipelines, electric 
utilities, telephone companies, and telegraph companies consisting of 
lines, cables and poles (in addition to (a) through (e) of this 
subdivision which also apply to such property), an expenditure for 
replacement of a material portion of the unit of property.

Except as provided in (d) and (e) of this subdivision, notwithstanding 
any other provision of this subdivision, the term ``excluded addition'' 
does not include any expenditure in connection with the repair, 
maintenance, rehabilitation or improvement of an identifiable unit of 
property which does not exceed $100.

[[Page 967]]

For this purpose all related expenditures with respect to the unit of 
property shall be treated as a single expenditure. For the purposes of 
(a), and (b) of this subdivision, an increase in productivity or 
capacity is substantial only if the increase is more than 25 percent. An 
expenditure which merely extends the productive life of an identifiable 
unit of property is not an increase in productivity within the meaning 
of (a) of this subdivision. Under (g) of this subdivision a replacement 
is material only if the portion replaced exceeds 5 percent of the unit 
of property with respect to which the replacement is made. For the 
purposes of this subdivision, a unit of property generally consists of 
each operating unit (that is, each separate machine or piece of 
equipment) which performs a discrete function and which the taxpayer 
customarily acquires for original installation and retires as a unit. 
The taxpayer's accounting classification of units of property will 
generally be accepted for purposes of this subdivision provided the 
classifications are reasonably consistent with the preceding sentence 
and are consistently applied. In the case of a building the unit of 
property generally consists of the building as well as its structural 
components; except that each building service system (such as an 
elevator, an escalator, the electrical system, or the heating and 
cooling system) is an identifiable unit for the purpose of (a), (b), 
(c), and (d) of this subdivision. However, both in the case of machinery 
and equipment and in the case of a building, for the purpose of applying 
(d)(1) of this subdivision a unit of property may consist of a part in 
or a component or portion of a larger unit of property. In the case of 
property described in (g) of this subdivision (such as a pipeline), a 
unit of property generally consists of each segment which performs a 
discrete function either as to capacity, service, transmission or 
distribution between identifiable points. Thus, for example, under this 
subdivision in the case of a vintage account of five automobiles each 
automobile is an identifiable unit of property (which is not merely a 
part in or a component or portion of larger unit of property within the 
meaning of (e) of this subdivision). Accordingly, the replacement of one 
of the automobiles (which is retired) with another automobile is an 
excluded addition under (d)(2) of this subdivision. Also the purchase of 
a sixth automobile is an expenditure for an additional identifiable unit 
of property and is an excluded addition under (d)(1) of this 
subdivision. An automobile air conditioner is also an identifiable unit 
of property for the purposes of (d)(1) of this subdivision, but not for 
the purposes of (d)(2) of this subdivision. Accordingly, the addition of 
an air conditioner to an automobile is an excluded addition under (d)(1) 
of this subdivision, but the replacement of an existing air conditioner 
in an automobile is not an excluded addition under (d)(2) of this 
subdivision (since it is merely the replacement of a part in an existing 
identifiable unit of property). The replacement of the air conditioner 
may, however, be an excluded addition under (e) of this subdivision, if 
the air conditioner replaced was retired in a retirement upon which gain 
or loss was recognized. The principles of this subdivision may be 
further illustrated by the following examples in which it is assumed 
(unless otherwise stated) that (e) of this subdivision does not apply:

    Example (1). For the taxable year, B pays or incurs only the 
following expenditures: (1) $5,000 for general maintenance of repair 
allowance property (as described in subdivision (iii) of this 
subparagraph) such as inspection, oiling, machine adjustments, cleaning, 
and painting; (2) $175 for replacement of bearings and gears in an 
existing lathe; (3) $125 for replacement of an electric starter (of the 
same capacity) and certain electrical wiring in an automatic drill 
press; (4) $300 for modification of a metal fabricating machine 
(including replacement of certain parts) which substantially increases 
its capacity; (5) $175 for repair of the same metal fabricating machine 
which does not substantially increase its capacity; (6) $800 for the 
replacement of an existing lathe with a new lathe; and (7) $65 for the 
repair of a drill press. Expenditures (1) through (3) are expenditures 
for the repair, maintenance, rehabilitation or improvement of property 
to which B can elect to apply the asset guideline class repair allowance 
described in subdivision (iii) of this subparagraph. Expenditure (4) is 
an excluded addition under (b) of this subdivision. Expenditure (5) is 
not an excluded addition. Expenditure (6) is an excluded addition under 
(d)(2) of this subdivision. Without regard to

[[Page 968]]

(a), (b), and (c) of this subdivision, expenditure (7) is not an 
excluded addition since the expenditure does not exceed $100.
    Example (2). Corporation M operates a steel plant which produces 
rails, blooms, billets, special bar sections, reinforcing bars, and 
large diameter line pipe. During the taxable year, corporation M: (1) 
relines an openhearth furnace; (2) places in service 20 new ingot molds; 
(3) replaces one reversing roll in the blooming mill; (4) overhauls the 
rail and billet mill with no increase in capacity; (5) replaces a roll 
stand in the 20-inch bar mill; and (6) overhauls the 11-inch bar mill 
and reducing stands increasing billet speed from 1,800 feet per minute 
to 2,300 feet per minute. Assume that each expenditure exceeds $100. 
Expenditure (1) is not an excluded addition. Expenditure (2) is an 
excluded addition under (d)(1) of this subdivision. Expenditure (3) is 
not an excluded addition since the expenditure for the reversing roll 
merely replaces a part in an existing identifiable unit of property. 
Expenditure (4) is not an excluded addition. Expenditure (5) is an 
excluded addition under (d)(2) of this subdivision since the roll stand 
is not merely a part of an existing identifiable unit of property. 
Expenditure (6) is an excluded addition under (a) of this subdivision 
since it increases the billet speed by more than 25 percent.
    Example (3). For the taxable year, corporation X pays or incurs the 
following expenditures: (1) $1,000 for two new temporary partition walls 
in the company's offices; (2) $1,400 for repainting the exterior of a 
terminal building; (3) $300 for repair of the roof of a warehouse; (4) 
$150 for replacement of two window frames and panes in the warehouse; 
and (5) $100 for plumbing repair. Expenditure (1) is an excluded 
addition under (d)(1) of this subdivision. None of the other 
expenditures are excluded additions.
    Example (4). For the taxable year, corporation Y pays or incurs the 
following expenditures: (1) $10,000 for expansion of a loading dock from 
600 square feet to 750 square feet; (2) $600 for replacement of two roof 
girders in a factory building; and (3) $9,500 for replacement of columns 
and girders supporting the floor of a second story loft storage area 
within the factory building in order to permit storage of supplies with 
a gross weight 50 percent greater than the previous capacity of the 
loft. Expenditure (1) is an excluded addition under (f) of this 
subdivision. Expenditure (2) is not an excluded addition. Expenditure 
(3) is an excluded addition under (b) of this subdivision.
    Example (5). Corporation A has an office building with an unadjusted 
basis of $10 million. The building has 10 elevators, five of which are 
manually operated and five of which are automatic. During 1971, 
corporation A:
    (1) Replaces the five manually operated elevators with highspeed 
automatic elevators at a cost of $400,000;
    (2) Replaces the cable in one of the existing automatic elevators at 
a cost of $1,700. The replacements of the elevators are excluded 
additions under (d)(2) of this subdivision. The replacement of the cable 
is not an excluded addition.
    Example (6). Taxpayer W, a cement manufacturer, engages in the 
following modification and maintenance activities during the taxable 
year: (1) Replaces eccentric-bearing, spindle, and wearing surface in a 
gyratory crusher; (2) places in service a new apron feeder and hammer 
mill; (3) replaces four buckets on a chain bucket elevator; (4) relines 
refractory surface in the burning zone of a rotary kiln; (5) installs 
additional new dust collectors; and (6) Replaces two 16-inch x 90-foot 
belts on his conveyer system. Assume that there is no increase in 
productivity or capacity and that each expenditure exceeds $100. 
Expenditure (1) is not an excluded addition. Expenditure (2) an excluded 
addition under (d)(1) of this subdivision. Expenditures (3) and (4) are 
not excluded additions. Expenditures (5) is an excluded addition under 
(d)(1) of this subdivision. Expenditure (6) is not an excluded addition.
    Example (7). Corporation X, a gas pipeline company, has, in addition 
to others, the following units of property: (1) A gathering pipeline for 
a field consisting of 25 gas wells; (2) the main transmission line 
between compressor stations (that is, in the case of a 500-mile main 
transmission line with a compressor station every 100 miles, each one 
hundred miles section between compressor stations is a separate unit of 
property); (3) a lateral transmission line from the main transmission 
line to a city border station; (4) a medium pressure distribution line 
to the northern portion of the city; and (5) a low pressure distribution 
line serving a group of approximately 200 residential customers off the 
medium pressure distribution line. In 1971, corporation X pays or incurs 
the following expenditures in connection with the repair, maintenance, 
rehabilitation or improvement of repair allowance property: (1) replaces 
a meter on a gas well; (2) in connection with the repair and 
rehabilitation of a unit of property consisting of a 2-mile gathering 
pipeline, replaces a 3,000-foot section of the gathering line; (3) in 
connection with the repair of leaks in a unit of property consisting of 
a 100-mile gas transmission line (that is, the 100 miles between 
compressor stations), replaces a 2,000-foot section of pipeline at one 
point; and (4) at another point replaces a 7-mile section of the same 
100-mile gas transmission line. Assume that none of these expenditures 
substantially increases capacity and that each expenditure exceeds $100. 
Expenditure (1) is an excluded

[[Page 969]]

addition under (d) of this subdivision. Expenditure (2) is an excluded 
addition under (g) of this subdivision since the portion replaced is 
more than 5 percent of the unit of property. Expenditure (3) is not an 
excluded addition. Expenditure (4) is an excluded addition under (g) of 
this subdivision.
    Example (8). Taxpayer Y, an electric utility company, has in 
addition to others, the following units of property: (1) A high voltage 
transmission circuit from the switching station (at the generating 
station) to the transmission station; (2) a series of 100 poles (fully 
dressed) supporting the circuit in (1); (3) a high voltage circuit from 
the transmission station to the distribution substation; (4) a high 
voltage distribution circuit (either radial or looped) from the 
distribution substation; (5) a transformer on a distribution pole; (6) a 
circuit breaker on a distribution pole; and (7) all 220 (and lower) volt 
circuit (including customer service connections) off the distribution 
circuit in (4). In 1971, taxpayer Y pays or incurs the following 
expenditures for the repair, maintenance, rehabilitation or improvement 
of repair allowance property: (1) Replaces 25 adjacent poles in a unit 
of property consisting of the 300 poles supporting a radial distribution 
circuit from a distribution substation; (2) replaces a transformer on 
one of the poles in (1); (3) replaces a cross-arm on one of the poles in 
(1); (4) replaces a 200-foot section of a 2-mile radial distribution 
circuit serving 100 residential customers; and (5) replaces a 2,000-foot 
section on a 10-mile high voltage circuit from a transmission station to 
a distribution substation which was destroyed by a casualty which 
taxpayer Y treated as an extraordinary retirement under paragraph 
(d)(3)(ii) of this section. Expenditure (1) is an excluded addition 
under (g) of this subdivision. Expenditure (2) is an excluded addition 
under (d)(2) of this subdivision. Expenditures (3) and (4) are not 
excluded additions. Expenditure (5) is an excluded addition under (e) of 
this subdivision.
    Example (9). Corporation Z, a telephone company, has in addition to 
others, the following units of property: (1) A buried feeder cable 3 
miles in length off a local switching station; (2) a buried subfeeder 
cable 1 mile in length off the feeder cable in (1); (3) all the 
distribution cable (and customer service drops) off the subfeeder cable 
in (2); (4) the 300 poles (fully dressed) supporting the distribution 
cable in (3); (5) a 10-mile local trunk cable which interconnects two 
local tandem switching stations; (6) a toll connecting trunk cable from 
a local tandem switching station to a long distance tandem switching 
station; (7) a toll trunk cable 50 miles in length from the access point 
at one city to the access point at another city. In 1971, corporation Z 
pays or incurs the following expenditures in connection with the repair, 
maintenance, rehabilitation or improvement of repair allowance property: 
(1) replaces 100 feet of distribution cable in a unit of property 
consisting of 8 miles of local distribution cable (plus customer service 
drops); (2) replaces an amplifier in the distribution system; and (3) 
replaces 10 miles of a unit of property consisting of a toll trunk cable 
50 miles in length. Expenditure (1) is not an excluded addition. 
Expenditure (2) is an excluded addition under (d)(2) of this 
subdivision. Expenditure (3) is an excluded addition under (g) of this 
subdivision.

    (vii) Definition of property improvement. The term ``property 
improvement'' means--
    (a) If the taxpayer treats expenditures for the asset guideline 
class under subdivision (iv) (a) of this subparagraph, the amount of all 
expenditures paid or incurred during the taxable year for the repair, 
maintenance, rehabilitation or improvement of repair allowance property 
in the asset guideline class, which exceeds the asset guideline class 
repair allowance for the taxable year; and
    (b) If the taxpayer treats expenditures for the asset guideline 
class under subdivision (iv) (b) of this subparagraph, the amount of 
each expenditure paid or incurred during the taxable year for the 
repair, maintenance, rehabilitation or improvement of property which is 
treated under sections 162, 212, and 263 as a capital expenditure.


The term ``property improvement'' does not include any expenditure for 
an excluded addition.
    (viii) Treatment of property improvements and excluded additions. If 
for the taxable year there is a property improvement as described in 
subdivision (vii) of this subparagraph or an excluded addition as 
described in subdivision (vi) of this subparagraph, the following rules 
shall apply--
    (a) The total amount of any property improvement for the asset 
guideline class determined under subdivision (vii)(a) of this 
subparagraph shall be capitalized in a single ``special basis vintage 
account'' of the taxable year in accordance with the taxpayer's election 
to apply this section for the taxable year (applied without regard to 
paragraph (b)(5)(v)(a) of this section). See subparagraph (3)(vi) of 
this paragraph for definition and treatment of a ``special basis vintage 
account''.

[[Page 970]]

    (b) Each property improvement determined under subdivision (vii)(b) 
of this subparagraph, if it is eligible property, shall be capitalized 
in a vintage account of the taxable year in accordance with the 
taxpayer's election to apply this section for the taxable year (applied 
without regard to paragraph (b)(5)(v)(a) of this section).
    (c) Each excluded addition, if it is eligible property, shall be 
capitalized in a vintage account of the taxable year in accordance with 
the taxpayer's election to apply this section for the taxable year.

For rule as to date on which a property improvement or an excluded 
addition is first placed in service, see paragraph (e)(1) (iii) and (iv) 
of this section.
    (ix) Examples. The principles of this subparagraph may be 
illustrated by the following examples:

    Example (1). For the taxable year 1972, B elects to apply this 
section. B has repair allowance property (as described in subdivision 
(iii) of this subparagraph) in asset guideline class 20.2 under Revenue 
Procedure 72-10 with an average unadjusted basis determined as provided 
in subdivision (iii) (a) of this subparagraph of $100,000 and repair 
allowance property in asset guideline class 24.4 with an average 
unadjusted basis of $300,000. The repair allowance percentage for asset 
guideline class 20.2 is 4.5 percent and for asset guideline class 24.4 
is 6.5 percent. The two asset guideline class repair allowances for 1972 
are $4,500 and $19,500, respectively, determined as follows:

                       Asset Guideline Class 20.2
 
$100,000 average unadjusted basis multiplied by 4.5 percent.      $4,500
 
                       Asset Guideline Class 24.4
 
$300,000 average unadjusted basis multiplied by 6.5 percent.     $19,500
 

    Example (2). The facts are the same as in example (1). During the 
taxable year 1972, B pays or incurs the following expenditures for the 
repair, maintenance, rehabilitation or improvement of repair allowance 
property in asset guideline class 20.2

General maintenance (including primarily labor costs)..........   $3,000
Replacement of parts in several machines (including labor costs    4,000
 of $1,650)....................................................
                                                                --------
                                                                   7,000
 


In addition, in connection with the rehabilitation and improvement of 
two other machines B pays or incurs $6,000 (including labor costs of 
$2,000) which is treated as an excluded addition because the capacity of 
the machines was substantially increased. For 1972, B elects to apply 
this section and to apply the asset guideline class repair allowance to 
asset guideline class 20.2. Since the asset guideline class repair 
allowance is $4,500, B can deduct $4,500 in accordance with subdivision 
(iv) (a) of this subparagraph. B must capitalize $2,500 in a special 
basis vintage account in accordance with subdivisions (vii) (a) and 
(viii) (a) of this subparagraph. Since the excluded addition is a 
capital item and is eligible property, B must also capitalize $6,000 in 
a vintage account in accordance with subdivision (viii) (c) of this 
subparagraph. B selects from the asset depreciation range an asset 
depreciation period of 17 years for the special basis vintage account. B 
includes the excluded addition in a vintage account of 1972 for which he 
also selects an asset depreciation period of 17 years.

    (3) Treatment of retirements--(i) In general. The rules of this 
subparagraph specify the treatment of all retirements from vintage 
accounts. The rules of Sec. 1.167(a)-8 shall not apply to any 
retirement from a vintage account. An asset in a vintage account is 
retired when such asset is permanently withdrawn from use in a trade or 
business or in the production of income by the taxpayer. A retirement 
may occur as a result of a sale or exchange, by other act of the 
taxpayer amounting to a permanent disposition of an asset, or by 
physical abandonment of an asset. A retirement may also occur by 
transfer of an asset to supplies or scrap.
    (ii) Definitions of ordinary and extraordinary retirements. The term 
``ordinary retirement'' means any retirement of section 1245 property 
from a vintage account which is not treated as an ``extraordinary 
retirement'' under this subparagraph. The retirement of an asset from a 
vintage account in a taxable year is an ``extraordinary retirement'' 
if--
    (a) The asset is section 1250 property;
    (b) The asset is section 1245 property which is retired as the 
direct result of fire, storm, shipwreck, or other casualty and the 
taxpayer, at his option consistently applied (taking into account type, 
frequency, and the size of such casualties) treats such retirements as 
extraordinary; or
    (c)(1) The asset is section 1245 property which is retired (other 
than by transfer to supplies or scrap) in a taxable year as the direct 
result of a cessation, termination, curtailment, or

[[Page 971]]

disposition of a business, manufacturing, or other income producing 
process, operation, facility or unit, and (2) the unadjusted basis 
(determined without regard to subdivision (vi) of this subparagraph) of 
all such assets so retired in such taxable year from such account as a 
direct result of the event described in (c)(1) of this subdivision 
exceeds 20 percent of the unadjusted basis of such account immediately 
prior to such event.

For the purposes of (c) of this subdivision, all accounts (other than a 
special basis vintage account as described in subdivision (vi) of this 
subparagraph) containing section 1245 property of the same vintage in 
the same asset guideline class, and from which a retirement as a direct 
result of such event occurs within the taxable year, shall be treated as 
a single vintage account. See subdivision (xi) of this subparagraph for 
special rule for item accounts. The principles of this subdivision may 
be illustrated by the following examples:

    Example (1). Taxpayer A is a processor and distributor of dairy 
products. Part of taxpayer A's operation is a bottle washing facility 
consisting of machines X, Y, and Z, each of which is in an item vintage 
account of 1971. Each item vintage account has an unadjusted basis of 
$1,000. Taxpayer A also has a 1971 multiple asset vintage account 
consisting of machines E, S, and C. Machines E and S, used in processing 
butter, each has an unadjusted basis of $10,000. Machine C used in 
capping bottles has an unadjusted basis of $1,000. In 1975, taxpayer A 
changes to the use of paper milk cartons and disposes of all bottle 
washing machines (X, Y, and Z) as well as machine C which was used in 
capping bottles. The sales of machine C, X, Y, and Z are the direct 
result of the termination of a manufacturing process. However, since the 
total unadjusted basis of the eligible section 1245 property retired as 
a direct result of such event is only $4,000 (which is less than 20 
percent of the total unadjusted basis of machines E, S, C, X, Y, and Z, 
$24,000) the sales are ordinary retirements. All the assets are in the 
same asset guideline class and are of the same vintage. Accordingly, 
machines E, S, C, X, Y, and Z are for this purpose treated as being in a 
single vintage account.
    Example (2). The facts are the same as in example (1) except that in 
1976, taxpayer A sells six of his 12 milk delivery trucks as a direct 
result of eliminating home deliveries to customers in the suburbs. 
Deliveries within the city require only six trucks. Each of the trucks 
has an unadjusted basis of $3,000. Six of the taxpayer's delivery trucks 
are in a multiple asset vintage account of 1974 and six are in a 
multiple asset vintage account of 1972. Neither account contains any 
other property. Four trucks are retired from the 1972 vintage account 
and two trucks are retired from the 1974 vintage account. The sales 
result from the curtailment of taxpayer A's home delivery operation. The 
unadjusted basis of the four trucks retired from the 1972 vintage 
exceeds 20 percent of the total unadjusted basis of the affected 
account. The same is true for the two trucks retired from the 1974 
vintage account. The sales of the trucks are extraordinary retirements.

    (d) The asset is section 1245 property which is retired after 
December 30, 1980 by a charitable contribution for which a deduction is 
allowable under section 170.
    (iii) Treatment of ordinary retirements. No loss shall be recognized 
upon an ordinary retirement. Gain shall be recognized only to the extent 
specified in this subparagraph. All proceeds from ordinary retirements 
shall be added to the depreciation reserve of the vintage account from 
which the retirement occurs. See subdivision (vi) of this subparagraph 
for optional allocation of basis in the case of a special basis vintage 
account. See subdivision (ix) of this subparagraph for recognition of 
gain when the depreciation reserve exceeds the unadjusted basis of the 
vintage account. The amount of salvage value for a vintage account shall 
be reduced (but not below zero) as of the beginning of the taxable year 
by the excess of (a) the depreciation reserve for the account, after 
adjustment for depreciation allowable for such taxable year and all 
other adjustments prescribed by this section (other than the adjustment 
prescribed by subdivision (ix) of this subparagraph), over (b) the 
unadjusted basis of the account less the amount of salvage value for the 
account before such reduction. Thus, in the case of a vintage account 
with an unadjusted basis of $1,000 and a salvage value of $100, to the 
extent that proceeds from ordinary retirements increase the depreciation 
reserve above $900, the salvage value is reduced. If the proceeds 
increase the depreciation reserve for the account to $1,000, the salvage 
value is reduced to zero. The unadjusted basis of the asset retired in 
an ordinary retirement is not removed from the account and the 
depreciation

[[Page 972]]

reserve for the account is not reduced by the depreciation allowable for 
the retired asset. The previously unrecovered basis of the retired asset 
will be recovered through the allowance for depreciation with respect to 
the vintage account. See subdivision (v)(a) of this subparagraph for 
treatment of retirements on which gain or loss is not recognized in 
whole or in part. See subdivision (v)(b) of this subparagraph for 
treatment of retirements by disposition to a member of an affiliated 
group as defined in section 1504(a). See subdivision (v)(c) of this 
subparagraph for treatment of transfers between members of an affiliated 
group of corporations or other related parties as extraordinary 
retirements.
    (iv) Treatment of extraordinary retirements. (a) Unless the 
transaction is governed by a special nonrecognition section of the Code 
such as 1031 or 337 or is one to which subdivision (v)(b) of this 
subparagraph applies, gain or loss shall be recognized upon an 
extraordinary retirement in the taxable year in which such retirement 
occurs subject to section 1231, section 165, and all other applicable 
provisions of law such as sections 1245 and 1250. If the asset which is 
retired in an extraordinary retirement is the only or last asset in the 
account, the account shall terminate and no longer be an account to 
which this section applies. In all other cases, the unadjusted basis of 
the retired asset shall be removed from the unadjusted basis of the 
vintage account, and the depreciation reserve established for the 
account shall be reduced by the depreciation allowable for the retired 
asset computed in the manner prescribed in paragraph (c) (1)(v)(b) of 
this section for determination of the adjusted basis of the asset. See 
subdivision (ix) of this subparagraph for recognition of gain in the 
case of an account containing section 1245 property when the 
depreciation reserve exceeds the unadjusted basis of the vintage 
account. See subdivision (iii) of this subparagraph for reduction of 
salvage value for such an account when the depreciation reserve exceeds 
the unadjusted basis of the account minus salvage value. See subdivision 
(v)(b) of this subparagraph for treatment of retirements by disposition 
to a member of an affiliated group as defined in section 1504(a).
    (b) The principles of this subdivision may be illustrated by the 
following examples:

    Example (1). Corporation X has a multiple asset vintage account of 
1971 consisting of assets K, R, A, and P all of which are section 1245 
property. The unadjusted basis of the account is $40,000. The unadjusted 
basis of asset A is $10,000. When the reserve for depreciation for the 
account is $20,000, asset A is sold in an extraordinary retirement for 
$8,000 in cash. The $10,000 unadjusted basis of asset A is removed from 
the account and the $5,000 depreciation allowable for asset A is removed 
from the reserve for depreciation. Gain in the amount of $3,000 (to 
which section 1245 applies) is recognized upon the sale of asset A.
    Example (2). Corporation X has an item vintage account of 1972 
consisting of residential apartment unit A. Unit A is section 1250 
property. It is residential rental property and meets the requirements 
of section 167(j)(2). Corporation X adopts the declining balance method 
of depreciation using a rate twice the straight line rate. The asset 
depreciation period is 40 years. Unit A has an unadjusted basis of 
$200,000. On June 30, 1974, when the reserve for depreciation for the 
account is $19,500, unit A is sold for $220,000. Since unit A is section 
1250 property, the sale is an extraordinary retirement in accordance 
with subdivision (ii)(a) of this subparagraph (without regard to 
subdivision (ii)(b) or (c) of this subparagraph). The adjusted basis of 
unit A is $180,500. Gain in the amount of $39,500 is recognized. The 
``additional depreciation'' (as defined in section 1250(b)) for unit A 
is $9,500. Accordingly, $9,500 is in accordance with section 1250 
treated as gain from the sale or exchange of an asset which is neither a 
capital asset nor property described in section 1231. The $30,000 
balance of the gain from the sale of unit A may be gain to which section 
1231 applies.

    (v) Special rule for certain retirements. (a) In the case of an 
ordinary retirement on which gain or loss is in whole or in part not 
recognized because of a special nonrecognition section of the Code, such 
as 1031 or 337, no part of the proceeds from such retirement shall be 
added to the depreciation reserve of the vintage account in accordance 
with subdivision (iii) of this subparagraph. Instead, such retirement 
shall for all purposes of this section be treated as an extraordinary 
retirement.
    (b) The provisions of Sec. 1.1502-13 shall apply to a retirement. 
In the case of an

[[Page 973]]

ordinary retirement to which the provisions of Sec. 1.1502-13 apply, no 
part of the proceeds from such retirement shall be added to the 
depreciation reserve of the vintage account in accordance with 
subdivision (iii) of this subparagraph. Instead, such retirement shall 
for all purposes of this section be treated as an extraordinary 
retirement.
    (c) In a case in which property is transferred, in a transaction 
which would without regard to this subdivision be treated as an ordinary 
retirement, during the taxable year in which first placed in service to 
a person who bears a relationship described in section 179(d)(2) (A) or 
(B), such transfer shall for all purposes of this section be treated as 
an extraordinary retirement.
    (d)(1) If, in the case of mass assets, it is impracticable for the 
taxpayer to maintain records from which he can establish the vintage of 
such assets as retirements occur, and if he adopts other reasonable 
recordkeeping practices, then the vintage of mass asset retirements may 
be determined by use of an appropriate mortality dispersion table. Such 
a mortality dispersion table may be based upon an acceptable sampling of 
the taxpayer's actual experience or other acceptable statistical or 
engineering techniques. Alternatively, the taxpayer may use a standard 
mortality dispersion table prescribed by the Commissioner for this 
purpose. If the taxpayer uses such standard mortality dispersion table 
for any taxable year of election, it must be used for all subsequent 
taxable years of election unless the taxpayer obtains the consent of the 
Commissioner to change to another dispersion table or to actual 
identification of retirements. For information requirements regarding 
mass assets, see paragraph (f)(5) of this section.
    (2) For purposes of this section, the term ``mass assets'' has the 
same meaning as when used in paragraph (e)(4) of Sec. 1.47-1.
    (e) The principles of this subdivision may be illustrated by the 
following examples:

    Example (1). Corporation X has a vintage account of 1971 consisting 
of machines A, B, and C, each with an unadjusted basis of $1,000. The 
unadjusted basis of the account is $3,000 and at the end of 1977 the 
reserve for depreciation is $2,100. On January 1, 1978, machine A is 
transferred to corporation Y solely for stock in the amount of $1,400 in 
a transaction to which section 351 applies. Since the adjusted basis of 
machine A is $300, a gain of $1,100 is realized, but no gain is 
recognized under section 351. Even though machine A was transferred in 
an ordinary retirement in accordance with (a) of this subdivision the 
rules for an extraordinary retirement are applied. The proceeds are not 
added to the reserve for depreciation for the account. Machine A is 
removed from the account, the unadjusted basis of the account is reduced 
by $1,000, and the reserve for depreciation for the account is reduced 
by $700.
    Example (2). The facts are the same as in example (1) except that 
the consideration received for machine A is stock of corporation Y in 
the amount of $1,200 and cash in the amount of $200. The result is the 
same as in example (1) except that gain is recognized in the amount of 
$200 all of which is gain to which section 1245 applies.
    Example (3). The facts are the same as in example (1) except that 
machine A is sold for $1,400 cash in an ordinary retirement and 
corporation X and corporation Y are includible corporations in an 
affiliated group as defined in section 1504(a) which files a 
consolidated return for 1978. Accordingly, (b) of this subdivision 
applies. The retirement is treated as an extraordinary retirement. 
Machine A is removed from the account, the unadjusted basis of the 
account is reduced by $1,000, and the reserve for depreciation for the 
account is reduced by $700. The gain of $1,100 is deferred gain to which 
Sec. 1.1502-13 applies.

    (vi) Treatment of special basis vintage accounts. A ``special basis 
vintage account'' is a vintage account for an amount of property 
improvement determined under subparagraph (2) (vii)(a) of this 
paragraph. In general, reference in this section to a ``vintage 
account'' shall include a special basis vintage account. The unadjusted 
basis of a special basis vintage account shall be recovered through the 
allowance for depreciation in accordance with this section over the 
asset depreciation period for the account. Except as provided in this 
subdivision, the unadjusted basis, adjusted basis and reserve for 
depreciation of such account shall not be allocated to any specific 
asset in the asset guideline class, and the provisions of this 
subparagraph shall not apply to such account. However, in the event of a 
sale, exchange or other disposition of ``repair allowance

[[Page 974]]

property'' (as described in subparagraph (2)(iii) of this paragraph) in 
an extraordinary retirement as described in subdivision (ii) of this 
subparagraph (or if the asset is not in a vintage account, in an 
abnormal retirement as described in Sec. 1.167(a)-8), the taxpayer may, 
if consistently applied to all such retirements in the taxable year and 
adequately identified in the taxpayer's books and records, elect to 
allocate the adjusted basis (as of the end of the taxable year) of all 
special basis vintage accounts for the asset guideline class to each 
such retired asset in the proportion that the adjusted basis of the 
retired asset (as of the beginning of the taxable year) bears to the 
adjusted basis of all repair allowance property in the asset guideline 
class at the beginning of the taxable year. The election to allocate 
basis in accordance with this subdivision shall be made on the tax 
return filed for the taxable year. The principles of this subdivision 
may be illustrated by the following example:

    Example. In addition to other property, the taxpayer has machines A, 
B, and C all in the same asset guideline class and each with an adjusted 
basis on January 1, 1977, of $10,000. The adjusted basis on January 1, 
1977, of all repair allowance property (as described in subparagraph 
(2)(iii) of this paragraph) in the asset guideline class is $90,000. The 
machines are sold in an extraordinary retirement in 1977. The taxpayer 
is entitled to and does elect to allocate basis in accordance with this 
subdivision. There is also a 1972 special basis vintage account for the 
asset guideline class, as follows:

------------------------------------------------------------------------
                                                                Dec. 31,
                                      Unadjusted   Reserve for    1977,
                                         basis    depreciation  adjusted
                                                                  basis
------------------------------------------------------------------------
1972 special basis vintage account,      $2,000       $1,100        $900
 for which the taxpayer selected an
 asset depreciation period of 10
 years, adopted the straight line
 method, and used the half-year
 convention.........................
------------------------------------------------------------------------


By application of this subdivision, the adjusted basis of machines A, B, 
and C is increased to $10,100 each (that is, $10,000/$90,000x$900 = 
$100). The unadjusted basis, reserve for depreciation and adjusted basis 
of the special basis vintage account are reduced, respectively, by one-
third (that is, $300/$900=\1/3\) in order to reflect the allocation of 
basis from the special basis vintage account.

    (vii) Reduction in the salvage value of a vintage account. (a) A 
taxpayer may apply this section without reducing the salvage value for a 
vintage account in accordance with this subdivision or in accordance 
with subdivision (viii) of this subparagraph (relating to transfers to 
supplies or scrap). See subdivision (iii) of this subparagraph for 
reduction of salvage value in certain circumstances in the amount of 
proceeds from ordinary retirements.
    (b) However, the taxpayer may, at his option, follow the consistent 
practice of reducing, as retirements occur, the salvage value for a 
vintage account by the amount of salvage value attributable to the 
retired asset, or the taxpayer may consistently follow the practice of 
so reducing the salvage value for a vintage account as extraordinary 
retirements occur while not reducing the salvage value for the account 
as ordinary retirements occur. If the taxpayer does not reduce the 
salvage value for a vintage account as ordinary retirements occur, the 
taxpayer may be entitled to a deduction in the taxable year in which the 
last asset is retired from the account in accordance with subdivision 
(ix) (b) of this subparagraph.
    (c) For purposes of this subdivision, the portion of the salvage 
value for a vintage account attributable to a retired asset may be 
determined by multiplying the salvage value for the account by a 
fraction, the numerator of which is the unadjusted basis of the retired 
asset and the denominator of which is the unadjusted basis of the 
account, or any other method consistently applied which reasonably 
reflects that portion of the salvage value for the account originally 
attributable to the retired asset.
    (d) In the case of ordinary retirements the taxpayer may--
    (1) In the case of retirements (other than by transfer to supplies 
or scrap) follow the consistent practice of reducing the salvage value 
for the account by the amount of salvage value attributable to the 
retired asset and not adding the same amount to the depreciation reserve 
for the account, and

[[Page 975]]

    (2) In the case of retirements by transfer to supplies or scrap, 
follow the consistent practice of reducing the salvage value for the 
account by the amount of salvage value attributable to the retired asset 
and not adding the same amount to the depreciation reserve for the 
account (in which case the basis in the supplies or scrap account of the 
retired asset will be zero) or follow the consistent practice of 
reducing the salvage value for the account by the amount of salvage 
value attributable to the retired asset and adding the same amount to 
the depreciation reserve for the account (up to an amount which does not 
increase the depreciation reserve to an amount in excess of the 
unadjusted basis of the account) in which case the basis in the supplies 
or scrap account of the retired asset will be the amount added to the 
depreciation reserve for the account.

Thus, for example, in the case of an ordinary retirement by transfer of 
an asset to supplies or scrap, the basis of the asset in the supplies or 
scrap account would either be zero or the amount added to the 
depreciation reserve of the vintage account from which the retirement 
occurred. When the depreciation reserve for the account equals the 
unadjusted basis of the account no further adjustment to salvage value 
for the account will be made. See subdivision (viii) of this 
subparagraph for special optional rule for reduction of salvage value in 
the case of an ordinary retirement by transfer of an asset to supplies 
or scrap.
    (e) In the event of a removal of property from a vintage account in 
accordance with paragraph (b)(4)(iii)(e), (5)(v)(b) or (6)(iii) of this 
section the salvage value for the account may be reduced by the amount 
of salvage value attributable to the asset removed determined as 
provided in (c) of this subdivision.
    (viii) Special optional adjustments for transfers to supplies or 
scrap. If the taxpayer does not follow the consistent practice of 
reducing, as ordinary retirements occur, the salvage value for a vintage 
account in accordance with subdivision (vii) of this subparagraph, the 
taxpayer may (in lieu of the method described in subdivision (vii) (c) 
and (d) of this subparagraph) follow the consistent practice of reducing 
salvage value as ordinary retirements occur by transfer of assets to 
supplies or scrap and of determining the basis (in the supplies or scrap 
account) as assets retired in an ordinary retirement by transfer to 
supplies or scrap, in the following manner--
    (a) The taxpayer may determine the value of the asset (not to exceed 
its unadjusted basis) by any reasonable method consistently applied 
(such as average cost, conditioned cost, or fair market value) if such 
method is adequately identified in the taxpayer's books and records.
    (b) The value attributable to the asset determined in accordance 
with (a) of this subdivision shall be subtracted from the salvage value 
for the account (to the extent thereof) and the greater of (1) the 
amount subtracted from the salvage value for the vintage account and (2) 
the value of the asset determined in accordance with (a) of this 
subdivision, shall be added to the reserve for depreciation of this 
vintage account.
    (c) The amount added to the reserve for depreciation of the vintage 
account in accordance with (b) of this subdivision shall be treated as 
the basis of the retired asset in the supplies or scrap account.

If the taxpayer makes the adjustments in accordance with this 
subdivision, the reserve for depreciation of the vintage account may 
exceed the unadjusted basis of the account, and in that event gain will 
be recognized in accordance with subdivision (ix) of this subparagraph.
    (ix) Recognition of gain or loss in certain situations. (a) In the 
case of a vintage account for section 1245 property, if at the end of 
any taxable year after adjustment for depreciation allowable for such 
taxable year and all other adjustments prescribed by this section, the 
depreciation reserve established for such account exceeds the unadjusted 
basis of the account, the entire amount of such excess shall be 
recognized as gain in such taxable year. Such gain--
    (1) Shall constitute gain to which section 1245 applies to the 
extent that it does not exceed the total amount of

[[Page 976]]

depreciation allowances in the depreciation reserve at the end of such 
taxable year, reduced by gain recognized pursuant to this subdivision 
with respect to the account previously treated as gain to which section 
1245 applies, and
    (2) May constitute gain to which section 1231 applies to the extent 
that it exceeds such total amount as so reduced.

In such event, the depreciation reserve shall be reduced by the amount 
of gain recognized, so that after such reduction the amount of the 
depreciation reserve is equal to the unadjusted basis of the account.
    (b) In the case of an account for section 1245 property, if at the 
time the last asset in the vintage account is retired the unadjusted 
basis of the account exceeds the depreciation reserve for the account 
(after all adjustments prescribed by this section), the entire amount of 
such excess shall be recognized in such taxable year as a loss under 
section 165 or as a deduction for depreciation under section 167. If the 
retirement of such asset occurs by sale or exchange on which gain or 
loss is recognized, the amount of such excess may constitute a loss 
subject to section 1231. Upon retirement of the last asset in a vintage 
account, the account shall terminate and no longer be an account to 
which this section applies. See subdivision (xi) of this subparagraph 
for treatment of certain multiple asset and item accounts.
    (c) The principles of this subdivision may be illustrated by the 
following example:

    Example. The taxpayer has a vintage account for section 1245 
property with an unadjusted basis of $1,000 and a depreciation reserve 
of $700 (of which $600 represents depreciation allowances and $100 
represents the proceeds of ordinary retirements from the account). If 
$500 is realized during the taxable year from ordinary retirements of 
assets from the account, the reserve is increased to $1,200, gain is 
recognized to the extent of $200 (the amount by which the depreciation 
reserve before further adjustment exceeds $1,000) and the depreciation 
reserve is then decreased to $1,000. The $200 of gain constitutes gain 
to which section 1245 applies. If the amount realized from ordinary 
retirements during the year had been $1,100 instead of $500, the gain of 
$800 would have consisted of $600 of gain to which section 1245 applies 
and $200 of gain to which section 1231 may apply.

    (x) Dismantling cost. The cost of dismantling, demolishing, or 
removing an asset in the process of a retirement from the vintage 
account shall be treated as an expense deductible in the year paid or 
incurred, and such cost shall not be subtracted from the depreciation 
reserve for the account.
    (xi) Special rule for treatment of multiple asset and item accounts. 
For the purposes of subdivision (ix)(b) of this subparagraph, all 
accounts (other than a special basis vintage account as described in 
subdivision (vi) of this subparagraph) of the same vintage in the same 
asset guideline class for which the taxpayer has selected the same asset 
depreciation period and adopted the same method of depreciation, and 
which contain only section 1245 property permitted by paragraph 
(b)(3)(ii) of this section to be included in the same vintage account, 
shall be treated as a single multiple asset vintage account.
    (4) Examples. The principles of this paragraph may be illustrated by 
the following examples:

    Example (1). (a)Taxpayer A has a multiple asset vintage account for 
selection 1245 property with an unadjusted basis of $1,000. All the 
assets were first placed in service by A on January 15, 1971. This 
account contains all of A's assets in a single asset guideline class. A 
elects to apply this section for 1971 and adopts the modified half-year 
convention. A estimates a salvage value for the account of $100 and this 
estimate is determined to be reasonable. (See subparagraph (1)(v) of 
this paragraph for limitation on adjustment of reasonable salvage 
value.) A adopts the straight line method of depreciation with respect 
to the account and selects a 10-year asset depreciation period. A does 
not follow a practice of reducing the salvage value for the account in 
the amount of salvage value attributable to each retired asset in 
accordance with subparagraph (3)(vii) of this paragraph. The 
depreciation allowance for each of the first 4 years is $100, that is 
\1/10\ multiplied by the unadjusted basis of $1,000, with reduction for 
salvage.
    (b) In the fifth year of the asset depreciation period, three assets 
are sold in an ordinary retirement for $300. Under paragraph (c)(1)(ii) 
of this section and subparagraph (3)(iii) of this paragraph, the 
proceeds of the retirement are added to the depreciation reserve as of 
the beginning of the fifth year. Accordingly, the reserve as of the 
beginning

[[Page 977]]

of the fifth year is $700, that is, $400 of depreciation as of the 
beginning of the year plus $300 proceeds from ordinary retirements. The 
depreciation allowance for the fifth year is $100, that is \1/10\ 
multiplied by the unadjusted basis of $1,000, without reduction for 
salvage. Accordingly, the depreciation reserve at the end of the fifth 
year is $800.
    (c) In the sixth year, asset X is sold in an extraordinary 
retirement for $30 and gain or loss is recognized. Under the first-year 
convention used by the taxpayer, the unadjusted basis of X, $300, is 
removed from the unadjusted basis of the vintage account as of the 
beginning of the sixth year and the depreciation reserve as of the 
beginning of such year is reduced to $650 by removing the depreciation 
applicable to asset X, $150 (see subparagraph (3)(iv) of this 
paragraph). Since the depreciation reserve ($650) exceeds the unadjusted 
basis of the account ($700) minus salvage value ($100) by $50, under 
subparagraph (3)(iii) of this paragraph, salvage value is reduced by 
$50. No depreciation is allowable for the sixth year.
    (d) In the seventh year, an asset is sold in an ordinary retirement 
for $110. This would increase the reserve as of the beginning of the 
seventh year to $760 and under subparagraph (3)(iii) of this paragraph 
the salvage value is reduced to zero. Under subparagraph (3)(ix)(a) of 
this paragraph the depreciation reserve is then decreased to $700 (the 
unadjusted basis of the account) and $60 is reported as gain, without 
regard to the adjusted basis of the asset. No depreciation is allowable 
for the seventh year since the depreciation reserve ($700) equals the 
unadjusted basis of the account ($700).
    (e)(1) In the eighth year, A elects to apply this section and to 
treat expenditures during the year for repair, maintenance, 
rehabilitation or improvement under subparagraph (2)(iii) and (iv)(a) of 
this paragraph (the ``guideline class repair allowance''). This results 
in the treatment of $300 as a property improvement for the asset 
guideline class. (See subparagraph (2)(vii) of this paragraph for 
definition of a property improvement.) The property improvement is 
capitalized in a special basis vintage account of the eighth taxable 
year (see subparagraph (2)(viii)(a) of this paragraph). A selects an 
asset depreciation period of 10 years and adopts the straight line 
method for the special basis vintage account. A adopts the modified 
half-year convention for the eighth year.
    (2) In the eighth year, A sells asset Y in an ordinary retirement 
for $175. Under paragraph (c)(1)(ii) of this section and subparagraph 
(3)(iii) of this paragraph, $175 is added to the depreciation reserve 
for the account as of the beginning of the taxable year. Since the 
depreciation reserve for the account ($875) exceeds the unadjusted basis 
of the account ($700) by $175, that amount of gain is recognized under 
subparagraph (3)(ix) of this paragraph. Upon recognition of gain in the 
amount of $175, the depreciation reserve for the account is reduced to 
$700.
    (3) No depreciation is allowable in the eighth year for the vintage 
account since the depreciation reserve ($700) equals the unadjusted 
basis of the account ($700). The depreciation allowable in the eighth 
year for the special basis vintage account is $15, that is, unadjusted 
basis of $300, multiplied by \1/10\, the asset depreciation period 
selected for the special basis vintage account, but limited to $15 under 
the modified half-year convention. (See paragraph (e)(1)(iv) of this 
section for treatment of $150 of the property improvement as first 
placed in service in the first half of the taxable year and $150 of the 
property improvement as first placed in service in the last half of the 
taxable year.)
    Example (2). Taxpayer B has a 1971 multiple asset vintage account 
for section 1245 property with an unadjusted basis of $100,000. B 
selects from the asset depreciation range an asset depreciation period 
of 10 years and adopts the straight line method of depreciation and the 
modified half-year convention. B establishes a salvage value for the 
account of $10,000. All the assets in the account are first placed in 
service on January 15, 1971. B follows the practice of reducing salvage 
value for the account as ordinary retirements occur in accordance with 
subparagraph (3)(vii) of this paragraph, but does not follow the 
optional practice of determining the basis of assets transferred to 
supplies or scrap in accordance with subparagraph (3)(vii) of this 
paragraph. No retirements occur during the first five years. The 
depreciation reserve at the beginning of the sixth year is $50,000. In 
the sixth year an asset with an unadjusted basis of $20,000 is 
transferred to supplies in an ordinary retirement. By application of 
subparagraph (3)(vii) (c) and (d)(2) of this paragraph B determines the 
reduction in salvage value for the account attributable to such asset to 
be $2,000 (that is, $20,000 / $100,000 x $10,000 = $2,000).

B reduces the salvage value for the account by $2,000 and adds 2,000 to 
the depreciation reserve for the account. The basis of the retired asset 
in the supplies account is $2,000. The depreciation allowable for the 
account for the sixth year is $10,000. The depreciation reserve for the 
account at the beginning of the seventh year is $62,000. At the mid-
point of the seventh year all the remaining assets in the account are 
sold in an ordinary retirement for $20,000, which is added to the 
depreciation reserve as of the beginning of the seventh year, thus 
increasing the reserve to $82,000. The $5,000 depreciation allowable for 
the account for the seventh year (one-half of a full-year's depreciation 
of $10,000) increases the depreciation reserve to $87,000. Under 
subparagraph (3)(ix)(b) of this paragraph, a

[[Page 978]]

loss of $13,000 subject to section 1231 is realized in the seventh year 
(that is, the excess of the unadjusted basis of $100,000 over the 
depreciation reserve of $87,000). No depreciation is allowable for the 
account after the mid-point of the seventh year since all the assets are 
retired and the account has terminated.

    (e) Accounting for eligible property--(1) Definition of first placed 
in service--(i) In general. The term ``first placed in service'' refers 
to the time the property is first placed in service by the taxpayer, not 
to the first time the property is placed in service. Property is first 
placed in service when first placed in a condition or state of readiness 
and availability for a specifically assigned function, whether in a 
trade or business, in the production of income, in a tax-exempt 
activity, or in a personal activity. In general, the provisions of 
paragraph (d)(1)(ii) and (d)(2) of Sec. 1.46-3 shall apply for the 
purpose of determining the date on which property is placed in service, 
but see subdivision (ii) of this subparagraph for special rule for 
certain replacement parts. In the case of a building which is intended 
to house machinery and equipment and which is constructed, 
reconstructed, or erected by or for the taxpayer and for the taxpayer's 
use, the building will ordinarily be placed in service on the date such 
construction, reconstruction, or erection is substantially complete and 
the building is in a condition or state of readiness and availability. 
Thus, for example, in the case of a factory building, such readiness and 
availability shall be determined without regard to whether the machinery 
or equipment which the building houses, or is intended to house, has 
been placed in service. However, in an appropriate case, as for example 
where the building is essentially an item of machinery or equipment, or 
the use of the building is so closely related to the use of the 
machinery or equipment that it clearly can be expected to be replaced or 
retired when the property it initially houses is replaced or retired, 
the determination of readiness or availability of the building shall be 
made by taking into account the readiness and availability of such 
machinery or equipment. The date on which depreciation begins under a 
convention used by the taxpayer or under a particular method of 
depreciation, such as the unit of production method or the retirement 
method, shall not determine the date on which the property is first 
placed in service. See paragraph (c)(2) of this section for application 
of a first-year convention to determine the allowance for depreciation 
of property in a vintage account.
    (ii) Certain replacement parts. Property (such as replacement parts) 
the cost or other basis of which is deducted as a repair expense in 
accordance with the asset guideline repair allowance described in 
paragraph (d)(2)(iii) of this section shall not be treated as placed in 
service.
    (iii) Property improvements and excluded additions. (a) Except as 
provided in (b) of this subdivision, a property improvement determined 
under paragraph (d)(2)(vii)(b) of this section, and an excluded addition 
(other than an excluded addition referred to in the succeeding sentence) 
is first placed in service when its cost is paid or incurred. The 
general rule in subdivision (i) of this subparagraph applies to an 
excluded addition described in paragraph (d) (2)(vi) (d), (e), (f), or 
(g) of this section.
    (b) If a property improvement or an excluded addition to which the 
first sentence of (a) of this subdivision applies is paid or incurred in 
part in one taxable year and in part in the succeeding taxable year (or 
in part in the first half of a taxable year and in part in the last half 
of the taxable year) the taxpayer may at his option consistently treat 
such property improvements and excluded additions under the general rule 
in subdivision (i) of this subparagraph.
    (iv) Certain property improvements. In the case of an amount of 
property improvement determined under paragraph (d)(2)(vii)(a) of this 
section, one-half of such amount is first placed in service in the first 
half of the taxable year in which the cost is paid or incurred and one-
half is first placed in service in the last half of such taxable year.
    (v) Special rules for clearing accounts. In the case of public 
utilities which consistently account for certain property through 
``clearing accounts,'' the date on which such property is first placed 
in service shall be determined in

[[Page 979]]

accordance with rules to be prescribed by the Commissioner.
    (2) Special rules for transferred property. If eligible property is 
first placed in service by the taxpayer during a taxable year of 
election, and the property is disposed of before the end of the taxable 
year, the election for such taxable year shall include such property 
unless such property is excluded in accordance with paragraph (b)(5) 
(iii), (iv, (v), (vi), or (vii) of this section.
    (3) Special rules in the case of certain transfers--(i) Transaction 
to which section 381(a) applies. (a) In general the acquiring 
corporation in a transaction to which section 381(a) applies is for the 
purposes of this section treated as if it were the distributor or 
transferor corporation.
    (b) If the distributor or transferor corporation (including any 
distributor or transferor corporation of any distributor or transferor 
corporation) has made an election to apply this section to eligible 
property transferred in a transaction to which section 381(a) applies, 
the acquiring corporation must segregate such eligible property (to 
which the distributor or transferor corporation elected to apply this 
section) into vintage accounts as nearly coextensive as possible with 
the vintage accounts created by the distributor or transferor 
corporation identified by reference to the year the property was first 
placed in service by the distributor or transferor corporation. The 
asset depreciation period for the vintage account in the hands of the 
distributor or transferor corporation must be used by the acquiring 
corporation. The method of depreciation adopted by the distributor or 
transferor corporation, shall be used by the acquiring corporation 
unless such corporation obtains the consent of the Commissioner to use 
another method of depreciation in accordance with paragraph (e) of Sec. 
1.446-1 or changes the method of depreciation under paragraph 
(c)(1)(iii) of this section.
    (c) The acquiring corporation may apply this section to the property 
so acquired only if the distributor or transferor corporation elected to 
apply this section to such property.
    (d) See paragraph (b)(7) of this section for special rule for 
certain property where there is a mere change in the form of conducting 
a trade or business.
    (ii) Partnerships, trusts, estates, donees, and corporations. Except 
as provided in subdivision (i) of this subparagraph with respect to 
transactions to which section 381(a) applies and subdivision (iv) of 
this subparagraph with respect to certain transfers between members of 
an affiliated group of corporations or other related parties, if 
eligible property is placed in service by an individual, trust, estate, 
partnership or corporation, the election to apply this section shall be 
made by the individual, trust, estate, partnership or corporation 
placing such property in service. For example, if a partnership places 
in service property contributed to the partnership by a partner, the 
partnership may elect to apply this section to such property. If the 
partnership does not make the election, this section will not apply to 
such property. See paragraph (b)(7) of this section for special rule for 
certain property where there is mere change in the form of conducting a 
trade or business.
    (iii) Leased property. The asset depreciation range and the asset 
depreciation period for eligible property subject to a lease shall be 
determined without regard to the period for which such property is 
leased, including any extensions or renewals of such period. See 
paragraph (b)(5)(v) of this section for exclusion of property amortized 
under paragraph (b) of Sec. 1.162-11 from an election to apply this 
section. In the case of a lessor of property, unless there is an asset 
guideline class in effect for lessors of such property, the asset 
guideline class for such property shall be determined as if the property 
were owned by the lessee. However, in the case of an asset guideline 
class based upon the type of property (such as trucks or railroad cars) 
as distinguished from the activity in which used, the property shall be 
classified without regard to the activity of the lessee. Notwithstanding 
the preceding sentence, if a lease with respect to property, which would 
be includible in an asset guideline class based upon the type of 
property under the preceding sentence (such as trucks or railroad

[[Page 980]]

cars), is entered into after March 12, 1971, and before April 23, 1973, 
or a written contract to execute such a lease is entered into during 
such period and such contract is binding on April 23, 1973, and at all 
times thereafter, and if the rent or rate of return is based on a 
classification of such property as if it were owned by the lessee, then 
such property shall be classified as if it were owned by the lessee. 
However, the preceding sentence shall not apply if pursuant to the terms 
or conditions of the lease or binding contract the rent or rate of 
return may be adjusted to take account of a change in the period for 
depreciation with respect to the property resulting from inclusion of 
the property in an asset guideline class based upon the type of property 
rather than in an asset guideline class based upon the activity of the 
lessee. Similarly, where the terms of such a lease or contract provide 
that the obligation of the taxpayer to enter into the lease is subject 
to a condition that the property be included in an asset guideline class 
based upon the activity of the lessee, the contract or lease will not be 
considered as binding upon the taxpayer, for purposes of this 
subdivision. See paragraph (b)(4)(iii)(b) of this section for general 
rule for classification of property according to primary use.
    (iv) Treatment of certain transfers between members of affiliated 
groups or other related persons. If section 38 property in an asset 
guideline class (determined without regard to whether the taxpayer 
elects to apply this section) is transferred by the taxpayer to a person 
who bears a relationship described in section 179(d)(2) (A) or (B), such 
property is in the same asset guideline class in the hands of 
transferee, and the transfer is neither described in section 381(a) nor 
treated as a disposition or cessation within the meaning of section 47, 
then the asset guideline period for such property selected by the 
taxpayer under this section shall not be shorter than the period used 
for computing the qualified investment with respect to the property 
under section 46(c). In a case in which the asset depreciation range for 
the asset guideline class which includes such property does not include 
the period for depreciation used by the transferor in computing the 
qualified investment with respect to such property, the transferee will 
not be permitted to include such property in an election under this 
section. However, in such a case, the transferor of the property may 
recompute the qualified investment for the year the property was placed 
in service using a period for depreciation which falls within the asset 
depreciation range.
    (f) Election with respect to eligible property--(1) Time and manner 
of election--(i) In general. An election to apply this section to 
eligible property shall be made with the income tax return filed for the 
taxable year in which the property is first placed in service (see 
paragraph (e)(1) of this section) by the taxpayer. In the case of an 
affiliated group of corporations (as defined in section 1504(a)) which 
makes a consolidated return with respect to income tax in accordance 
with section 1502 and the regulations thereunder, each corporation which 
joins in the making of such return may elect to apply this section for a 
taxable year. An election to compute the allowance for depreciation 
under this section is a method of accounting but the consent of the 
Commissioner will be deemed granted to make an annual election. For 
election by a partnership see section 703 (b) and paragraph (e)(3)(ii) 
of this section. If the taxpayer does not file a timely return (taking 
into account extensions of the time for filing) for the taxable year in 
which the property is first placed in service, the election shall be 
filed at the time the taxpayer files his first return for that year. The 
election may be made with an amended return filed within the time 
prescribed by law (including extensions) for filing the original return 
for the taxable year of election. If an election is not made within the 
time and in the manner prescribed in this paragraph, no election may be 
made for such taxable year (by the filing of an amended return or in any 
other manner) with respect to any eligible property placed in service in 
the taxable year.
    (ii) Other elections under this section. All other elections under 
this section may be made only within the time and

[[Page 981]]

in the manner prescribed by subdivision (i) of this subparagraph with 
respect to an election to apply this section.
    (iii) Effective date. See paragraph (f)(6) of this section for the 
effective date of this paragraph.
    (2) Information required. A taxpayer who elects to apply this 
section must specify in the election:
    (i) That the taxpayer makes such election and consents to and agrees 
to apply, all the provisions of this section;
    (ii) The asset guideline class for each vintage account of the 
taxable year;
    (iii) The first-year convention adopted by the taxpayer for the 
taxable year of election;
    (iv) Whether the special 10 percent used property rule described in 
paragraph (b)(5)(iii) of this section has been applied to exclude used 
property from the election;
    (v) Whether the taxpayer elects to apply the asset guideline class 
repair allowance described in paragraph (d)(2)(iii) of this section;
    (vi) Whether the taxpayer elects for the taxable year to allocate 
the adjusted basis of a special basis vintage account in accordance with 
paragraph (d)(3)(vi) of this section;
    (vii) Whether any eligible property for which the taxpayer was not 
required or permitted to make an election was excluded because of the 
special rules of paragraph (b)(5)(v) or (6), or paragraph (e)(3)(i) or 
(iv) of this section;
    (viii) Whether any ``section 38 property'' was excluded under 
paragraph (b)(5)(iv) of this section from the election to apply this 
section;
    (ix) If the taxpayer is an electric or gas utility, whether the 
taxpayer elects to apply this section on the basis of a composite asset 
guideline class in accordance with paragraph (b)(4)(iii)(a) of this 
section; and
    (x) Such other information as may reasonably be required.

The information required under this subparagraph may be provided in 
accordance with rules prescribed by the Commissioner for reasonable 
grouping of assets or accounts. Form 4832 is provided for making an 
election and for submission of the information required. An election may 
be made and the information submitted only in accordance with Form 4832. 
An election to apply this section will not be rendered invalid under 
this subparagraph so long as there is substantial compliance, in good 
faith, with the requirements of this subparagraph.
    (3) Irrevocable election. An election to apply this section to 
eligible property for any taxable year may not be revoked or changed 
after the time for filing the election prescribed under subparagraph (1) 
of this paragraph has expired. No other election under this section may 
be revoked or changed after such time unless expressly provided for 
under this section. (See paragraph (b)(5)(v)(b) of this section for 
special rule.)
    (4) Special conditions to election to apply this section--(i) 
Maintenance of books and records. The taxpayer may not elect to apply 
this section for a taxable year unless the taxpayer maintains the books 
and records required under this section. In addition to any other 
information required under this section, the taxpayer's books and 
records must specify--
    (a) The asset depreciation period selected by the taxpayer for each 
vintage account;
    (b) If the taxpayer applies the modified half-year convention, the 
total cost or other basis of all eligible property first placed in 
service in the first half of the taxable year and the total cost or 
other basis of all eligible property first placed in service in the last 
half of the taxable year;
    (c) The unadjusted basis and salvage value for each vintage account, 
and the amount, if any, by which gross salvage value was decreased under 
section 167 (f);
    (d) Each asset guideline class for which the taxpayer elects to 
apply the asset guideline class repair allowance described in paragraph 
(d)(2)(iii) of this section;
    (e) The amount of property improvement, determined under paragraph 
(d)(2)(vii)(a) of this section, for each asset guideline class for which 
the taxpayer elects to apply the asset guideline class repair allowance;
    (f) A reasonable description of property excluded from an election 
to apply

[[Page 982]]

this section and the basis for the exclusion;
    (g) The total unadjusted basis of all assets retired during the 
taxable year from each asset guideline class, and the proceeds realized 
during the taxable year from such retirements; and
    (h) The vintage (that is, the taxable year in which established) of 
the assets retired during the year from each asset guideline class.

For purposes of paragraph (f)(4)(i) (g) and (h) of this section, all 
accounts of the same vintage and asset guideline class may be treated as 
a single account. The taxpayer must specify the information required 
under paragraph (f)(4)(i) (g) and (h) without regard to the retirement 
of an asset by transfer to a supplies account for reuse.
    (ii) Response to survey. Taxpayers who elect to apply this section 
must respond to infrequent data surveys conducted by the Treasury 
Department. These periodic surveys, which will be conducted on the basis 
of scientifically sound sampling methods, are designed to obtain data 
(including industry asset acquisitions and retirements) used to keep the 
asset guideline classes and periods up to date.
    (iii) Effect of noncompliance. An election to apply this section 
will not be rendered invalid under this subparagraph so long as there is 
substantial compliance, in good faith, with the requirements of this 
subparagraph.
    (5) Mass assets. In the case of mass assets, if the taxpayer assigns 
retirements to vintage accounts in the manner provided in paragraph 
(d)(3)(v)(c) of this section, the following information must be supplied 
with form 4832:
    (i) Whether the taxpayer used the standard mortality dispersion 
curve or a curve based upon his own experience, and
    (ii) Such other reasonable information as may be required by the 
Commissioner.
    (6) Effective date. The rules in this paragraph apply to elections 
for taxable years ending on or after December 31, 1978. In the case of 
an election for a taxable year ending before December 31, 1978, the 
rules in paragraph (f) of this section, in effect before the amendments 
made by T.D. 7593 approved January 11, 1979, shall apply. See 26 CFR 
Sec. 1.167(a)-11(f) (1977) for paragraph (f) of this section as it 
appeared before the amendments made by T.D. 7593.
    (g) Relationship to other provisions--(1) Useful life--(i) In 
general. Except as provided in subdivision (ii) of this subparagraph, an 
election to apply this section to eligible property constitutes an 
agreement under section 167(d) and this section to treat the asset 
depreciation period for each vintage account as the useful life of the 
property in such account for all purposes of the Code, including 
sections 46, 47, 48, 57, 163(d), 167(c), 167(f)(2), 179, 312(m), 514(a), 
and 4940(c). For example, since section 167(c) requires a useful life of 
at least 3 years and the asset depreciation period selected is treated 
as the useful life for purposes of section 167(c), the taxpayer may 
adopt a method of depreciation described in section 167(b) (2) or (3) 
for an account only if the asset depreciation period selected for the 
account is at least 3 years.
    (ii) Special rules. (a) For the purposes of paragraph (d) of this 
section, the anticipated period of use (estimated at the close of the 
taxable year in which the asset is first placed in service) on the basis 
of which salvage value is estimated, shall be determined without regard 
to the asset depreciation period for the property.
    (b) For the purposes of sections 162 and 263 and the regulations 
thereunder, whether an expenditure prolongs the life of an asset shall 
be determined on the basis of the anticipated period of use of the asset 
(estimated at the close of the taxable year in which the asset is first 
placed in service) without regard to the asset depreciation period for 
such asset.
    (c) The determination whether a transaction with respect to 
qualified property constitutes a sale or a lease of such property shall 
be made without regard to the asset depreciation period for the 
property.
    (d) The principles of this subdivision may be illustrated by the 
following example:

    Example. Corporation X has assets in asset guideline class 32.3 
which are used in the manufacture of stone and clay products. The asset 
depreciation range for assets in asset

[[Page 983]]

guideline class 32.3 is from 12 to 18 years. Assume that corporation X 
selects 14 years as the asset depreciation period for all assets in 
asset guideline class 32.3. Under paragraph (d)(1)(i) of this section, 
corporation X must estimate salvage value on the basis of the 
anticipated period of use of the property (determined as of the close of 
the taxable year in which the property is first placed in service). The 
anticipated period of use must also be used for purposes of sections 162 
and 263 in determining whether an expenditure materially prolongs the 
useful life of an asset. The anticipated period of use of an asset is 
determined without regard to the asset depreciation period of 14 years. 
Corporation X has, among other assets in the asset guideline class, 
machines A, B, and C. Corporation X estimates the anticipated period of 
use of machines A, B, and C as 8 years, 14 years, and 22 years, 
respectively. These estimates are reasonable and will be used for 
estimating salvage value and for purposes of sections 162 and 263.

    (2) Section 167(d) agreements. If the taxpayer has, prior to January 
1, 1971, entered into a section 167(d) agreement which applies to any 
eligible property, the taxpayer will be permitted to withdraw the 
eligible property from the agreement provided that an election is made 
to apply this section to such property. The statement of intent to 
withdraw eligible property from such an agreement must be made in an 
election filed for the taxable year in which the property is first 
placed in service. The withdrawal, in accordance with this subparagraph, 
of any eligible property from a section 167(d) agreement shall not 
affect any other property covered by such an agreement.
    (3) Relationship to the straight line method--(i) In general. For 
purposes of determining the amount of depreciation which would be 
allowable under the straight line method of depreciation, such amount 
shall be computed with respect to any property in a vintage account 
using the straight line method in the manner described in paragraph 
(c)(1)(i) of this section and a rate based upon the period for the 
vintage account selected from the asset depreciation range. Thus, for 
example, section 57(a)(3) requires a taxpayer to compute an amount using 
the straight line method of depreciation if the taxpayer uses an 
accelerated method of depreciation. For purposes of section 57(a)(3), 
the amount for property in a vintage account shall be computed using the 
asset depreciation period for the vintage account selected from the 
asset depreciation range. In the case of property to which the taxpayer 
does not elect to apply this section, such amount computed by using the 
straight line method shall be determined under Sec. 1.167(b)-1 without 
regard to this section.
    (ii) Examples. The principles of this subparagraph may be 
illustrated by the following example:

    Example. (a) Corporation X places a new asset in service to which it 
elects to apply this section. The cost of the asset is $200,000 and the 
estimated salvage value is zero. The taxpayer selects 9 years from the 
applicable asset depreciation range of 8 to 12 years. Corporation X 
adopts the double declining balance method of depreciation and thus the 
rate of depreciation is 22.2 percent (twice the applicable straight line 
rate). The depreciation allowance in the first year would be $44,400, 
that is, 22.2 percent of $200,000.
    (b) Assume that the provisions of section 57(a)(3) apply to the 
property. The amount of the tax preference would be $22,200, that is, 
the excess of the depreciation allowed under this section ($44,400) over 
the depreciation which would have been allowable if the taxpayer had 
used the period selected from the asset depreciation range and the 
straight line rate ($22,200).

(Secs. 167(m), 85 Stat. 508 (26 U.S.C. 167(m) and 7805, 68A Stat. 917, 
(26 U.S.C. 7805))

[T.D. 7272, 38 FR 9967, Apr. 23, 1973]

    Editorial Note: For Federal Register citations affecting Sec. 
1.167(a)-11, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and on GPO Access.



Sec. 1.167(a)-12  Depreciation based on class lives for property first 
placed in service before January 1, 1971.

    (a) In general--(1) Summary. This section provides an elective class 
life system for determining the reasonable allowance for depreciation of 
certain classes of assets for taxable years ending after December 31, 
1970. The system applies only to assets placed in service before January 
1, 1971. Depreciation for such assets during periods prior to January 1, 
1971, may have been determined in accordance with Revenue Procedure 62-
21. Accordingly, rules are provided which permit taxpayers to apply the 
system in taxable years ending after

[[Page 984]]

December 31, 1970, to such assets without the necessity of changing or 
regrouping their depreciation accounts other than as previously required 
by Revenue Procedure 62-21. The system is designed to minimize disputes 
between taxpayers and the Internal Revenue Service as to the useful life 
of assets, salvage value, and repairs. See Sec. 1.167(a)-11 for a 
similar system for property placed in service after December 31, 1970. 
See paragraph (d)(2) of Sec. 1.167(a)-11 for treatment of expenditures 
for the repair, maintenance, rehabilitation or improvement of certain 
property. The system provided by this section is optional with the 
taxpayer. An election under this section applies only to qualified 
property in an asset guideline class for which an election is made and 
only for the taxable year of election. The taxpayer's election is made 
with the income tax return for the taxable year. This section also 
revokes the reserve ratio test for taxable years ending after December 
31, 1970, and provides transitional rules for taxpayers who after 
January 11, 1971, adopt Revenue Procedure 62-21 for a taxable year 
ending prior to January 1, 1971.
    (2) Revocation of reserve ratio test and other matters. Except as 
otherwise expressly provided in this section and in paragraph (b)(5)(vi) 
of Sec. 1.167(a)-11, the provisions of Revenue Procedure 62-21 shall 
not apply to any property for any taxable year ending after December 31, 
1970, whether or not the taxpayer elects to apply this section to any 
property. See paragraph (f) of this section for rules for the adoption 
of Revenue Procedure 62-21 for taxable years ending prior to January 1, 
1971.
    (3) Definition of qualified property. The term ``qualified 
property'' means tangible property which is subject to the allowance for 
depreciation provided by section 167(a), but only if--
    (i) An asset guideline class and asset guideline period are in 
effect for such property for the taxable year, and
    (ii) The property is first placed in service by the taxpayer before 
January 1, 1971,
    (iii) The property is placed in service before January 1, 1971, but 
first placed in service by the taxpayer after December 31, 1970, and is 
not includible in an election under Sec. 1.167(a)-11 by reason of Sec. 
1.167(a)-11(b)(7) (property acquired as a result of a mere change in 
form) or Sec. 1.167(a)-11(e)(3)(i) (certain property acquired in a 
transaction to which section 381(a) applies), or
    (iv) The property is acquired and first placed in service by the 
taxpayer after December 31, 1970, pursuant to a binding written contract 
entered into prior to January 1, 1971, and is excluded in accordance 
with paragraph (b)(5)(iv) of Sec. 1.167(a)-11 from an election to apply 
Sec. 1.167(a)-11.

The provisions of paragraph (e)(1) of Sec. 1.167(a)-11 apply in 
determining whether property is first placed in service before January 
1, 1971. See subparagraph (4)(ii) of this paragraph for special rules 
for the exclusion of property from the definition of qualified property.
    (4) Requirements of election--(i) In general. An election to apply 
this section to qualified property must be made within the time and in 
the manner specified in paragraph (e) of this section. The election must 
specify that the taxpayer consents to and agrees to apply all the 
provisions of this section. The election may be made separately for each 
asset guideline class. Thus, a taxpayer may for the taxable year elect 
to apply this section to one, more than one, or all asset guideline 
classes in which he has qualified property. An election to apply this 
section for a taxable year must include all qualified property in the 
asset guideline class for which the election is made.
    (ii) Special rules for exclusion of property from application of 
this section. (a) If for the taxable year of election, the taxpayer 
computes depreciation under section 167(k) or computes amortization 
under sections 169, 185, 187, 188, or paragraph (b) of Sec. 1.162-11 
with respect to property, such property is not qualified property for 
such taxable year. If for the taxable year of election, the taxpayer 
computes depreciation under any method of depreciation (other than a 
method described in the preceding sentence) not permitted by 
subparagraph (5)(v) of this paragraph for any property in an asset 
guideline class (other than subsidiary assets excluded from an election 
under (b) of this subdivision), no property in such asset

[[Page 985]]

guideline class is qualified property for such taxable year.
    (b) The taxpayer may exclude from an election to apply this section 
all (but not less than all) subsidiary assets. Subsidiary assets so 
excluded are not qualified property for such taxable year. For purposes 
of this subdivision the term ``subsidiary assets'' includes jigs, dies, 
molds, returnable containers, glassware, silverware, textile mill cam 
assemblies, and other equipment includable in Group One, Class 5, of 
Revenue Procedure 62-21 which is usually and properly accounted for 
separately from other property and under a method of depreciation not 
expressed in terms of years.
    (iii) Special rule for certain public utility property. (a) In the 
case of public utility property described in section 167(1)(3)(A)(iii) 
for which no guideline life was prescribed in Revenue Procedure 62-21 
(or for which reference was made in Revenue Procedure 62-21 to lives or 
rates established by governmental regulatory agencies) of a taxpayer 
which--
    (1) Is entitled to use a method of depreciation other than a 
``subsection (1) method'' of depreciation (as defined in section 
167(1)(3)(F)) only if it uses the ``normalization method of accounting'' 
(as defined in section 167(1)(3)(G)) with respect to such property, or
    (2) Is entitled for the taxable year to use only a ``subsection (1) 
method'' of depreciation,

such property shall be qualified property (as defined in subparagraph 
(3) of this paragraph) only if the taxpayer normalizes the tax deferral 
resulting from the election to apply this section.
    (b) The taxpayer will be considered to normalize the tax deferral 
resulting from the election to apply this section only if it computes 
its tax expense for purposes of establishing its cost of service for 
ratemaking purposes and for reflecting operating results in its 
regulated books of account using a period for depreciation no less than 
the period used for computing its depreciation expense for ratemaking 
purposes and for reflecting operating results in its regulated books of 
account for the taxable year, and the taxpayer makes adjustments to a 
reserve to reflect the deferral of taxes resulting from the use of a 
period for depreciation under section 167 in accordance with an election 
to apply this section different from the period used for computing its 
depreciation expense for ratemaking purposes and for reflecting 
operating results in its regulated books of account for the taxable 
year. A determination whether the taxpayer is considered to normalize 
under this subdivision the tax deferral resulting from the election to 
apply this section shall be made in a manner consistent with the 
principles for determining whether a taxpayer is using the 
``normalization method of accounting'' (within the meaning of section 
167(1)(3)(G)). See Sec. 1.167(l)-1(h).
    (c) If a taxpayer, which has elected to apply this section to any 
qualified public utility property and is required under (a) of this 
subdivision to normalize the tax deferral resulting from the election to 
apply this section to such property, fails to normalize such tax 
deferral, the election to apply this section to such property shall 
terminate as of the beginning of the taxable year for which the taxpayer 
fails to normalize such tax deferral. Application of this section to 
such property for any period prior to the termination date will not be 
affected by this termination.
    (5) Determination of reasonable allowance for depreciation--(i) In 
general. The allowance for depreciation of qualified property to which 
the taxpayer elects to apply this section shall be determined in 
accordance with this section. The annual allowance for depreciation is 
determined by using the method of depreciation adopted by the taxpayer 
and a rate based upon a life permitted by this section. In the case of 
the straight-line method of depreciation, the rate of depreciation shall 
be based upon the class life (or individual life if the taxpayer assigns 
individual depreciable lives in accordance with subdivision (iii) of 
this subparagraph) used by the taxpayer with respect to the assets in 
the asset guideline class. Such rate will be applied to the unadjusted 
basis of the asset guideline class (individual assets or depreciation 
accounts if the taxpayer assigns individual depreciable lives). In the 
case of the sum of the years-digits method of depreciation,

[[Page 986]]

the rate of depreciation will be determined based upon the remaining 
life of the class (or individual remaining lives if the taxpayer assigns 
such lives in accordance with subdivision (iii) of this subparagraph) 
and is applied to the adjusted basis of the class (or individual 
accounts or assets) as of the beginning of the taxable year of election. 
The remaining life of a depreciation account is determined by dividing 
the unrecovered cost or other basis of the account, as computed by 
straight-line depreciation, by the gross cost or unadjusted basis of the 
account, and multiplying the result by the class life used with respect 
to the account. In the case of the declining balance method of 
depreciation, the rate of depreciation for the asset guideline class 
shall be based upon the class life (or individual life if the taxpayer 
assigns such lives in accordance with subdivision (iii) of this 
subparagraph). Such rate is applied to the adjusted basis of the class 
(or individual accounts or assets) as of the beginning of the taxable 
year of election.
    (ii) Reasonable allowance by reference to class lives. The amount of 
depreciation for all qualified property in an asset guideline class to 
which the taxpayer elects to apply this section will constitute the 
reasonable allowance provided by section 167(a) and the depreciation for 
the asset guideline class will not be adjusted if--
    (a) The taxpayer's qualified property is accounted for in one or 
more depreciation accounts which conform to the asset guideline class, 
and the depreciation for each such account is determined by using a rate 
based upon a life not less than the class life, or
    (b) The taxpayer's qualified property is accounted for in one or 
more depreciation accounts (whether or not conforming to the asset 
guideline class) for which depreciation is determined at a rate based 
upon the taxpayer's estimate of the lives of the assets (instead of the 
class life) and the total amount of depreciation so determined for the 
asset guideline class for the taxable year of election is not more than 
would be permitted under (a) of this subdivision for such year using the 
method of depreciation adopted by the taxpayer for the property.

See subdivision (vii) of this subparagraph for determination of 
reasonable allowance if depreciation exceeds the amount permitted by 
this subdivision. See paragraph (b) of this section for rules regarding 
the determination of ``class life''. For rules for regrouping 
depreciation accounts to conform to the asset guideline class, see 
subdivision (iv) of this subparagraph.
    (iii) Consistency when individual lives are used. If the taxpayer 
assigns individual depreciable lives to assets in accordance with 
subdivision (ii)(b) of this subparagraph, even though the total amount 
of depreciation for the asset guideline class will not be adjusted, the 
lives assigned to the various assets in the asset guideline class must 
be reasonably in proportion to their relative expected periods of use in 
the taxpayer's business. Thus, although the taxpayer who uses individual 
asset lives normally has latitude in thereby allocating the depreciation 
for the asset guideline class among the assets, if the lives are grossly 
disproportionate (as where a short life is assigned to one asset and a 
long life to another even though the expected periods of use are the 
same), the taxpayer's allocation of depreciation to particular assets or 
depreciation accounts may be adjusted. For example, the taxpayer's 
allocation may be adjusted for purposes of determining adjusted basis 
under section 1016(a) or in allocating depreciation to the 50-percent 
limitation on percentage depletion provided by section 613(a). See 
paragraph (d) of this section for rules regarding the use of individual 
asset lives for purposes of classifying retirements as normal or 
abnormal.
    (iv) Regrouping depreciation accounts. Without the consent of the 
Commissioner, the taxpayer may for any taxable year for which he elects 
to apply this section to an asset guideline class, regroup his accounts 
for that and all succeeding taxable years to conform to the asset 
guideline class. Other changes in accounting, including a change from 
item accounts to multiple-asset accounting, may be made with the consent 
of the Commissioner. No depreciation accounts for which the straight 
line or sum of the years-digits method of depreciation is adopted may be 
combined under this section which

[[Page 987]]

would not be permitted to be combined under part III of Revenue 
Procedure 65-13, as in effect on January 1, 1971. Accordingly, whether 
or not the taxpayer adopted the guideline system of Revenue Procedure 
62-21 for a taxable year to which part III of Revenue Procedure 65-13 is 
applicable, the depreciation allowance for any taxable year of election 
under this section may not exceed that amount which would have been 
allowed for such year if the taxpayer had used item accounts or year of 
acquisition accounts. Thus, for example, if a calendar year taxpayer 
acquired a $90 asset on the first day of each year from 1966 through 
1970, placed such assets in a single multiple asset account, adopted the 
sum of the years-digits method of depreciation and used a 5-year 
depreciable life for such assets, and in 1971 uses the 5-year class life 
determined under paragraph (b) of this section, the depreciation 
allowance for such assets in 1971 under this section may not exceed $60, 
that is, the amount which would be allowed if the taxpayer had used year 
of acquisition accounts for the assets for the years 1966 through 1970.

For purposes of this subparagraph, a taxpayer's depreciation accounts 
conform to the asset guideline class if each depreciation account 
includes only assets of the same asset guideline class.
    (v) Method of depreciation. The same method of depreciation must be 
applied to all property in a single depreciation account. The method of 
depreciation is subject to the limitations of section 167 (c), (j), and 
(l). Except as otherwise provided in this subdivision, the taxpayer must 
apply a method of depreciation described in section 167(b) (1), (2), or 
(3) for qualified property to which the taxpayer elects to apply this 
section. A method of depreciation permitted under section 167(b)(4) may 
be used under this section if the method was used by the taxpayer with 
respect to the property for his last taxable year ending before January 
1, 1971, the method is expressed in terms of years, the taxpayer 
establishes to the satisfaction of the Commissioner that the method is 
both a reasonable and consistent method, and if the taxpayer applies 
paragraph (b)(2) of this section (relating to class lives in special 
situations) to determine a class life, that the method of determining 
such class life is consistent with the principles of Revenue Procedure 
62-21 as applied to such a method. If the taxpayer has applied a method 
of depreciation with respect to the property which is not described in 
section 167(b) (1), (2), (3), or (4) (as permitted under the preceding 
sentence), he must change under this section to a method of depreciation 
described in section 167(b) (1), (2), or (3) for the first taxable year 
for which an election is made under this section. Other changes in 
depreciation method may be made with the consent of the Commissioner 
(see sec. 446 and the regulations thereunder). (See also sec. 167(e).)
    (vi) Salvage value. In applying the method of depreciation adopted 
by the taxpayer, the annual allowance for depreciation is determined 
without adjustment for the salvage value of the property, except that no 
depreciation account may be depreciated below a reasonable salvage value 
for the account. See paragraph (c) of this section for definition and 
treatment of salvage value.
    (vii) Reasonable allowance when depreciation exceeds amount based on 
class life. In the event that the total amount of depreciation claimed 
by the taxpayer on his income tax return, in a claim for refund, or 
otherwise, for an asset guideline class with respect to which an 
election is made under this section for the taxable year, exceeds the 
maximum amount permitted under subdivision (ii)(a) of this 
subparagraph--
    (a) If the excess is established to the satisfaction of the 
Commissioner to be the result of a good faith mistake by the taxpayer in 
determining the maximum amount permitted under subdivision (ii) (a) of 
this subparagraph, the taxpayer's election to apply this section will be 
treated as valid and only such excess will be disallowed, and
    (b) In all other cases, the taxpayer's election to apply this 
section to the asset guideline class for the taxable year is invalid and 
the reasonable allowance for depreciation will be determined without 
regard to this section. (See Sec. 1.167(a)-1 (b) for rules regarding 
the estimated useful life of property.)

[[Page 988]]

    (b) Determination of class lives--(1) Class lives in general. The 
class life determined under this paragraph (without regard to any range 
or variance permitted with respect to class lives under Sec. 1.167(a)-
11) will be applied for purposes of determining whether the allowance 
for depreciation for qualified property included in an election under 
this section is subject to adjustment. The taxpayer is not required to 
use the class life determined under this paragraph for purposes of 
determining the allowance for depreciation. Except as provided in 
subparagraph (2) of this paragraph, the class life of qualified property 
to which the taxpayer elects to apply this section is the shorter of--
    (i) The asset guideline period for the asset guideline class as set 
forth in Revenue Procedure 72-10 as in effect on March 1, 1972 (applied 
without regard to any special provision therein with respect to property 
predominantly used outside the United States), or
    (ii) The asset guideline period for the asset guideline class as set 
forth in any supplement or revision of Revenue Procedure 72-10, but only 
if and to the extent by express reference in such supplement or revision 
made applicable for the purpose of changing the asset guideline period 
or classification of qualified property to which this section applies.

See paragraph (e)(3)(iii) of this section for requirement that the 
election for the taxable year specify the class life for each asset 
guideline class. Generally, the applicable asset guideline class and 
asset guideline period for qualified property to which the taxpayer has 
elected to apply this section will not be changed for the taxable year 
of election to reflect any supplement or revision thereof after the 
taxable year. However, if expressly provided in such a supplement or 
revision, the taxpayer may, at his option in the manner specified 
therein, apply the revised or supplemented asset guideline classes or 
periods to such property for such taxable year and succeeding taxable 
years. The principles of this subparagraph may be illustrated by the 
following example:

    Example. (i) Corporation X, a calendar year taxpayer, has assets in 
asset guideline class 20.4 of Revenue Procedure 72-10 which were placed 
in service by corporation X in 1967, 1968, and 1970. Corporation X also 
has assets in asset guideline class 22.1 of Revenue Procedure 72-10 
which were placed in service at various times prior to 1971. Corporation 
X has no other qualified property. Corporation X elects to apply this 
section for 1971 to both classes. Assume that the class lives are 
determined under this subparagraph and not under subparagraph (2) of 
this paragraph.
    (ii) The class lives for asset guideline classes 20.4 and 22.1 are 
their respective asset guideline periods of 12 years and 9 years in 
Revenue Procedure 72-10.
    (iii) Accordingly, in the election for the taxable year, in 
accordance with paragraph (e)(3)(iii) of this section, corporation X 
specifies a class life of 12 years for asset guideline class 20.4 and a 
class life of 9 years for asset guideline class 22.1

    (2) Class lives in special situations. Notwithstanding subparagraph 
(1) of this paragraph, for the purposes of this section the class life 
for the asset guideline class determined under this subparagraph shall 
be used if such class life is shorter than the class life determined 
under subparagraph (1) of this paragraph. If property described in 
paragraph (a)(2)(iii) of this section in an asset guideline class is 
acquired by the taxpayer in a transaction to which section 381(a) 
applies, for purposes of this subparagraph such property shall be 
segregated from other property in the class and treated as in a separate 
asset guideline class, and the class life for that asset guideline class 
under this subparagraph shall be the shortest class life the transferor 
was entitled to use under this section for such property on the date of 
such transfer. In all other cases, the class life for the asset 
guideline class for purposes of this subparagraph shall be the shortest 
class life (within the meaning of sec. 4, part II, of Revenue Procedure 
62-21) which can be justified by application of secs. 3.02(a), 3.03(a), 
or 3.05, part II, of Revenue Procedure 62-21 (other than the portion of 
such sec. 3.05 dealing with justification of a class life by reference 
to facts and circumstances) for the taxpayer's last taxable year ending 
prior to January 1, 1971.

A class life justified by application of section 3.03(a), Part II, of 
Revenue Procedure 62-21 shall not be shorter than can be justified under 
the Adjustment Table for Class Lives in Part III of such Revenue 
Procedure. For purposes of

[[Page 989]]

this subparagraph and paragraph (f)(1)(iii) of this section, the reserve 
ratio test is met only if the taxpayer's reserve ratio does not exceed 
the upper limit of the appropriate reserve ratio range or in the 
alternative during the transitional period there provided does not 
exceed the appropriate ``transitional upper limit'' in section 3, Part 
II, of Revenue Procedure 65-13. References to Revenue Procedure 62-21 
include all morifications, amendments, and supplements thereto as of 
January 1, 1971. The guideline form of the reserve ratio test, as 
described in Revenue Procedure 65-13, may be applied for purposes of 
this subparagraph in a manner consistent with the rules contained in 
section 7, Part II, of Revenue Procedure 65-13 and sections 3.02, 3.03, 
and 3.05, Part II, of Revenue Procedure 62-21. The principles of this 
subparagraph may be illustrated by the following examples:

    Example (1). Corporation X, a calendar year taxpayer, has all its 
assets in asset guideline class 20.4 of Revenue Procedure 72-10 which 
were placed in service by corporation X prior to 1971. Corporation X 
elects to apply this section for 1971. For taxable years 1967 through 
1969, corporation X had used a class life (within the meaning of section 
4, Part II, of Revenue Procedure 62-21) for asset guideline class 20.4 
of 12 years. The asset guideline period in Revenue Procedure 72-10 in 
effect for 1971 is also 12 years. Assume that for 1969 corporation X's 
reserve ratio was below the appropriate reserve ratio lower limit. 
However, corporation X could not justify a class life shorter than the 
asset guideline period of 12 years for 1970 since corporation X had not 
used the 12-year class life for a period at least equal to one-half of 
12 years. (See section 3.03(a), Part II, of Revenue Procedure 62-21.) 
Accordingly, the class life for asset guideline class 20.4 in 1971 is 
the asset guideline period of 12 years in accordance with subparagraph 
(1) of this paragraph.
    Example (2). The facts are the same as in example (1) except that 
corporation X had used a class life of 10 years for guideline class 20.4 
since 1967. Corporation X had not used the class life of 10 years for a 
period at least equal to one-half of 10 years. However, in 1968 
corporation X's 10-year class life was accepted on audit by the Internal 
Revenue Service and corporation X met the reserve ratio test in 1970 for 
guideline class 20.4 using a test life of 10 years. (See section 3.05, 
Part II, of Revenue Procedure 62-21.) Accordingly, the class life of 10 
years is justified for 1970 and the class life for 1971 is 10 years in 
accordance with this subparagraph. If the taxpayer's class life had not 
been audited and accepted for 1968, and in the absence of other 
circumstances, the taxpayer could not justify a class life shorter than 
the asset guideline period of 12 years since it had not used the 10-year 
class life for a period at least equal to one-half of 10 years. (See 
section 3.02, Part II, of Revenue Procedure 62-21.)
    Example (3). Corporation Y, a calendar year taxpayer, has all its 
assets in asset guideline class 13.3 of Revenue Procedure 72-10 which 
were placed in service from 1960 through 1970. Corporation Y elects to 
apply this section for 1971. The asset guideline period in Revenue 
Procedure 72-10 in effect for 1971 is 16 years. Since 1963 corporation Y 
had used a class life of 16 years for asset guideline 13.3. At the end 
of 1969 corporation Y's reserve ratio for guideline class 13.3 was 36 
percent. With a growth rate of 8 percent and a test life of 16 years the 
appropriate reserve ratio lower limit was 37 percent. Corporation Y's 
reserve ratio of 36 percent was below the lower limit of the appropriate 
reserve ratio range. Corporation Y had used the 16-year class life for 
at least eight years. A class life of 13.5 years for 1970 was justified 
by application of section 3.03(a), Part II, of Revenue Procedure 62-21 
and the Adjustment Table for Class Lives in Part III, of Revenue 
Procedure 62-21. The class life for 1971 is 13.5 years in accordance 
with this subparagraph.

    (3) Classification of property--(i) In general. Property to which 
this section applies shall be included in the asset guideline class for 
the activity in which the property is primarily used in the taxable year 
of election. See paragraph (d)(5) of this section for rule regarding the 
classification of leased property.
    (ii) Insubstantial activity. The provisions of Revenue Produce 62-21 
with respect to classification of assets used in an activity which is 
insubstantial may be applied under this section.
    (iii) Special rule for certain public utilities. An electric or gas 
utility which in accordance with Revenue Procedure 64-21 used a 
composite guideline class basis for applying Revenue Procedure 62-21 for 
its last taxable year prior to January 1, 1971, may apply Revenue 
Procedure 72-10 and this section on the basis of such composite asset 
guideline class determined as provided in Revenue Procedure 64-21. For 
the purposes of this section all property in the composite guideline 
class shall be treated as included in a single asset guideline class.

[[Page 990]]

    (c) Salvage value--(1) In general--(i) Definition of gross salvage 
value. ``Gross salvage'' value is the amount (determined at or as of the 
time of acquisition but without regard to the application of Revenue 
Procedure 62-21) which is estimated will be realized upon a sale or 
other disposition of qualified property when it is no longer useful in 
the taxpayer's trade or business or in the production of his income and 
is to be retired from service, without reduction for the cost of 
removal, dismantling, demolition, or similar operations. ``Net salvage'' 
is gross salvage reduced by the cost of removal, dismantling, 
demolition, or similar operations. If a taxpayer customarily sells or 
otherwise disposes of property at a time when such property is still in 
good operating condition, the gross salvage value of such property is 
the amount expected to be realized upon such sale or disposition, and 
under certain circumstances, as where such property is customarily sold 
at a time when it is still relatively new, the gross salvage value may 
constitute a relatively large proportion of the unadjusted basis of such 
property.
    (ii) Definition of salvage value. ``Salvage value'' for purposes of 
this section means gross or net salvage value less the amount, if any, 
by which reduced by application of section 167(f). Generally, as 
provided in section 167(f), a taxpayer may reduce the gross or net 
salvage value for an account by an amount which does not exceed 10 
percent of the unadjusted basis of the personal property (as defined in 
section 167(f)(2)) in the account.
    (2) Estimation of salvage value--(i) In general. For the first 
taxable year for which he elects to apply this section, the taxpayer 
must (in accordance with paragraph (e)(3)(iv)(c) of this section) 
establish salvage value for all qualified property to which the election 
applies. The taxpayer may (in accordance with subparagraph (1) of this 
paragraph) determine either gross or net salvage, but an election under 
this section does not constitute permission to change the manner of 
estimating salvage. Permission to change the manner of estimating 
salvage must be obtained by filing form 3115 with the Commissioner of 
Internal Revenue, Washington, D.C. 20224, within the time otherwise 
permitted for the taxable year or before September 6, 1973. Salvage 
value in succeeding taxable years of election will be determined by 
adjustments of such initial salvage value for the account, as 
retirements occur. This salvage value established by the taxpayer for 
the first taxable year of election will not be redetermined merely as a 
result of fluctuations in price levels or as a result of other 
circumstances occurring after the close of such taxable year. See 
paragraph (e)(3)(iv) of this section for requirements that the taxpayer 
specify in his election the aggregate amount of salvage value for an 
asset guideline class and that the taxpayer maintain records reasonably 
sufficient to identify the salvage value established for each 
depreciation account in the class.
    (ii) Salvage as limitation on depreciation. In no case may an 
account be depreciated under this section below a reasonable salvage 
value, after taking into account any reduction in gross or net salvage 
value permitted by section 167(f). For example, if the salvage value of 
an account for 1971 is $75, the unadjusted basis of the account is $500, 
and the depreciation reserve is $425, no depreciation is allowable for 
1971.
    (iii) Special rule for first taxable year. If for a taxable year 
ending prior to January 1, 1971, the taxpayer had adopted Revenue 
Procedure 62-21 prior to January 12, 1971 (see paragraph (f)(2) of this 
section), no adjustment in the amount of depreciation allowable for any 
taxable year ending prior to January 1, 1971, shall be made solely by 
reason of establishing salvage value under this paragraph for any 
taxable year ending after December 31, 1970. The principles of this 
subdivision may be illustrated by the following example:

    Example. Taxpayer A had adopted Revenue Procedure 62-21 prior to 
January 12, 1971, for taxable years prior to 1971. Taxpayer A had not 
taken into account any salvage value for account No. 1 which is one of 
four depreciation accounts A has in the class. The reserve ratio test 
has been met for all years prior to 1971 and in accordance with Revenue 
Procedure 62-21 no adjustments in depreciable lives or salvage values 
were made. At the end of A's taxable year 1970, the unadjusted basis of 
account No. 1 was $10,000 and the reserve for depreciation was $9,800. 
Pursuant to this

[[Page 991]]

paragraph, A establishes a salvage value of $400 for account No. 1 
(determined at or as of the time of acquisition). This salvage value is 
determined to be correct. No depreciation is allowable for account No. 1 
in 1971. No depreciation is disallowed for any taxable year prior to 
1971, solely by reason of establishing salvage value under this 
paragraph.

    (3) Limitation on adjustment of reasonable salvage value. The 
salvage value established by the taxpayer for a depreciation account 
will not be redetermined if it is reasonable. Since the determination of 
salvage value is a matter of estimation, minimal adjustments will not be 
made. The salvage value established by the taxpayer will be deemed to be 
reasonable unless there is sufficient basis for a determination of an 
amount of salvage value for the account which exceeds the salvage value 
established by the taxpayer for the account by an amount greater than 10 
percent of the unadjusted basis of the account at the close of such 
taxable year. If the salvage value established by the taxpayer for the 
account is not within the 10-percent range or if the taxpayer follows 
the practice of understating his estimates of salvage to take advantage 
of this subdivision, and if there is a determination of an amount of 
salvage value for the account for the taxable year which exceeds the 
salvage value established by the taxpayer for the account for such 
taxable year, an adjustment will be made by increasing the salvage value 
established by the taxpayer for the account by an amount equal to the 
difference between the salvage value as determined and the salvage value 
established by the taxpayer for the account. For the purposes of this 
subdivision, a determination of salvage value shall include all 
determinations at all levels of audit and appellate proceedings, and as 
well as all final determinations within the meaning of section 
1313(a)(1). This subparagraph shall apply to each such determination.
    (4) Examples. The principles of this paragraph may be illustrated by 
the following examples in which it is assumed that the taxpayer has 
established salvage value in accordance with this paragraph and has not 
followed a practice of understating his estimates of salvage value:

    Example (1). Taxpayer B elects to apply this section for 1971. 
Assets Y and Z are the only assets in a multiple asset account of 1967, 
the year in which the assets were acquired. The unadjusted basis of 
asset Y is $50,000 and the unadjusted basis of asset Z is $30,000. B 
estimated a gross salvage value of $55,000 at the time of acquisition. 
The property qualified under section 167(f)(2) and B reduced the amount 
of salvage taken into account by $8,000 (that is, 10 percent of $80,000, 
under sec. 167(f)). Thus, in accordance with this paragraph and 
paragraph (e)(3)(iv)(c) of this section, B establishes a salvage value 
of $47,000 for the account for 1971. Assume that there is not sufficient 
basis for determining a salvage value for the account greater $52,000 
(that is $60,000 minus the $8,000 reduction under sec. 167(f)). Since 
the salvage value of $47,000 established by B for the account is within 
the 10 percent range, it is reasonable. Salvage for the account will not 
be redetermined.
    Example (2). The facts are the same as in example (1) except that B 
estimated a gross salvage value of $50,000 and establishes a salvage 
value of $42,000 for the account (that is, $50,000 minus the $8,000 
reduction under section 167(f)). There is sufficient basis for 
determining an amount of salvage value greater than $50,000 (that is, 
$58,000 minus the $8,000 reduction under section 167(f)). The salvage 
value of $42,000 established by B for the account can be redetermined 
without regard to the limitation in subparagraph (3) of this paragraph, 
since it is not within the 10 percent range. Upon audit of B's tax 
return for 1971 (a year in which the redetermination would affect the 
amount of depreciation allowable for the account), salvage value is 
determined to be $52,000 after taking into account the reduction under 
section 167(f). Salvage value for the account will be adjusted to 
$52,000.
    Example (3). The facts are the same as in example (1) except that 
upon audit of B's tax return for 1971 the examining officer determines 
the salvage value to be $58,000 (that is, $66,000 minus the $8,000 
reduction under section 167(f)), and proposes to adjust salvage value 
for the account to $58,000 which will result in disallowing an amount of 
depreciation for the taxable year. B does not agree with the finding of 
the examining officer. After receipt of a ``30-day letter,'' B waives a 
district conference and initiates proceedings before the Appellate 
Division. In consideration of the case by the Appellate Division it is 
concluded that there is not sufficient basis for determining an amount 
of salvage value for the account in excess of $55,000 (that is, $63,000 
minus the $8,000 reduction under section 167(f)). Since the salvage 
value of $47,000 established by B for the account is within the 10 
percent range, it is reasonable. Salvage value for the account will not 
be redetermined.

[[Page 992]]

    Example (4). For 1971, taxpayer C elects to apply this section to 
factory building X which is in an item account of 1965, the year in 
which the building was acquired. The unadjusted basis of factory 
building X is $90,000. C estimated a gross salvage value for the account 
of $10,000. The property did not qualify under section 167(f)(2). Thus, 
C establishes a salvage value of $10,000 for the account for 1971. 
Assume that there is not sufficient basis for determining a salvage 
value for the account greater than $14,000. Since the salvage value of 
$10,000 established by C for the account is within the 10-percent range, 
it is reasonable. Salvage value for the account will not be 
redetermined.

    (d) Accounting for qualified property--(1) In general. Qualified 
property for which the taxpayer elects to apply this section may be 
accounted for in any number of item or multiple asset accounts.
    (2) Retirements of qualified property--(i) In general. The 
provisions of this subparagraph and Sec. 1.167(a)-8 apply to 
retirements of qualified property to which the taxpayer elects to apply 
this section for the taxable year. See subdivision (iii) of this 
subparagraph for special rule for normal retirements.
    (ii) Adjusted basis of assets retired. In the case of a taxpayer who 
depreciates qualified property in a multiple-asset account conforming to 
the asset guideline class at a rate based on the class life in 
accordance with paragraph (a)(5)(ii)(a) of this section, Sec. 1.167(a)-
8(c) (relating to basis of assets retired) shall be applied by assuming 
that the class life is the average expected useful life of the assets in 
the account. See Sec. 1.167(a)-8, generally, for the basis of assets 
retired.
    (iii) Definition of normal retirements. Notwithstanding Sec. 
1.167(a)- 8(b), the determination whether a retirement of qualified 
property is normal or abnormal shall be made in light of all the facts 
and circumstances, primarily with reference to the expected period of 
use of the asset in the taxpayer's business without regard to paragraph 
(a)(5)(ii) of this section. A retirement is not abnormal unless the 
taxpayer can show that the withdrawal of the asset was not due to a 
cause which would customarily be contemplated (in light of the 
taxpayer's practice and experience) in setting a depreciation rate for 
the assets without regard to paragraph (a)(5)(ii) of this section. Thus, 
for example, a retirement is normal if made within the range of years 
which would customarily be taken into account in setting such 
depreciation rate and if the asset has reached a condition at which, in 
the normal course of events, the taxpayer customarily retires similar 
assets from use in his business. A retirement may be abnormal if the 
asset is withdrawn at an earlier time or under other circumstances, as, 
for example, when the asset has been damaged by casualty or has lost its 
usefulness suddenly as the result of extraordinary obsolescence.
    (3) Special rules--(i) In general. The provisions of this 
subparagraph shall apply to qualified property in a taxable year for 
which an election to apply this section is made.
    (ii) Repairs. For the purpose of sections 162 and 263 and the 
regulations thereunder, whether an expenditure prolongs the life of an 
asset shall be determined by reference to the expected period of use of 
the asset in the taxpayer's business without regard to paragraph 
(a)(5)(ii) of this section.
    (iii) Sale and lease. For the purpose of comparison with the term of 
a lease of such property, the remaining life of qualified property shall 
be determined by reference to the expected period of use of the asset in 
the taxpayer's business without regard to paragraph (a)(5)(ii) of this 
section.
    (4) Expected period of use. For the purposes of subparagraphs (2) 
and (3) of this paragraph, the determination of the expected period of 
use of an asset shall be made in light of all the facts and 
circumstances. The expected period of use of a particular asset will not 
necessarily coincide with the class life used for depreciation (or with 
the individual asset life for depreciation under the alternative method 
in paragraph (a)(5)(ii) (b) of this section for applying the class 
life). Thus, for example, if the question is whether an asset has been 
leased for a period less than, equal to or greater than its remaining 
life, the determination shall be based on the remaining expected period 
of use of the individual asset without regard to the fact that the asset 
is depreciated at a rate based on the class life in accordance with 
paragraph (a)(5)(ii)(a) of this section.

[[Page 993]]

    (5) Leased property. In the case of a lessor of qualified property, 
unless there is an asset guideline class in effect for such lessors, the 
asset guideline class for such property shall be determined by reference 
to the activity in which such property is primarily used by the lessee. 
See paragraph (b)(3) of this section for general rule for classification 
of qualified property according to primary use. However, in the case of 
an asset guideline class based upon the type of property (such as trucks 
or railroad cars), as distinguished from the activity in which used, the 
property shall be classified without regard to the activity of the 
lessee.
    (e) Election under this section--(1) Consent to change in method of 
accounting. An election to apply this section for a taxable year ending 
after December 31, 1970, is a method of accounting but the consent of 
the Commissioner will be deemed granted to make an annual election.
    (2) Election for taxable years ending after December 31, 1976. For 
taxable years ending after December 31, 1976, the election to apply this 
section for a taxable year shall be made by attaching to the income tax 
return a statement that an election under this section is being made. If 
the taxpayer does not file a timely return (taking into account 
extensions of time for filing) for the taxable year, the election shall 
be made at the time the taxpayer files his first return for the taxable 
year. The election may be made with an amended return only if such 
amended return is filed no later than the time prescribed by law 
(including extensions thereof) for filing the return for the taxable 
year. A taxpayer who makes an election under this subparagraph must 
maintain books and records reflecting the information described in 
paragraph (e)(3) (ii) and (iii) of this section.
    (3) Election for taxable years ending on or before December 31, 
1976. (i) For taxable years ending on or before December 31, 1976, the 
election to apply this section for a taxable year may be made by filing 
Form 5006 with the income tax return for the taxable year. If the 
taxpayer does not file a timely return (taking into account extensions 
of time for filing) for the taxable year, the election shall be filed at 
the time the taxpayer files his first return for the taxable year. The 
election may be made with an amended return only if such amended return 
is filed no later than the later of (a) the time prescribed by law 
(including extensions thereof) for filing the return for the taxable 
year, or (b) November 5, 1973.
    (ii) The election to apply this section for a taxable year ending on 
or before December 31, 1976, will be deemed to be made if the tax return 
(filed within the periods referred to in paragraph (e)(3)(i) of this 
section) contains information sufficient to establish the following:
    (a) Each asset guideline class for which the election is intended to 
apply;
    (b) The class life for each such asset guideline class and whether 
the class life is determined under paragraph (b)(1) or (2) of this 
section;
    (c) For each asset guideline class, as of the end of the taxable 
year of election, (1) the total unadjusted basis of all qualified 
property, (2) the aggregate of the reserves for depreciation of all 
accounts in the asset guideline class, and (3) the aggregate of the 
salvage value established for all accounts in the asset guideline class; 
and
    (d) Whether the taxpayer is an electric or gas utility using a 
composite asset guideline class basis in accordance with paragraph 
(b)(3)(iii) of this section.

If an election is deemed to be made under this subdivision (ii), the 
taxpayer will be deemed to have consented to apply all the provisions of 
this section.
    (iii) A taxpayer to whom the election applies shall maintain books 
and records for each asset guideline class reasonably sufficient to 
identify the unadjusted basis, reserve for depreciation and salvage 
value established for each depreciation account in such asset guidelines 
class.
    (f) Depreciation for taxable years ending before January 1, 1971--
(1) Adoption of Revenue Procedure 62-21--(i) In general. Except as 
provided in subdivision (ii) of this subparagraph, a taxpayer may elect 
to be examined under the provisions of Revenue Procedure 62-21 for a 
taxable year ending before January 1, 1971, only in accordance with the

[[Page 994]]

rules of this paragraph. The election must specify:
    (a) That the taxpayer makes such election and consents to, and 
agrees to apply, all the provisions of this paragraph;
    (b) Each guideline class and taxable year for which the taxpayer 
elects to be examined under Revenue Procedure 62-21;
    (c) The class life claimed for each such guideline class;
    (d) The class life and the total amount of the depreciation for the 
guideline class claimed on the last income tax return for such taxable 
year filed prior to January 12, 1971 (or in case no income tax return 
was filed prior to January 12, 1971, on the first income tax return 
filed for such taxable year);
    (e) The class life claimed and the total amount of depreciation for 
the guideline class under the election to apply Revenue Procedure 62-21, 
in accordance with this paragraph, for the taxable year; and
    (f) If the class life or total amount of depreciation for the 
guideline class is different in (d) and (e) of this subdivision, a 
reasonable description of the computation of the class life in (e) of 
this subdivision, the amount of difference in tax liability resulting 
therefrom, and the amount of any refund or reduction in any deficiency 
in tax. The election shall be made in an amended tax return or claim for 
refund (or by a supplement to the tax return or claim) for the taxable 
year, and if the class life or total amount of depreciation for the 
guideline class is different in accordance with (f) of this subdivision, 
such difference shall be reflected in the amended tax return or claim 
for refund. Forms may be provided for making the election and submission 
of the information. In the case of an election made after issuance of 
such forms and more than 30 days after publication of notice thereof in 
the Internal Revenue Bulletin, the election may be made and the 
information submitted only in accordance with such forms. An election 
will not otherwise be invalid under this paragraph so long as there is 
substantial compliance, in good faith, with the requirements of this 
paragraph.
    (ii) Special rule. The provisions of this subparagraph shall not 
apply to a guideline class in any taxable year for which the taxpayer 
has prior to January 12, 1971, adopted Revenue Procedure 62-21 for such 
class. See subparagraph (2) of this paragraph for determination of 
adoption of Revenue Procedure 62-21 prior to January 12, 1971.
    (iii) Justification of class life claimed and limitations on 
refunds. If the taxpayer elects for a taxable year to be examined under 
the provisions of Revenue Procedure 62-21 in accordance with subdivision 
(i) of this subparagraph, any of the provisions of Revenue Procedure 62-
21 may be applied to justify a class life claimed on the income tax 
return filed for such year or to offset an increase in tax liability for 
such year. Unless it meets the reserve ratio test, no class life will be 
accepted on audit which (after all other adjustments in tax liability 
for such year) results in a reduction (or further reduction) in the 
amount of tax liability shown on the income tax return (specified in 
subdivision (i)(d) of this subparagraph) for such taxable year, or 
results in an amount of loss carryback or carryover to any taxable year, 
but if it is justified under Revenue Procedure 62-21 and meets the 
reserve ratio test, a class life will be accepted on audit without 
regard to the foregoing limitations and, for example, may produce a 
refund or credit against tax. For example, if a class life of 9 years is 
otherwise justified under Revenue Procedure 62-21 for 1969, but the 
taxpayer does not meet the reserve ratio test for 1969 using a test life 
of 9 years, a class life of 9 years (or any class life justified under 
Revenue Procedure 62-21) will be accepted on audit under Revenue 
Procedure 62-21 pursuant to an election in accordance with this 
paragraph provided it does not result in the reduction or further 
reduction in tax liability or in an amount of loss carryback or 
carryover as described in the preceding sentence. On the other hand, for 
example, if a class life of 10 years is justified under Revenue 
Procedure 62-21 for 1969 and the taxpayer meets the reserve ratio test 
for 1969 using a test life of 10 years, a class life of 10 years will be 
accepted on audit under Revenue Procedure 62-21 pursuant to an

[[Page 995]]

election in accordance with this paragraph even though it results in a 
reduction or further reduction in tax liability or in an amount of loss 
carryback or carryover as described above and produces a refund of tax. 
For purposes of this section, the term ``audit'' includes examination of 
claims for refund or credit against tax.
    (iv) Definitions. For purposes of this paragraph, the determination 
whether the reserve ratio test is met shall be made in accordance with 
that portion of paragraph (b)(2) of this section which is by express 
reference therein made applicable to this paragraph. In addition, the 
guideline form of the reserve ratio test, as described in Revenue 
Procedure 65-13, may be applied. For purposes of this paragraph, 
references to Revenue Procedure 62-21 include all modifications, 
amendments, and supplements thereto as of January 11, 1971. The terms 
``class life'' and ``guideline class'' have the same meaning as in 
Revenue Procedure 62-21.
    (2) Determination whether Revenue Procedure 62-21 adopted prior to 
January 12, 1971--(i) In general. For the purposes of this paragraph, a 
taxpayer will be treated as having adopted prior to January 12, 1971, 
Revenue Procedure 62-21 for a guideline class for a taxable year ending 
before January 1, 1971, only if--
    (a) For the guideline class and taxable year, the taxpayer adopted 
Revenue Procedure 62-21 by expressly so indicating on the income tax 
return filed for such taxable year prior to January 12, 1971;
    (b) For the guideline class and taxable year, the taxpayer adopted 
Revenue Procedure 62-21 prior to January 12, 1971, by expressly so 
indicating in a proceeding before the Internal Revenue Service (such as 
upon examination of the income tax return for such taxable year) and 
there is reasonable evidence to that effect; or
    (c) There is other reasonable evidence that prior to January 12, 
1971, the taxpayer adopted Revenue Procedure 62-21 for the guideline 
class and taxable year.

If not treated under (b) or (c) of this subdivision as having done so 
for the last taxable year ending before January 1, 1971, and if the 
taxpayer files his first income tax return for such taxable year after 
January 11, 1971, the taxpayer will be treated as having adopted Revenue 
Procedure 62-21 prior to January 12, 1971, for a guideline class for 
such taxable year if he expressly so indicated on that return, or is 
treated under this subparagraph as having adopted Revenue Procedure 62-
21 prior to January 12, 1971, for that guideline class for the 
immediately preceding taxable year.
    (ii) Examples. The principles of this subparagraph may be 
illustrated by the following examples:

    Example (1). Taxpayer A, an individual who uses the calendar year as 
his taxable year, has property in Group Three, Class 16(a), of Revenue 
Procedure 62-21. On A's income tax return for 1968, filed prior to 
January 12, 1971, he adopted Revenue Procedure 62-21 for the guideline 
class by so indicating under ``Summary of Depreciation'' in the 
appropriate schedule of Form 1040 for 1968. Under subdivision (i) (a) of 
this subparagraph, A is treated as having adopted Revenue Procedure 62-
21 for the guideline class for 1968 prior to January 12, 1971.
    Example (2). Taxpayer B, an individual who uses the calendar year as 
his taxable year, has property in Group Two, Class 5, of Revenue 
Procedure 62-21. B filed timely income tax returns for 1966 through 1968 
but did not adopt Revenue Procedures 62-21 on any of such returns. In 
1969 upon audit of B's taxable years 1966 through 1968, B exercised his 
option to be examined under the provisions of Revenue Procedure 62-21. 
The Revenue Agent's report shows that B was examined under Revenue 
Procedure 62-21 for taxable years 1966 through 1968. B will be treated 
under subdivision (ii)(b) of this subparagraph as having adopted Revenue 
Procedure 62-21 for such years prior to January 12, 1971.
    Example (3). The facts are the same as in example (2) except that B 
did not upon examination by the Revenue Agent in 1969 exercise his 
option to be examined under Revenue Procedure 62-21. B has six accounts 
in the guideline class, Nos. 1 through 6. The Revenue Agent proposed to 
lengthen the depreciable lives on accounts Nos. 2 and 3 from 8 years to 
12 years. In proceedings before the Appellate Division in 1970, B 
exercised his option to be examined under the provisions of Revenue 
Procedure 62-21. This is shown by correspondence between B and the 
Appellate Conferee as well as by other documents in the case before the 
Appellate Division. The case was settled on that basis before the 
Appellate Division without adjustment of the depreciable lives for B's 
accounts Nos. 2 and 3. B will be treated under subdivision (ii) (b)

[[Page 996]]

of this subparagraph as having adopted Revenue Procedure 62-21 for 
taxable years 1966 through 1968 prior to January 12, 1971.
    Example (4). Corporation X uses the calendar year as its taxable 
year and has assets in Group Two, Class 5, of Revenue Procedure 62-21. 
Beginning in 1964, corporation X used the guideline life of 10 years as 
the depreciable life for all assets in the guideline class. In 1967, 
corporation X's taxable years 1964 through 1966 were examined and 
corporation X exercised its option to be examined under the provisions 
of Revenue Procedure 62-21. Corporation X did not adopt Revenue 
Procedure 62-21 on any of its income tax returns, for the years 1964 
through 1970. Corporation X has not been examined since 1967, but has 
continued to use the guideline life of 10 years for all property in the 
guideline class including additions since 1966. Corporation X will be 
treated under subdivision (ii) (c) and (d) of this subparagraph as 
having adopted Revenue Procedure 62-21 prior to January 12, 1971, for 
taxable years 1964 through 1970.
    Example (5). Corporation Y uses the calendar year as its taxable 
year and has asset in Group Two, Class 5, of Revenue Procedure 62-21. 
Since 1964, corporation Y has used various depreciable lives, based on 
the facts and circumstances, for different accounts in the guideline 
class. Corporation Y was examined in 1968 for taxable years 1965 through 
1967. Corporation Y was also examined in 1970 for taxable years 1968 and 
1969. Corporation Y did not exercise its option to be examined under the 
provisions of Revenue Procedure 62-21. Corporation Y has not adopted 
Revenue Procedure 62-21 on any income tax return. For taxable years 1964 
through 1970, corporation Y's class life (within the meaning of section 
4, Part II, of Revenue Procedure 62-21) was between 12 and 14 years. In 
August of 1971, corporation Y filed amended income tax returns for 1968 
and 1969, and an income tax return for 1970, using a depreciable life of 
10 years (equal to the guideline life) for all assets in the guideline 
class. Corporation Y will not be treated as having adopted Revenue 
Procedure 62-21 prior to January 12, 1971.
    Example (6). Corporation Z uses the calendar year as its taxable 
year and has assets in group 2, class 5, of Revenue Procedure 62-21. 
Corporation Z adopted Revenue Procedure 62-21 for this guideline class 
by expressly so indicating on its tax return for 1966, which was filed 
before January 12, 1971. Corporation Z computed its allowable 
depreciation for 1966 as if it adopted Revenue Procedure 62-21 for this 
guideline class for its taxable years 1962 through 1965, although it had 
earlier filed its tax returns for those years without regard to Revenue 
Procedure 62-21. The depreciation thus claimed in 1966 was less than 
what would have been allowable if corporation Z first adopted Revenue 
Procedure 62-21 in 1966. This was the result of certain accounts 
becoming fully depreciated through use of Revenue Procedure 62-21 in 
computing depreciation for 1962 through 1965. In addition, in deferred 
tax accounting procedures employed before January 12, 1971, for 
financial reporting purposes, corporation Z calculated its tax deferrals 
on the basis that it had adopted Revenue Procedure 62-21 for the years 
1962 through 1965. Corporation Z will be treated under subdivision (i) 
(c) of this subparagraph as having adopted Revenue Procedure 62-21 for 
taxable years 1962 through 1965 prior to January 12, 1971.

(Sec. 167(m), 85 Stat. 508 (26 U.S.C. 167))

[T.D. 7278, 38 FR 14923, June 7, 1973, as amended by T.D. 7315, 39 FR 
20195, June 7, 1974; T.D. 7517, 42 FR 58934, Nov. 14, 1977]



Sec. 1.167(a)-13T  Certain elections for intangible property (temporary).

    For rules applying the elections under section 13261(g) (2) and (3) 
of the Omnibus Budget Reconciliation Act of 1993 to intangible property 
described in section 167(f), see Sec. 1.197-1T.

[59 FR 11922, Mar. 15, 1994]



Sec. 1.167(a)-14  Treatment of certain intangible property excluded from 
section 197.

    (a) Overview. This section provides rules for the amortization of 
certain intangibles that are excluded from section 197 (relating to the 
amortization of goodwill and certain other intangibles). These excluded 
intangibles are specifically described in Sec. 1.197-2(c) (4), (6), 
(7), (11), and (13) and include certain computer software and certain 
other separately acquired rights, such as rights to receive tangible 
property or services, patents and copyrights, certain mortgage servicing 
rights, and rights of fixed duration or amount. Intangibles for which an 
amortization amount is determined under section 167(f) and intangibles 
otherwise excluded from section 197 are amortizable only if they qualify 
as property subject to the allowance for depreciation under section 
167(a).
    (b) Computer software--(1) In general. [Reserved]. For further 
guidance, see Sec. 1.167(a)-14T(b)(1).
    (2) Exceptions. Paragraph (b)(1) of this section does not apply to 
the cost of computer software properly and consistently taken into 
account under

[[Page 997]]

Sec. 1.162-11. The cost of acquiring an interest in computer software 
that is included, without being separately stated, in the cost of the 
hardware or other tangible property is treated as part of the cost of 
the hardware or other tangible property that is capitalized and 
depreciated under other applicable sections of the Internal Revenue 
Code.
    (3) Additional rules. Rules similar to those in Sec. 1.197-2 
(f)(1)(iii), (f)(1)(iv), and (f)(2) (relating to the computation of 
amortization deductions and the treatment of contingent amounts) apply 
for purposes of this paragraph (b).
    (c) Certain interests or rights not acquired as part of a purchase 
of a trade or business--(1) Certain rights to receive tangible property 
or services. The amount of the deduction for a right (other than a right 
acquired as part of a purchase of a trade or business) to receive 
tangible property or services under a contract or from a governmental 
unit (as specified in section 167(f)(2) and Sec. 1.197-2(c)(6)) is 
determined as follows:
    (i) Amortization of fixed amounts. The basis of a right to receive a 
fixed amount of tangible property or services is amortized for each 
taxable year by multiplying the basis of the right by a fraction, the 
numerator of which is the amount of tangible property or services 
received during the taxable year and the denominator of which is the 
total amount of tangible property or services received or to be received 
under the terms of the contract or governmental grant. For example, if a 
taxpayer acquires a favorable contract right to receive a fixed amount 
of raw materials during an unspecified period, the taxpayer must 
amortize the cost of acquiring the contract right by multiplying the 
total cost by a fraction, the numerator of which is the amount of raw 
materials received under the contract during the taxable year and the 
denominator of which is the total amount of raw materials received or to 
be received under the contract.
    (ii) Amortization of unspecified amount over fixed period. The cost 
or other basis of a right to receive an unspecified amount of tangible 
property or services over a fixed period is amortized ratably over the 
period of the right. (See paragraph (c)(3) of this section regarding 
renewals).
    (iii) Amortization in other cases. [Reserved]
    (2) Rights of fixed duration or amount. The amount of the deduction 
for a right (other than a right acquired as part of a purchase of a 
trade or business) of fixed duration or amount received under a contract 
or granted by a governmental unit (specified in section 167(f)(2) and 
Sec. 1.197-2(c)(13)) and not covered by paragraph (c)(1) of this 
section is determined as follows:
    (i) Rights to a fixed amount. The basis of a right to a fixed amount 
is amortized for each taxable year by multiplying the basis by a 
fraction, the numerator of which is the amount received during the 
taxable year and the denominator of which is the total amount received 
or to be received under the terms of the contract or governmental grant.
    (ii) Rights to an unspecified amount over fixed duration of less 
than 15 years. The basis of a right to an unspecified amount over a 
fixed duration of less than 15 years is amortized ratably over the 
period of the right.
    (3) Application of renewals. (i) For purposes of paragraphs (c) (1) 
and (2) of this section, the duration of a right under a contract (or 
granted by a governmental unit) includes any renewal period if, based on 
all of the facts and circumstances in existence at any time during the 
taxable year in which the right is acquired, the facts clearly indicate 
a reasonable expectancy of renewal.
    (ii) The mere fact that a taxpayer will have the opportunity to 
renew a contract right or other right on the same terms as are available 
to others, in a competitive auction or similar process that is designed 
to reflect fair market value and in which the taxpayer is not 
contractually advantaged, will generally not be taken into account in 
determining the duration of such right provided that the bidding 
produces a fair market value price comparable to the price that would be 
obtained if the rights were purchased immediately after renewal from a 
person (other than the person granting the renewal) in an arm's-length 
transaction.
    (iii) The cost of a renewal not included in the terms of the 
contract or

[[Page 998]]

governmental grant is treated as the acquisition of a separate 
intangible asset.
    (4) Patents and copyrights. If the purchase price of an interest 
(other than an interest acquired as part of a purchase of a trade or 
business) in a patent or copyright described in section 167(f)(2) and 
Sec. 1.197-2(c)(7) is payable on at least an annual basis as either a 
fixed amount per use or a fixed percentage of the revenue derived from 
the use of the patent or copyright, the depreciation deduction for a 
taxable year is equal to the amount of the purchase price paid or 
incurred during the year. Otherwise, the basis of such patent or 
copyright (or an interest therein) is depreciated either ratably over 
its remaining useful life or under section 167(g) (income forecast 
method). If a patent or copyright becomes valueless in any year before 
its legal expiration, the adjusted basis may be deducted in that year.
    (5) Additional rules. The period of amortization under paragraphs 
(c) (1) through (4) of this section begins when the intangible is placed 
in service, and rules similar to those in Sec. 1.197-2(f)(2) apply for 
purposes of this paragraph (c).
    (d) Mortgage servicing rights--(1) In general. The amount of the 
deduction for mortgage servicing rights described in section 167(f)(3) 
and Sec. 1.197-2(c)(11) is determined by using the straight line method 
described in Sec. 1.167(b)-1 (except that the salvage value is treated 
as zero) and an amortization period of 108 months beginning on the first 
day of the month that the rights are placed in service. Mortgage 
servicing rights are not depreciable to the extent the rights are 
stripped coupons under section 1286.
    (2) Treatment of rights acquired as a pool--(i) In general. Except 
as provided in paragraph (d)(2)(ii) of this section, all mortgage 
servicing rights acquired in the same transaction or in a series of 
related transactions are treated as a single asset (the pool) for 
purposes of determining the depreciation deduction under this paragraph 
(d) and any gain or loss from the sale, exchange, or other disposition 
of the rights. Thus, if some (but not all) of the rights in a pool 
become worthless as a result of prepayments, no loss is recognized by 
reason of the prepayment and the adjusted basis of the pool is not 
affected by the unrecognized loss. Similarly, any amount realized from 
the sale or exchange of some (but not all) of the mortgage servicing 
rights is included in income and the adjusted basis of the pool is not 
affected by the realization.
    (ii) Multiple accounts. If the taxpayer establishes multiple 
accounts within a pool at the time of its acquisition, gain or loss is 
recognized on the sale or exchange of all mortgage servicing rights 
within any such account.
    (3) Additional rules. Rules similar to those in Sec. 1.197-
2(f)(1)(iii), (f)(1)(iv), and (f)(2) (relating to the computation of 
amortization deductions and the treatment of contingent amounts) apply 
for purposes of this paragraph (d).
    (e) Effective dates--(1) In general. This section applies to 
property acquired after January 25, 2000, except that Sec. 1.167(a)-
14(c)(2) (depreciation of the cost of certain separately acquired 
rights) and so much of Sec. 1.167(a)-14(c)(3) as relates to Sec. 
1.167(a)-14(c)(2) apply to property acquired after August 10, 1993 (or 
July 25, 1991, if a valid retroactive election has been made under Sec. 
1.197-1T).
    (2) Change in method of accounting. [Reserved]. For further 
guidance, see Sec. 1.167(a)-14T(e)(2).
    (3) Qualified property, 50-percent bonus depreciation property, 
qualified New York Liberty Zone property, or section 179 property. 
[Reserved]. For further guidance, see Sec. 1.167(a)-14T(e)(3).

[T.D. 8867, 65 FR 3825, Jan. 25, 2000, as amended by T.D. 9091, 68 FR 
52990, Sept. 8, 2003]



Sec. 1.167(a)-14T  Treatment of certain intangible property excluded 
from section 197 (temporary).

    (a) For further guidance, see Sec. 1.167(a)-14(a).
    (b) Computer software--(1) In general. The amount of the deduction 
for computer software described in section 167(f)(1) and Sec. 1.197-
2(c)(4) is determined by amortizing the cost or other basis of the 
computer software using the straight line method described in Sec. 
1.167(b)-1 (except that its salvage value is treated as zero) and an 
amortization period of 36 months beginning on the first day of the month 
that the

[[Page 999]]

computer software is placed in service. Before determining the 
amortization deduction allowable under this paragraph (b), the cost or 
other basis of computer software that is section 179 property, as 
defined in section 179(d)(1)(A)(ii), must be reduced for any portion of 
the basis the taxpayer properly elects to treat as an expense under 
section 179. In addition, the cost or other basis of computer software 
that is qualified property under section 168(k)(2) or Sec. 1.168(k)-1T, 
50-percent bonus depreciation property under section 168(k)(4) or Sec. 
1.168(k)-1T, or qualified New York Liberty Zone property under section 
1400L(b) or Sec. 1.1400L(b)-1T, must be reduced by the amount of the 
additional first year depreciation deduction allowed or allowable, 
whichever is greater, under section 168(k) or section 1400L(b) for the 
computer software. If costs for developing computer software that the 
taxpayer properly elects to defer under section 174(b) result in the 
development of property subject to the allowance for depreciation under 
section 167, the rules of this paragraph (b) will apply to the 
unrecovered costs. In addition, this paragraph (b) applies to the cost 
of separately acquired computer software if the cost to acquire the 
software is separately stated and the cost is required to be capitalized 
under section 263(a).
    (b)(2)-(e)(1) For further guidance, see Sec. 1.167(a)-14(b)(2) 
through (e)(1).
    (e)(2) Change in method of accounting. See Sec. 1.197-2(l)(4) for 
rules relating to changes in method of accounting for property to which 
Sec. 1.167(a)-14T applies. However, see Sec. 1.168(k)-1T(g)(4) or 
1.1400L(b)-1T(g)(4) for rules relating to changes in method of 
accounting for computer software to which the third sentence in Sec. 
1.167(a)-14T(b)(1) applies.
    (3) Qualified property, 50-percent bonus depreciation property, 
qualified New York Liberty Zone property, or section 179 property. This 
section also applies to computer software that is qualified property 
under section 168(k)(2) or qualified New York Liberty Zone property 
under section 1400L(b) acquired by a taxpayer after September 10, 2001, 
and to computer software that is 50-percent bonus depreciation property 
under section 168(k)(4) acquired by a taxpayer after May 5, 2003. This 
section also applies to computer software that is section 179 property 
placed in service by a taxpayer in a taxable year beginning after 2002 
and before 2006. This section expires on September 4, 2006.

[T.D. 9091, 68 FR 52991, Sept. 8, 2003; 68 FR 63734, Nov. 10, 2003]



Sec. 1.167(b)-0  Methods of computing depreciation.

    (a) In general. Any reasonable and consistently applied method of 
computing depreciation may be used or continued in use under section 
167. Regardless of the method used in computing depreciation, deductions 
for depreciation shall not exceed such amounts as may be necessary to 
recover the unrecovered cost or other basis less salvage during the 
remaining useful life of the property. The reasonableness of any claim 
for depreciation shall be determined upon the basis of conditions known 
to exist at the end of the period for which the return is made. It is 
the responsibility of the taxpayer to establish the reasonableness of 
the deduction for depreciation claimed. Generally, depreciation 
deductions so claimed will be changed only where there is a clear and 
convincing basis for a change.
    (b) Certain methods. Methods previously found adequate to produce a 
reasonable allowance under the Internal Revenue Code of 1939 or prior 
revenue laws will, if used consistently by the taxpayer, continue to be 
acceptable under section 167(a). Examples of such methods which continue 
to be acceptable are the straight line method, the declining balance 
method with the rate limited to 150 percent of the applicable straight 
line rate, and under appropriate circumstances, the unit of production 
method. The methods described in section 167(b) and Sec. Sec. 1.167(b)-
1, 1.167(b)-2, 1.167(b)-3, and 1.167(b)-4 shall be deemed to produce a 
reasonable allowance for depreciation except as limited under section 
167(c) and Sec. 1.167(c)-1. See also Sec. 1.167(e)-1 for rules 
relating to change in method of computing depreciation.
    (c) Application of methods. In the case of item accounts, any method 
which results in a reasonable allowance for depreciation may be selected 
for each item of property, but such method

[[Page 1000]]

must thereafter be applied consistently to that particular item. In the 
case of group, classified, or composite accounts, any method may be 
selected for each account. Such method must be applied to that 
particular account consistently thereafter but need not necessarily be 
applied to acquisitions of similar property in the same or subsequent 
years, provided such acquisitions are set up in separate accounts. See, 
however, Sec. 1.167(e)-1 and section 446 and the regulations 
thereunder, for rules relating to changes in the method of computing 
depreciation, and Sec. 1.167(c)-1 for restriction on the use of certain 
methods. See also Sec. 1.167(a)-7 for definition of account.



Sec. 1.167(b)-1  Straight line method.

    (a) In general. Under the straight line method the cost or other 
basis of the property less its estimated salvage value is deductible in 
equal annual amounts over the period of the estimated useful life of the 
property. The allowance for depreciation for the taxable year is 
determined by dividing the adjusted basis of the property at the 
beginning of the taxable year, less salvage value, by the remaining 
useful life of the property at such time. For convenience, the allowance 
so determined may be reduced to a percentage or fraction. The straight 
line method may be used in determining a reasonable allowance for 
depreciation for any property which is subject to depreciation under 
section 167 and it shall be used in all cases where the taxpayer has not 
adopted a different acceptable method with respect to such property.
    (b) Illustrations. The straight line method is illustrated by the 
following examples:

    Example (1). Under the straight line method items may be depreciated 
separately:

------------------------------------------------------------------------
                                  Cost or               Depreciation
                                   other    Useful        allowable
         Year and item             basis     life  ---------------------
                                   less    (years)
                                 salaries            1954    1955   1956
------------------------------------------------------------------------
1954:
  Asset A......................    $1,600       4      \1\   $400   $400
                                                      $200
  Asset B......................    12,000      40      \1\    300    300
                                                       150
------------------------------------------------------------------------
\1\ In this example it is assumed that the assets were placed in service
  on July 1, 1954.

    Example (2). In group, classified, or composite accounting, a number 
of assets with the same or different useful lives may be combined into 
one account, and a single rate of depreciation, i.e., the group, 
classified, or composite rate used for the entire account. In the case 
of group accounts, i.e., accounts containing assets which are similar in 
kind and which have approximately the same estimated useful lives, the 
group rate is determined from the average of the useful lives of the 
assets. In the case of classified or composite accounts, the classified 
or composite rate is generally computed by determining the amount of one 
year's depreciation for each item or each group of similar items, and by 
dividing the total depreciation thus obtained by the total cost or other 
basis of the assets. The average rate so obtained is to be used as long 
as subsequent additions, retirements, or replacements do not 
substantially alter the relative proportions of different types of 
assets in the account. An example of the computation of a classified or 
composite rate follows:

------------------------------------------------------------------------
                         Estimated useful life
  Cost or other basis           (years)            Annual depreciation
------------------------------------------------------------------------
         $10,000                       5                   $2,000
          10,000                      15                      667
                                               -------------------------
          20,000        ......................              2,667
------------------------------------------------------------------------


Average rate is 13.33 percent ($2,667/$20,000) unadjusted for salvage. 
Assuming the estimated salvage value is 10 percent of the cost or other 
basis, the rate adjusted for salvage will be 13.33 percent minus 10 
percent of 13.33 percent (13.33%-1.33%), or 12 percent.
    Example (3). The use of the straight line method for group, 
classified, or composite accounts is illustrated by the following 
example: A taxpayer filing his returns on a calendar year basis 
maintains an asset account for which a group rate of 20 percent has been 
determined, before adjustment for salvage. Estimated salvage is 
determined to be 6\2/3\ percent, resulting in an adjusted rate of 18.67 
percent. During the years illustrated, the initial investment, 
additions, retirements, and salvage recoveries, which were determined 
not to change the composition of the group sufficiently to require a 
change in rate, were assumed to have been made as follows:
    1954--Initial investment of $12,000.
    1957--Retirement $2,000, salvage realized $200.
    1958--Retirement $2,000, salvage realized $200.
    1959--Retirement $4,000, salvage realized $400.
    1959--Additions $10,000.
    1960--Retirement $2,000, no salvage realized.
    1961--Retirement $2,000, no salvage realized.

[[Page 1001]]



                   Depreciable Asset Account and Depreciation Computation on Average Balances
----------------------------------------------------------------------------------------------------------------
                                     Asset                             Asset
               Year                 balance   Current     Current     balance   Average     Rate      Allowable
                                    Jan. 1   additions  retirements   Dec. 31   balance  (percent)  depreciation
----------------------------------------------------------------------------------------------------------------
1954.............................  ........    $12,000  ...........   $12,000    $6,000      18.67      $1,120
1955.............................   $12,000  .........  ...........    12,000    12,000      18.67       2,240
1956.............................    12,000  .........  ...........    12,000    12,000      18.67       2,240
1957.............................    12,000  .........      $2,000     10,000    11,000      18.67       2,054
1958.............................    10,000  .........       2,000      8,000     9,000      18.67       1,680
1959.............................     8,000     10,000       4,000     14,000    11,000      18.67       2,054
1960.............................    14,000  .........       2,000     12,000    13,000      18.67       2,427
1961.............................    12,000  .........       2,000     10,000    11,000      18.67       2,054
----------------------------------------------------------------------------------------------------------------


                                   Corresponding Depreciation Reserve Account
----------------------------------------------------------------------------------------------------------------
                                                                                                   Depreciation
              Year                 Depreciation    Depreciation       Current         Salvage      reserve Dec.
                                  reserve Jan. 1     allowable      retirements      realized           31
----------------------------------------------------------------------------------------------------------------
1954............................  ..............          $1,120  ..............  ..............          $1,120
1955............................          $1,120           2,240  ..............  ..............           3,360
1956............................           3,360           2,240  ..............  ..............           5,600
1957............................           5,600           2,054          $2,000            $200           5,854
1958............................           5,854           1,680           2,000             200           5,734
1959............................           5,734           2,054           4,000             400           4,188
1960............................           4,188           2,427           2,000  ..............           4,615
1961............................           4,615           2,054           2,000  ..............           4,669
----------------------------------------------------------------------------------------------------------------



Sec. 1.167(b)-2  Declining balance method.

    (a) Application of method. Under the declining balance method a 
uniform rate is applied each year to the unrecovered cost or other basis 
of the property. The unrecovered cost or other basis is the basis 
provided by section 167(g), adjusted for depreciation previously allowed 
or allowable, and for all other adjustments provided by section 1016 and 
other applicable provisions of law. The declining balance rate may be 
determined without resort to formula. Such rate determined under section 
167(b)(2) shall not exceed twice the appropriate straight line rate 
computed without adjustment for salvage. While salvage is not taken into 
account in determining the annual allowances under this method, in no 
event shall an asset (or an account) be depreciated below a reasonable 
salvage value. However, see section 167(f) and Sec. 1.167(f)-1 for 
rules which permit a reduction in the amount of salvage value to be 
taken into account for certain personal property acquired after October 
16, 1962. Also, see section 167(c) and Sec. 1.167(c)-1 for restrictions 
on the use of the declining balance method.
    (b) Illustrations. The declining balance method is illustrated by 
the following examples:

    Example (1). A new asset having an estimated useful life of 20 years 
was purchased on January 1, 1954, for $1,000. The normal straight line 
rate (without adjustment for salvage) is 5 percent, and the declining 
balance rate at twice the normal straight line rate is 10 percent. The 
annual depreciation allowances for 1954, 1955, and 1956 are as follows:

------------------------------------------------------------------------
                                                 Declining
                                                  balance   Depreciation
               Year                    Basis       rate       allowance
                                                 (percent)
------------------------------------------------------------------------
1954..............................      $1,000          10         $100
1955..............................         900          10           90
1956..............................         810          10           81
------------------------------------------------------------------------

    Example (2). A taxpayer filing his returns on a calendar year basis 
maintains a group account to which a 5 year life and a 40 percent 
declining balance rate are applicable. Original investment, additions, 
retirements, and salvage recoveries are the same as those set forth in 
example (3) of paragraph (b) of Sec. 1.167(b)-1. Although salvage value 
is not taken into consideration in computing a declining balance rate, 
it must be recognized and accounted for when assets are retired.

[[Page 1002]]



                             Depreciable Asset Account and Depreciation Computation Using Average Asset and Reserve Balances
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                          Average
                                                   Asset    Current     Current      Asset                reserve        Net        Rate      Allowable
                      Year                        balance  additions  retirements   balance   Average     before     depreciable   (pct.)   depreciation
                                                  Jan. 1                            Dec. 31            depreciation    balance
--------------------------------------------------------------------------------------------------------------------------------------------------------
1954...........................................  ........    $12,000  ...........   $12,000    $6,000  ............      $6,000         40      $2,400
1955...........................................   $12,000  .........  ...........    12,000    12,000      $2,400         9,600         40       3,840
1956...........................................    12,000  .........  ...........    12,000    12,000       6,240         5,760         40       2,304
1957...........................................    12,000  .........      $2,000     10,000    11,000       7,644         3,356         40       1,342
1958...........................................    10,000  .........       2,000      8,000     9,000       7,186         1,814         40         726
1959...........................................     8,000     10,000       4,000     14,000    11,000       5,212         5,788         40       2,315
1960...........................................    14,000  .........       2,000     12,000    13,000       4,727         8,273         40       3,309
1961...........................................    12,000  .........       2,000     10,000    11,000       6,036         4,964         40       1,986
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                                                  Depreciation Reserve
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                   Average
                                                                  Reserve    Current     Salvage  Reserve Dec.     reserve      Allowable   Reserve Dec.
                              Year                                Jan. 1   retirements  realized   31, before      before     depreciation    31, after
                                                                                                  depreciation  depreciation                depreciation
--------------------------------------------------------------------------------------------------------------------------------------------------------
1954...........................................................  ........  ...........  ........  ............  ............      $2,400        $2,400
1955...........................................................    $2,400  ...........  ........      $2,400        $2,400         3,840         6,240
1956...........................................................     6,240  ...........  ........       6,240         6,240         2,304         8,544
1957...........................................................     8,544      $2,000       $200       6,744         7,644         1,342         8,086
1958...........................................................     8,086       2,000        200       6,286         7,186           726         7,012
1959...........................................................     7,012       4,000        400       3,412         5,212         2,315         5,727
1960...........................................................     5,727       2,000   ........       3,727         4,727         3,309         7,036
1961...........................................................     7,036       2,000   ........       5,036         6,036         1,986         7,022
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Where separate depreciation accounts are maintained by year of 
acquisition and there is an unrecovered balance at the time of the last 
retirement, such unrecovered balance may be deducted as part of the 
depreciation allowance for the year of such retirement. Thus, if the 
taxpayer had kept separate depreciation accounts by year of acquisition 
and all the retirements shown in the example above were from 1954 
acquisitions, depreciation would be computed on the 1954 and 1959 
acquisitions as follows:

                                                                    1954 Acquisitions
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                               Asset                                Asset             Avg. reserve      Net
                    Year                      balance  Acquisitions    Current     balance   Average     before     depreciable     Rate      Allowable
                                              Jan. 1                 retirements   Dec. 31   balance  depreciation    balance    (percent)  depreciation
--------------------------------------------------------------------------------------------------------------------------------------------------------
1954.......................................  ........     $12,000    ...........   $12,000    $6,000  ............      $6,000          40      $2,400
1955.......................................   $12,000  ............  ...........    12,000    12,000      $2,400         9,600          40       3,840
1956.......................................    12,000  ............  ...........    12,000    12,000       6,240         5,760          40       2,304
1957.......................................    12,000  ............      $2,000     10,000    11,000       7,644         3,356          40       1,342
1958.......................................    10,000  ............       2,000      8,000     9,000       7,186         1,814          40         726
1959.......................................     8,000  ............       4,000      4,000     6,000       5,212           788          40         315
1960.......................................     4,000  ............       2,000      2,000     3,000       2,727           273          40         109
1961.......................................     2,000  ............       2,000   ........     1,000         836           164   .........     \1\ 164
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Balance allowable as depreciation in the year of retirement of the last survivor of the 1954 acquisitions.


                                                       Depreciation Reserve for 1954 Acquisitions
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                   Average
                                                                  Reserve    Current     Salvage  Reserve Dec.     reserve      Allowable   Reserve Dec.
                              Year                                Jan. 1   retirements  realized   31, before      before     depreciation    31, after
                                                                                                  depreciation  depreciation                depreciation
--------------------------------------------------------------------------------------------------------------------------------------------------------
1954...........................................................  ........  ...........  ........  ............  ............      $2,400        $2,400
1955...........................................................    $2,400  ...........  ........      $2,400        $2,400         3,840         6,240
1956...........................................................     6,240  ...........  ........       6,240         6,240         2,304         8,544
1957...........................................................     8,544      $2,000       $200       6,744         7,644         1,342         8,086
1958...........................................................     8,086       2,000        200       6,286         7,186           726         7,012

[[Page 1003]]

 
1959...........................................................     7,012       4,000        400       3,412         5,212           315         3,727
1960...........................................................     3,727       2,000   ........       1,727         2,727           109         1,836
1961...........................................................     1,836       2,000   ........        (164)          836           164    ............
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                                                    1959 Acquisitions
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                Asset                  Asset             Reserve Dec.      Net                              Reserve Dec.
                    Year                       balance  Acquisition   balance    Avg.     31, before   depreciable    Rate      Allowable     31, after
                                               Jan. 1                 Dec. 31   balance  depreciation    balance     percent  depreciation  depreciation
--------------------------------------------------------------------------------------------------------------------------------------------------------
1959........................................  ........     $10,000    $10,000    $5,000        None        $5,000         40      $2,000        $2,000
1960........................................   $10,000  ...........    10,000    10,000      $2,000         8,000         40       3,200         5,200
1961........................................    10,000  ...........    10,000    10,000       5,200         4,800         40       1,920         7,120
--------------------------------------------------------------------------------------------------------------------------------------------------------


In the above example, the allowable depreciation on the 1954 
acquisitions totals $11,200. This amount when increased by salvage 
realized in the amount of $800, equals the entire cost or other basis of 
the 1954 acquisitions ($12,000).

    (c) Change in estimated useful life. In the declining balance method 
when a change is justified in the useful life estimated for an account, 
subsequent computations shall be made as though the revised useful life 
had been originally estimated. For example, assume that an account has 
an estimated useful life of ten years and that a declining balance rate 
of 20 percent is applicable. If, at the end of the sixth year, it is 
determined that the remaining useful life of the account is six years, 
computations shall be made as though the estimated useful life was 
originally determined as twelve years. Accordingly, the applicable 
depreciation rate will be 16\2/3\ percent. This rate is thereafter 
applied to the unrecovered cost or other basis.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6712, 29 FR 
3653, Mar. 24, 1964]



Sec. 1.167(b)-3  Sum of the years-digits method.

    (a) Applied to a single asset--(1) General rule. Under the sum of 
the years-digits method annual allowances for depreciation are computed 
by applying changing fractions to the cost or other basis of the 
property reduced by estimated salvage. The numerator of the fraction 
changes each year to a number which corresponds to the remaining useful 
life of the asset (including the year for which the allowance is being 
computed), and the denominator which remains constant is the sum of all 
the years digits corresponding to the estimated useful life of the 
asset. See section 167(c) and Sec. 1.167(c)-1 for restrictions on the 
use of the sum of the years-digits method.
    (i) Illustrations. Computation of depreciation allowances on a 
single asset under the sum of the years-digits method is illustrated by 
the following examples:

    Example (1). A new asset having an estimated useful life of five 
years was acquired on January 1, 1954, for $1,750. The estimated salvage 
is $250. For a taxpayer filing his returns on a calendar year basis, the 
annual depreciation allowances are as follows:

----------------------------------------------------------------------------------------------------------------
                                                                Cost or
                                                                 other
                             Year                                basis   Fraction\1\    Allowable   Depreciation
                                                                 less                 depreciation     reserve
                                                                salvage
----------------------------------------------------------------------------------------------------------------
1954.........................................................    $1,500      \5/15\         $500          $500
1955.........................................................     1,500      \4/15\          400           900
1956.........................................................     1,500      \3/15\          300         1,200
1957.........................................................     1,500      \2/15\          200         1,400
1958.........................................................     1,500      \1/15\          100         1,500
                                                              --------------------------------------------------
 
Unrecovered value (salvage)..................................  ........  ...........  ............        $250
----------------------------------------------------------------------------------------------------------------
\1\ The denominator of the fraction is the sum of the digits representing the years of useful life, i.e., 5, 4,
  3, 2, and 1, or 15.

    Example (2). Assume in connection with an asset acquired in 1954 
that three-fourths of a year's depreciation is allowable in that year.

[[Page 1004]]

The following illustrates a reasonable method of allocating 
depreciation:

----------------------------------------------------------------------------------------------------------------
                                                                   Depreciation       Allowable depreciation
                                                                      for 12    --------------------------------
                                                                      months        1954       1955       1956
----------------------------------------------------------------------------------------------------------------
1st year.........................................................        $500      (\3/4\)    (\1/4\)
                                                                                      $375       $125
2d year..........................................................         400    .........    (\3/4\)    (\1/4\)
                                                                                                  300       $100
3d year..........................................................         300    .........  .........    (\3/4\)
                                                                                                             225
                                                                  ----------------------------------------------
  Total..........................................................  ............        375        425        325
----------------------------------------------------------------------------------------------------------------

    (ii) Change in useful life. Where in the case of a single asset, a 
change is justified in the useful life, subsequent computations shall be 
made as though the remaining useful life at the beginning of the taxable 
year of change were the useful life of a new asset acquired at such time 
and with a basis equal to the unrecovered cost or other basis of the 
asset at that time. For example, assume that a new asset with an 
estimated useful life of ten years is purchased in 1954. At the time of 
making out his return for 1959, the taxpayer finds that the asset has a 
remaining useful life of seven years from January 1, 1959. Depreciation 
for 1959 should then be computed as though 1959 were the first year of 
the life of an asset estimated to have a useful life of seven years, and 
the allowance for 1959 would be \7/28\ of the unrecovered cost or other 
basis of the asset after adjustment for salvage.
    (2) Remaining life--(i) Application. Under the sum of the years-
digits method, annual allowances for depreciation may also be computed 
by applying changing fractions to the unrecovered cost or other basis of 
the asset reduced by estimated salvage. The numerator of the fraction 
changes each year to a number which corresponds to the remaining useful 
life of the asset (including the year for which the allowance is being 
computed), and the denominator changes each year to a number which 
represents the sum of the digits corresponding to the years of estimated 
remaining useful life of the asset. For decimal equivalents of such 
fractions, see Table I of subdivision (ii) of this subparagraph. For 
example, a new asset with an estimated useful life of 10 years is 
purchased January 1, 1954, for $6,000. Assuming a salvage value of $500, 
the depreciation allowance for 1954 is $1,000 ($5,500x0.1818, the 
applicable rate from Table I). For 1955, the unrecovered balance is 
$4,500, and the remaining life is 9 years. The depreciation allowance 
for 1955 would then be $900 ($4,500x0.2000, the applicable rate from 
Table I).
    (ii) Table I. This table shows decimal equivalents of sum of the 
years-digits fractions corresponding to remaining lives from 1 to 100 
years.

 Table I--Decimal Equivalents for Use of Sum of the Years-Digits Method,
                         Based on Remaining Life
------------------------------------------------------------------------
                                                                Decimal
                   Remaining life (years)                     equivalent
------------------------------------------------------------------------
100.0.......................................................     0.0198
99.9........................................................      .0198
99.8........................................................      .0198
99.7........................................................      .0199
99.6........................................................      .0199
99.5........................................................      .0199
99.4........................................................      .0199
99.3........................................................      .0199
99.2........................................................      .0200
99.1........................................................      .0200
99.0........................................................      .0200
98.9........................................................      .0200
98.8........................................................      .0200
98.7........................................................      .0201
98.6........................................................      .0201
98.5........................................................      .0201
98.4........................................................      .0201
98.3........................................................      .0201
98.2........................................................      .0202
98.1........................................................      .0202
98.0........................................................      .0202
97.9........................................................      .0202
97.8........................................................      .0202
97.7........................................................      .0203
97.6........................................................      .0203
97.5........................................................      .0203
97.4........................................................      .0203
97.3........................................................      .0203
97.2........................................................      .0204
97.1........................................................      .0204
97.0........................................................      .0204
96.9........................................................      .0204
96.8........................................................      .0204
96.7........................................................      .0205
96.6........................................................      .0205
96.5........................................................      .0205
96.4........................................................      .0205
96.3........................................................      .0206
96.2........................................................      .0206
96.1........................................................      .0206
96.0........................................................      .0206
95.9........................................................      .0206
95.8........................................................      .0207
95.7........................................................      .0207
95.6........................................................      .0207
95.5........................................................      .0207
95.4........................................................      .0207
95.3........................................................      .0208
95.2........................................................      .0208
95.1........................................................      .0208
95.0........................................................      .0208
94.9........................................................      .0209
94.8........................................................      .0209
94.7........................................................      .0209

[[Page 1005]]

 
94.6........................................................      .0209
94.5........................................................      .0209
94.4........................................................      .0210
94.3........................................................      .0210
94.2........................................................      .0210
94.1........................................................      .0210
94.0........................................................      .0211
93.9........................................................      .0211
93.8........................................................      .0211
93.7........................................................      .0211
93.6........................................................      .0211
93.5........................................................      .0212
93.4........................................................      .0212
93.3........................................................      .0212
93.2........................................................      .0212
93.1........................................................      .0213
93.0........................................................      .0213
92.9........................................................      .0213
92.8........................................................      .0213
92.7........................................................      .0213
92.6........................................................      .0214
92.5........................................................      .0214
92.4........................................................      .0214
92.3........................................................      .0214
92.2........................................................      .0215
92.1........................................................      .0215
92.0........................................................      .0215
91.9........................................................      .0215
91.8........................................................      .0216
91.7........................................................      .0216
91.6........................................................      .0216
91.5........................................................      .0216
91.4........................................................      .0216
91.3........................................................      .0217
91.2........................................................      .0217
91.1........................................................      .0217
91.0........................................................      .0217
90.9........................................................      .0218
90.8........................................................      .0218
90.7........................................................      .0218
90.6........................................................      .0218
90.5........................................................      .0219
90.4........................................................      .0219
90.3........................................................      .0219
90.2........................................................      .0219
90.1........................................................      .0220
90.0........................................................      .0220
89.9........................................................      .0220
89.8........................................................      .0220
89.7........................................................      .0221
89.6........................................................      .0221
89.5........................................................      .0221
89.4........................................................      .0221
89.3........................................................      .0221
89.2........................................................      .0222
89.1........................................................      .0222
89.0........................................................      .0222
88.9........................................................      .0222
88.8........................................................      .0223
88.7........................................................      .0223
88.6........................................................      .0223
88.5........................................................      .0223
88.4........................................................      .0224
88.3........................................................      .0224
88.2........................................................      .0224
88.1........................................................      .0224
88.0........................................................      .0225
87.9........................................................      .0225
87.8........................................................      .0225
87.7........................................................      .0225
87.6........................................................      .0226
87.5........................................................      .0226
87.4........................................................      .0226
87.3........................................................      .0226
87.2........................................................      .0227
87.1........................................................      .0227
87.0........................................................      .0227
86.9........................................................      .0228
86.8........................................................      .0228
86.7........................................................      .0228
86.6........................................................      .0228
86.5........................................................      .0229
86.4........................................................      .0229
86.3........................................................      .0229
86.2........................................................      .0229
86.1........................................................      .0230
86.0........................................................      .0230
85.9........................................................      .0230
85.8........................................................      .0230
85.7........................................................      .0231
85.6........................................................      .0231
85.5........................................................      .0231
85.4........................................................      .0231
85.3........................................................      .0232
85.2........................................................      .0232
85.1........................................................      .0232
85.0........................................................      .0233
84.9........................................................      .0233
84.8........................................................      .0233
84.7........................................................      .0233
84.6........................................................      .0234
84.5........................................................      .0234
84.4........................................................      .0234
84.3........................................................      .0234
84.2........................................................      .0235
84.1........................................................      .0235
84.0........................................................      .0235
83.9........................................................      .0236
83.8........................................................      .0236
83.7........................................................      .0236
83.6........................................................      .0236
83.5........................................................      .0237
83.4........................................................      .0237
83.3........................................................      .0237
83.2........................................................      .0238
83.1........................................................      .0238
83.0........................................................      .0238
82.9........................................................      .0238
82.8........................................................      .0239
82.7........................................................      .0239
82.6........................................................      .0239
82.5........................................................      .0240
82.4........................................................      .0240
82.3........................................................      .0240
82.2........................................................      .0240
82.1........................................................      .0241
82.0........................................................      .0241
81.9........................................................      .0241
81.8........................................................      .0242
81.7........................................................      .0242
81.6........................................................      .0242
81.5........................................................      .0242
81.4........................................................      .0243
81.3........................................................      .0243
81.2........................................................      .0243
81.1........................................................      .0244

[[Page 1006]]

 
81.0........................................................      .0244
80.9........................................................      .0244
80.8........................................................      .0244
80.7........................................................      .0245
80.6........................................................      .0245
80.5........................................................      .0245
80.4........................................................      .0246
80.3........................................................      .0246
80.2........................................................      .0246
80.1........................................................      .0247
80.0........................................................      .0247
79.9........................................................      .0247
79.8........................................................      .0248
79.7........................................................      .0248
79.6........................................................      .0248
79.5........................................................      .0248
79.4........................................................      .0249
79.3........................................................      .0249
79.2........................................................      .0249
79.1........................................................      .0250
79.0........................................................      .0250
78.9........................................................      .0250
78.8........................................................      .0251
78.7........................................................      .0251
78.6........................................................      .0251
78.5........................................................      .0252
78.4........................................................      .0252
78.3........................................................      .0252
78.2........................................................      .0253
78.1........................................................      .0253
78.0........................................................      .0253
77.9........................................................      .0253
77.8........................................................      .0254
77.7........................................................      .0254
77.6........................................................      .0254
77.5........................................................      .0255
77.4........................................................      .0255
77.3........................................................      .0255
77.2........................................................      .0256
77.1........................................................      .0256
77.0........................................................      .0256
76.9........................................................      .0257
76.8........................................................      .0257
76.7........................................................      .0257
76.6........................................................      .0258
76.5........................................................      .0258
76.4........................................................      .0258
76.3........................................................      .0259
76.2........................................................      .0259
76.1........................................................      .0259
76.0........................................................      .0260
75.9........................................................      .0260
75.8........................................................      .0260
75.7........................................................      .0261
75.6........................................................      .0261
75.5........................................................      .0261
75.4........................................................      .0262
75.3........................................................      .0262
75.2........................................................      .0262
75.1........................................................      .0263
75.0........................................................      .0263
74.9........................................................      .0264
74.8........................................................      .0264
74.7........................................................      .0264
74.6........................................................      .0265
74.5........................................................      .0265
74.4........................................................      .0265
74.3........................................................      .0266
74.2........................................................      .0266
74.1........................................................      .0266
74.0........................................................      .0267
73.9........................................................      .0267
73.8........................................................      .0267
73.7........................................................      .0268
73.6........................................................      .0268
73.5........................................................      .0268
73.4........................................................      .0269
73.3........................................................      .0269
73.2........................................................      .0270
73.1........................................................      .0270
73.0........................................................      .0270
72.9........................................................      .0271
72.8........................................................      .0271
72.7........................................................      .0271
72.6........................................................      .0272
72.5........................................................      .0272
72.4........................................................      .0272
72.3........................................................      .0273
72.2........................................................      .0273
72.1........................................................      .0274
72.0........................................................      .0274
71.9........................................................      .0274
71.8........................................................      .0275
71.7........................................................      .0275
71.6........................................................      .0275
71.5........................................................      .0276
71.4........................................................      .0276
71.3........................................................      .0277
71.2........................................................      .0277
71.1........................................................      .0277
71.0........................................................      .0278
70.9........................................................      .0278
70.8........................................................      .0279
70.7........................................................      .0279
70.6........................................................      .0279
70.5........................................................      .0280
70.4........................................................      .0280
70.3........................................................      .0280
70.2........................................................      .0281
70.1........................................................      .0281
70.0........................................................      .0282
69.9........................................................      .0282
69.8........................................................      .0282
69.7........................................................      .0283
69.6........................................................      .0283
69.5........................................................      .0284
69.4........................................................      .0284
69.3........................................................      .0284
69.2........................................................      .0285
69.1........................................................      .0285
69.0........................................................      .0286
68.9........................................................      .0286
68.8........................................................      .0287
68.7........................................................      .0287
68.6........................................................      .0287
68.5........................................................      .0288
68.4........................................................      .0288
68.3........................................................      .0289
68.2........................................................      .0289
68.1........................................................      .0289
68.0........................................................      .0290
67.9........................................................      .0290
67.8........................................................      .0291
67.7........................................................      .0291
67.6........................................................      .0292
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[[Page 1007]]

 
67.4........................................................      .0292
67.3........................................................      .0293
67.2........................................................      .0293
67.1........................................................      .0294
67.0........................................................      .0294
66.9........................................................      .0295
66.8........................................................      .0295
66.7........................................................      .0295
66.6........................................................      .0296
66.5........................................................      .0296
66.4........................................................      .0297
66.3........................................................      .0297
66.2........................................................      .0298
66.1........................................................      .0298
66.0........................................................      .0299
65.9........................................................      .0299
65.8........................................................      .0299
65.7........................................................      .0300
65.6........................................................      .0300
65.5........................................................      .0301
65.4........................................................      .0301
65.3........................................................      .0302
65.2........................................................      .0302
65.1........................................................      .0303
65.0........................................................      .0303
64.9........................................................      .0303
64.8........................................................      .0304
64.7........................................................      .0304
64.6........................................................      .0305
64.5........................................................      .0305
64.4........................................................      .0306
64.3........................................................      .0306
64.2........................................................      .0307
64.1........................................................      .0307
64.0........................................................      .0308
63.9........................................................      .0308
63.8........................................................      .0309
63.7........................................................      .0309
63.6........................................................      .0310
63.5........................................................      .0310
63.4........................................................      .0311
63.3........................................................      .0311
63.2........................................................      .0312
63.1........................................................      .0312
63.0........................................................      .0313
62.9........................................................      .0313
62.8........................................................      .0313
62.7........................................................      .0314
62.6........................................................      .0314
62.5........................................................      .0315
62.4........................................................      .0315
62.3........................................................      .0316
62.2........................................................      .0316
62.1........................................................      .0317
62.0........................................................      .0317
61.9........................................................      .0318
61.8........................................................      .0318
61.7........................................................      .0319
61.6........................................................      .0319
61.5........................................................      .0320
61.4........................................................      .0320
61.3........................................................      .0321
61.2........................................................      .0322
61.1........................................................      .0322
61.0........................................................      .0323
60.9........................................................      .0323
60.8........................................................      .0324
60.7........................................................      .0324
60.6........................................................      .0325
60.5........................................................      .0325
60.4........................................................      .0326
60.3........................................................      .0326
60.2........................................................      .0327
60.1........................................................      .0327
60.0........................................................      .0328
59.9........................................................      .0328
59.8........................................................      .0329
59.7........................................................      .0329
59.6........................................................      .0330
59.5........................................................      .0331
59.4........................................................      .0331
59.3........................................................      .0332
59.2........................................................      .0332
59.1........................................................      .0333
59.0........................................................      .0333
58.9........................................................      .0334
58.8........................................................      .0334
58.7........................................................      .0335
58.6........................................................      .0336
58.5........................................................      .0336
58.4........................................................      .0337
58.3........................................................      .0337
58.2........................................................      .0338
58.1........................................................      .0338
58.0........................................................      .0339
57.9........................................................      .0340
57.8........................................................      .0340
57.7........................................................      .0341
57.6........................................................      .0341
57.5........................................................      .0342
57.4........................................................      .0342
57.3........................................................      .0343
57.2........................................................      .0344
57.1........................................................      .0344
57.0........................................................      .0345
56.9........................................................      .0345
56.8........................................................      .0346
56.7........................................................      .0347
56.6........................................................      .0347
56.5........................................................      .0348
56.4........................................................      .0348
56.3........................................................      .0349
56.2........................................................      .0350
56.1........................................................      .0350
56.0........................................................      .0351
55.9........................................................      .0351
55.8........................................................      .0352
55.7........................................................      .0353
55.6........................................................      .0353
55.5........................................................      .0354
55.4........................................................      .0355
55.3........................................................      .0355
55.2........................................................      .0356
55.1........................................................      .0356
55.0........................................................      .0357
54.9........................................................      .0358
54.8........................................................      .0358
54.7........................................................      .0359
54.6........................................................      .0360
54.5........................................................      .0360
54.4........................................................      .0361
54.3........................................................      .0362
54.2........................................................      .0362
54.1........................................................      .0363
54.0........................................................      .0364
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[[Page 1008]]

 
53.8........................................................      .0365
53.7........................................................      .0366
53.6........................................................      .0366
53.5........................................................      .0367
53.4........................................................      .0368
53.3........................................................      .0368
53.2........................................................      .0369
53.1........................................................      .0370
53.0........................................................      .0370
52.9........................................................      .0371
52.8........................................................      .0372
52.7........................................................      .0372
52.6........................................................      .0373
52.5........................................................      .0374
52.4........................................................      .0374
52.3........................................................      .0375
52.2........................................................      .0376
52.1........................................................      .0377
52.0........................................................      .0377
51.9........................................................      .0378
51.8........................................................      .0379
51.7........................................................      .0379
51.6........................................................      .0380
51.5........................................................      .0381
51.4........................................................      .0382
51.3........................................................      .0382
51.2........................................................      .0383
51.1........................................................      .0384
51.0........................................................      .0385
50.9........................................................      .0385
50.8........................................................      .0386
50.7........................................................      .0387
50.6........................................................      .0388
50.5........................................................      .0388
50.4........................................................      .0389
50.3........................................................      .0390
50.2........................................................      .0391
50.1........................................................      .0391
50.0........................................................      .0392
49.9........................................................      .0393
49.8........................................................      .0394
49.7........................................................      .0394
49.6........................................................      .0395
49.5........................................................      .0396
49.4........................................................      .0397
49.3........................................................      .0398
49.2........................................................      .0398
49.1........................................................      .0399
49.0........................................................      .0400
48.9........................................................      .0401
48.8........................................................      .0402
48.7........................................................      .0402
48.6........................................................      .0403
48.5........................................................      .0404
48.4........................................................      .0405
48.3........................................................      .0406
48.2........................................................      .0406
48.1........................................................      .0407
48.0........................................................      .0408
47.9........................................................      .0409
47.8........................................................      .0410
47.7........................................................      .0411
47.6........................................................      .0411
47.5........................................................      .0412
47.4........................................................      .0413
47.3........................................................      .0414
47.2........................................................      .0415
47.1........................................................      .0416
47.0........................................................      .0417
46.9........................................................      .0418
46.8........................................................      .0418
46.7........................................................      .0419
46.6........................................................      .0420
46.5........................................................      .0421
46.4........................................................      .0422
46.3........................................................      .0423
46.2........................................................      .0424
46.1........................................................      .0425
46.0........................................................      .0426
45.9........................................................      .0426
45.8........................................................      .0427
45.7........................................................      .0428
45.6........................................................      .0429
45.5........................................................      .0430
45.4........................................................      .0431
45.3........................................................      .0432
45.2........................................................      .0433
45.1........................................................      .0434
45.0........................................................      .0435
44.9........................................................      .0436
44.8........................................................      .0437
44.7........................................................      .0438
44.6........................................................      .0439
44.5........................................................      .0440
44.4........................................................      .0440
44.3........................................................      .0441
44.2........................................................      .0442
44.1........................................................      .0443
44.0........................................................      .0444
43.9........................................................      .0445
43.8........................................................      .0446
43.7........................................................      .0447
43.6........................................................      .0448
43.5........................................................      .0449
43.4........................................................      .0450
43.3........................................................      .0451
43.2........................................................      .0452
43.1........................................................      .0453
43.0........................................................      .0455
42.9........................................................      .0456
42.8........................................................      .0457
42.7........................................................      .0458
42.6........................................................      .0459
42.5........................................................      .0460
42.4........................................................      .0461
42.3........................................................      .0462
42.2........................................................      .0463
42.1........................................................      .0464
42.0........................................................      .0465
41.9........................................................      .0466
41.8........................................................      .0467
41.7........................................................      .0468
41.6........................................................      .0469
41.5........................................................      .0471
41.4........................................................      .0472
41.3........................................................      .0473
41.2........................................................      .0474
41.1........................................................      .0475
41.0........................................................      .0476
40.9........................................................      .0477
40.8........................................................      .0478
40.7........................................................      .0480
40.6........................................................      .0481
40.5........................................................      .0482
40.4........................................................      .0483
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[[Page 1009]]

 
40.2........................................................      .0485
40.1........................................................      .0487
40.0........................................................      .0488
39.9........................................................      .0489
39.8........................................................      .0490
39.7........................................................      .0491
39.6........................................................      .0493
39.5........................................................      .0494
39.4........................................................      .0495
39.3........................................................      .0496
39.2........................................................      .0497
39.1........................................................      .0499
39.0........................................................      .0500
38.9........................................................      .0501
38.8........................................................      .0502
38.7........................................................      .0504
38.6........................................................      .0505
38.5........................................................      .0506
38.4........................................................      .0508
38.3........................................................      .0509
38.2........................................................      .0510
38.1........................................................      .0511
38.0........................................................      .0513
37.9........................................................      .0514
37.8........................................................      .0515
37.7........................................................      .0517
37.6........................................................      .0518
37.5........................................................      .0519
37.4........................................................      .0521
37.3........................................................      .0522
37.2........................................................      .0524
37.1........................................................      .0525
37.0........................................................      .0526
36.9........................................................      .0528
36.8........................................................      .0529
36.7........................................................      .0530
36.6........................................................      .0532
36.5........................................................      .0533
36.4........................................................      .0525
36.3........................................................      .0536
36.2........................................................      .0538
36.1........................................................      .0539
36.0........................................................      .0541
35.9........................................................      .0542
35.8........................................................      .0543
35.7........................................................      .0545
35.6........................................................      .0546
35.5........................................................      .0548
35.4........................................................      .0549
35.3........................................................      .0551
35.2........................................................      .0552
35.1........................................................      .0554
35.0........................................................      .0556
34.9........................................................      .0557
34.8........................................................      .0559
34.7........................................................      .0560
34.6........................................................      .0562
34.5........................................................      .0563
34.4........................................................      .0565
34.3........................................................      .0566
34.2........................................................      .0566
34.1........................................................      .0570
34.0........................................................      .0571
33.9........................................................      .0573
33.8........................................................      .0575
33.7........................................................      .0576
33.6........................................................      .0578
33.5........................................................      .0580
33.4........................................................      .0581
33.3........................................................      .0583
33.2........................................................      .0585
33.1........................................................      .0586
33.0........................................................      .0588
32.9........................................................      .0590
32.8........................................................      .0592
32.7........................................................      .0593
32.6........................................................      .0595
32.5........................................................      .0597
32.4........................................................      .0599
32.3........................................................      .0600
32.2........................................................      .0602
32.1........................................................      .0604
32.0........................................................      .0606
31.9........................................................      .0608
31.8........................................................      .0610
31.7........................................................      .0611
31.6........................................................      .0613
31.5........................................................      .0615
31.4........................................................      .0617
31.3........................................................      .0619
31.2........................................................      .0621
31.1........................................................      .0623
31.0........................................................      .0625
30.9........................................................      .0627
30.8........................................................      .0629
30.7........................................................      .0631
30.6........................................................      .0633
30.5........................................................      .0635
30.4........................................................      .0637
30.3........................................................      .0639
30.2........................................................      .0641
30.1........................................................      .0643
30.0........................................................      .0645
29.9........................................................      .0647
29.8........................................................      .0649
29.7........................................................      .0651
29.6........................................................      .0653
29.5........................................................      .0656
29.4........................................................      .0658
29.3........................................................      .0660
29.2........................................................      .0662
29.1........................................................      .0664
29.0........................................................      .0667
28.9........................................................      .0669
28.8........................................................      .0671
28.7........................................................      .0673
28.6........................................................      .0675
28.5........................................................      .0678
28.4........................................................      .0680
28.3........................................................      .0682
28.2........................................................      .0685
28.1........................................................      .0687
28.0........................................................      .0690
27.9........................................................      .0692
27.8........................................................      .0694
27.7........................................................      .0697
27.6........................................................      .0699
27.5........................................................      .0702
27.4........................................................      .0704
27.3........................................................      .0707
27.2........................................................      .0709
27.1........................................................      .0712
27.0........................................................      .0714
26.9........................................................      .0717
26.8........................................................      .0719
26.7........................................................      .0722

[[Page 1010]]

 
26.6........................................................      .0724
26.5........................................................      .0727
26.4........................................................      .0730
26.3........................................................      .0732
26.2........................................................      .0735
26.1........................................................      .0738
26.0........................................................      .0741
25.9........................................................      .0743
25.8........................................................      .0746
25.7........................................................      .0749
25.6........................................................      .0752
25.5........................................................      .0754
25.4........................................................      .0757
25.3........................................................      .0760
25.2........................................................      .0763
25.1........................................................      .0766
25.0........................................................      .0769
24.9........................................................      .0772
24.8........................................................      .0775
24.7........................................................      .0778
24.6........................................................      .0781
24.5........................................................      .0784
24.4........................................................      .0787
24.3........................................................      .0790
24.2........................................................      .0793
24.1........................................................      .0797
24.0........................................................      .0800
23.9........................................................      .0803
23.8........................................................      .0806
23.7........................................................      .0809
23.6........................................................      .0813
23.5........................................................      .0816
23.4........................................................      .0819
23.3........................................................      .0823
23.2........................................................      .0826
23.1........................................................      .0830
23.0........................................................      .0833
22.9........................................................      .0837
22.8........................................................      .0840
22.7........................................................      .0844
22.6........................................................      .0847
22.5........................................................      .0851
22.4........................................................      .0854
22.3........................................................      .0858
22.2........................................................      .0862
22.1........................................................      .0866
22.0........................................................      .0870
21.9........................................................      .0873
21.8........................................................      .0877
21.7........................................................      .0881
21.6........................................................      .0885
21.5........................................................      .0888
21.4........................................................      .0892
21.3........................................................      .0896
21.2........................................................      .0901
21.1........................................................      .0905
21.0........................................................      .0909
20.9........................................................      .0913
20.8........................................................      .0917
20.7........................................................      .0921
20.6........................................................      .0925
20.5........................................................      .0930
20.4........................................................      .0934
20.3........................................................      .0939
20.2........................................................      .0943
20.1........................................................      .0948
20.0........................................................      .0952
19.9........................................................      .0957
19.8........................................................      .0961
19.7........................................................      .0966
19.6........................................................      .0970
19.5........................................................      .0975
19.4........................................................      .0980
19.3........................................................      .0985
19.2........................................................      .0990
19.1........................................................      .0995
19.0........................................................      .1000
18.9........................................................      .1005
18.8........................................................      .1010
18.7........................................................      .1015
18.6........................................................      .1020
18.5........................................................      .1025
18.4........................................................      .1030
18.3........................................................      .1036
18.2........................................................      .1041
18.1........................................................      .1047
18.0........................................................      .1053
17.9........................................................      .1058
17.8........................................................      .1063
17.7........................................................      .1069
17.6........................................................      .1074
17.5........................................................      .1080
17.4........................................................      .1086
17.3........................................................      .1092
17.2........................................................      .1098
17.1........................................................      .1105
17.0........................................................      .1111
16.9........................................................      .1117
16.8........................................................      .1123
16.7........................................................      .1129
16.6........................................................      .1135
16.5........................................................      .1142
16.4........................................................      .1148
16.3........................................................      .1155
16.2........................................................      .1162
16.1........................................................      .1169
16.0........................................................      .1176
15.9........................................................      .1183
15.8........................................................      .1190
15.7........................................................      .1197
15.6........................................................      .1204
15.5........................................................      .1211
15.4........................................................      .1218
15.3........................................................      .1226
15.2........................................................      .1234
15.1........................................................      .1242
15.0........................................................      .1250
14.9........................................................      .1257
14.8........................................................      .1265
14.7........................................................      .1273
14.6........................................................      .1281
14.5........................................................      .1289
14.4........................................................      .1297
14.3........................................................      .1306
14.2........................................................      .1315
14.1........................................................      .1324
14.0........................................................      .1333
13.9........................................................      .1342
13.8........................................................      .1350
13.7........................................................      .1359
13.6........................................................      .1368
13.5........................................................      .1378
13.4........................................................      .1387
13.3........................................................      .1397
13.2........................................................      .1407
13.1........................................................      .1418

[[Page 1011]]

 
13.0........................................................      .1429
12.9........................................................      .1438
12.8........................................................      .1448
12.7........................................................      .1458
12.6........................................................      .1469
12.5........................................................      .1479
12.4........................................................      .1490
12.3........................................................      .1502
12.2........................................................      .1514
12.1........................................................      .1526
12.0........................................................      .1538
11.9........................................................      .1549
11.8........................................................      .1561
11.7........................................................      .1573
11.6........................................................      .1585
11.5........................................................      .1597
11.4........................................................      .1610
11.3........................................................      .1624
11.2........................................................      .1637
11.1........................................................      .1652
11.0........................................................      .1667
10.9........................................................      .1680
10.8........................................................      .1693
10.7........................................................      .1707
10.6........................................................      .1721
10.5........................................................      .1736
10.4........................................................      .1751
10.3........................................................      .1767
10.2........................................................      .1783
10.1........................................................      .1800
10.0........................................................      .1818
9.9.........................................................      .1833
9.8.........................................................      .1849
9.7.........................................................      .1865
9.6.........................................................      .1882
9.5.........................................................      .1900
9.4.........................................................      .1918
9.3.........................................................      .1938
9.2.........................................................      .1957
9.1.........................................................      .1978
9.0.........................................................      .2000
8.9.........................................................      .2018
8.8.........................................................      .2037
8.7.........................................................      .2057
8.6.........................................................      .2077
8.5.........................................................      .2099
8.4.........................................................      .2121
8.3.........................................................      .2145
8.2.........................................................      .2169
8.1.........................................................      .2195
8.0.........................................................      .2222
7.9.........................................................      .2244
7.8.........................................................      .2267
7.7.........................................................      .2292
7.6.........................................................      .2317
7.5.........................................................      .2344
7.4.........................................................      .2372
7.3.........................................................      .2401
7.2.........................................................      .2432
7.1.........................................................      .2465
7.0.........................................................      .2500
6.9.........................................................      .2527
6.8.........................................................      .2556
6.7.........................................................      .2587
6.6.........................................................      .2619
6.5.........................................................      .2653
6.4.........................................................      .2689
6.3.........................................................      .2727
6.2.........................................................      .2768
6.1.........................................................      .2811
6.0.........................................................      .2857
5.9.........................................................      .2892
5.8.........................................................      .2929
5.7.........................................................      .2969
5.6.........................................................      .3011
5.5.........................................................      .3056
5.4.........................................................      .3103
5.3.........................................................      .3155
5.2.........................................................      .3210
5.1.........................................................      .3269
5.0.........................................................      .3333
4.9.........................................................      .3379
4.8.........................................................      .3429
4.7.........................................................      .3481
4.6.........................................................      .3538
4.5.........................................................      .3600
4.4.........................................................      .3667
4.3.........................................................      .3739
4.2.........................................................      .3818
4.1.........................................................      .3905
4.0.........................................................      .4000
3.9.........................................................      .4063
3.8.........................................................      .4130
3.7.........................................................      .4205
3.6.........................................................      .4286
3.5.........................................................      .4375
3.4.........................................................      .4474
3.3.........................................................      .4583
3.2.........................................................      .4706
3.1.........................................................      .4844
3.0.........................................................      .5000
2.9.........................................................      .5088
2.8.........................................................      .5185
2.7.........................................................      .5294
2.6.........................................................      .5417
2.5.........................................................      .5556
2.4.........................................................      .5714
2.3.........................................................      .5897
2.2.........................................................      .6111
2.1.........................................................      .6364
2.0.........................................................      .6667
1.9.........................................................      .6786
1.8.........................................................      .6923
1.7.........................................................      .7083
1.6.........................................................      .7273
1.5.........................................................      .7500
1.4.........................................................      .7778
1.3.........................................................      .8125
1.2.........................................................      .8571
1.1.........................................................      .9167
1.0.........................................................     1.0000
------------------------------------------------------------------------

    Note: For determination of decimal equivalents of remaining lives 
falling between those shown in the above table, the taxpayer may use the 
next longest life shown in the table, interpolate from the table, or use 
the following formula from which the table was derived.

D=2R/(W+2F)(W+1)

where:

D=Decimal equivalent.
R=Remaining life.

[[Page 1012]]

W=Whole number of years in remaining life.
F=Fractional part of a year in remaining life.

If the taxpayer desires to carry his calculations of decimal equivalents 
to a greater number of decimal places than is provided in the table, he 
may use the formula. The procedure adopted must be consistently followed 
thereafter.

    (b) Applied to group, classified, or composite accounts--(1) General 
rule. The sum of the years-digits method may be applied to group, 
classified, or composite accounts in accordance with the plan described 
in subparagraph (2) of this paragraph or in accordance with other plans 
as explained in subparagraph (3) of this paragraph.
    (2) Remaining life plan. The remaining life plan as applied to a 
single asset is described in paragraph (a)(2) of this section. This plan 
may also be applied to group, classified, or composite accounts. Under 
this plan the allowance for depreciation is computed by applying 
changing fractions to the unrecovered cost or other basis of the account 
reduced by estimated salvage. The numerator of the fraction changes each 
year to a number which corresponds to the remaining useful life of the 
account (including the year for which the allowance is being computed), 
and the denominator changes each year to a number which represents the 
sum of the years digits corresponding to the years of estimated 
remaining useful life of the account. Decimal equivalents of such 
fractions can be obtained by use of Table I under paragraph (a)(2)(ii) 
of this section. The proper application of this method requires that the 
estimated remaining useful life of the account be determined each year. 
This determination, of course, may be made each year by analysis, i.e., 
by determining the remaining lives for each of the components in the 
account, and averaging them. The estimated remaining life of any 
account, however, may also be determined arithmetically. For example, it 
may be computed by dividing the unrecovered cost or other basis of the 
account, as computed by straight line depreciation, by the gross cost or 
other basis of the account, and multiplying the result by the average 
life of the assets in the account. Salvage value is not a factor for the 
purpose of determining remaining life. Thus, if a group account with an 
average life of ten years had at January 1, 1958, a gross asset balance 
of $12,600 and a depreciation reserve computed on the straight line 
method of $9,450, the remaining life of the account at January 1, 1958, 
would be computed as follows:

$12,600-$9,450/$12,600x10 years equals 2.50 years.

    Example. The use of the sum of the years-digits method with group, 
classified, or composite accounts under the remaining life plan is 
illustrated by the following example:

A calendar year taxpayer maintains a group account to which a five-year 
life is applicable. Original investment, additions, retirements, and 
salvage recoveries are the same as those set forth in example (3) of 
paragraph (b) of Sec. 1.167(b)-1.

[[Page 1013]]


                                                             Depreciation Computations on a Group Account Under Remaining Life Plan
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                          1         2         3         4         5         6         7         8         9        10        11        12        13        14
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
 


------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                               Straight    Straight   Remaining    Asset    Current    Salvage        Sum of the years digits depreciation
                                                                                 line        line        life     balance  additions  realized -------------------------------------------------
                                                                                amount     reserve   -----------  reduced   reduced  ---------- Accumulated  Unrecovered    Rate      Allowable
                                                                              -----------------------               by         by                 reserve       Jan. 1    based on  depreciation
                                     Asset                            Average                         [Col. (1)-  salvage   salvage                Jan. 1   ------------- Col. (7) -------------
               Year                 balance   Current     Current      asset                           Col. (6)/---------------------          -------------                from
                                    Jan. 1   additions  retirements   balance             Col. (5)-      Col.                                      Prior                   Table 1   Col. (12)x
                                                                               Col. (4)/   Col. (3)     (1)]x      Col.     Col (2)x              reserve+    Col. (8)-  ----------  Col. (13)+
                                                                                  life   accumulated   average     (1)x      (100%-              Col. (14)+   Col. (11)              \1/2\ Col.
                                                                                            Jan. 1     service    (100%-     6.67%)              Col. (10)-                           (9)xF\2\
                                                                                                         life     6.67%)                          Col. (3)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
1954.............................  ........    $12,000  ...........    $6,000       \1\  ...........       5.00  ........    $11,200  ........  ...........  ...........    0.3333      $1,866
                                                                                 $1,200
1955.............................   $12,000  .........  ...........    12,000     2,400      $1,200        4.50   $11,200  .........  ........      $1,866       $9,334      .3600       3,360
1956.............................    12,000  .........  ...........    12,000     2,400       3,600        3.50    11,200  .........  ........       5,226        5,974      .4375       2,614
1957.............................    12,000  .........      $2,000     11,000     2,200       6,000        2.50    11,200  .........      $200       7,840        3,360      .5556       1,867
1958.............................    10,000  .........       2,000      9,000     1,800       6,200        1.90     9,333  .........       200       7,907        1,426      .6786         968
1959.............................     8,000     10,000       4,000     11,000     2,200       6,000        1.25     7,466      9,333       400       7,075          391      .8125       1,874
1960.............................    14,000  .........       2,000     13,000     2,600       4,200        3.50    13,066  .........  ........       5,349        7,717      .4375       3,376
1961.............................    12,000  .........       2,000     11,000     2,200       4,800        3.00    11,200  .........  ........       6,725        4,475      .5000       2,238
1962.............................  ........  .........  ...........  ........  ........       5,000   .........  ........  .........  ........       6,963
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ \1/2\ year's amount.
\2\ F=Rate based on average service life (0.3333 in this example).


[[Page 1014]]

    (3) Other plans for application of the sum of the years-digits 
method. Taxpayers who wish to use the sum of the years-digits method in 
computing depreciation for group, classified, or composite accounts in 
accordance with a sum of the years digits plan other than the remaining 
life plan described herein may do so only with the consent of the 
Commissioner. Request for permission to use plans other than that 
described shall be addressed to the Commissioner of Internal Revenue, 
Washington, D.C. 20224.



Sec. 1.167(b)-4  Other methods.

    (a) Under section 167(b)(4) a taxpayer may use any consistent method 
of computing depreciation, such as the sinking fund method, provided 
depreciation allowances computed in accordance with such method do not 
result in accumulated allowances at the end of any taxable year greater 
than the total of the accumulated allowances which could have resulted 
from the use of the declining balance method described in section 
167(b)(2). This limitation applies only during the first two-thirds of 
the useful life of the property. For example, an asset costing $1,000 
having a useful life of six years may be depreciated under the declining 
balance method in accordance with Sec. 1.167(b)-2, at a rate of 33\1/3\ 
percent. During the first four years or \2/3\ of its useful life, 
maximum depreciation allowances under the declining balance method would 
be as follows:

------------------------------------------------------------------------
                                     Current     Accumulated
                                  depreciation  depreciation    Balance
------------------------------------------------------------------------
Cost of asset...................  ............  ............      $1,000
First year......................         $333          $333          667
Second year.....................          222           555          445
Third year......................          148           703          297
Fourth year.....................           99           802          198
------------------------------------------------------------------------


An annual allowance computed by any other method under section 167(b)(4) 
could not exceed $333 for the first year, and at the end of the second 
year the total allowances for the two years could not exceed $555. 
Likewise, the total allowances for the three years could not exceed $703 
and for the four years could not exceed $802. This limitation would not 
apply in the fifth and sixth years. See section 167(c) and Sec. 
1.167(c)-1 for restriction on the use of certain methods.
    (b) It shall be the responsibility of the taxpayer to establish to 
the satisfaction of the Commissioner that a method of depreciation under 
section 167(b)(4) is both a reasonable and consistent method and that it 
does not produce depreciation allowances in excess of the amount 
permitted under the limitations provided in such section.



Sec. 1.167(c)-1  Limitations on methods of computing depreciation under 
section 167(b) (2), (3), and (4).

    (a) In general. (1) Section 167(c) provides limitations on the use 
of the declining balance method described in section 167(b)(2), the sum 
of the years-digits method described in section 167(b)(3), and certain 
other methods authorized by section 167(b)(4). These methods are 
applicable only to tangible property having a useful life of three years 
or more. If construction, reconstruction, or erection by the taxpayer 
began before January 1, 1954, and was completed after December 31, 1953, 
these methods apply only to that portion of the basis of the property 
which is properly attributable to such construction, reconstruction, or 
erection after December 31, 1953. Property is considered as constructed, 
reconstructed, or erected by the taxpayer if the work is done for him in 
accordance with his specifications. The portion of the basis of such 
property attributable to construction, reconstruction, or erection after 
December 31, 1953, consists of all costs of the property allocable to 
the period after December 31, 1953, including the cost or other basis of 
materials entering into such work. It is not necessary that such 
materials be acquired after December 31, 1953, or that they be new in 
use. If construction or erection by the taxpayer began after December 
31, 1953, the entire cost or other basis of such construction or 
erection qualifies for these methods of depreciation. In the case of 
reconstruction of property, these methods do not apply to any part of 
the adjusted basis of such property on December 31, 1953. For purposes 
of this section, construction, reconstruction, or erection by the 
taxpayer begins when physical work is

[[Page 1015]]

started on such construction, reconstruction, or erection.
    (2) If the property was not constructed, reconstructed, or erected 
by the taxpayer, these methods apply only if it was acquired after 
December 31, 1953, and if the original use of the property commences 
with the taxpayer and commences after December 31, 1953. For the purpose 
of the preceding sentence, property shall be deemed to be acquired when 
reduced to physical possession, or control. The term ``original use'' 
means the first use to which the property is put, whether or not such 
use corresponds to the use of such property by the taxpayer. For 
example, a reconditioned or rebuilt machine acquired after December 31, 
1953, will not be treated as being put to original use by the taxpayer 
even though it is put to a different use, nor will a horse acquired for 
breeding purposes be treated as being put to original use by the 
taxpayer if prior to the purchase the horse was used for racing 
purposes. See Sec. Sec. 1.167(b)-2, 1.167 (b)-3, and 1.167(b)-4 for 
application of the various methods.
    (3) Assets having an estimated average useful life of less than 
three years shall not be included in a group, classified, or composite 
account to which the methods described in Sec. Sec. 1.167 (b)-2, 
1.167(b)-3, and 1.167(b)-4 are applicable. However, an incidental 
retirement of an asset from such an account prior to the expiration of a 
useful life of three years will not prevent the application of these 
methods to such an account.
    (4) See section 381(c)(6) and the regulations thereunder for rules 
covering the use of depreciation methods by acquiring corporations in 
the case of certain corporate acquisitions.
    (5) See Sec. Sec. 1.1502-12(g) and 1.1502-13 for provisions dealing 
with depreciation of property received by a member of an affiliated 
group from another member of the group during a consolidated return 
period.
    (6) Except in the cases described in subparagraphs (4) and (5) of 
this paragraph, the methods of depreciation described in Sec. Sec. 
1.167(b)-2, 1.167(b-(3), and 1.167(b)-4 are not applicable to property 
in the hands of a distributee, vendee, transferee, donee, or grantee 
unless the original use of the property begins with such person and the 
conditions required by section 167(c) and this section are otherwise 
met. For example, these methods of depreciation may not be used by a 
corporation with respect to property which it acquires from an 
individual or partnership in exchange for its stock. Similarly, if an 
individual or partnership receives property in a distribution upon 
dissolution of a corporation, these methods of depreciation may not be 
used with respect to property so acquired by such individual or 
partnership. As a further example, these methods of depreciation may not 
be used by a partnership with respect to contributed property, nor by a 
partner with respect to partnership property distributed to him. 
Moreover, where a partnership is entitled to use these depreciation 
methods, and the optional adjustment to basis of partnership property 
provided by section 743 is applicable, (i) in the case of an increase in 
the adjusted basis of the partnership property under such section, the 
transferee partner with respect to whom such adjustment is applicable 
shall not be entitled to use such methods with respect to such increase, 
and (ii) in the case of a decrease in the adjusted basis of the 
partnership property under such section, the transferee partner with 
respect to whom such adjustment is applicable shall include in his 
income an amount equal to the portion of the depreciation deducted by 
the partnership which is attributable to such decrease.
    (b) Illustrations. (1) The application of these methods to property 
constructed, reconstructed, or erected by the taxpayer after December 
31, 1953, may be illustrated by the following examples:

    Example (1). If a building with a total cost of $100,000 is 
completed after December 31, 1953, and the portion attributable to 
construction after December 31, 1953, is determined by engineering 
estimates or by cost accounting records to be $30,000, the methods 
referred to in paragraph (a)(1) of this section are applicable only to 
the $30,000 portion of the total.
    Example (2). In 1954, a taxpayer has an old machine with an 
unrecovered cost of $1,000. If he contracts to have it reconditioned, or 
reconditions it himself, at a cost of an additional $5,000, only the 
$5,000 may be depreciated under the methods referred to in paragraph 
(a)(1) of this section, whether or not the materials used for 
reconditioning are new in use.

[[Page 1016]]

    Example (3). A taxpayer who acquired a building in 1940 makes major 
maintenance or repair expenditures in 1954 of a type which must be 
capitalized. For these expenditures the taxpayer may use a method of 
depreciation different from that used on the building (for example, the 
methods referred to in paragraph (a)(1) of this section) only if he 
accounts for such expenditures separately from the account which 
contained the original building. In such case, the unadjusted basis on 
any parts replaced shall be removed from the asset account and shall be 
charged to the appropriate depreciation reserve account. In the 
alternative he may capitalize such expenditures by charging them to the 
depreciation reserve account for the building.

    (2) The application of these methods to property which was not 
constructed, reconstructed, or erected by the taxpayer but which was 
acquired after December 31, 1953, may be illustrated by the following 
examples:

    Example (1). A taxpayer contracted in 1953 to purchase a new machine 
which he acquired in 1954 and put into first use in that year. He may 
use the methods referred to in paragraph (a)(1) of this section, in 
recovering the cost of the new machine.
    Example (2). A taxpayer instead of reconditioning his old machine 
buys a ``factory reconditioned'' machine in 1954 to replace it. He 
cannot apply the methods referred to in paragraph (a)(1) of this 
section, to any part of the cost of the reconditioned machine since he 
is not the first user of the machine.
    Example (3). In 1954, a taxpayer buys a house for $20,000 which had 
been used as a personal residence and thus had not been subject to 
depreciation allowances. He makes a capital addition of $5,000 and rents 
the property to another. The taxpayer may use the methods referred to in 
paragraph (a)(1) of this section, only with respect to the $5,000 cost 
of the addition.

    (c) Election to use methods. Subject to the limitations set forth in 
paragraph (a) of this section, the methods of computing the allowance 
for depreciation specified in section 167(b) (2), (3), and (4) may be 
adopted without permission and no formal election is required. In order 
for a taxpayer to elect to use these methods for any property described 
in paragraph (a) of this section, he need only compute depreciation 
thereon under any of these methods for any taxable year ending after 
December 31, 1953, in which the property may first be depreciated by 
him. The election with respect to any property shall not be binding with 
respect to acquisitions of similar property in the same year or 
subsequent year which are set up in separate accounts. If a taxpayer has 
filed his return for a taxable year ending after December 31, 1953, for 
which the return is required to be filed on or before September 15, 
1956, an election to compute the depreciation allowance under any of the 
methods specified in section 167 (b) or a change in such an election may 
be made in an amended return or claim for refund filed on or before 
September 15, 1956.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7244, 37 FR 28897, Dec. 30, 1972; T.D. 8560, 59 FR 
41674, Aug. 15, 1994; T.D. 8597, 60 FR 36679, July 18, 1995]



Sec. 1.167(d)-1  Agreement as to useful life and rates of depreciation.

    After August 16, 1954, a taxpayer may, for taxable years ending 
after December 31, 1953, enter into an agreement with respect to the 
estimated useful life, method and rate of depreciation and treatment of 
salvage of any property which is subject to the allowance for 
depreciation. An application for such agreement may be made to the 
district director for the internal revenue district in which the 
taxpayer's return is required to be filed. Such application shall be 
filed in quadruplicate and shall contain in such detail as may be 
practical the following information:
    (a) The character and location of the property.
    (b) The original cost or other basis and date of acquisition.
    (c) Proper adjustments to the basis including depreciation 
accumulated to the first taxable year to be covered by the agreement.
    (d) Estimated useful life and estimated salvage value.
    (e) Method and rate of depreciation.
    (f) Any other facts and circumstances pertinent to making a 
reasonable estimate of the useful life of the property and its salvage 
value.

The agreement must be in writing and must be signed by the taxpayer and 
by the district director. The agreement must be signed in quadruplicate, 
and two of the signed copies will be returned to the taxpayer. The 
agreement

[[Page 1017]]

shall set forth its effective date, the estimated remaining useful life, 
the estimated salvage value, and rate and method of depreciation of the 
property and the facts and circumstances taken into consideration in 
adoption of the agreement, and shall relate only to depreciation 
allowances for such property on and after the effective date of the 
agreement. Such an agreement shall be binding on both parties until such 
time as facts and circumstances which were not taken into account in 
making the agreement are shown to exist. The party wishing to modify or 
change the agreement shall have the responsibility of establishing the 
existence of such facts and circumstances. Any change in the useful life 
or rate specified in such agreement shall be effective only 
prospectively, that is, it shall be effective beginning with the taxable 
year in which notice of the intention to change, including facts and 
circumstances warranting the adjustment of useful life and rate, is sent 
by the party proposing the change to the other party and is sent by 
registered mail, if such notice is mailed before September 3, 1958, or 
is sent by certified mail or registered mail, if such notice is mailed 
after September 2, 1958. A copy of the agreement (and any modification 
thereof) shall be filed with the taxpayer's return for the first taxable 
year which is affected by the agreement (or any modification thereof). A 
signed copy should be retained with the permanent records of the 
taxpayer. For rules relating to changes in method of depreciation, see 
Sec. 1.167(e)-1 and section 446 and the regulations thereunder.



Sec. 1.167(e)-1  Change in method.

    (a) In general. [Reserved]. For further guidance, see Sec. 
1.167(e)-1T(a).
    (b) Declining balance to straight line. In the case of an account to 
which the method described in section 167(b)(2) is applicable, a 
taxpayer may change without the consent of the Commissioner from the 
declining balance method of depreciation to the straight line method at 
any time during the useful life of the property under the following 
conditions. Such a change may not be made if a provision prohibiting 
such a change is contained in an agreement under section 167(d). When 
the change is made, the unrecovered cost or other basis (less a 
reasonable estimate for salvage) shall be recovered through annual 
allowances over the estimated remaining useful life determined in 
accordance with the circumstances existing at the time. With respect to 
any account, this change will be permitted only if applied to all the 
assets in the account as defined in Sec. 1.167(a)-7. If the method of 
depreciation described in section 167(b)(2) (the declining balance 
method of depreciation using a rate not exceeding 200 percent of the 
straight line rate) is an acceptable method of depreciation with respect 
to a particular account, the taxpayer may elect under this paragraph to 
change to the straight line method of depreciation even if with respect 
to that particular account the declining balance method is permitted 
under a provision other than section 167(b)(2). Thus, for example, in 
the case of section 1250 property to which section 167(j)(1) is 
applicable, section 167(b) does not apply, but the declining balance 
method of depreciation using 150 percent of the straight line rate is an 
acceptable method of depreciation under section 167(j)(1)(B). 
Accordingly, the taxpayer may elect under this paragraph to change to 
the straight line method of depreciation with respect to such property. 
Similarly, if the taxpayer acquired used property before July 25, 1969, 
and adopted the 150 percent declining balance method of depreciation 
permitted with respect to such property under Sec. 1.167(b)-0(b), the 
taxpayer may elect under this paragraph to change to the straight line 
method of depreciation with respect to such property. The taxpayer shall 
furnish a statement with respect to the property which is the subject of 
the change showing the date of acquisition, cost or other basis, amounts 
recovered through depreciation and other allowances, the estimated 
salvage value, the character of the property, the remaining useful life 
of the property, and such other information as may be required. The 
statement shall be attached to the taxpayer's return for the taxable 
year in which the change is made. A change to the straight line method 
must be adhered to for the entire taxable year of

[[Page 1018]]

the change and for all subsequent taxable years unless, with the consent 
of the Commissioner, a change to another method is permitted.
    (c) Change with respect to section 1245 property. (1) In respect of 
his first taxable year beginning after December 31, 1962, a taxpayer may 
elect, without the consent of the Commissioner, to change the method of 
depreciation of section 1245 property (as defined in section 1245(a)(3)) 
from any declining balance method or sum of the years-digits method to 
the straight line method. With respect to any account (as defined in 
Sec. 1.167(a)-7), this change may be made notwithstanding any provision 
to the contrary in an agreement under section 167(d), but such change 
shall constitute (as of the first day of such taxable year) a 
termination of such agreement as to all property in such account. With 
respect to any account, this change will be permitted only if applied to 
all the section 1245 property in the account. The election shall be made 
by a statement on, or attached to, the return for such taxable year 
filed on or before the last day prescribed by law, including any 
extensions thereof, for filing such return.
    (2) When an election under this paragraph is made in respect of 
section 1245 property in an account, the unrecovered cost or other basis 
(less a reasonable estimate for salvage) of all the section 1245 
property in the account shall be recovered through annual allowances 
over the estimated remaining useful life determined in accordance with 
the circumstances existing at that time. If there is other property in 
such account, the other property shall be placed in a separate account 
and depreciated by using the same method as was used before the change 
permitted by this paragraph, but the estimated useful life of such 
property shall be redetermined in accordance with Sec. 1.167(b)-2, or 
1.167(b)-3, whichever is applicable. The taxpayer shall maintain records 
which permit specific identification of the section 1245 property in the 
account with respect to which the election is made, and any other 
property in such account. The records shall also show for all the 
property in the account the date of acquisition, cost or other basis, 
amounts recovered through depreciation and other allowances, the 
estimated salvage value, the character of the property, and the 
remaining useful life of the property. A change to the straight line 
method under this paragraph must be adhered to for the entire taxable 
year of the change and for all subsequent taxable years unless, with the 
consent of the Commissioner, a change to another method is permitted.
    (d) Change with respect to section 1250 property. (1) In respect of 
his first taxable year beginning after July 24, 1969, a taxpayer may 
elect, without the consent of the Commissioner, to change the method of 
depreciation of section 1250 property (as defined in section 1250(c)) 
from any declining balance method or sum of the years-digits method to 
the straight line method. With respect to any account (as defined in 
Sec. 1.167(a)-7) this change may be made notwithstanding any provision 
to the contrary in an agreement under section 167(d), but such change 
will constitute (as of the first day of such taxable year) a termination 
of such agreement as to all property in such account. With respect to 
any account, this change will be permitted only if applied to all the 
section 1250 property in the account. The election shall be made by a 
statement on, or attached to, the return for such taxable year filed on 
or before the last day prescribed by law, including extensions thereof, 
for filing such return.
    (2) When an election under this paragraph is made in respect of 
section 1250 property in an account, the unrecovered cost or other basis 
(less a reasonable estimate for salvage) of all the section 1250 
property in the account shall be recovered through annual allowances 
over the estimated remaining useful life determined in accordance with 
the circumstances existing at that time. If there is other property in 
such account, the other property shall be placed in a separate account 
and depreciated by using the same method as was used before the change 
permitted by this paragraph, but the estimated useful life of such 
property shall be redetermined in accordance with Sec. 1.167(b)-2 or 
Sec. 1.167(b)-3, whichever is applicable. The taxpayer shall maintain 
records which permit specific

[[Page 1019]]

identification of the section 1250 property in the account with respect 
to which the election is made and any other property in such account. 
The records shall also show for all the property in the account the date 
of the acquisition, cost or other basis, amounts recovered through 
depreciation and other allowances, the estimated salvage value, the 
character of the property, and the estimated remaining useful life of 
the property. A change to the straight line method under this paragraph 
must be adhered to for the entire taxable year of the change and for all 
subsequent taxable years unless, with the consent of the Commissioner, a 
change to another method is permitted.
    (e) Effective date. [Reserved]. For further guidance, see the first 
two sentences of Sec. 1.167(e)-1T(e).

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6832, 30 FR 
8573, July 7, 1965; T.D. 7166, 37 FR 5245, Mar. 11, 1972; T.D. 9105, 69 
FR 7, Jan. 2, 2004]



Sec. 1.167(e)-1T  Change in method (temporary).

    (a) In general. (1) Any change in the method of computing the 
depreciation allowances with respect to a particular account (other than 
a change in method permitted or required by reason of the operation of 
former section 167(j)(2) and Sec. 1.167(j)-3(c)) is a change in method 
of accounting, and such a change will be permitted only with the consent 
of the Commissioner, except that certain changes to the straight line 
method of depreciation will be permitted without consent as provided in 
former section 167(e)(1), (2), and (3). Except as provided in paragraphs 
(c) and (d) of this section, a change in method of computing 
depreciation will be permitted only with respect to all the assets 
contained in a particular account as defined in Sec. 1.167(a)-7. Any 
change in the percentage of the current straight line rate under the 
declining balance method, for example, from 200 percent of the straight 
line rate to any other percent of the straight line rate, or any change 
in the interest factor used in connection with a compound interest or 
sinking fund method, will constitute a change in method of depreciation. 
Any request for a change in method of depreciation shall be made in 
accordance with section 446(e) and the regulations under section 446(e). 
For rules covering the use of depreciation methods by acquiring 
corporations in the case of certain corporate acquisitions, see section 
381(c)(6) and the regulations under section 381(c)(6).
    (2) Paragraphs (b), (c), and (d) of this section apply to property 
for which depreciation is determined under section 167 (other than under 
section 168, section 1400I, section 1400L, or under section 168 prior to 
its amendment by the Tax Reform Act of 1986 (100 Stat. 2121)) of the 
Internal Revenue Code.
    (b)-(d) [Reserved]. For further guidance, see Sec. 1.167(e)-1(b) 
through (d).
    (e) Effective date. This section applies on or after December 30, 
2003. For the applicability of regulations before December 30, 2003, see 
Sec. 1.167(e)-1 in effect prior to December 30, 2003 (Sec. 1.167(e)-1 
as contained in 26 CFR part 1 edition revised as of April 1, 2003). The 
applicability of this section expires on or before December 29, 2006.

[T.D. 9105, 69 FR 7, Jan. 2, 2004; 69 FR 5273, Feb. 4, 2004]



Sec. 1.167(f)-1  Reduction of salvage value taken into account for 
certain personal property.

    (a) In general. For taxable years beginning after December 31, 1961, 
and ending after October 16, 1962, a taxpayer may reduce the amount 
taken into account as salvage value in computing the allowance for 
depreciation under section 167(a) with respect to ``personal property'' 
as defined in section 167(f)(2) and paragraph (b) of this section. The 
reduction may be made in an amount which does not exceed 10 percent of 
the basis of the property for determining depreciation, as of the time 
as of which salvage value is required to be determined (or when salvage 
value is redetermined), taking into account all adjustments under 
section 1016 other than (1) the adjustment under section 1016(a)(2) for 
depreciation allowed or allowable to the taxpayer, and (2) the 
adjustment under section 1016(a)(19) for a credit earned by the taxpayer 
under section 38, to the extent such adjustment is reflected in the 
basis for depreciation. See paragraph (c) of Sec. 1.167(a)-1 for the 
definition of

[[Page 1020]]

salvage value, the time for making the determination, the 
redetermination of salvage value, and the general rules with respect to 
the treatment of salvage value. See also section 167(g) and Sec. 
1.167(g)-1 for basis for depreciation. A reduction of the amount taken 
into account as salvage value with respect to any property shall not be 
binding with respect to other property. In no event shall an asset (or 
an account) be depreciated below a reasonable salvage value after taking 
into account the reduction in salvage value permitted by section 167(f) 
and this section.
    (b) Definitions and special rules. The following definitions and 
special rules apply for purposes of section 167(f) and this section.
    (1) Personal property. The term ``personal property'' shall include 
only depreciable--
    (i) Tangible personal property (as defined in section 48 and the 
regulations thereunder) and
    (ii) Intangible personal property

which has an estimated useful life (determined at the time of 
acquisition) of 3 years or more and which is acquired after October 16, 
1962. Such term shall not include livestock. The term ``livestock'' 
includes horses, cattle, hogs, sheep, goats, and mink and other 
furbearing animals, irrespective of the use to which they are put or the 
purpose for which they are held. The original use of the property need 
not commence with the taxpayer so long as he acquired it after October 
16, 1962; thus, the property may be new or used. For purposes of 
determining the estimated useful life, the provisions of paragraph (b) 
of Sec. 1.167(a)-1 shall be applied. For rules determining when 
property is acquired, see subparagraph (2) of this paragraph. For 
purposes of determining the types of intangible personal property which 
are subject to the allowance for depreciation, see Sec. 1.167(a)-3.
    (2) Acquired. In determining whether property is acquired after 
October 16, 1962, property shall be deemed to be acquired when reduced 
to physical possession, or control. Property which has not been used in 
the taxpayer's trade or business or held for the production of income 
and which is thereafter converted by the taxpayer to such use shall be 
deemed to be acquired on the date of such conversion. In addition, 
property shall be deemed to be acquired if constructed, reconstructed, 
or erected by the taxpayer. If construction, reconstruction, or erection 
by the taxpayer began before October 17, 1962, and was completed after 
October 16, 1962, section 167(f) and this section apply only to that 
portion of the basis of the property which is properly attributable to 
such construction, reconstruction, or erection after October 16, 1962. 
Property is considered as constructed, reconstructed, or erected by the 
taxpayer if the work is done for him in accordance with his 
specifications. The portion of the basis of such property attributable 
to construction, reconstruction, or erection after October 16, 1962, 
consists of all costs of the property allocable to the period after 
October 16, 1962, including the cost or other basis of materials 
entering into such work. It is not necessary that such materials be 
acquired after October 16, 1962, or that they be new in use. If 
construction or erection by the taxpayer began after October 16, 1962, 
the entire cost or other basis of such construction or erection 
qualifies for the reduction provided for by section 167(f) and this 
section. In the case of reconstruction of property, section 167(f) and 
this section do not apply to any part of the adjusted basis of such 
property on October 16, 1962. For purposes of this section, 
construction, reconstruction, or erection by the taxpayer begins when 
physical work is started on such construction, reconstruction, or 
erection.
    (c) Illustrations. The provisions of paragraphs (a) and (b) of this 
section may be illustrated by the following examples:

    Example (1). Taxpayer A purchases a new asset for use in his 
business on January 1, 1963, for $10,000. The asset qualifies for the 
investment credit under section 38 and for the additional first-year 
depreciation allowance under section 179. A is entitled to an investment 
credit of $700 (7%x$10,000) and elects to take an additional first-year 
depreciation allowance of $2,000 (20%x$10,000). The basis for 
depreciation (determined in accordance with the provisions of section 
167(g) and Sec. 1.167(g)-1) is computed as follows:

Purchase price................................................   $10,000

[[Page 1021]]

 
Less: Adjustment required for taxable years               $700
 beginning before Jan. 1, 1964, under section
 1016(a)(19), for the investment credit.............
Adjustment required under section 1016(a)(2) for the     2,000
 additional first-year depreciation allowance.......
-----------------------------------------------------
                                                         2,700
                                                               ---------
Basis for depreciation for the taxable year 1963..............     7,300
                                                     ===========
 


However, the basis of the property for determining depreciation as of 
the time as of which salvage value is required to be determined is 
$10,000, the purchase price of the property. A files his income tax 
returns on a calendar year basis and uses the straight line method of 
depreciation. A estimates that he will use the asset in his business for 
10 years after which it will have a salvage value of $500, which is less 
than $1,000 (10%x$10,000, the basis of the property for determining 
depreciation as of the time as of which salvage value is required to be 
determined). For the taxable year 1963 A may deduct $730 as the 
depreciation allowance. As of January 1, 1964, the basis of the asset is 
increased by $700 in accordance with paragraph (d) of Sec. 1.48-7. In 
computing his total depreciation allowance on the asset, A may reduce 
the amount taken into account as salvage value to zero and may claim 
depreciation deductions (including the additional first-year 
depreciation allowance) totaling $10,000. See paragraph (d) of Sec. 
1.48-7 for the computation of depreciation for taxable years beginning 
after December 31, 1963, where there is an increase in basis of property 
subject to the investment credit.
    Example (2). Assume the same facts as in example (1) except that A 
in a subsequent taxable year redetermines the estimate of the useful 
life of the asset and at the same time also redetermines the estimate of 
salvage value. Assume also that at such time the only reductions 
reflected in the basis are for depreciation allowed or allowable. 
Accordingly, the reduction under section 167(f) and this section will be 
computed with regard to the purchase price and not the unrecovered basis 
for depreciation at the time of the redetermination.
    Example (3). Assume the same facts as in example (1) except that A 
estimates that the asset will have a salvage value of $1,200 at the end 
of its useful life. In computing his depreciation for the asset, A may 
reduce the amount to be taken into account as salvage value to $200 
($1,200-$1,000). Accordingly, A may claim depreciation deductions 
(including the additional first-year depreciation allowance) totaling 
$9,800, i.e., the purchase price of the property ($10,000) less the 
amount taken into account as salvage value ($200).
    Example (4). Assume the same facts as in example (1) except that the 
taxpayer had taken into account salvage value of only $200 but that the 
estimated salvage value had actually been $700. The amount of salvage 
value taken into account by the taxpayer is permissible since the 
reduction of salvage value by $500 ($700-$200) would be within the limit 
provided for in section 167 (f), i.e., $1,000 (10%x$10,000).
    Example (5). On January 1, 1963, taxpayer B, a taxicab operator, 
traded his old taxicab plus cash for a new one, which had an estimated 
useful life of three years, in a transaction qualifying as a nontaxable 
exchange. The old taxicab had an adjusted basis of $2,500. B was allowed 
$3,000 for his old taxicab and paid $1,000 in cash. The basis of the new 
taxicab for determining depreciation (as determined under section 167(g) 
and Sec. 1.167(g)-1) is the adjusted basis of the old taxicab at the 
time of trade-in ($2,500) plus the additional cash paid out ($1,000), or 
$3,500. In computing his depreciation allowance on the new taxicab, B 
may reduce the amount taken into account as salvage value by $350 (10% 
of $3,500).
    Example (6). Taxpayer C purchases a new asset for use in his 
business on January 1, 1963, for $10,000. At the time of purchase, the 
asset has an estimated useful life of 10 years and an estimated salvage 
value of $1,500. C elects to compute his depreciation allowance for the 
asset by the declining balance method of depreciation, using a rate of 
20% which is twice the normal straight line rate of 10% (without 
adjustment for salvage value). C files his income tax returns on a 
calendar year basis. In computing his depreciation allowance for the 
year 1966, C changes his method of determining the depreciation 
allowance for the asset from the declining balance method to the 
straight line method (in which salvage value is accounted for in 
determining the annual depreciation allowances) in accordance with the 
provisions of section 167(e) and paragraph (b) of Sec. 1.167(e)-1. He 
also wishes to reduce the amount of salvage value taken into account in 
accordance with the provisions of section 167(f) and this section. At 
the close of the year 1966, the only reductions reflected in the basis 
of the asset are for depreciation allowances. Thus, C may reduce the 
amount of salvage value taken into account by $1,000 (10%x$10,000, the 
basis of the asset when it was acquired), and, therefore, will account 
for salvage value of only $500 in computing his depreciation allowance 
for the asset in 1966 and subsequent years.
    Example (7). Taxpayer D purchases a station wagon for his personal 
use on January 1, 1962, for $4,500. On January 1, 1963, D converts the 
use of the station wagon to his business, and at that time it has an 
estimated useful life of 4 years, an estimated salvage value of $500, 
and a basis of $3,000 (as determined under section 167 (g) and Sec. 
1.167 (g)-1). Thus,

[[Page 1022]]

for purposes of section 167 (f) and this section, D is deemed to have 
acquired the station wagon on January 1, 1963. D elects the straight 
line method of depreciation in computing the depreciation allowance for 
the station wagon and also wishes to reduce the amount of salvage value 
taken into account in accordance with the provisions of section 167(f) 
and this section. Accordingly, D may reduce the amount of salvage value 
taken into account by $300 (10% of $3,000). D files his income tax 
returns on a calendar year basis. His depreciation allowance for the 
year 1963 would be computed as follows:

Basis for depreciation..............................  ........    $3,000
Less:
  Salvage value.....................................      $500
  Reduction permitted by section 167(f).............       300
                                                     -----------
                                                                     200
                                                               ---------
Amount to be depreciated over the useful life.................     2,800
 


D's depreciation allowance on the station wagon for the year 1963 would 
be $700 ($2,800 divided by 4, the remaining useful life).

[T.D. 6712, 29 FR 3654, Mar. 24, 1964, as amended by T.D. 6838, 30 FR 
9064, July 20, 1965]



Sec. 1.167(g)-1  Basis for depreciation.

    The basis upon which the allowance for depreciation is to be 
computed with respect to any property shall be the adjusted basis 
provided in section 1011 for the purpose of determining gain on the sale 
or other disposition of such property. In the case of property which has 
not been used in the trade or business or held for the production of 
income and which is thereafter converted to such use, the fair market 
value on the date of such conversion, if less than the adjusted basis of 
the property at that time, is the basis for computing depreciation.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960. Redesignated, T.D. 6712, 29 FR 
3653, Mar. 24, 1964]



Sec. 1.167(h)-1  Life tenants and beneficiaries of trusts and estates.

    (a) Life tenants. In the case of property held by one person for 
life with remainder to another person, the deduction for depreciation 
shall be computed as if the life tenant were the absolute owner of the 
property so that he will be entitled to the deduction during his life, 
and thereafter the deduction, if any, shall be allowed to the 
remainderman.
    (b) Trusts. If property is held in trust, the allowable deduction is 
to be apportioned between the income beneficiaries and the trustee on 
the basis of the trust income allocable to each, unless the governing 
instrument (or local law) requires or permits the trustee to maintain a 
reserve for depreciation in any amount. In the latter case, the 
deduction is first allocated to the trustee to the extent that income is 
set aside for a depreciation reserve, and any part of the deduction in 
excess of the income set aside for the reserve shall be apportioned 
between the income beneficiaries and the trustee on the basis of the 
trust income (in excess of the income set aside for the reserve) 
allocable to each. For example:
    (1) If under the trust instrument or local law the income of a trust 
computed without regard to depreciation is to be distributed to a named 
beneficiary, the beneficiary is entitled to the deduction to the 
exclusion of the trustee.
    (2) If under the trust instrument or local law the income of a trust 
is to be distributed to a named beneficiary, but the trustee is directed 
to maintain a reserve for depreciation in any amount, the deduction is 
allowed to the trustee (except to the extent that income set aside for 
the reserve is less than the allowable deduction). The same result would 
follow if the trustee sets aside income for a depreciation reserve 
pursuant to discretionary authority to do so in the governing 
instrument.

No effect shall be given to any allocation of the depreciation deduction 
which gives any beneficiary or the trustee a share of such deduction 
greater than his pro rata share of the trust income, irrespective of any 
provisions in the trust instrument except as otherwise provided in this 
paragraph when the trust instrument or local law requires or permits the 
trustee to maintain a reserve for depreciation.
    (c) Estates. In the case of an estate the allowable deduction shall 
be apportioned between the estate and the heirs legatees, and devisees 
on the basis of income of the estate which is allocable to each.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960. Redesignated, T.D. 6712, 29 FR 
3653, Mar. 24, 1964]

[[Page 1023]]



Sec. 1.167(i)-1  Depreciation of improvements in the case of mines, etc.

    Property used in the trade or business or held for the production of 
income which is subject to the allowance for depreciation provided in 
section 611 shall be treated for all purposes of the Code as if it were 
property subject to the allowance for depreciation under section 167. 
The preceding sentence shall not limit the allowance for depreciation 
otherwise allowable under section 611.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960. Redesignated, T.D. 6712, 29 FR 
3653, Mar. 24, 1964]



Sec. 1.167(l)-1  Limitations on reasonable allowance in case of property 
of certain public utilities.

    (a) In general--(1) Scope. Section 167(l) in general provides 
limitations on the use of certain methods of computing a reasonable 
allowance for depreciation under section 167(a) with respect to ``public 
utility property'' (see paragraph (b) of this section) for all taxable 
years for which a Federal income tax return was not filed before August 
1, 1969. The limitations are set forth in paragraph (c) of this section 
for ``pre-1970 public utility property'' and in paragraph (d) of this 
section for ``post-1969 public utility property.'' Under section 167(l), 
a taxpayer may always use a straight line method (or other ``subsection 
(l) method'' as defined in paragraph (f) of this section). In general, 
the use of a method of depreciation other than a subsection (l) method 
is not prohibited by section 167(l) for any taxpayer if the taxpayer 
uses a ``normalization method of regulated accounting'' (described in 
paragraph (h) of this section). In certain cases, the use of a method of 
depreciation other than a subsection (l) method is not prohibited by 
section 167(l) if the taxpayer used a ``flow-through method of regulated 
accounting'' described in paragraph (i) of this section) for its ``July 
1969 regulated accounting period'' (described in paragraph (g) of this 
section) whether or not the taxpayer uses either a normalization or a 
flow-through method of regulated accounting after its July 1969 
regulated accounting period. However, in no event may a method of 
depreciation other than a subsection (l) method be used in the case of 
pre-1970 public utility property unless such method of depreciation is 
the ``applicable 1968 method'' (within the meaning of paragraph (e) of 
this section). The normalization requirements of section 167(l) with 
respect to public utility property defined in section 167(l)(3)(A) 
pertain only to the deferral of Federal income tax liability resulting 
from the use of an accelerated method of depreciation for computing the 
allowance for depreciation under section 167 and the use of straight 
line depreciation for computing tax expense and depreciation expense for 
purposes of establishing cost of services and for reflecting operating 
results in regulated books of account. Regulations under section 167(l) 
do not pertain to other book-tax timing differences with respect to 
State income taxes, F.I.C.A. taxes, construction costs, or any other 
taxes and items. The rules provided in paragraph (h)(6) of this section 
are to insure that the same time period is used to determine the 
deferred tax reserve amount resulting from the use of an accelerated 
method of depreciation for cost of service purposes and the reserve 
amount that may be excluded from the rate base or included in no-cost 
capital in determining such cost of services. The formula provided in 
paragraph (h)(6)(ii) of this section is to be used in conjunction with 
the method of accounting for the reserve for deferred taxes (otherwise 
proper under paragraph (h)(2) of this section) in accordance with the 
accounting requirements prescribed or approved, if applicable, by the 
regulatory body having jurisdiction over the taxpayer's regulated books 
of account. The formula provides a method to determine the period of 
time during which the taxpayer will be treated as having received 
amounts credited or charged to the reserve account so that the 
disallowance of earnings with respect to such amounts through rate base 
exclusion or treatment as no-cost capital will take into account the 
factor of time for which such amounts are held by the taxpayer. The 
formula serves to limit the amount of such disallowance.
    (2) Methods of depreciation. For purposes of section 167(l), in the 
case of a

[[Page 1024]]

declining balance method each different uniform rate applied to the 
unrecovered cost or other basis of the property is a different method of 
depreciation. For purposes of section 167(l), a change in a uniform rate 
of depreciation due to a change in the useful life of the property or a 
change in the taxpayer's unrecovered cost or other basis for the 
property is not a change in the method of depreciation. The use of 
``guideline lives'' or ``class lives'' for Federal income tax purposes 
and different lives on the taxpayer's regulated books of account is not 
treated for purposes of section 167(l) as a different method of 
depreciation. Further, the use of an unrecovered cost or other basis or 
salvage value for Federal income tax purposes different from the basis 
or salvage value used on the taxpayer's regulated books of account is 
not treated as a different method of depreciation.
    (3) Application of certain other provisions to public utility 
property. For rules with respect to application of the investment credit 
to public utility property, see section 46(e). For rules with respect to 
the application of the class life asset depreciation range system, 
including the treatment of the use of ``class lives'' for Federal income 
tax purposes and different lives on the taxpayer's regulated books of 
account, see Sec. 1.167(a)-11 and Sec. 1.167(a)-12.
    (4) Effect on agreements under section 167(d). If the taxpayer has 
entered into an agreement under section 167(d) as to any public utility 
property and such agreement requires the use of a method of depreciation 
prohibited by section 167(l), such agreement shall terminate as to such 
property. The termination, in accordance with this subparagraph, shall 
not affect any other property (whether or not public utility property) 
covered by the agreement.
    (5) Effect of change in method of depreciation. If, because the 
method of depreciation used by the taxpayer with respect to public 
utility property is prohibited by section 167(l), the taxpayer changes 
to a method of depreciation not prohibited by section 167(l), then when 
the change is made the unrecovered cost or other basis shall be 
recovered through annual allowances over the estimated remaining useful 
life determined in accordance with the circumstances existing at that 
time.
    (b) Public utility property--(1) In general. Under section 
167(l)(3)(A), property is ``public utility property'' during any period 
in which it is used predominantly in a ``section 167(l) public utility 
activity''. The term ``section 167(l) public utility activity'' means 
the trade or business of the furnishing or sale of--
    (i) Electrical energy, water, or sewage disposal services,
    (ii) Gas or steam through a local distribution system,
    (iii) Telephone services,
    (iv) Other communication services (whether or not telephone 
services) if furnished or sold by the Communications Satellite 
Corporation for purposes authorized by the Communications Satellite Act 
of 1962 (47 U.S.C. 701), or
    (v) Transportation of gas or steam by pipeline,

if the rates for such furnishing or sale, as the case may be, are 
regulated, i.e., have been established or approved by a regulatory body 
described in section 167(l)(3)(A). The term ``regulatory body described 
in section 167(l)(3)(A)'' means a State (including the District of 
Columbia) or political subdivision thereof, any agency or 
instrumentality of the United States, or a public service or public 
utility commission or other body of any State or political subdivision 
thereof similar to such a commission. The term ``established or 
approved'' includes the filing of a schedule of rates with a regulatory 
body which has the power to approve such rates, even though such body 
has taken no action on the filed schedule or generally leaves 
undisturbed rates filed by the taxpayer involved.
    (2) Classification of property. If property is not used solely in a 
section 167(l) public utility activity, such property shall be public 
utility property if its predominant use is in a section 167(l) public 
utility activity. The predominant use of property for any period shall 
be determined by reference to the proper accounts to which expenditures 
for such property are chargeable under the system of regulated accounts 
required to be used for the period for which the determination

[[Page 1025]]

is made and in accordance with the principles of Sec. 1.46-3(g)(4) 
(relating to credit for investment in certain depreciable property). 
Thus, for example, for purposes of determining whether property is used 
predominantly in the trade or business of the furnishing or sale of 
transportation of gas by pipeline, or furnishing or sale of gas through 
a local distribution system, or both, the rules prescribed in Sec. 
1.46-3(g)(4) apply, except that accounts 365 through 371, inclusive 
(Transmission Plant), shall be added to the accounts enumerated in 
subdivision (i) of such paragraph (g)(4).
    (c) Pre-1970 public utility property--(1) Definition. (i) Under 
section 167(l)(3)(B), the term ``pre-1970 public utility property'' 
means property which was public utility property at any time before 
January 1, 1970. If a taxpayer acquires pre-1970 public utility 
property, such property shall be pre-1970 public utility property in the 
hands of the taxpayer even though such property may have been acquired 
by the taxpayer in an arm's-length cash sale at fair market value or in 
a tax-free exchange. Thus, for example, if corporation X which is a 
member of the same controlled group of corporations (within the meaning 
of section 1563(a)) as corporation Y sells pre-1970 public utility 
property to Y, such property is pre-1970 public utility property in the 
hands of Y. The result would be the same if X and Y were not members of 
the same controlled group of corporations.
    (ii) If the basis of public utility property acquired by the 
taxpayer in a transaction is determined in whole or in part by reference 
to the basis of any of the taxpayer's pre-1970 public utility property 
by reason of the application of any provision of the code, and if 
immediately after the transaction the adjusted basis of the property 
acquired is less than 200 percent of the adjusted basis of such pre-1970 
public utility property immediately before the transaction, the property 
acquired is pre-1970 public utility property.
    (2) Methods of depreciation not prohibited. Under section 167(l)(1), 
in the case of pre-1970 public utility property, the term ``reasonable 
allowance'' as used in section 167(a) means, for a taxable year for 
which a Federal income tax return was not filed before August 1, 1969, 
and in which such property is public utility property, an allowance 
(allowable without regard to section 167(l)) computed under--
    (i) A subsection (l) method, or
    (ii) The applicable 1968 method (other than a subsection (l) method) 
used by the taxpayer for such property, but only if--
    (a) The taxpayer uses in respect of such taxable year a 
normalization method of regulated accounting for such property,
    (b) The taxpayer used a flow-through method of regulated accounting 
for such property for its July 1969 regulated accounting period, or
    (c) The taxpayer's first regulated accounting period with respect to 
such property is after the taxpayer's July 1969 regulated accounting 
period and the taxpayer used a flow-through method of regulated 
accounting for its July 1969 regulated accounting period for public 
utility property of the same kind (or if there is no property of the 
same kind, property of the most similar kind) most recently placed in 
service. See paragraph (e)(5) of this section for determination of same 
(or similar) kind.
    (3) Flow-through method of regulated accounting in certain cases. 
See paragraph (e)(6) of this section for treatment of certain taxpayers 
with pending applications for change in method of accounting as being 
deemed to have used a flow-through method of regulated accounting for 
the July 1969 regulated accounting period.
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example (1). Corporation X, a calendar-year taxpayer subject to the 
jurisdiction of a regulatory body described in section 167(l)(3)(A), 
used the straight line method of depreciation (a subsection (l) method) 
for all of its public utility property for which depreciation was 
allowable on its Federal income tax return for 1967 (the latest taxable 
year for which X, prior to August 1, 1969, filed a return). Assume that 
under paragraph (e) of this section, X's applicable 1968 method is a 
subsection (l) method with respect to all of its public utility 
property. Thus, with respect to its pre-1970 public utility property, X 
may only use a straight line method (or any other subsection (l) method) 
of depreciation for all taxable years after 1967.

[[Page 1026]]

    Example (2). Corporation Y, a calendar-year taxpayer subject to the 
jurisdiction of the Federal Power Commission, is engaged exclusively in 
the transportation of gas by pipeline. On its Federal income tax return 
for 1967 (the latest taxable year for which Y, prior to August 1, 1969, 
filed a return), Y used the declining balance method of depreciation 
using a rate of 150 percent of the straightline rate for all of its 
nonsection 1250 public utility property with respect to which 
depreciation was allowable. Assume that with respect to all of such 
property, Y's applicable 1968 method under paragraph (e) of this section 
is such 150 percent declining balance method. Assume that Y used a 
normalization method of regulated accounting for all relevant regulated 
accounting periods. If Y continues to use a normalization method of 
regulated accounting, Y may compute its reasonable allowance for 
purposes of section 167(a) using such 150 percent declining balance 
method for its nonsection 1250 pre-1970 public utility property for all 
taxable years beginning with 1968, provided the use of such method is 
allowable without regard to section 167(l). Y may also use a subsection 
(l) method for any of such pre-1970 public utility property for all 
taxable years beginning after 1967. However, because each different 
uniform rate applied to the basis of the property is a different method 
of depreciation, Y may not use a declining balance method of 
depreciation using a rate of twice the straight line rate for any of 
such pre-1970 public utility property for any taxable year beginning 
after 1967.
    Example (3). Assume the same facts as in example (2) except that 
with respect to all of its nonsection 1250 pre-1970 public utility 
property accounted for in its July 1969 regulated accounting period Y 
used a flow-through method of regulated accounting for such period. 
Assume further that such property is the property on the basis of which 
the applicable 1968 method is established for pre-1970 public utility 
property of the same kind, but having a first regulated accounting 
period after the taxpayer's July 1969 regulated accounting period. 
Beginning with 1968, with respect to such property Y may compute its 
reasonable allowance for purposes of section 167(a) using the declining 
balance method of depreciation and a rate of 150 percent of the straight 
line rate, whether it uses a normalization or flow-through method of 
regulated accounting after its July 1969 regulated accounting period, 
provided the use of such method is allowable without regard to section 
167(l).

    (d) Post-1969 public utility property--(1) In general. Under section 
167(l)(3)(C), the term ``post-1969 public utility property'' means any 
public utility property which is not pre-1970 public utility property.
    (2) Methods of depreciation not prohibited. Under section 167(l)(2), 
in the case of post-1969 public utility property, the term ``reasonable 
allowance'' as used in section 167(a) means, for a taxable year, an 
allowance (allowable without regard to section 167(l)) computed under--
    (i) A subsection (l) method,
    (ii) A method of depreciation otherwise allowable under section 167 
if, with respect to the property, the taxpayer uses in respect of such 
taxable year a normalization method of regulated accounting, or
    (iii) The taxpayer's applicable 1968 method (other than a subsection 
(l) method) with respect to the property in question, if the taxpayer 
used a flow-through method of regulated accounting for its July 1969 
regulated accounting period for the property of the same (or similar) 
kind most recently placed in service, provided that the property in 
question is not property to which an election under section 167(l)(4)(A) 
applies. See Sec. 1.167(l)(2) for rules with respect to an election 
under section 167(l)(4)(A). See paragraph (e)(5) of this section for 
definition of same (or similar) kind.
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example (1). Corporation X is engaged exclusively in the trade or 
business of the transportation of gas by pipeline and is subject to the 
jurisdiction of the Federal Power Commission. With respect to all its 
public utility property, X's applicable 1968 method (as determined under 
paragraph (e) of this section) is the straight line method of 
depreciation. X may determine its reasonable allowance for depreciation 
under section 167(a) with respect to its post-1969 public utility 
property under a straight line method (or other subsection (l) method) 
or, if X uses a normalization method of regulated accounting, any other 
method of depreciation, provided that the use of such other method is 
allowable under section 167 without regard to section 167(l).
    Example (2). Assume the same facts as in example (1) except that 
with respect to all of X's post-1969 public utility property the 
applicable 1968 method (as determined under paragraph (e) of this 
section) is the declining balance method using a rate of 150 percent of 
the straight line rate. Assume further that all of X's pre-1970 public 
utility property was

[[Page 1027]]

accounted for in its July 1969 regulated accounting period, and that X 
used a flow-through method of regulated accounting for such period. X 
may determine its reasonable allowance for depreciation under section 
167 with respect to its post-1969 public utility property by using the 
straight line method of depreciation (or any other subsection (l) 
method), by using any method otherwise allowable under section 167 (such 
as a declining balance method) if X uses a normalization method of 
regulated accounting, or, by using the declining balance method using a 
rate of 150 percent of the straight line rate, whether or not X uses a 
normalization or a flow-through method of regulated accounting.

    (e) Applicable 1968 method--(1) In general. Under section 
167(l)(3)(D), except as provided in subparagraphs (3) and (4) of this 
paragraph, the term ``applicable 1968 method'' means with respect to any 
public utility property--
    (i) The method of depreciation properly used by the taxpayer in its 
Federal income tax return with respect to such property for the latest 
taxable year for which a return was filed before August 1, 1969,
    (ii) If subdivision (i) of this subparagraph does not apply, the 
method of depreciation properly used by the taxpayer in its Federal 
income tax return for the latest taxable year for which a return was 
filed before August 1, 1969, with respect to public utility property of 
the same kind (or if there is no property of the same kind, property of 
the most similar kind) most recently placed in service before the end of 
such latest taxable year, or
    (iii) If neither subdivision (i) nor (ii) of this subparagraph 
applies, a subsection (l) method.

If, on or after August 1, 1969, the taxpayer files an amended return for 
the taxable year referred to in subdivisions (i) and (ii) of this 
subparagraph, such amended return shall not be taken into consideration 
in determining the applicable 1968 method. The term ``applicable 1968 
method'' if such new method results to any public utility property, for 
the year of change and subsequent years, a method of depreciation 
otherwise allowable under section 167 to which the taxpayer changes from 
an applicable 1968 method if such new method results in a lesser 
allowance for depreciation for such property under section 167 in the 
year of change and the taxpayer secures the Commissioner's consent to 
the change in accordance with the procedures of section 446(e) and Sec. 
1.446-1.
    (2) Placed in service. For purposes of this section, property is 
placed in service on the date on which the period for depreciation 
begins under section 167. See, for example, Sec. 1.167(a)-10(b) and 
Sec. 1.167(a)-11(c)(2). If under an averaging convention property which 
is placed in service (as defined in Sec. 1.46-3(d)(ii)) by the taxpayer 
on different dates is treated as placed in service on the same date, 
then for purposes of section 167(l) the property shall be treated as 
having been placed in service on the date the period for depreciation 
with respect to such property would begin under section 167 absent such 
averaging convention. Thus, for example, if, except for the fact that 
the averaging convention used assumes that all additions and retirements 
made during the first half of the year were made on the first day of the 
year, the period of depreciation for two items of public utility 
property would begin on January 10 and March 15, respectively, then for 
purposes of determining the property of the same (or similar) kind most 
recently placed in service, such items of property shall be treated as 
placed in service on January 10 and March 15, respectively.
    (3) Certain section 1250 property. If a taxpayer is required under 
section 167(j) to use a method of depreciation other than its applicable 
1968 method with respect to any section 1250 property, the term 
``applicable 1968 method'' means the method of depreciation allowable 
under section 167(j) which is the most nearly comparable method to the 
applicable 1968 method determined under subparagraph (1) of this 
paragraph. For example, if the applicable 1968 method on new section 
1250 property is the declining balance method using 200 percent of the 
straight line rate, the most nearly comparable method allowable for new 
section 1250 property under section 167(j) would be the declining 
balance method using 150 percent of the straight line rate. If the 
applicable 1968 method determined under subparagraph (1) of this 
paragraph is the sum of the years-digits

[[Page 1028]]

method, the term ``most nearly comparable method'' refers to any method 
of depreciation allowable under section 167(j).
    (4) Applicable 1968 method in certain cases. (i)(a) Under section 
167(l)(3)(E), if the taxpayer evidenced within the time and manner 
specified in (b) of this subdivision (i) the intent to use a method of 
depreciation under section 167 (other than its applicable 1968 method as 
determined under subparagraph (1) or (3) of this paragraph or a 
subsection (l) method) with respect to any public utility property, such 
method of depreciation shall be deemed to be the taxpayer's applicable 
1968 method with respect to such public utility property and public 
utility property of the same (or most similar) kind subsequently placed 
in service.
    (b) Under this subdivision (i), the intent to use a method of 
depreciation under section 167 is evidenced--
    (1) By a timely application for permission for a change in method of 
accounting filed by the taxpayer before August 1, 1969, or
    (2) By the use of such method of depreciation in the computation by 
the taxpayer of its tax expense for purposes of reflecting operating 
results in its regulated books of account for its July 1969 regulated 
accounting period, as established in the manner prescribed in paragraph 
(g)(1) (i), (ii), or (iii) of this section.
    (ii)(a) If public utility property is acquired in a transaction in 
which its basis in the hands of the transferee is determined in whole or 
in part by reference to its basis in the hands of the transferor by 
reason of the application of any provision of the Code, or in a transfer 
(including any purchase for cash or in exchange) from a related person, 
then in the hands of the transferee the applicable 1968 method with 
respect to such property shall be determined by reference to the 
treatment in respect of such property in the hands of the transferor.
    (b) For purposes of this subdivision (ii), the term ``related 
person'' means a person who is related to another person if either 
immediately before or after the transfer--
    (1) The relationship between such persons would result in a 
disallowance of losses under section 267 (relating to disallowance of 
losses, etc., between related taxpayers) or section 707(b) (relating to 
losses disallowed, etc., between partners and controlled partnerships) 
and the regulations thereunder, or
    (2) Such persons are members of the same controlled group of 
corporations, as defined in section 1563(a) (relating to definition of 
controlled group of corporations), except that ``more than 50 percent'' 
shall be substituted for ``at least 80 percent'' each place it appears 
in section 1563(a) and the regulations thereunder.
    (5) Same or similar. The classification of property as being of the 
same (or similar) kind shall be made by reference to the function of the 
public utility to which the primary use of the property relates. 
Property which performs the identical function in the identical manner 
shall be treated as property of the same kind. The determination that 
property is of a similar kind shall be made by reference to the proper 
account to which expenditures for the property are chargeable under the 
system of regulated accounts required to be used by the taxpayer for the 
period in which the property in question was acquired. Property, the 
expenditure for which is chargeable to the same account, is property of 
the most similar kind. Property, the expenditure for which is chargeable 
to an account for property which serves the same general function, is 
property of a similar kind. Thus, for example, if corporation X, a 
natural gas company, subject to the jurisdiction of the Federal Power 
Commission, had property properly chargeable to account 366 (relating to 
transmission plant structures and improvements) acquired an additional 
structure properly chargeable to account 366, under the uniform system 
of accounts prescribed for natural gas companies (class A and class B) 
by the Federal Power Commission, effective September 1, 1968, the 
addition would constitute property of the same kind if it performed the 
identical function in the identical manner. If, however, the addition 
did not perform the identical function in the identical manner, it would 
be property of the most similar kind.

[[Page 1029]]

    (6) Regulated method of accounting in certain cases. Under section 
167(l)(4)(B), if with respect to any pre-1970 public utility property 
the taxpayer filed a timely application for change in method of 
accounting referred to in subparagraph (4)(i)(b)(1) of this paragraph 
and with respect to property of the same (or similar) kind most recently 
placed in service the taxpayer used a flow-through method of regulated 
accounting for its July 1969 regulated accounting period, then for 
purposes of section 167(l)(1)(B) and paragraph (c) of this section the 
taxpayer shall be deemed to have used a flow-through method of regulated 
accounting with respect to such pre-1970 public utility property.
    (7) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example (1). Corporation X is a calendar-year taxpayer. On its 
Federal income tax return for 1967 (the latest taxable year for which X, 
prior to August 1, 1969, filed a return) X used a straight line method 
of depreciation with respect to certain public utility property placed 
in service before 1965 and used the declining balance method of 
depreciation using 200 percent of the straight line rate (double 
declining balance) with respect to the same kind of public utility 
property placed in service after 1964. In 1968 and 1970, X placed in 
service additional public utility property of the same kind. The 
applicable 1968 method with respect to the above described public 
utility property is shown in the following chart:

----------------------------------------------------------------------------------------------------------------
        Property held in 1970             Placed in service      Method on 1967 return    Applicable 1968 method
----------------------------------------------------------------------------------------------------------------
Group 1..............................  Before 1965............  Straight line..........  Straight line.
Group 2..............................  After 1964 and before    Double declining         Double declining
                                        1968.                    balance.                 balance.
Group 3..............................  After 1967 and before    .......................   Do.
                                        1969.
Group 4..............................  After 1968.............  .......................   Do.
----------------------------------------------------------------------------------------------------------------

    Example (2). Corporation Y is a calendar-year taxpayer engaged 
exclusively in the trade or business of the furnishing of electrical 
energy. In 1954, Y placed in service hydroelectric generators and for 
all purposes Y has taken straight line depreciation with respect to such 
generators. In 1960, Y placed in service fossil fuel generators and for 
all purposes since 1960 has used the declining balance method of 
depreciation using a rate of 150 percent of the straight line rate 
(computed without reduction for salvage) with respect to such 
generators. After 1960 and before 1970 Y did not place in service any 
generators. In 1970, Y placed in service additional hydroelectric 
generators. The applicable 1968 method with respect to the hydroelectric 
generators placed in service in 1970 would be the straight line method 
because it was the method used by Y on its return for the latest taxable 
year for which Y filed a return before August 1, 1969, with respect to 
property of the same kind (i.e., hydroelectric generators) most recently 
placed in service.
    Example (3). Assume the same facts as in example (2), except that 
the generators placed in service in 1970 were nuclear generators. The 
applicable 1968 method with respect to such generators is the declining 
balance method using a rate of 150 percent of the straight line rate 
because, with respect to property of the most similar kind (fossil fuel 
generators) most recently placed in service, Y used such declining 
balance method on its return for the latest taxable year for which it 
filed a return before August 1, 1969.

    (f) Subsection (l) method. Under section 167(l)(3)(F), the term 
``subsection (l) method'' means a reasonable and consistently applied 
ratable method of computing depreciation which is allowable under 
section 167(a), such as, for example, the straight line method or a unit 
of production method or machine-hour method. The term ``subsection (l) 
method'' does not include any declining balance method (regardless of 
the uniform rate applied), sum of the years-digits method, or method of 
depreciation which is allowable solely by reason of section 167(b)(4) or 
(j)(1)(C).
    (g) July 1969 regulated accounting period--(1) In general. Under 
section 167(l)(3)(I), the term ``July 1969 regulated accounting period'' 
means the taxpayer's latest accounting period ending before August 1, 
1969, for which the taxpayer regularly computed, before January 1, 1970, 
its tax expense for purposes of reflecting operating results in its 
regulated books of account. The computation by the taxpayer of such tax 
expense may be established by reference to the following:
    (i) The most recent periodic report of a period ending before August 
1, 1969, required by a regulatory body described in section 167(l)(3)(A) 
having jurisdiction over the taxpayer's regulated books of account which 
was filed with such body before January 1, 1970 (whether or not such 
body has jurisdiction over rates).
    (ii) If subdivision (i) of this subparagraph does not apply, the 
taxpayer's

[[Page 1030]]

most recent report to its shareholders for a period ending before August 
1, 1969, but only if such report was distributed to the shareholders 
before January 1, 1970, and if the taxpayer's stocks or securities are 
traded in an established securities market during such period. For 
purposes of this subdivision, the term ``established securities market'' 
has the meaning assigned to such term in Sec. 1.453-3(d)(4).
    (iii) If subdivisions (i) and (ii) of this subparagraph do not 
apply, entries made to the satisfaction of the district director before 
January 1, 1970, in its regulated books of account for its most recent 
accounting period ending before August 1, 1969.
    (2) July 1969 method of regulated accounting in certain 
acquisitions. If public utility property is acquired in a transaction in 
which its basis in the hands of the transferee is determined in whole or 
in part by reference to its basis in the hands of the transferor by 
reason of the application of any provision of the Code, or in a transfer 
(including any purchase for cash or in exchange) from a related person, 
then in the hands of the transferee the method of regulated accounting 
for such property's July 1969 regulated accounting period shall be 
determined by reference to the treatment in respect of such property in 
the hands of the transferor. See paragraph (e)(4)(ii) of this section 
for definition of ``related person''.
    (3) Determination date. For purposes of section 167(l), any 
reference to a method of depreciation under section 167(a), or a method 
of regulated accounting, taken into account by the taxpayer in computing 
its tax expense for its July 1969 regulated accounting period shall be a 
reference to such tax expense as shown on the periodic report or report 
to shareholders to which subparagraph (1) (i) or (ii) of this paragraph 
applies or the entries made on the taxpayer's regulated books of account 
to which subparagraph (1)(iii) of this paragraph applies. Thus, for 
example, assume that regulatory body A having jurisdiction over public 
utility property with respect to X's regulated books of account requires 
X to reflect its tax expense in such books using the same method of 
depreciation which regulatory body B uses for determining X's cost of 
service for ratemaking purposes. If in 1971, in the course of approving 
a rate change for X, B retroactively determines X's cost of service for 
ratemaking purposes for X's July 1969 regulated accounting period using 
a method of depreciation different from the method reflected in X's 
regulated books of account as of January 1, 1970, the method of 
depreciation used by X for its July 1969 regulated accounting period 
would be determined without reference to the method retroactively used 
by B in 1971.
    (h) Normalization method of accounting--(1) In general. (i) Under 
section 167(l), a taxpayer uses a normalization method of regulated 
accounting with respect to public utility property--
    (a) If the same method of depreciation (whether or not a subsection 
(l) method) is used to compute both its tax expense and its depreciation 
expense for purposes of establishing cost of service for ratemaking 
purposes and for reflecting operating results in its regulated books of 
account, and
    (b) If to compute its allowance for depreciation under section 167 
it uses a method of depreciation other than the method it used for 
purposes described in (a) of this subdivision, the taxpayer makes 
adjustments consistent with subparagraph (2) of this paragraph to a 
reserve to reflect the total amount of the deferral of Federal income 
tax liability resulting from the use with respect to all of its public 
utility property of such different methods of depreciation.
    (ii) In the case of a taxpayer described in section 167(l) (1) (B) 
or (2) (C), the reference in subdivision (i) of this subparagraph shall 
be a reference only to such taxpayer's ``qualified public utility 
property''. See Sec. 1.167(l)-2(b) for definition of ``qualified public 
utility property''.
    (iii) Except as provided in this subparagraph, the amount of Federal 
income tax liability deferred as a result of the use of different method 
of depreciation under subdivision (i) of this subparagraph is the excess 
(computed without regard to credits) of the amount the tax liability 
would have been had a subsection (l) method been used over the amount of 
the actual tax liability. Such amount shall be taken into account for 
the taxable year in

[[Page 1031]]

which such different methods of depreciation are used. If, however, in 
respect of any taxable year the use of a method of depreciation other 
than a subsection (l) method for purposes of determining the taxpayer's 
reasonable allowance under section 167(a) results in a net operating 
loss carryover (as determined under section 172) to a year succeeding 
such taxable year which would not have arisen (or an increase in such 
carryover which would not have arisen) had the taxpayer determined his 
reasonable allowance under section 167(a) using a subsection (l) method, 
then the amount and time of the deferral of tax liability shall be taken 
into account in such appropriate time and manner as is satisfactory to 
the district director.
    (2) Adjustments to reserve. (i) The taxpayer must credit the amount 
of deferred Federal income tax determined under subparagraph (1)(i) of 
this paragraph for any taxable year to a reserve for deferred taxes, a 
depreciation reserve, or other reserve account. The taxpayer need not 
establish a separate reserve account for such amount but the amount of 
deferred tax determined under subparagraph (1) (i) of this paragraph 
must be accounted for in such a manner so as to be readily identifiable. 
With respect to any account, the aggregate amount allocable to deferred 
tax under section 167(l) shall not be reduced except to reflect the 
amount for any taxable year by which Federal income taxes are greater by 
reason of the prior use of different methods of depreciation under 
subparagraph (1)(i) of this paragraph. An additional exception is that 
the aggregate amount allocable to deferred tax under section 167(l) may 
be properly adjusted to reflect asset retirements or the expiration of 
the period for depreciation used in determining the allowance for 
depreciation under section 167(a).

    (ii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example (1). Corporation X is exclusively engaged in the 
transportation of gas by pipeline subject to the jurisdiction of the 
Federal Power Commission. With respect to its post-1969 public utility 
property, X is entitled under section 167(l)(2)(B) to use a method of 
depreciation other than a subsection (l) method if it uses a 
normalization method of regulated accounting. With respect to such 
property, X has not made any election under Sec. 1.167(a)-11 (relating 
to depreciation based on class lives and asset depreciation ranges). In 
1972, X places in service public utility property with an unadjusted 
basis of $2 million, and an estimated useful life of 20 years. X uses 
the declining balance method of depreciation with a rate twice the 
straight line rate. If X uses a normalization method of regulated 
accounting, the amount of depreciation allowable under section 167(a) 
with respect to such property for 1972 computed under the double 
declining balance method would be $200,000. X computes its tax expense 
and depreciation expense for purposes of determining its cost of service 
for rate-making purposes and for reflecting operating results in its 
regulated books of account using the straight line method of 
depreciation (a subsection (l) method). A depreciation allowance 
computed in this manner is $100,000. The excess of the depreciation 
allowance determined under the double declining balance method 
($200,000) over the depreciation expense computed using the straight 
line method ($100,000) is $100,000. Thus, assuming a tax rate of 48 
percent, X used a normalization method of regulated accounting for 1972 
with respect to property placed in service that year if for 1972 it 
added to a reserve $48,000 as taxes deferred as a result of the use by X 
of a method of depreciation for Federal income tax purposes different 
from that used for establishing its cost of service for ratemaking 
purposes and for reflecting operating results in its regulated books of 
account.
    Example (2). Assume the same facts as in example (1), except that X 
elects to apply Sec. 1.167(a)-11 with respect to all eligible property 
placed in service in 1972. Assume further that all property X placed in 
service in 1972 is eligible property. One hudnred percent of the asset 
guideline period for such property is 22 years and the asset 
depreciation range is from 17.5 years to 26.5 years. X uses the double 
declining balance method of depreciation, selects an asset depreciation 
period of 17.5 years, and applies the half-year convention (described in 
Sec. 1.167(a)-11(c)(2)(iii)). In 1972, the depreciation allowable under 
section 167(a) with respect to property placed in service in 1972 is 
$114,285 (determined without regard to the normalization requirements in 
Sec. 1.167(a)-11(b)(6) and in section 167(l)). X computes its tax 
expense for purposes of determining its cost of service for ratemaking 
purposes and for reflecting operating results in its regulated books of 
account using the straight line method of depreciation (a subsection (l) 
method), an estimated useful life of 22 years (that is, 100 percent of 
the asset guideline period), and the half-year convention. A 
depreciation allowance computed in this manner is $45,454. Assuming a 
tax rate of 48 percent, the amount

[[Page 1032]]

that X must add to a reserve for 1972 with respect to property placed in 
service that year in order to qualify as using a normalization method of 
regulated accounting under section 167(l) (3) (G) is $27,429 and the 
amount in order to satisfy the normalization requirements of Sec. 
1.167(a)-11(b)(6) is $5,610. X determined such amounts as follows:

(1) Depreciation allowance on tax return (determined without    $114,285
 regard to section 167(l) and Sec.  1.167(a)-11(b) (6))....
(2) Line (1), recomputed using a straight line method.......      57,142
                                                             -----------
(3) Difference in depreciation allowance attributable to         $57,143
 different methods (line (1) minus line (2))................
(4) Amount to add to reserve under this paragraph (48             27,429
 percent of line (3)).......................................
                                                             ===========
(5) Amount in line (2)......................................     $57,142
(6) Line (5), recomputed by using an estimated useful life        45,454
 of 22 years and the half-year convention...................
                                                             -----------
(7) Difference in depreciation allowance attributable to         $11,688
 difference in depreciation periods.........................
(8) Amount to add to reserve under Sec.  1.167(a)-11(b) (6)       5,610
 (ii) (48 percent of line (7))..............................
                                                             ===========
 


If, for its depreciation expense for purposes of determining its cost of 
service for ratemaking purposes and for reflecting operating results in 
its regulated books of account, X had used a period in excess of the 
asset guideline period of 22 years, the total amount in lines (4) and 
(8) in this example would not be changed.
    Example (3). Corporation Y, a calendar-year taxpayer which is 
engaged in furnishing electrical energy, made the election provided by 
section 167(l) (4) (a) with respect to its ``qualified public utility 
property'' (as defined in Sec. 1.167(l)-2(b)). In 1971, Y placed in 
service qualified public utility property which had an adjusted basis of 
$2 million, estimated useful life of 20 years, and no salvage value. 
With respect to property of the same kind most recently placed in 
service, Y used a flow-through method of regulated accounting for its 
July 1969 regulated accounting period and the applicable 1968 method is 
the declining balance method of depreciation using 200 percent of the 
straight line rate. The amount of depreciation allowable under the 
double declining balance method with respect to the qualified public 
utility property would be $200,000. Y computes its tax expense and 
depreciation expense for purposes of determining its cost of service for 
ratemaking purposes and for reflecting operating results in its 
regulated books of account using the straight line method of 
depreciation. A depreciation allowance with respect to the qualified 
public utility property determined in this manner is $100,000. The 
excess of the depreciation allowance determined under the double 
declining balance method ($200,000) over the depreciation expense 
computed using the straight line method ($100,000) is $100,000. Thus, 
assuming a tax rate of 48 percent, Y used a normalization method of 
regulated accounting for 1971 if for 1971 it added to a reserve $48,000 
as tax deferred as a result of the use by Y of a method of depreciation 
for Federal income tax purposes with respect to its qualified public 
utility property which method was different from that used for 
establishing its cost of service for ratemaking purposes and for 
reflecting operating results in its regulated books of account for such 
property.
    Example (4). Corporation Z, exclusively engaged in a public utility 
activity did not use a flow-through method of regulated accounting for 
its July 1969 regulated accounting period. In 1971, a regulatory body 
having jurisdiction over all of Z's property issued an order applicable 
to all years beginning with 1968 which provided, in effect, that Z use 
an accelerated method of depreciation for purposes of section 167 and 
for determining its tax expenses for purposes of reflecting operating 
results in its regulated books of account. The order further provided 
that Z normalize 50 percent of the tax deferral resulting from the use 
of the accelerated method of depreciation and that Z flow-through 50 
percent of the tax deferral resulting therefrom. Under section 167(l), 
the method of accounting provided in the order would not be a 
normalization method of regulated accounting because Z would not be 
permitted to normalize 100 percent of the tax deferral resulting from 
the use of an accelerated method of depreciation. Thus, with respect to 
its public utility property for purposes of section 167, Z may only use 
a subsection (l) method of depreciation.
    Example (5). Assume the same facts as in example (4) except that the 
order of the regulatory body provided, in effect, that Z normalize 100 
percent of the tax deferral with respect to 50 percent of its public 
utility property and flow-through the tax savings with respect to the 
other 50 percent of its property. Because the effect of such an order 
would allow Z to flow-through a portion of the tax savings resulting 
from the use of an accelerated method of depreciation, Z would not be 
using a normalization method of regulated accounting with respect to any 
of its properties. Thus, with respect to its public utility property for 
purposes of section 167, Z may only use a subsection (l) method of 
depreciation.

    (3) Establishing compliance with normalization requirements in 
respect of operating books of account. The taxpayer may establish 
compliance with the requirement in subparagraph (l)(i) of this

[[Page 1033]]

paragraph in respect of reflecting operating results, and adjustments to 
a reserve, in its operating books of account by reference to the 
following:
    (i) The most recent periodic report for a period beginning before 
the end of the taxable year, required by a regulatory body described in 
section 167(l)(3)(A) having jurisdiction over the taxpayer's regulated 
operating books of account which was filed with such body before the due 
date (determined with regard to extensions) of the taxpayer's Federal 
income tax return for such taxable year (whether or not such body has 
jurisdiction over rates).
    (ii) If subdivision (i) of this subparagraph does not apply, the 
taxpayer's most recent report to its shareholders for the taxable year 
but only if (a) such report was distributed to the shareholders before 
the due date (determined with regard to extensions) of the taxpayer's 
Federal income tax return for the taxable year and (b) the taxpayer's 
stocks or securities are traded in an established securities market 
during such taxable year. For purposes of this subdivision, the term 
``established securities market'' has the meaning assigned to such term 
in Sec. 1.453-3(d)(4).
    (iii) If neither subdivision (i) nor (ii) of this subparagraph 
applies, entries made to the satisfaction of the district director 
before the due date (determined with regard to extensions) of the 
taxpayer's Federal income tax return for the taxable year in its 
regulated books of account for its most recent period beginning before 
the end of such taxable year.
    (4) Establishing compliance with normalization requirements in 
computing cost of service for ratemaking purposes. (i) In the case of a 
taxpayer which used a flow-through method of regulated accounting for 
its July 1969 regulated accounting period or thereafter, with respect to 
all or a portion of its pre-1970 public utility property, if a 
regulatory body having jurisdiction to establish the rates of such 
taxpayer as to such property (or a court which has jurisdiction over 
such body) issues an order of general application (or an order of 
specific application to the taxpayer) which states that such regulatory 
body (or court) will permit a class of taxpayers of which such taxpayer 
is a member (or such taxpayer) to use the normalization method of 
regulated accounting to establish cost of service for ratemaking 
purposes with respect to all or a portion of its public utility 
property, the taxpayer will be presumed to be using the same method of 
depreciation to compute both its tax expense and its depreciation 
expense for purposes of establishing its cost of service for ratemaking 
purposes with respect to the public utility property to which such order 
applies. In the event that such order is in any way conditional, the 
preceding sentence shall not apply until all of the conditions contained 
in such order which are applicable to the taxpayer have been fulfilled. 
The taxpayer shall establish to the satisfaction of the Commissioner or 
his delegate that such conditions have been fulfilled.
    (ii) In the case of a taxpayer which did not use the flow-through 
method of regulated accounting for its July 1969 regulated accounting 
period or thereafter (including a taxpayer which used a subsection (l) 
method of depreciation to compute its allowance for depreciation under 
section 167(a) and to compute its tax expense for purposes of reflecting 
operating results in its regulated books of account), with respect to 
any of its public utility property, it will be presumed that such 
taxpayer is using the same method of depreciation to compute both its 
tax expense and its depreciation expense for purposes of establishing 
its cost of service for ratemaking purposes with respect to its post-
1969 public utility property. The presumption described in the preceding 
sentence shall not apply in any case where there is (a) an expression of 
intent (regardless of the manner in which such expression of intent is 
indicated) by the regulatory body (or bodies), having jurisdiction to 
establish the rates of such taxpayer, which indicates that the policy of 
such regulatory body is in any way inconsistent with the use of the 
normalization method of regulated accounting by such taxpayer or by a 
class of taxpayers of which such taxpayer is a member, or (b) a decision 
by a court having jurisdiction over such regulatory body which decision 
is in any way inconsistent with the use of

[[Page 1034]]

the normalization method of regulated accounting by such taxpayer or a 
class of taxpayers of which such taxpayer is a member. The presumption 
shall be applicable on January 1, 1970, and shall, unless rebutted, be 
effective until an inconsistent expression of intent is indicated by 
such regulatory body or by such court. An example of such an 
inconsistent expression of intent is the case of a regulatory body which 
has, after the July 1969 regulated accounting period and before January 
1, 1970, directed public utilities subject to its ratemaking 
jurisdiction to use a flow-through method of regulated accounting, or 
has issued an order of general application which states that such agency 
will direct a class of public utilities of which the taxpayer is a 
member to use a flow-through method of regulated accounting. The 
presumption described in this subdivision may be rebutted by evidence 
that the flow-through method of regulated accounting is being used by 
the taxpayer with respect to such property.
    (iii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example (1). Corporation X is a calendar-year taxpayer and its 
``applicable 1968 method'' is a straight line method of depreciation. 
Effective January 1, 1970, X began collecting rates which were based on 
a sum of the years-digits method of depreciation and a normalization 
method of regulated accounting which rates had been approved by a 
regulatory body having jurisdiction over X. On October 1, 1971, a court 
of proper jurisdiction annulled the rate order prospectively, which 
annulment was not appealed, on the basis that the regulatory body had 
abused its discretion by determining the rates on the basis of a 
normalization method of regulated accounting. As there was no 
inconsistent expression of intent during 1970 or prior to the due date 
of X's return for 1970, X's use of the sum of the years-digits method of 
depreciation for purposes of section 167 on such return was proper. For 
1971, the presumption is in effect through September 30. During 1971, X 
may use the sum of the years-digits method of depreciation for purposes 
of section 167 from January 1 through September 30, 1971. After 
September 30, 1971, and for taxable years after 1971, X must use a 
straight line method of depreciation until the inconsistent court 
decision is no longer in effect.
    Example (2). Assume the same facts as in example (1), except that 
pursuant to the order of annulment, X was required to refund the portion 
of the rates attributable to the use of the normalization method of 
regulated accounting. As there was no inconsistent expression of intent 
during 1970 or prior to the due date of X's return for 1970, X has the 
benefit of the presumption with respect to its use of the sum of the 
years-digits method of depreciation for purposes of section 167, but 
because of the retroactive nature of the rate order X must file an 
amended return for 1970 using a straight line method of depreciation. As 
the inconsistent decision by the court was handed down prior to the due 
date of X's Federal income tax return for 1971, for 1971 and thereafter 
the presumption of subdivision (ii) of this subparagraph does not apply. 
X must file its Federal income tax returns for such years using a 
straight line method of depreciation.
    Example (3). Assume the same facts as in example (2), except that 
the annulment order was stayed pending appeal of the decision to a court 
of proper appellate jurisdiction, X has the benefit of the presumption 
as described in example (2) for the year 1970, but for 1971 and 
thereafter the presumption of subdivision (ii) of this subparagraph does 
not apply. Further, X must file an amended return for 1970 using a 
straight line method of depreciation and for 1971 and thereafter X must 
file its returns using a straight line method of depreciation unless X 
and the district director have consented in writing to extend the time 
for assessment of tax for 1970 and thereafter with respect to the issue 
of normalization method of regulated accounting for as long as may be 
necessary to allow for resolution of the appeal with respect to the 
annulment of the rate order.

    (5) Change in method of regulated accounting. The taxpayer shall 
notify the district director of a change in its method of regulated 
accounting, an order by a regulatory body or court that such method be 
changed, or an interim or final rate determination by a regulatory body 
which determination is inconsistent with the method of regulated 
accounting used by the taxpayer immediately prior to the effective date 
of such rate determination. Such notification shall be made within 90 
days of the date that the change in method, the order, or the 
determination is effective. In the case of a change in the method of 
regulated accounting, the taxpayer shall recompute its tax liability for 
any affected taxable year and such recomputation shall be made in the 
form of an amended return where necessary unless the taxpayer and the 
district director have consented in

[[Page 1035]]

writing to extend the time for assessment of tax with respect to the 
issue of normalization method of regulated accounting.
    (6) Exclusion of normalization reserve from rate base. (i) 
Notwithstanding the provisions of subparagraph (1) of this paragraph, a 
taxpayer does not use a normalization method of regulated accounting if, 
for ratemaking purposes, the amount of the reserve for deferred taxes 
under section 167(l) which is excluded from the base to which the 
taxpayer's rate of return is applied, or which is treated as no-cost 
capital in those rate cases in which the rate of return is based upon 
the cost of capital, exceeds the amount of such reserve for deferred 
taxes for the period used in determining the taxpayer's tax expense in 
computing cost of service in such ratemaking.
    (ii) For the purpose of determining the maximum amount of the 
reserve to be excluded from the rate base (or to be included as no-cost 
capital) under subdivision (i) of this subparagraph, if solely an 
historical period is used to determine depreciation for Federal income 
tax expense for ratemaking purposes, then the amount of the reserve 
account for the period is the amount of the reserve (determined under 
subparagraph (2) of this paragraph) at the end of the historical period. 
If solely a future period is used for such determination, the amount of 
the reserve account for the period is the amount of the reserve at the 
beginning of the period and a pro rata portion of the amount of any 
projected increase to be credited or decrease to be charged to the 
account during such period. If such determination is made by reference 
both to an historical portion and to a future portion of a period, the 
amount of the reserve account for the period is the amount of the 
reserve at the end of the historical portion of the period and a pro 
rata portion of the amount of any projected increase to be credited or 
decrease to be charged to the account during the future portion of the 
period. The pro rata portion of any increase to be credited or decrease 
to be charged during a future period (or the future portion of a part-
historical and part-future period) shall be determined by multiplying 
any such increase or decrease by a fraction, the numerator of which is 
the number of days remaining in the period at the time such increase or 
decrease is to be accrued, and the denominator of which is the total 
number of days in the period (or future portion).
    (iii) The provisions of subdivision (i) of this subparagraph shall 
not apply in the case of a final determination of a rate case entered on 
or before May 31, 1973. For this purpose, a determination is final if 
all rights to request a review, a rehearing, or a redetermination by the 
regulatory body which makes such determination have been exhausted or 
have lapsed. The provisions of subdivision (ii) of this subparagraph 
shall not apply in the case of a rate case filed prior to June 7, 1974 
for which a rate order is entered by a regulatory body having 
jurisdiction to establish the rates of the taxpayer prior to September 
5, 1974, whether or not such order is final, appealable, or subject to 
further review or reconsideration.
    (iv) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example (1). Corporation X is exclusively engaged in the 
transportation of gas by pipeline subject to the jurisdiction of the Z 
Power Commission. With respect to its post-1969 public utility property, 
X is entitled under section 167(l)(2)(B) to use a method of depreciation 
other than a subsection (l) method if it uses a normalization method of 
regulated accounting. With respect to X the Z Power Commission for 
purposes of establishing cost of service uses a recent consecutive 12-
month period ending not more than 4 months prior to the date of filing a 
rate case adjusted for certain known changes occurring within a 9-month 
period subsequent to the base period. X's rate case is filed on January 
1, 1975. The year 1974 is the recorded test period for X's rate case and 
is the period used in determining X's tax expense in computing cost of 
service. The rates are contemplated to be in effect for the years 1975, 
1976, and 1977. The adjustments for known changes relate only to wages 
and salaries. X's rate base at the end of 1974 is $145,000,000. The 
amount of the reserve for deferred taxes under section 167(l) at the end 
of 1974 is $1,300,000, and the reserve is projected to be $4,400,000 at 
the end of 1975, $6,500,000 at the end of 1976, and $9,800,000 at the 
end of 1977. X does not use a normalization method of regulated 
accounting if the Z Power Commission excludes more than $1,300,000 from 
the rate base to which X's rate of return is

[[Page 1036]]

applied. Similarly, X does not use a normalization method of regulated 
accounting if, instead of the above, the Z Power Commission, in 
determining X's rate of return which is applied to the rate base, 
assigns to no-cost capital an amount that represents the reserve account 
for deferred tax that is greater than $1,300,000.
    Example (2). Assume the same facts as in example (1) except that the 
adjustments for known changes in cost of service made by the Z Power 
Commission include an additional depreciation expense that reflects the 
installation of new equipment put into service on January 1, 1975. 
Assume further that the reserve for deferred taxes under section 167(1) 
at the end of 1974 is $1,300,000 and that the monthly net increases for 
the first 9 months of 1975 are projected to be:

January 1-31................................................    $310,000
February 1-28...............................................     300,000
March 1-31..................................................     300,000
April 1-30..................................................     280,000
May 1-31....................................................     270,000
June 1-30...................................................     260,000
July 1-31...................................................     260,000
August 1-31.................................................     250,000
September 1-30..............................................     240,000
                                                             -----------
                                                              $2,470,000
 


For its regulated books of account X accrues such increases as of the 
last day of the month but as a matter of convenience credits increases 
or charges decreases to the reserve account on the 15th day of the month 
following the whole month for which such increase or decrease is 
accrued. The maximum amount that may be excluded from the rate base is 
$2,470,879 (the amount in the reserve at the end of the historical 
portion of the period ($1,300,000) and a pro rata portion of the amount 
of any projected increase for the future portion of the period to be 
credited to the reserve ($1,170,879)). Such pro rata portion is computed 
(without regard to the date such increase will actually be posted to the 
account) as follows:

$310,000x243/273 =..........................................    $275,934
300,000x215/273 =...........................................     236,264
300,000x184/273 =...........................................     202,198
280,000x154/273 =...........................................     157,949
270,000x123/273 =...........................................     121,648
260,000x93/273 =............................................      88,571
260,000x62/273 =............................................      59,048
250,000x31/273 =............................................      28,388
240,000x1/273=..............................................         879
                                                             -----------
                                                              $1,170,879
 

    Example (3). Assume the same facts as in example (1) except that for 
purposes of establishing cost of service the Z Power Commission uses a 
future test year (1975). The rates are contemplated to be in effect for 
1975, 1976, and 1977. Assume further that plant additions, depreciation 
expense, and taxes are projected to the end of 1975 and that the reserve 
for deferred taxes under section 167(l) is $1,300,000 for 1974 and is 
projected to be $4,400,000 at the end of 1975. Assume also that the Z 
Power Commission applies the rate of return to X's 1974 rate base of 
$145,000,000. X and the Z Power Commission through negotiation arrive at 
the level of approved rates. X uses a normalization method of regulated 
accounting only if the settlement agreement, the rate order, or record 
of the proceedings of the Z Power Commission indicates that the Z Power 
Commission did not exclude an amount representing the reserve for 
deferred taxes from X's rate base ($145,000,000) greater than $1,300,000 
plus a pro rata portion of the projected increases and decreases that 
are to be credited or charged to the reserve account for 1975. Assume 
that for 1975 quarterly net increases are projected to be:

1st quarter.................................................    $910,000
2nd quarter.................................................     810,000
3rd quarter.................................................     750,000
4th quarter.................................................     630,000
                                                             -----------
  Total.....................................................  $3,100,000
 


For its regulated books of account X will accrue such increases as of 
the last day of the quarter but as a matter of convenience will credit 
increases or charge decreases to the reserve account on the 15th day of 
the month following the last month of the quarter for which such 
increase or decrease will be accrued. The maximum amount that may be 
excluded from the rate base is $2,591,480 (the amount of the reserve at 
the beginning of the period ($1,300,000) plus a pro rata portion 
($1,291,480) of the $3,100,000 projected increase to be credited to the 
reserve during the period). Such portion is computed (without regard to 
the date such increase will actually be posted to the account) as 
follows:

$910,000x276/365=...........................................    $688,110
810,000x185/365=............................................     410,548
750,000x93/365=.............................................     191,096
630,000x1/365=..............................................       1,726
                                                             -----------
                                                              $1,291,480
 

    (i) Flow-through method of regulated accounting. Under section 
167(l)(3)(H), a taxpayer uses a flow-through method of regulated 
accounting with respect to public utility property if it uses the same 
method of depreciation (other than a subsection (l) method) to compute 
its allowance for depreciation under section 167 and to compute its tax 
expense for purposes of reflecting operating results in its regulated 
books of account unless such method is the same method used by the 
taxpayer to determine its depreciation expense for purposes of 
reflecting operating results in its regulated books of account. Except 
as provided in the preceding sentence, the method of depreciation used

[[Page 1037]]

by a taxpayer with respect to public utility property for purposes of 
determining cost of service for ratemaking purposes or rate base for 
ratemaking purposes shall not be considered in determining whether the 
taxpayer used a flow-through method of regulated accounting. A taxpayer 
may establish use of a flow-through method of regulated accounting in 
the same manner that compliance with normalization requirements in 
respect of operating books of account may be established under paragraph 
(h)(4) of this section.

[T.D. 7315, 39 FR 20195, June 7, 1974]



Sec. 1.167(l)-2  Public utility property; election as to post-1969 
property representing growth in capacity.

    (a) In general. Section 167(l)(2) prescribes the methods of 
depreciation which may be used by a taxpayer with respect to its post-
1969 public utility property. Under section 167(l)(2) (A) and (B) the 
taxpayer may use a subsection (l) method of depreciation (as defined in 
section 167(l)(3)(F)) or any other method of depreciation which is 
otherwise allowable under section 167 if, in conjunction with the use of 
such other method, such taxpayer uses the normalization method of 
accounting (as defined in section 167(l)(3)(G)). Paragraph (2)(C) of 
section 167(l) permits a taxpayer which used the flow-through method of 
accounting for its July 1969 accounting period (as these terms are 
defined in section 167(l)(3) (H) and (I), respectively) to use its 
applicable 1968 method of depreciation with respect to certain property. 
Section 167(l)(3)(D) describes the term ``applicable 1968 method''. 
Accordingly, a regulatory agency is not precluded by section 167(l) from 
requiring such a taxpayer subject to its jurisdiction to continue to use 
the flow-through method of accounting unless the taxpayer makes the 
election pursuant to section 167(l)(4)(A) and this section. Whether or 
not the election is made, if such a regulatory agency permits the 
taxpayer to change from the flow-through method of accounting, 
subsection (l)(2) (A) or (B) would apply and such taxpayer could, 
subject to the provisions of section 167(e) and the regulations 
thereunder (relating to change in method), use a subsection (l) method 
of depreciation or, if the taxpayer uses the normalization method of 
accounting, any other method of depreciation otherwise allowable under 
section 167.
    (1) Election. Under subparagraph (A) of section 167(l)(4), if the 
taxpayer so elects, the provisions of paragraph (2)(C) of section 167(l) 
shall not apply to its qualified public utility property (as such term 
is described in paragraph (b) of this section). In such case the 
taxpayer making the election shall use a method of depreciation 
prescribed by section 167(l)(2) (A) or (B) with respect to such 
property.
    (2) Property to which election shall apply. (i) Except as provided 
in subdivision (ii) of this subparagraph the election provided by 
section 167(l)(4)(A) shall apply to all of the qualified public utility 
property of the taxpayer.
    (ii) In the event that the taxpayer wishes the election provided by 
section 167(l)(4)(A) to apply to only a portion of its qualified public 
utility property, it must clearly identify the property to be subject to 
the election in the statement of election described in paragraph (e) of 
this section. Where all property which performs a certain function is 
included within the election, the election shall apply to all future 
acquisitions of qualified public utility property which perform the same 
function. Where only certain property within a functional group of 
property is included within the election, the election shall apply only 
to property which is of the same kind as the included property.
    (iii) The provisions of subdivision (ii) of this subparagraph may be 
illustrated by the following examples:

    Example (1). Corporation A, an electric utility company, wishes to 
have the election provided by section 167(l)(4)(A) apply only with 
respect to its production plant. A statement that the election shall 
apply only with respect to production plant will be sufficient to 
include within the election all of the taxpayer's qualified production 
plant of any kind. All public utility property of the taxpayer other 
than production plant will not be subject to the election.
    Example (2). Corporation B, an electric utility company, wishes to 
have the election provided by section 167(l)(4)(A) apply only with 
respect to nuclear production plant. A statement which clearly indicates 
that only nuclear production plant will be included in the election will 
be sufficient to exclude

[[Page 1038]]

from the election all public utility property other than nuclear 
production plant.

    (b) Qualified public utility property--(1) Definition. For purposes 
of this section the term ``qualified public utility property'' means 
post-1969 public utility property to which section 167(l)(2)(C) applies, 
or would apply if the election described in section 167(l)(4)(A) had not 
been made, to the extent that such property constitutes property which 
increases the productive or operational capacity of the taxpayer with 
respect to the goods or services described in section 167(l)(3)(A) and 
does not represent the replacement of existing capacity. In the event 
that particular assets which are post-1969 public utility property both 
replace existing public utility property and increase the productive or 
operational capacity of the taxpayer, only that portion of each such 
asset which is properly allocable, pursuant to the provisions of 
subparagraph (3)(v) of this paragraph or paragraph (c)(2) of this 
section (as the case may be), to increasing the productive or 
operational capacity of the taxpayer shall be qualified public utility 
property.
    (2) Limitation on use of formula method. A taxpayer which makes the 
election with respect to all of its post-1969 public utility property 
may determine the amount of its qualified public utility property by 
using the formula method described in paragraph (c) of this section or, 
where the taxpayer so chooses, it may use any other method based on 
engineering data which is satisfactory to the Commissioner. A taxpayer 
which chooses to include only a portion of its post-1969 public utility 
property in the election described in paragraph (a)(1) of this section 
shall, in a manner satisfactory to the Commissioner and consistent with 
the provisions of subparagraph (3) of this paragraph, use a method based 
on engineering data. If a taxpayer uses the formula method described in 
paragraph (c) of this section, it must continue to use such method with 
respect to additions made in subsequent taxable years. The taxpayer may 
change from an engineering method to the formula method described in 
paragraph (c) of this section by filing a statement described in 
paragraph (h) of this section if it could have used such formula method 
for the prior taxable year.
    (3) Measuring capacity under an engineering method in the case of a 
general election. (i) The provisions of this subparagraph apply in the 
case of an election made with respect to all of the post-1969 public 
utility property of the taxpayer.
    (ii) A taxpayer which uses a method based on engineering data to 
determine the portion of its additions for a taxable year which 
constitutes qualified public utility property shall make such 
determination with reference to its ``adjusted capacity'' as of the 
first day of the taxable year during which such additions are placed in 
service. For purposes of this subparagraph, the term ``adjusted 
capacity'' means the taxpayer's capacity as of January 1, 1970, adjusted 
upward in the manner described in subdivision (iii) of this subparagraph 
for each taxable year ending after December 31, 1969, and before the 
first day of the taxable year during which the additions described in 
the preceding sentence are placed in service.
    (iii) The adjustment described in this subdivision for each taxable 
year shall be equal to the number of units of capacity by which 
additions for the taxable year of public utility property with respect 
to which the election had been made exceed the number of units of 
capacity of retirements for such taxable year of public utility property 
with respect to which the flow-through method of accounting was being 
used at the time of their retirement. If for any taxable year the 
computation in the preceding sentence results in a negative amount, such 
negative amount shall be taken into account as a reduction in the amount 
of the adjustment (computed without regard to this sentence) in 
succeeding taxable years.
    (iv) The provisions of this subparagraph may be illustrated by the 
following table which assumes that the taxpayer's adjusted capacity as 
of January 1, 1970, was 5,000 units:

[[Page 1039]]



--------------------------------------------------------------------------------------------------------------------------------------------------------
                           1                                    2               3               4                5               6               7
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                             Units of
                                                                          Flow-through                       Adjusted         Actual         qualified
                          Year                              Additions      retirements    Net additions    capacity \1\      capacity      additions \1\
                                                                                                                                                \2\
--------------------------------------------------------------------------------------------------------------------------------------------------------
1970...................................................            1000             700             300             5000            5300             300
1971...................................................             300             500            (200)            5300            5100
1972...................................................             500             200             300             5300            5400             100
1973...................................................             400             800            (400)            5400            5000
1974...................................................             600             400             200             5400            5200
1975...................................................             800             300             500             5400            5700             300
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Capacity as of Jan. 1, 1970, plus amounts in column 7 for years prior to the year for which determination is being made.
\2\ Column 6 minus column 5.

    (v) The qualified portion of the basis for depreciation (as defined 
in section 167(g)) of each asset or group of assets (if group or 
composite accounting is used by the taxpayer) subject to the election 
shall be determined using the following ratio:

Qualified portion of basis of asset / Total basis of asset = Units of 
qualified additions computed in column 7 on chart / Units of capacity of 
additions computed in column 2 on chart.

    (c) Formula method of determining amount of property subject to 
election--(1) In general. The following formula method may be used to 
determine the amount of qualified public utility property:

    Step 1. Find the total cost (within the meaning of section 1012) to 
the taxpayer of additions during the taxable year of all post-1969 
public utility property with respect to which section 167(l)(2)(C) would 
apply if the election had not been made.
    Step 2. Aggregate the cost (within the meaning of section 1012) to 
the taxpayer of all retirements during the taxable year of public 
utility property with respect to which the flow-through method of 
accounting was being used at the time of their retirement.
    Step 3. Subtract the figure reached in step 2 from the figure 
reached in step 1.


In the event that the figure reached in step 2 exceeds the figure 
reached in step 1 such excess shall be carried forward to the next 
taxable year and shall be aggregated with the cost (within the meaning 
of section 1012) to the taxpayer of all retirements referred to in step 
2 for such next taxable year.
    (2) Allocation of bases. The amount of qualified public utility 
property as determined in accordance with the formula method described 
in subparagraph (1) of this paragraph shall be allocated to the basis 
for depreciation (as defined in section 167(g)) of each asset or group 
of assets (if group or composite accounting is used by the taxpayer) 
subject to the election using the following ratio:

Amount of qualified additions computed in step 3 / Amount of total 
additions computed in step 1 = Qualified portion of basis of asset / 
Total basis of asset.

    (d) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example (1). Corporation A, a telephone company subject to the 
jurisdiction of the Federal Communications Commission, elected, pursuant 
to the provisions of section 167(l)(4)(A) and this section, with respect 
to all of its qualified post-1969 public utility property to have the 
provisions of paragraph (2) (C) of section 167(l) not apply. In 1971 the 
Corporation added new underground cable with a cost (within the meaning 
of section 1012) to it of $4 million to its underground cable account. 
In the same year it retired public utility property with a cost (within 
the meaning of section 1012) to Corporation A of $1.5 million. The flow-
through method of accounting was being used with respect to all of the 
retired property at the time of retirement. Using the formula method 
described in paragraph (c) of this section, the amount of qualified 
underground cable would be determined as follows:

 
                                                                 Million
 
Step 1. Aggregate cost of flow-through additions..............      $4.0
Step 2. Cost of all flow-through retirements..................       1.5
                                                               ---------
Step 3. Figure reached in step 1 less figure reached in step 2       2.5
 


The amount of qualified public utility property to which section 
167(l)(2)(C) will not apply is $2.5 million. Pursuant to the provisions 
of paragraph (c)(2) of this section, the amount of qualified public 
utility property would be allocated to the basis for depreciation (as 
defined in section 167(g)) of an asset with a total basis for 
depreciation of $2 million as follows:


[[Page 1040]]


$2.5 million (figure in step 3)/$4 million (figure in step 1) = 
Qualified portion of basis of asset/$2 million Qualified portion of 
basis of asset =$1.25 million.
    Example (2). In 1972 Corporation A (the corporation described in 
example (1)) added underground cable with a cost (within the meaning of 
section 1012) to it of $1 million. In the same year the cost (within the 
meaning of section 1012) to the corporation of retirements of public 
utility property with respect to which the flow-through method of 
accounting was being used was $3 million. There were no other additions 
or retirements. The amount of qualified public utility property would be 
determined as follows:

 
                                                                Million
 
Step 1. Aggregate cost of flow-through additions.............      $1.0
Step 2. Cost of all flow-through retirements.................       3.0
                                                              ----------
Step 3. Figure reached in step 1 less figure reached in step       (2.0)
 2...........................................................
 


Since retirements of flow-through public utility property for the year 
1972 exceeded additions made during such year, the excess retirements, 
$2.0 million, must be carried forward to be aggregated with retirements 
for 1973.
    Example (3). Corporation B, a gas pipeline company subject to the 
jurisdiction of the Federal Power Commission, made the election provided 
by section 167(l)(4)(A) and this section with respect to all of its 
post-1969 public utility property. Corporation B chose to use an 
engineering data method of determining which property was subject to the 
election provided by this section. In 1970, the corporation replaced a 
portion of its pipeline with respect to which the flow-through method of 
accounting was being used at the time of its retirement which had a peak 
capacity on January 1, 1970, of 100,000 thousand cubic feet (M c.f.) per 
day at a pressure of 14.73 pounds per square inch absolute (p.s.i.a.) 
with pipe with a capacity of 125,000 M c.f. per day at 14.73 p.s.i.a. 
Assuming that there were no other additions or retirements, using an 
engineering data method one-fifth of the new pipeline would be property 
subject to the election of this section effective for its taxable year 
beginning on January 1, 1971.
    Example (4). In 1970 Corporation C (with the same characteristics as 
the corporation described in example (3)) extended its pipeline 5 miles 
further than it extended on January 1, 1970. Assuming that there were no 
other additions or retirements, the entire extension would be property 
subject to the election provided by this section effective for its 
taxable year beginning on January 1, 1971.
    Example (5). As a result of a change of service areas between two 
corporations, in 1970 Corporation D (with the same characteristics as 
the corporation described in example (3)) retired a pipeline running 
north and south and replaced it with a pipeline of equal length and 
capacity running east and west. No part of the pipeline running east and 
west is property subject to the election.

    (e) Manner of making election. The election described in paragraph 
(a) of this section shall be made by filing, in duplicate, with the 
Commissioner of Internal Revenue, Washington, D.C. 20224, Attention, 
T:I:E, a statement of such election.
    (f) Content of statement. The statement described in paragraph (e) 
of this section shall indicate that an election is being made under 
section 167(l) of the Internal Revenue Code of 1954, and it shall 
contain the following information:
    (1) The name, address, and taxpayer identification number of the 
taxpayer,
    (2) Whether the taxpayer will use the formula method of determining 
the amount of its qualified public utility property described in 
paragraph (c) of this section, or an engineering method, and
    (3) Where the taxpayer wishes to include only a portion of its 
public utility property in the election pursuant to the provisions of 
paragraph (a)(2) of this section, a description sufficient to clearly 
identify the property to be included.
    (g) Time for making election. The election permitted by this section 
shall be made by filing the statement described in paragraph (e) of this 
section not later than Monday, June 29, 1970.
    (h) Change of method of determining amount of qualified property. 
Where a taxpayer which has elected pursuant to the provisions of section 
167(l)(4)(A) wishes to change, pursuant to the provisions of paragraph 
(b)(2) of this section, from an engineering data method of determining 
which of its property is qualified public utility property to the 
formula method described in paragraph (c) of this section, it may do so 
by filing a statement to that effect at the time that it files its 
income tax return, with the district director or director of the 
regional service center, with whom the taxpayer's income tax return is 
required to be filed.
    (i) Revocability of election. An election made under section 167(l) 
shall be irrevocable.

[[Page 1041]]

    (j) Effective date. The election prescribed by section 167(l)(4)(A) 
and this section shall be effective for taxable years beginning after 
December 31, 1970.

[T.D. 7045, 35 FR 8933, June 10, 1970. Redesignated by T.D. 7315, 39 FR 
20195, June 7, 1974]



Sec. 1.167(l)-3  Multiple regulation, asset acquisitions, 
reorganizations, etc.

    (a) Property not entirely subject to jurisdiction of one regulatory 
body--(1) In general. If a taxpayer which uses a method of depreciation 
other than a subsection (l) method of depreciation is required by a 
regulatory body having jurisdiction over less than all of its property 
to use, or not to use, a method of regulated accounting (i.e., 
normalization or flow-through), such taxpayer shall be considered as 
using, or not using, such method of regulated accounting only with 
respect to property subject to the jurisdiction of such regulatory body. 
In the case of property which is contained in a multiple asset account, 
the provisions of Sec. 1.167(a)-7(c) and Sec. 1.167 (a)-11(c)(1)(iv) 
apply to prohibit depreciating a single account by two or more different 
methods.
    (2) Jurisdiction of regulatory body. For purposes of this paragraph, 
a regulatory body is considered to have jurisdiction over property of a 
taxpayer if expenses with respect to the property are included in cost 
of service as determined by the regulatory body for ratemaking purposes 
or for reflecting operating results in its regulated books of account. 
For example, if regulatory body A, having jurisdiction over 60 percent 
of an item of X corporation's public utility property, required X to use 
the flow-through method of regulated accounting in circumstances which 
would bar X from using a method of depreciation under section 167(a) 
other than a subsection (l) method, and if regulatory body B, having 
jurisdiction over the remaining 40 percent of such item of property does 
not so require X to use the flow-through method of regulated accounting 
(or if the remaining 40 percent is not subject to the jurisdiction of 
any regulatory body), then with respect to 60 percent of the adjusted 
basis of the property X is prohibited from using a method of 
depreciation for purposes of section 167(a) other than a subsection (1) 
method. If in such example, A, having jurisdiction over 60 percent of 
X's public utility property, had jurisdiction over 100 percent of a 
particular generator, then with respect to the generator X would be 
prohibited from using a method of depreciation other than a subsection 
(l) method.
    (3) Public utility property subject to more than one regulatory 
body. If a regulatory body having jurisdiction over public utility 
property with respect to the taxpayer's regulated books of account 
requires the taxpayer to reflect its tax expense in such books in the 
manner used by the regulatory body having jurisdiction over the public 
utility property for purposes of determining the taxpayer's cost of 
service for ratemaking purposes, the rules of subparagraphs (1) and (2) 
of this paragraph shall apply.
    (b) Leasing transactions--(1) Leased property. Public utility 
property as defined in paragraph (b) of Sec. 1.167(l)-1 includes 
property which is leased by a taxpayer where the leasing of such 
property is part of the lessor's section 167(l) public utility activity. 
Thus, such leased property qualifies as public utility property even 
though the predominant use of such property by the lessee is in other 
than a section 167(l) public utility activity. Further, leased property 
qualifies as public utility property under section 167(l) even though 
the leasing is not part of the lessor's public utility activity if the 
predominant use of such property by the lessee or any sublessee is in a 
section 167(l) public utility activity. However, the limitations of 
section 167(l) apply to a taxpayer only if such taxpayer is subject to 
the jurisdiction of a regulatory body described in a section 
167(l)(3)(A). For example, if a financial institution purchases property 
which it then leases to a lessee which uses such property predominantly 
in a section 167(l) public utility activity, the property qualifies as 
public utility property. However, because the financial institution's 
rates for leasing the property are not subject to the jurisdiction of a 
regulatory body described in section 167(l)(3)(A), the provisions of 
section 167(l) do not apply to the depreciation deductions taken with 
respect to

[[Page 1042]]

the property by the financial institution. For possible application of 
section 167(l) to the lessee, see subparagraph (2) of this paragraph.
    (2) Certain rental payments. Under section 167(l)(5), if a taxpayer 
leases property which is public utility property and the regulatory body 
having jurisdiction over such property for purposes of determining the 
taxpayer's operating results in its regulated books of account or for 
ratemaking purposes allows only an amount of such lessee's expenses with 
respect to the lease which is less than the amount which the taxpayer 
deducts for purposes of its Federal income tax liability, then a portion 
of the difference between such amounts shall not be allowed as a 
deduction by the taxpayer for purposes of its Federal income tax 
liability in such manner and time as the Commissioner or his delegate 
may determine consistent with the principles of Sec. 1.167(l)-1 and 
this section applicable as to when a method of depreciation other than a 
subsection (1) method may be used for purposes of section 167(a).
    (c) Certain partnership arrangements. Under section 167(l)(5), if 
property held by a partnership is not public utility property in the 
hands of the partnership but would be public utility property if an 
election was made under section 761 to be excluded from partnership 
treatment, then section 167(l) shall be applied by treating the partners 
as directly owning the property in proportion to their partnership 
interests.
    (d) Cross reference. See Sec. 1.167(l)-1(c)(1) for treatment of 
certain property as ``pre-1970 public utility property'' and Sec. 
1.167(l)-1(e)(4)(ii) for applicable 1968 method in the case of property 
acquired in certain transactions.

[T.D. 7315, 39 FR 20202, June 7, 1974]



Sec. 1.167(l)-4  Public utility property; election to use asset 
depreciation range system.

    (a) Application of section 167(l) to certain property subject to 
asset depreciation range system. If the taxpayer elects to compute 
depreciation under the asset depreciation range system described in 
Sec. 1.167(a)-11 with respect to certain public utility property placed 
in service after December 31, 1970, see Sec. 1.167(a)-11(b) (6).

(Sec. 167 of the Internal Revenue Code of 1954 (26 U.S.C. 167) and sec. 
7805 of the Internal Revenue Code of 1954 (26 U.S.C. 7805))

[T.D. 7128, 36 FR 11939, June 23, 1971. Redesignated by T.D. 7315, 39 FR 
20203, June 7, 1974]



Sec. 1.167(m)-1  Class lives.

    (a) For rules regarding the election to use the class life system 
authorized by section 167(m), see the provisions of Sec. 1.167(a)-11.

(Sec. 167(m), 85 Stat. 508 (26 U.S.C. 167))

[T.D. 7272, 38 FR 9986, Apr. 23, 1973]



Sec. 1.168-5  Special rules.

    (a) Retirement-replacement-betterment (RRB) property--(1) RRB 
replacement property placed in service before January 1, 1985. (i) 
Except as provided in paragraph (a)(1)(ii) of this section, the recovery 
deduction for the taxable year for retirement-replacement-betterment 
(RRB) replacement property (as defined in paragraph (a)(3) of this 
section) placed in service before January 1, 1985, shall be (in lieu of 
the amount determined under section 168(b)) an amount determined by 
applying to the unadjusted basis (as defined in section 168(d)(1) and 
the regulations thereunder) of such property the applicable percentage 
determined in accordance with the following table:

------------------------------------------------------------------------
                                         And the year the property is
                                             placed in service is:
      If the recovery year is:       -----------------------------------
                                        1981     1982     1983     1984
------------------------------------------------------------------------
                                         The applicable percentage is:
 
1...................................      100       50       33       25
2...................................  .......       50       45       38
3...................................  .......  .......       22       25
4...................................  .......  .......  .......       12
------------------------------------------------------------------------

    (ii) The provisions of paragraph (a)(1)(i) of this section do not 
apply to any taxpayer who did not use the RRB method of depreciation 
under section 167 as of December 31, 1980. In such case, RRB replacement 
property placed in service by the taxpayer after December 31, 1980, 
shall be treated as other 5-year recovery property under section 168.
    (2) RRB replacement property placed in service after December 31, 
1984. RRB replacement property placed in service

[[Page 1043]]

after December 31, 1984, is treated as other 5-year recovery property 
under section 168.
    (3) RRB replacement property defined. RRB replacement property, for 
purposes of section 168, means replacement track material (including 
rail, ties, other track material, and ballast) installed by a railroad 
(including a railroad switching or terminal company) if--
    (i) The replacement is made pursuant to a scheduled program for 
replacement.
    (ii) The replacement is made pursuant to observations by 
maintenance-of-way personnel of specific track material needing 
replacement.
    (iii) The replacement is made pursuant to the detection by a rail-
test car of specific track material needing replacement, or
    (iv) The replacement is made as a result of a casualty.

Replacements made as a result of a casualty shall be RRB replacement 
property only to the extent that, in the case of each casualty, the 
replacement cost with respect to the replacement track material exceeds 
$50,000.
    (4) Recovery of adjusted basis of RRB property as of December 31, 
1980. The taxpayer shall recover the adjusted basis of RRB property (as 
defined in section 168(g)(6)) as of December 31, 1980, over a period of 
not less than 5 years and not more than 50 years, using a rate of 
recovery consistent with any method described in section 167(b), 
including the method described in section 167(b)(2), switching to the 
method described in section 167(b)(3) at a time to maximize the 
deduction. For purposes of determining the recovery allowance under this 
subparagraph, salvage value shall be disregarded and, in the case of a 
taxpayer that depreciated RRB property placed in service before January 
1, 1981, using the RRB method consistently for all periods after 
February 28, 1913, the adjusted basis of RRB property is the adjusted 
basis for purposes of determining the deduction for retirements under 
the RRB method, with no adjustment for depreciation sustained prior to 
March 1, 1913.
    (5) RRB property (which is not RRB replacement property) placed in 
service after December 31, 1980. Property placed in service by the 
taxpayer after December 31, 1980, which is not RRB replacement property 
and which, under the taxpayer's method of depreciation as of December 
31, 1980, would have been depreciated by the taxpayer under the RRB 
method, is treated as other property under section 168.
    (b)-(f) [Reserved]

[T.D. 8116, 51 FR 46619, Dec. 24, 1986]



Sec. 1.168(a)-1T  Modified accelerated cost recovery system (temporary).

    (a) Section 168 determines the depreciation allowance for tangible 
property that is of a character subject to the allowance for 
depreciation provided in section 167(a) and that is placed in service 
after December 31, 1986 (or after July 31, 1986, if the taxpayer made an 
election under section 203(a)(1)(B) of the Tax Reform Act of 1986; 100 
Stat. 2143). Except for property excluded from the application of 
section 168 as a result of section 168(f) or as a result of a 
transitional rule, the provisions of section 168 are mandatory for all 
eligible property. The allowance for depreciation under section 168 
constitutes the amount of depreciation allowable under section 167(a). 
The determination of whether tangible property is property of a 
character subject to the allowance for depreciation is made under 
section 167 and the regulations under section 167.
    (b) This section is applicable on and after February 27, 2004.
    (c) The applicability of this section expires on or before February 
26, 2007.

[T.D. 9115, 69 FR 9533, Mar. 1, 2004; 69 FR 17586, Apr. 5, 2004]



Sec. 1.168(b)-1T  Definitions (temporary).

    (a) Definitions. For purposes of section 168 and the regulations 
under section 168, the following definitions apply:
    (1) Depreciable property is property that is of a character subject 
to the allowance for depreciation as determined under section 167 and 
the regulations under section 167.
    (2) MACRS property is tangible, depreciable property that is placed 
in service after December 31, 1986 (or after July 31, 1986, if the 
taxpayer made an election under section 203(a)(1)(B) of

[[Page 1044]]

the Tax Reform Act of 1986; 100 Stat. 2143) and subject to section 168, 
except for property excluded from the application of section 168 as a 
result of section 168(f) or as a result of a transitional rule.
    (3) Unadjusted depreciable basis is the basis of property for 
purposes of section 1011 without regard to any adjustments described in 
section 1016(a)(2) and (3). This basis reflects the reduction in basis 
for the percentage of the taxpayer's use of property for the taxable 
year other than in the taxpayer's trade or business (or for the 
production of income), for any portion of the basis the taxpayer 
properly elects to treat as an expense under section 179, and for any 
adjustments to basis provided by other provisions of the Internal 
Revenue Code and the regulations under the Code (other than section 
1016(a)(2) and (3)) (for example, a reduction in basis by the amount of 
the disabled access credit pursuant to section 44(d)(7)). For property 
subject to a lease, see section 167(c)(2).
    (4) Adjusted depreciable basis is the unadjusted depreciable basis 
of the property, as defined in Sec. 1.168(b)-1T(a)(3), less the 
adjustments described in section 1016(a)(2) and (3).
    (b) Effective date. (1) This section is applicable on February 27, 
2004.
    (2) The applicability of this section expires on or before February 
26, 2007.

[T.D. 9115, 69 FR 9533, Mar. 1, 2004; 69 FR 17586, Apr. 5, 2004]



Sec. 1.168(d)-0  Table of contents for the applicable convention rules.

    This section lists the major paragraphs in Sec. 1.168(d)-1.

   Sec. 1.168(d)-1 Applicable conventions--Half-year and mid-quarter 
                              conventions.

    (a) In general.
    (b) Additional rules for determining whether the mid-quarter 
convention applies and for applying the applicable convention.
    (1) Property described in section 168(f).
    (2) Listed property.
    (3) Property placed in service and disposed of in the same taxable 
year.
    (4) Aggregate basis of property.
    (5) Special rules for affiliated groups.
    (6) Special rule for partnerships and S corporations.
    (7) Certain nonrecognition transactions.
    (c) Disposition of property subject to the half-year or mid-quarter 
convention.
    (1) In general.
    (2) Example.
    (d) Effective date.

[T.D. 8444, 57 FR 48981, Oct. 29, 1992]



Sec. 1.168(d)-1  Applicable convention--Half-year and mid-quarter 
conventions.

    (a) In general. Under section 168(d), the half-year convention 
applies to depreciable property (other than certain real property 
described in section 168(d)(2)) placed in service during a taxable year, 
unless the mid-quarter convention applies to the property. Under section 
168(d)(3)(A), the mid-quarter convention applies to depreciable property 
(other than certain real property described in section 168(d)(2)) placed 
in service during a taxable year if the aggregate basis of property 
placed in service during the last three months of the taxable year 
exceeds 40 percent of the aggregate basis of property placed in service 
during the taxable year (``the 40-percent test''). Thus, if the 
depreciable property is placed in service during a taxable year that 
consists of three months or less, the mid-quarter convention applies to 
the property. Under section 168(d)(3)(b)(i), the depreciable basis of 
nonresidential real property, residential rental property, and any 
railroad grading or tunnel bore is disregarded in applying the 40-
percent test. For rules regarding property that is placed in service and 
disposed of in the same taxable year, see paragraph (b)(3) of this 
section. For the definition of ``aggregate basis of property,'' see 
paragraph (b)(4) if this section.
    (b) Additional rules for determining whether the mid-quarter 
convention applies and for applying the applicable convention--(1) 
Property described in section 168(f). In determining whether the 40-
percent test is testified for a taxable year, the depreciable basis of 
property described in section 168(f) (property to which section 168 does 
not apply) is not taken into account.
    (2) Listed property. The depreciable basis of listed property (as 
defined in section 280F(d)(4) and the regulations thereunder) placed in 
service during a taxable year is taken into account (unless otherwise 
excluded) in applying the 40-percent test.

[[Page 1045]]

    (3) Property placed in service and disposed of in the same taxable 
year. (i) and (ii) [Reserved] For further guidance, see Sec. 1.168(d)-
1T(b)(3)(i) and (ii).
    (4) Aggregate basis of property. For purposes of the 40-percent 
test, the term ``aggregate basis of property'' means the sum of the 
depreciable bases of all items of depreciable property that are taken 
into account in applying the 40-percent test. ``Depreciable basis'' 
means the basis of depreciable property for purposes of determining gain 
under sections 1011 through 1024. The depreciable basis for the taxable 
year the property is placed in service reflects the reduction in basis 
for--
    (i) Any portion of the basis the taxpayer properly elects to treat 
as an expense under section 179;
    (ii) Any adjustment to basis under section 48(q); and
    (iii) The percentage of the taxpayer's use of the property for the 
taxable year other than in the taxpayer's trade or business (or for the 
production of income), but is determined before any reduction for 
depreciation under section 167(a) for that taxable year.
    (5) Special rules for affiliated groups--(i) In the case of a 
consolidated group (as defined in Sec. 1.1502-1(h)), all members of the 
group that are included on the consolidated return are treated as one 
taxpayer for purposes of applying the 40-percent test. Thus, the 
depreciable bases of all property placed in service by members of a 
consolidated group during a consolidated return year are taken into 
account (unless otherwise excluded) in applying the 40-percent test to 
determine whether the mid-quarter convention applies to property placed 
in service by the members during the consolidated return year. The 40-
percent test is applied separately to the depreciable bases of property 
placed in service by any member of an affiliated group that is not 
included in a consolidated return of the taxable year in which the 
property is placed in service.
    (ii) In the case of a corporation formed by a member or members of a 
consolidated group and that is itself a member of the consolidated group 
(``newly-formed subsidiary''), the depreciable bases of property placed 
in service by the newly-formed subsidiary in the consolidated return 
year in which it is formed is included with the depreciable bases of 
property placed in service during the consolidated return year by the 
other members of the consolidated group in applying the 40-percent test. 
If depreciable property is placed in service by a newly-formed 
subsidiary during the consolidated return year in which it was formed, 
the newly-formed subsidiary is considered as being in existence for the 
entire consolidated return year for purposes of applying the applicable 
convention to determine when the recovery period begins.
    (iii) The provisions of paragraph (b)(5)(ii) of this section are 
illustrated by the following example.

    Example. Assume a member of a consolidated group that files its 
return on a calendar-year basis forms a subsidiary on August 1. The 
subsidiary places depreciable property in service on August 5. If the 
mid-quarter convention applies to property placed in service by the 
members of the consolidated group (including the newly-formed 
subsidiary), the property placed in service by the subsidiary on August 
5 is deemed placed in service on the mid-point of the third quarter of 
the consolidated return year (i.e., August 15). If the mid-quarter 
convention does not apply, the property is deemed placed in service on 
the mid-point of the consolidated return year (i.e., July 1).

    (iv) In the case of a corporation that joins or leaves a 
consolidated group, the depreciable bases of property placed in service 
by the corporation joining or leaving the group during the portion of 
the consolidated return year that the corporation is a member of the 
consolidated group is included with the depreciable bases of property 
placed in service during the consolidated return year by the other 
members in applying the 40-percent test. The depreciable bases of 
property placed in service by the joining or leaving member in the 
taxable year before it joins or after it leaves the consolidated group 
is not taken into account by the consolidated group in applying the 40-
percent test for the consolidated return year. If a corporation leaves a 
consolidated group and joins another consolidated group, each 
consolidated group takes into account, in applying the 40-percent test, 
the depreciable bases of property placed in service by

[[Page 1046]]

the corporation while a member of the group.
    (v) The provisions of paragraph (b)(5)(iv) of this section are 
illustrated by the following example.

    Example. Assume Corporations A and B file a consolidated return on a 
calendar-year basis. Corporation C, also a calendar-year taxpayer, 
enters the consolidated group on July 1 and is included on the 
consolidated return for that taxable year. The depreciable bases of 
property placed in service by C during the period of July 1 to December 
31 is included with the depreciable bases of property placed in service 
by A and B during the entire consolidated return year in applying the 
40-percent test. The depreciable bases of property placed in service by 
C from January 1 to June 30 is not taken into account by the 
consolidated group in applying the 40-percent test. If C was a member of 
another consolidated group during the period from January 1 to June 30, 
that consolidated group would include the depreciable bases of property 
placed in service by C during that period.

    (vi) A corporation that joins or leaves a consolidated group during 
a consolidated year is considered as being a member of the consolidated 
group for the entire consolidated return year for purposes of applying 
the applicable convention to determine when the recovery period begins 
for depreciable property placed in service by the corporation during the 
portion of the consolidated return year that the corporation is a member 
of the group.
    (vii) If depreciable property is placed in service by a corporation 
in the taxable year ending immediately before it joins a consolidated 
group or beginning immediately after it leaves a consolidated group, the 
applicable convention is applied to the property under either the full 
taxable year rules or the short taxable year rules, as applicable.
    (viii) The provisions of paragraphs (d)(5)(vi) and (vii) of this 
section are illustrated by the following example.

    Example. Assume that on July 1, C, a calendar-return corporation, 
joins a consolidated group that files a return on a calendar-year basis. 
The short taxable year rules apply to C for the period of January 1 to 
June 30. However, in applying the applicable convention to determine 
when the recovery period begins for depreciable property placed in 
service for the period of July 1 to December 31, C is considered as 
being a member of the consolidated group for the entire consolidated 
return year. Thus, if the half-year convention applies to depreciable 
property placed in service by the consolidated group (taking into 
account the depreciable bases of property placed in service by C after 
June 30), the property is deemed placed in service on the mid-point of 
the consolidated return year (i.e., July 1, if the group did not have a 
short taxable year).

    (ix) In the case of a transfer of depreciable property between 
members of a consolidated group, the following special rules apply for 
purposes of applying the 40-percent test. Property that is placed in 
service by one member of a consolidated group and transferred to another 
member of the same group is considered as placed in service on the date 
that it is placed in service by the transferor member, and the date it 
is placed in service by the transferee member is disregarded. In the 
case of multiple transfers of property between members of a consolidated 
group, the property is considered as placed in service on the date that 
the first member places the property in service, and the dates it is 
placed in service by other members are disregarded. The depreciable 
basis of the transferred property that is taken into account in applying 
the 40-percent test is the depreciable basis of the property in the 
hands of the transferor member (as determined under paragraph (b)(4) of 
this section), or, in the case of multiple transfers of property between 
members, the depreciable basis in the hands of the first member that 
placed the property in service.
    (x) The provisions of paragraph (b)(5)(ix) of this section are 
illustrated by the following example.

    Example. Assume the ABC consolidated group files its return on a 
calendar-year basis. A, a member of the consolidated group, purchases 
depreciable property costing $50,000 and places the property in service 
on January 5, 1991. On December 1, 1991, the property is transferred for 
$75,000 to B, another member of the consolidated group. In applying the 
40-percent test to the members of the consolidated group for 1991, the 
property is considered as placed in service on January 5, the date that 
A placed the property in service, and the depreciable basis of the 
property that is taken into account is $50,000.

    (6) Special rule for partnerships and S corporations. In the case of 
property

[[Page 1047]]

placed in service by a partnership or an S corporation, the 40-percent 
test is generally applied at the partnership or corporate level. 
However, if a partnership or an S corporation is formed or availed of 
for the principal purpose of either avoiding the application of the mid-
quarter convention or having the mid-quarter convention apply where it 
otherwise would not, the 40-percent test is applied at the partner, 
shareholder, or other appropriate level.
    (7) Certain nonrecognition transaction--(i) Except as provided in 
paragraph (b)(6) of this section, if depreciable property is transferred 
in a transaction described in section 168(i)(7)(B)(i) (other than in a 
transaction between members of a consolidated group) in the same taxable 
year that the property is placed in service by the transferor, the 40-
percent test is applied by treating the transferred property as placed 
in service by the transferee on the date of transfer. Thus, if the 
aggregate basis of property (including the transferred property) placed 
in service by the transferee during the last three months of its taxable 
year exceeds 40 percent of the aggregate basis of property (including 
the transferred property) placed in service by the transferee during the 
taxable year, the mid-quarter convention applies to the transferee's 
depreciable property, including the transferred property. The 
depreciable basis of the transferred property is not taken into account 
by the transferor in applying the 40-percent test for the taxable year 
that the transferor placed the property in service.
    (ii) In applying the applicable convention to determine when the 
recovery period for the transferred property begins, the date on which 
the transferor placed the property in service must be used. Thus, for 
example, if the mid-quarter convention applies, the recovery period for 
the transferred property begins on the mid-point of the quarter of the 
taxable year that the transferor placed the property in service. If the 
transferor placed the transferred property in service in a short taxable 
year, then for purposes of applying the applicable convention and 
allocating the depreciation deduction between the transferor and the 
transferee, the transferor is treated as having a full 12-month taxable 
year commencing on the first day of the short taxable year. The 
depreciation deduction for the transferor's taxable year in which the 
property was placed in service is allocated between the transferor and 
the transferee based on the number of months in the transferor's taxable 
year that each party held the property in service. For purposes of 
allocating the depreciation deduction, the transferor takes into account 
the month in which the property was placed in service but does not take 
into account the month in which the property was transferred. The 
transferee is allocated the remaining portion of the depreciation 
deduction for the transferor's taxable year in which the property was 
transferred. For the remainder of the transferee's current taxable year 
(if the transferee has a different taxable year than the transferor) and 
for subsequent taxable years, the depreciation deduction for the 
transferee is calculated by allocating to the transferee's taxable year 
the depreciation attributable to each recovery year, or portion thereof, 
that falls within the transferee's taxable year.
    (iii) If the applicable convention for the transferred property has 
not been determined by the time the transferor files its income tax 
return for the year of transfer because the transferee's taxable year 
has not ended, the transferor may use either the mid-quarter or the 
half-year convention in determining the depreciation deduction for the 
property. However, the transferor must specify on the depreciation form 
filed for the taxable year that the applicable convention has not been 
determined for the property. If the transferee determines that a 
different convention applies to the transferred property, the transferor 
should redetermine the depreciation deduction on the property, and, 
within the period of limitation, should file an amended income tax 
return for the taxable year and pay any additional tax due plus 
interest.
    (iv) The provisions of the paragraph (b)(7) are illustrated by the 
following example.

    Example. (i) During 1991, C, a calendar-year taxpayer, purchases 
satellite equipment costing $100,000, and computer equipment

[[Page 1048]]

costing $15,000. The satellite equipment is placed in service in 
January, and the computer equipment in February. On October 1, C 
transfers the computer equipment to Z Partnership in a transaction 
described in section 721. During 1991, Z, a calendar-year partnership, 
purchases 30 office desks for a total of $15,000. The desks are placed 
in service in June. These are the only items of depreciable property 
placed in service by C and Z during 1991.
    (ii) In applying the 40-percent test, because C transferred the 
computer equipment in a transaction described in section 168(i)(7)(B)(i) 
in the same taxable year that C placed it in service, the computer 
equipment is treated as placed in service by the transferee, Z, on the 
date of transfer, October 1. The 40-percent test is satisfied with 
respect to Z, because the computer equipment is placed in service during 
the last three months of Z's taxable year and its basis ($15,000) 
exceeds 40 percent of the aggregate basis of property placed in service 
by Z during the taxable year (desks and computer equipment with an 
aggregate basis of $30,000).
    (iii) In applying the mid-quarter convention to determine when the 
computer equipment is deemed to be placed in service, the date on which 
C placed the property in service is used. Accordingly, because C placed 
the computer equipment in service during the first quarter of its 
taxable year, the computer equipment is deemed placed in service on 
February 15, 1991, the mid-point of the first quarter of C's taxable 
year. The depreciation deduction allowable for C's 1991 taxable year, 
$5,250 ($15,000x40 percentx10.\5/12\), is allocated between C and Z 
based on the number of months in C's taxable year that C and Z held the 
property in service. Thus, because the property was in service for 11 
months during C's 1991 taxable year and C held it for 8 of those 11 
months, C is allocated $3,818 (\8/11\x$5,250). Z is allocated $1,432, 
the remaining \3/11\ of the $5,250 depreciation deduction for C's 1991 
taxable year. For 1992, Z's depreciation deduction for the computer 
equipment is $3,900, the sum of the remaining 1.5 months of depreciation 
deduction for the first recovery year and 10.5 months of depreciation 
deduction for the second recovery year (($15,000x40 percentx1.\5/
12\)+($9,000x40 [percentx10.\5/12\)).

    (c) Disposition of property subject to the half-year or mid-quarter 
convention--(1) In general. If depreciable property is subject to the 
half-year (or mid-quarter) convention in the taxable year in which it is 
placed in service, it also is subject to the half-year (or mid-quarter) 
convention in the taxable year in which it is disposed of.
    (2) Example. The provisions of paragraph (c)(1) of this section are 
illustrated by the following example.

    Example. In October 1991, B, a calendar-year taxpayer, purchases and 
places in service a light general purpose truck costing $10,000. B does 
not elect to expense any part of the cost of the truck, and this is the 
only item of depreciable property placed in service by B during 1991. 
The 40-percent test is satisfied and the mid-quarter convention applies, 
because the truck is placed in service during the last three months of 
the taxable year and no other assets are placed in service in that year. 
In April 1993 (prior to the end of the truck's recovery period), B sells 
the truck. The mid-quarter convention applies in determining the 
depreciation deduction for the truck in 1993, the year of disposition.

    (d) Effective dates--(1) In general. This section applies to 
depreciable property placed in service in taxable years ending after 
January 30, 1991. For depreciable property placed in service after 
December 31, 1986, in taxable years ending on or before January 30, 
1991, a taxpayer may use a method other than the method provided in this 
section in applying the 40-percent test and the applicable convention, 
provided the method is reasonable and is consistently applied to the 
taxpayer's property.
    (2) Qualified property, 50-percent bonus depreciation property, or 
qualified New York Liberty Zone property. [Reserved]. For further 
guidance, see Sec. 1.168(d)-1T(d).
    (3) Like-kind exchanges and involuntary conversions. [Reserved] For 
further guidance, see Sec. 1.168(d)-1T(d)(3)(i).

[T.D. 8444, 57 FR 48981, Oct. 29, 1992, as amended by T.D. 9091, 68 FR 
52991, Sept. 8, 2003; T.D. 9115, 69 FR 9533, Mar. 1, 2004]



Sec. 1.168(d)-1T  Applicable conventions--Half-year and mid-quarter 
conventions (temporary).

    (a) through (b)(2) [Reserved]. For further guidance, see Sec. 
1.168(d)-1(a) through (b)(2).
    (b)(3) Property placed in service and disposed of in the same 
taxable year--(i) Under section 168(d)(3)(B)(ii), the depreciable basis 
of property placed in service and disposed of in the same taxable year 
is not taken into account in determining whether the 40-percent test is 
satisfied. However, the depreciable

[[Page 1049]]

basis of property placed in service, disposed of, subsequently 
reacquired, and again placed in service, by the taxpayer in the same 
taxable year must be taken into account in applying the 40-percent test, 
but the basis of the property is only taken into account on the later of 
the dates that the property is placed in service by the taxpayer during 
the taxable year. Further, see Sec. 1.168(i)-6T(c)(4)(v)(B) and Sec. 
1.168(i)-6T(f) for rules relating to property placed in service and 
exchanged or involuntarily converted during the same taxable year.
    (ii) The applicable convention, as determined under this section, 
applies to all depreciable property (except nonresidential real 
property, residential rental property, and any railroad grading or 
tunnel bore) placed in service by the taxpayer during the taxable year, 
excluding property placed in service and disposed of in the same taxable 
year. However, see Sec. 1.168(i)-6T(c)(4)(v)(A) and Sec. 1.168(i)-
6T(f) for rules relating to MACRS property that has a basis determined 
under section 1031(d) or section 1033(b). No depreciation deduction is 
allowed for property placed in service and disposed of during the same 
taxable year. However, see Sec. 1.168(k)-1T(f)(1) for rules relating to 
qualified property or 50-percent bonus depreciation property, and Sec. 
1.1400L(b)-1T(f)(1) for rules relating to qualified New York Liberty 
Zone property, that is placed in service by the taxpayer in the same 
taxable year in which either a partnership is terminated as a result of 
a technical termination under section 708(b)(1)(B) or the property is 
transferred in a transaction described in section 168(i)(7).
    (b)(3)(iii) through (d)(1) For further guidance, see Sec. 1.168(d)-
1(b)(3)(iii) through (d)(1).
    (d)(2) Qualified property, 50-percent bonus depreciation property, 
or qualified New York Liberty Zone property. This section also applies 
to qualified property under section 168(k)(2) or qualified New York 
Liberty Zone property under section 1400L(b) acquired by a taxpayer 
after September 10, 2001, and to 50-percent bonus depreciation property 
under section 168(k)(4) acquired by a taxpayer after May 5, 2003. This 
section expires on September 4, 2006.
    (3) Like-kind exchanges and involuntary conversions. (i) The last 
sentence in paragraph (b)(3)(i) and the second sentence in paragraph 
(b)(3)(ii) of this section apply to exchanges to which section 1031 
applies, and involuntary conversions to which section 1033 applies, of 
MACRS property for which the time of disposition and the time of 
replacement both occur after February 27, 2004.
    (ii) The applicability of this section expires on or before February 
26, 2007.

[T.D. 9091, 68 FR 52991, Sept. 8, 2003; 68 FR 63734, Nov. 10, 2003, as 
amended by T.D. 9115, 69 FR 9533, Mar. 1, 2004; 69 FR 17586, Apr. 5, 
2004]



Sec. 1.168(f)(8)-1T  Safe-harbor lease information returns concerning 
qualified mass commuting vehicles (temporary).

    In general. Form 6793, Safe Harbor Lease Information Return, is 
obsolete for safe harbor lease agreements executed after June 30, 1985. 
The parties to a safe harbor lease agreement under section 168(f)(8) 
executed after June 30, 1985 must file with their timely filed 
(including extensions) Federal income tax returns for the taxable year 
during which the lease term begins a statement containing the following 
information:
    (a) The name, address, and taxpayer identification number of the 
lessor and the lessee;
    (b) A description of the property with respect to which safe-harbor 
lease treatment is claimed;
    (c) The date on which the lessee places the property in service, the 
date on which the lease begins, and the term of the lease;
    (d) The recovery property class of the leased property under section 
168(c)(2) (for example, 5-year);
    (e) The terms of the payments between the parties to the lease 
transaction;
    (f) The unadjusted basis of the property as defined in section 
168(d)(1) and its adjusted basis as determined under Sec. 5c.168(f)(8)-
6(b)(3); and
    (g) If the lessor is a partnership or grantor trust, the name, 
address, and taxpayer identification number of the

[[Page 1050]]

partners or beneficiaries and the service center at which the income tax 
return of each partner or beneficiary is filed.

The lessor's failure to file the above-described statement shall void 
such agreement as a safe-harbor lease under section 168(f)(8) as of the 
date of the execution of the lease agreement. For rules regarding 
extensions of time for filing elections, see Sec. 1.9100-1.

[T.D. 8033, 50 FR 27224, July 2, 1985]



Sec. 1.168(h)-1  Like-kind exchanges involving tax-exempt use property.

    (a) Scope. (1) This section applies with respect to a direct or 
indirect transfer of property among related persons, including transfers 
made through a qualified intermediary (as defined in Sec. 1.1031(k)-
1(g)(4)) or other unrelated person, (a transfer) if--
    (i) Section 1031 applies to any party to the transfer or to any 
related transaction; and
    (ii) A principal purpose of the transfer or any related transaction 
is to avoid or limit the application of the alternative depreciation 
system (within the meaning of section 168(g)).
    (2) For purposes of this section, a person is related to another 
person if they bear a relationship specified in section 267(b) or 
section 707(b)(1).
    (b) Allowable depreciation deduction for property subject to this 
section--(1) In general. Property (tainted property) transferred 
directly or indirectly to a taxpayer by a related person (related party) 
as part of, or in connection with, a transaction in which the related 
party receives tax-exempt use property (related tax-exempt use property) 
will, if the tainted property is subject to an allowance for 
depreciation, be treated in the same manner as the related tax-exempt 
use property for purposes of determining the allowable depreciation 
deduction under section 167(a). Under this paragraph (b), the tainted 
property is depreciated by the taxpayer over the remaining recovery 
period of, and using the same depreciation method and convention as that 
of, the related tax-exempt use property.
    (2) Limitations--(i) Taxpayer's basis in related tax-exempt use 
property. The rules of this paragraph (b) apply only with respect to so 
much of the taxpayer's basis in the tainted property as does not exceed 
the taxpayer's adjusted basis in the related tax-exempt use property 
prior to the transfer. Any excess of the taxpayer's basis in the tainted 
property over its adjusted basis in the related tax-exempt use property 
prior to the transfer is treated as property to which this section does 
not apply. This paragraph (b)(2)(i) does not apply if the related tax-
exempt use property is not acquired from the taxpayer (e.g., if the 
taxpayer acquires the tainted property for cash but section 1031 
nevertheless applies to the related party because the transfer involves 
a qualified intermediary).
    (ii) Application of section 168(i)(7). This section does not apply 
to so much of the taxpayer's basis in the tainted property as is subject 
to section 168(i)(7).
    (c) Related tax-exempt use property. (1) For purposes of paragraph 
(b) of this section, related tax-exempt use property includes--
    (i) Property that is tax-exempt use property (as defined in section 
168(h)) at the time of the transfer; and
    (ii) Property that does not become tax-exempt use property until 
after the transfer if, at the time of the transfer, it was intended that 
the property become tax-exempt use property.
    (2) For purposes of determining the remaining recovery period of the 
related tax-exempt use property in the circumstances described in 
paragraph (c)(1)(ii) of this section, the related tax-exempt use 
property will be treated as having, prior to the transfer, a lease term 
equal to the term of any lease that causes such property to become tax-
exempt use property.
    (d) Examples. The following examples illustrate the application of 
this section. The examples do not address common law doctrines or other 
authorities that may apply to recharacterize or alter the effects of the 
transactions described therein. Unless otherwise indicated, parties to 
the transactions are not related to one another.

    Example 1. (i) X owns all of the stock of two subsidiaries, B and Z. 
X, B and Z do not file a consolidated federal income tax return. On May 
5, 1995, B purchases an aircraft (FA) for $1 million and leases it to a 
foreign airline whose income is not subject to United States

[[Page 1051]]

taxation and which is a tax-exempt entity as defined in section 
168(h)(2). On the same date, Z owns an aircraft (DA) with a fair market 
value of $1 million, which has been, and continues to be, leased to an 
airline that is a United States taxpayer. Z's adjusted basis in DA is 
$0. The next day, at a time when each aircraft is still worth $1 
million, B transfers FA to Z (subject to the lease to the foreign 
airline) in exchange for DA (subject to the lease to the airline that is 
a United States taxpayer). Z realizes gain of $1 million on the 
exchange, but that gain is not recognized pursuant to section 1031(a) 
because the exchange is of like-kind properties. Assume that a principal 
purpose of the transfer of DA to B or of FA to Z is to avoid the 
application of the alternative depreciation system. Following the 
exchange, Z has a $0 basis in FA pursuant to section 1031(d). B has a $1 
million basis in DA.
    (ii) B has acquired property from Z, a related person; Z's gain is 
not recognized pursuant to section 1031(a); Z has received tax-exempt 
use property as part of the transaction; and a principal purpose of the 
transfer of DA to B or of FA to Z is to avoid the application of the 
alternative depreciation system. Accordingly, the transaction is within 
the scope of this section. Pursuant to paragraph (b) of this section, B 
must recover its $1 million basis in DA over the remaining recovery 
period of, and using the same depreciation method and convention as that 
of, FA, the related tax-exempt use property.
    (iii) If FA did not become tax-exempt use property until after the 
exchange, it would still be related tax-exempt use property and 
paragraph (b) of this section would apply if, at the time of the 
exchange, it was intended that FA become tax-exempt use property.
    Example 2. (i) X owns all of the stock of two subsidiaries, B and Z. 
X, B and Z do not file a consolidated federal income tax return. B and Z 
each own identical aircraft. B's aircraft (FA) is leased to a tax-exempt 
entity as defined in section 168(h)(2) and has a fair market value of $1 
million and an adjusted basis of $500,000. Z's aircraft (DA) is leased 
to a United States taxpayer and has a fair market value of $1 million 
and an adjusted basis of $10,000. On May 1, 1995, B and Z exchange 
aircraft, subject to their respective leases. B realizes gain of 
$500,000 and Z realizes gain of $990,000, but neither person recognizes 
gain because of the operation of section 1031(a). Moreover, assume that 
a principal purpose of the transfer of DA to B or of FA to Z is to avoid 
the application of the alternative depreciation system.
    (ii) As in Example 1, B has acquired property from Z, a related 
person; Z's gain is not recognized pursuant to section 1031(a); Z has 
received tax-exempt use property as part of the transaction; and a 
principal purpose of the transfer of DA to B or of FA to Z is to avoid 
the application of the alternative depreciation system. Thus, the 
transaction is within the scope of this section even though B has held 
tax-exempt use property for a period of time and, during that time, has 
used the alternative depreciation system with respect to such property. 
Pursuant to paragraph (b) of this section, B, which has a substituted 
basis determined pursuant to section 1031(d) of $500,000 in DA, must 
depreciate the aircraft over the remaining recovery period of FA, using 
the same depreciation method and convention. Z holds tax-exempt use 
property with a basis of $10,000, which must be depreciated under the 
alternative depreciation system.
    (iii) Assume the same facts as in paragraph (i) of this Example 2, 
except that B and Z are members of an affiliated group that files a 
consolidated federal income tax return. Of B's $500,000 basis in DA, 
$10,000 is subject to section 168(i)(7) and therefore not subject to 
this section. The remaining $490,000 of basis is subject to this 
section. But see Sec. 1.1502-80(f) making section 1031 inapplicable to 
intercompany transactions occurring in consolidated return years 
beginning on or after July 12, 1995.

    (e) Effective date. This section applies to transfers made on or 
after April 20, 1995.

[T.D. 8667, 61 FR 18676, Apr. 29, 1996]



Sec. 1.168(i)-0  Table of contents for the general asset account rules.

    This section lists the major paragraphs contained in Sec. 1.168(i)-
1.

                Sec. 1.168(i)-1 General asset accounts.

    (a) Scope.
    (b) Definitions.
    (1) Unadjusted depreciable basis.
    (2) Unadjusted depreciable basis of the general asset account.
    (3) Adjusted depreciable basis of the general asset account.
    (4) Expensed cost.
    (c) Establishment of general asset accounts.
    (1) Assets eligible for general asset accounts.
    (i) General rules.
    (ii) Special rules for assets generating foreign source income.
    (2) Grouping assets in general asset accounts.
    (i) General rules.
    (ii) Special rules.
    (d) Determination of depreciation allowance.
    (1) In general.
    (2) [Reserved]. For further guidance see the entry for Sec. 
1.168(i)-1T(d)(2).
    (e) Disposition of an asset from a general asset account.

[[Page 1052]]

    (1) Scope.
    (2) General rules for a disposition.
    (i) No immediate recovery of basis.
    (ii) Treatment of amount realized.
    (iii) Effect of disposition on a general asset account.
    (iv) Coordination with nonrecognition provisions.
    (v) Examples.
    (3) Special rules.
    (i) [Reserved]. For further guidance see the entry for Sec. 
1.168(i)-1T(e)(3)(i).
    (ii) Disposition of all assets remaining in a general asset account.
    (iii) Disposition of an asset in a qualifying disposition.
    (iv) Transactions subject to section 168(i)(7).
    (v) and (vi) [Reserved]. For further guidance see the entries for 
Sec. 1.168(i)-1T(e)(3)(v) and (vi).
    (f) through (f)(2)(i) [Reserved]. For further guidance see the 
entries for Sec. 1.168(i)-1T(f) through (f)(2)(i).
    (ii) Formula for determining foreign source income, gain, or loss.
    (3) Section 904(d) separate categories.
    (g) Assets subject to recapture.
    (h) Changes in use.
    (1) Conversion to personal use.
    (2) Change in use results in a different recovery period and/or 
depreciation method.
    (i) No effect on general asset account election.
    (ii) Asset is removed from the general asset account.
    (iii) New general asset account is established.
    (i) and (j). [Reserved]. For further guidance, see the entries for 
Sec. 1.168(i)-1T(i) and (j).
    (k) Election.
    (1) Irrevocable election.
    (2) Time for making election.
    (3) Manner of making election.
    (l) [Reserved]. For further guidance, see the entry for Sec. 
1.168(i)-1T(l).

[T.D. 8566, 59 FR 51371, Oct. 11, 1994, as amended by T.D. 9115, 69 FR 
9534, Mar. 1, 2004; T.D. 9132, 69 FR 33842, June 17, 2004]



Sec. 1.168(i)-0T  Table of contents for the general asset account rules 
(temporary).

    This section lists the major paragraphs contained in Sec. 1.168(i)-
1T.

          Sec. 1.168(i)-1T General asset accounts (temporary).

    (a) through (d)(1) [Reserved]. For further guidance, see the entries 
for Sec. 1.168(i)-1(a) through (d)(1).
    (d)(2) Special rule for passenger automobiles.
    (e) through (e)(3) [Reserved]. For further guidance, see the entries 
for Sec. 1.168(i)-1(e) through (e)(3).
    (e)(3)(i) In general.
    (e)(3)(ii) through (e)(3)(iv) [Reserved]. For further guidance, see 
the entries for Sec. 1.168(i)-1(e)(3)(ii) through (iv).
    (e)(3)(v) Transactions subject to section 1031 or 1033.
    (vi) Anti-abuse rule.
    (f) Assets generating foreign source income.
    (1) In general.
    (2) Source of ordinary income, gain, or loss.
    (i) Source determined by allocation and apportionment of 
depreciation allowed.
    (f)(2)(ii) through (h)(2) [Reserved]. For further guidance, see the 
entries for Sec. 1.168(i)-1(f)(2)(ii) through (h)(2).
    (i) Identification of disposed or converted asset.
    (j) Effect of adjustments on prior dispositions.
    (k)(1) through (k)(3) [Reserved]. For further guidance, see the 
entries for Sec. 1.168(i)-1 (k)(1) through (k)(3).
    (l) Effective date.
    (l)(1) through (l)(3) [Reserved]. For further guidance, see the 
entries for Sec. 1.168(i)-1(l)(1) through (l)(3).

[T.D. 9115, 69 FR 9534, Mar. 1, 2004]



Sec. 1.168(i)-1  General asset accounts.

    (a) Scope. This section provides rules for general asset accounts 
under section 168(i)(4). The provisions of this section apply only to 
assets for which an election has been made under paragraph (k) of this 
section.
    (b) Definitions. For purposes of this section, the following 
definitions apply:
    (1) Unadjusted depreciable basis is the basis of an asset for 
purposes of section 1011 without regard to any adjustments described in 
section 1016(a)(2) and (3). This basis reflects the reduction in basis 
for the percentage of the taxpayer's use of property for the taxable 
year other than in the taxpayer's trade or business (or for the 
production of income), for any portion of the basis the taxpayer 
properly elects to treat as an expense under section 179, and for any 
adjustments to basis provided by other provisions of the Internal 
Revenue Code and the regulations under the Internal Revenue Code (other 
than section 1016(a)(2) and (3)) (for example, a reduction in basis by 
the amount of the

[[Page 1053]]

disabled access credit pursuant to section 44(d)(7)). For property 
subject to a lease, see section 167(c)(2).
    (2) Unadjusted depreciable basis of the general asset account is the 
sum of the unadjusted depreciable bases of all assets included in the 
general asset account.
    (3) Adjusted depreciable basis of the general asset account is the 
unadjusted depreciable basis of the general asset account less the 
adjustments to basis described in sections 1016(a)(2) and (3).
    (4) Expensed cost is the amount of any allowable credit or deduction 
treated as a deduction allowable for depreciation or amortization for 
purposes of section 1245 (for example, a credit allowable under section 
30 or a deduction allowable under section 179, 179A, or 190).
    (c) Establishment of general asset accounts--(1) Assets eligible for 
general asset accounts--(i) General rules. Assets that are subject to 
either the general depreciation system of section 168(a) or the 
alternative depreciation system of section 168(g) may be accounted for 
in one or more general asset accounts. An asset may be included in a 
general asset account only to the extent of the asset's unadjusted 
depreciable basis (for example, if, in 1995, a taxpayer places in 
service an asset that costs $20,000 and elects under section 179 to 
expense $17,500 of that asset's cost, the unadjusted depreciable basis 
of the asset is $2,500 and, therefore, only $2,500 of the asset's cost 
may be included in a general asset account). However, an asset is not to 
be included in a general asset account if the asset is used both in a 
trade or business (or for the production of income) and in a personal 
activity at any time during the taxable year in which the asset is first 
placed in service by the taxpayer.
    (ii) Special rules for assets generating foreign source income--(A) 
Assets that generate foreign source income, both United States and 
foreign source income, or combined gross income of a FSC (as defined in 
section 922), DISC (as defined in section 992(a)), or possessions 
corporation (as defined in section 936) and its related supplier, may be 
included in a general asset account if the requirements of paragraph 
(c)(2)(i) of this section are satisfied. If, however, the inclusion of 
these assets in a general asset account results in a substantial 
distortion of income, the Commissioner may disregard the general asset 
account election and make any reallocations of income or expense 
necessary to clearly reflect income.
    (B) A general asset account shall be treated as a single asset for 
purposes of applying the rules in Sec. 1.861- 9T(g)(3) (relating to 
allocation and apportionment of interest expense under the asset 
method). A general asset account that generates income in more than one 
grouping of income (statutory and residual) is a multiple category asset 
(as defined in Sec. 1.861-9T(g)(3)(ii)), and the income yield from the 
general asset account must be determined by applying the rules for 
multiple category assets as if the general asset account were a single 
asset.
    (2) Grouping assets in general asset accounts--(i) General rules. If 
a taxpayer makes the election under paragraph (k) of this section, 
assets that are subject to the election are grouped into one or more 
general asset accounts. Assets that are eligible to be grouped into a 
single general asset account may be divided into more than one general 
asset account. Each general asset account must include only assets 
that--
    (A) Have the same asset class (for further guidance, see Rev. Proc. 
87-56, 1987-2 C.B. 674, and Sec. 601.601(d)(2)(ii)(b) of this chapter);
    (B) Have the same applicable depreciation method;
    (C) Have the same applicable recovery period;
    (D) Have the same applicable convention; and
    (E) Are placed in service by the taxpayer in the same taxable year.
    (ii) Special rules. In addition to the general rules in paragraph 
(c)(2)(i) of this section, the following rules apply when establishing 
general asset accounts--
    (A) Assets without an asset class, but with the same characteristics 
described in paragraphs (c)(2)(i)(B), (C), (D), and (E) of this section, 
may be grouped into a general asset account;
    (B) Assets subject to the mid-quarter convention may only be grouped 
into a general asset account with assets that

[[Page 1054]]

are placed in service in the same quarter of the taxable year;
    (C) Assets subject to the mid-month convention may only be grouped 
into a general asset account with assets that are placed in service in 
the same month of the taxable year;
    (D) Passenger automobiles for which the depreciation allowance is 
limited under section 280F(a) must be grouped into a separate general 
asset account; and
    (E) Assets subject to paragraph (h)(2)(iii)(A) of this section 
(change in use results in a shorter recovery period and/or a more 
accelerated depreciation method) for which the depreciation allowance 
for the year of change (as defined in Sec. 1.168(i)-4(a)) is not 
determined by using an optional depreciation table must be grouped into 
a separate general asset account.
    (d) Determination of depreciation allowance--(1) In general. 
Depreciation allowances are determined for each general asset account by 
using the applicable depreciation method, recovery period, and 
convention for the assets in the account. The depreciation allowances 
are recorded in a depreciation reserve account for each general asset 
account. The allowance for depreciation under this section constitutes 
the amount of depreciation allowable under section 167(a).
    (2) [Reserved]. For further guidance, see Sec. 1.168(i)-1T(d)(2).
    (e) Disposition of an asset from a general asset account--(1) Scope. 
This paragraph (e) provides rules applicable to dispositions of assets 
included in a general asset account. For purposes of this paragraph (e), 
an asset in a general asset account is disposed of when ownership of the 
asset is transferred or when the asset is permanently withdrawn from use 
either in the taxpayer's trade or business or in the production of 
income. A disposition includes the sale, exchange, retirement, physical 
abandonment, or destruction of an asset. A disposition also occurs when 
an asset is transferred to a supplies, scrap, or similar account. A 
disposition does not include, however, the retirement of a structural 
component of real property.
    (2) General rules for a disposition--(i) No immediate recovery of 
basis. Immediately before a disposition of any asset in a general asset 
account, the asset is treated as having an adjusted basis of zero for 
purposes of section 1011. Therefore, no loss is realized upon the 
disposition of an asset from the general asset account. Similarly, where 
an asset is disposed of by transfer to a supplies, scrap, or similar 
account, the basis of the asset in the supplies, scrap, or similar 
account will be zero.
    (ii) Treatment of amount realized. Any amount realized on a 
disposition is recognized as ordinary income (notwithstanding any other 
provision of subtitle A of the Internal Revenue Code (Code)) to the 
extent the sum of the unadjusted depreciable basis of the general asset 
account and any expensed cost (as defined in paragraph (b)(4) of this 
section) for assets in the account exceeds any amounts previously 
recognized as ordinary income upon the disposition of other assets in 
the account. The recognition and character of any excess amount realized 
are determined under other applicable provisions of the Code (other than 
sections 1245 and 1250 or provisions of the Code that treat gain on a 
disposition as subject to section 1245 or 1250).
    (iii) Effect of disposition on a general asset account. The 
unadjusted depreciable basis and the depreciation reserve of the general 
asset account are not affected as a result of a disposition of an asset 
from the general asset account.
    (iv) Coordination with nonrecognition provisions. For purposes of 
determining the basis of an asset acquired in a transaction described in 
paragraph (e)(3)(iii)(B)(4) of this section (relating to certain 
nonrecognition provisions), the amount of ordinary income recognized 
under this paragraph (e)(2) is treated as the amount of gain recognized 
on the disposition.
    (v) Examples. The following examples illustrate the application of 
this paragraph (e)(2).

    Example 1. (i) R, a calendar-year corporation, maintains one general 
asset account for ten machines. The machines cost a total of $10,000 and 
were placed in service in June 1995. Of the ten machines, one machine 
costs $8,200 and nine machines cost a total of $1,800. Assume this 
general asset account has a depreciation method of 200 percent declining 
balance, a recovery period of 5 years, and

[[Page 1055]]

a half-year convention. R does not make a section 179 election for any 
of the machines. As of January 1, 1996, the depreciation reserve of the 
account is $2,000 [(($10,000-$0) x 40%)/2].
    (ii) On February 8, 1996, R sells the machine that cost $8,200 to an 
unrelated party for $9,000. Under paragraph (e)(2)(i) of this section, 
this machine has an adjusted basis of zero.
    (iii) On its 1996 tax return, R recognizes the amount realized of 
$9,000 as ordinary income because such amount does not exceed the 
unadjusted depreciable basis of the general asset account ($10,000), 
plus any expensed cost for assets in the account ($0), less amounts 
previously recognized as ordinary income ($0). Moreover, the unadjusted 
depreciable basis and depreciation reserve of the account are not 
affected by the disposition of the machine. Thus, the depreciation 
allowance for the account in 1996 is $3,200 (($10,000-$2,000)x40%).
    Example 2. (i) The facts are the same as in Example 1. In addition, 
on June 4, 1997, R sells seven machines to an unrelated party for a 
total of $1,100. In accordance with paragraph (e)(2)(i) of this section, 
these machines have an adjusted basis of zero.
    (ii) On its 1997 tax return, R recognizes $1,000 as ordinary income 
(the unadjusted depreciable basis of $10,000, plus the expensed cost of 
$0, less the amount of $9,000 previously recognized as ordinary income). 
The recognition and character of the excess amount realized of $100 
($1,100-$1,000) are determined under applicable provisions of the Code 
other than section 1245 (such as section 1231). Moreover, the unadjusted 
depreciable basis and depreciation reserve of the account are not 
affected by the disposition of the machines. Thus, the depreciation 
allowance for the account in 1997 is $1,920 (($10,000-$5,200)x40%).

    (3) Special rules. (i) [Reserved]. For further guidance, see Sec. 
1.168(i)-1T(e)(3)(i).
    (ii) Disposition of all assets remaining in a general asset 
account--(A) Optional termination of a general asset account. Upon the 
disposition of all of the assets, or the last asset, in a general asset 
account, a taxpayer may apply this paragraph (e)(3)(ii) to recover the 
adjusted depreciable basis of the general asset account (rather than 
having paragraph (e)(2) of this section apply). Under this paragraph 
(e)(3)(ii), the general asset account terminates and the amount of gain 
or loss for the general asset account is determined under section 
1001(a) by taking into account the adjusted depreciable basis of the 
general asset account at the time of the disposition. The recognition 
and character of the gain or loss are determined under other applicable 
provisions of the Code, except that the amount of gain subject to 
section 1245 (or section 1250) is limited to the excess of the 
depreciation allowed or allowable for the general asset account, 
including any expensed cost (or the excess of the additional 
depreciation allowed or allowable for the general asset account), over 
any amounts previously recognized as ordinary income under paragraph 
(e)(2) of this section.
    (B) Example. The following example illustrates the application of 
this paragraph (e)(3)(ii).

    Example. (i) T, a calendar-year corporation, maintains a general 
asset account for 1,000 calculators. The calculators cost a total of 
$60,000 and were placed in service in 1995. Assume this general asset 
account has a depreciation method of 200 percent declining balance, a 
recovery period of 5 years, and a half-year convention. T does not make 
a section 179 election for any of the calculators. In 1996, T sells 200 
of the calculators to an unrelated party for a total of $10,000 and 
recognizes the $10,000 as ordinary income in accordance with paragraph 
(e)(2) of this section.
    (ii) On March 26, 1997, T sells the remaining calculators in the 
general asset account to an unrelated party for $35,000. T chooses to 
apply paragraph (e)(3)(ii) of this section. As a result, the account 
terminates and gain or loss is determined for the account.
    (iii) On the date of disposition, the adjusted depreciable basis of 
the account is $23,040 (unadjusted depreciable basis of $60,000 less the 
depreciation allowed or allowable of $36,960). Thus, in 1997, T 
recognizes gain of $11,960 (amount realized of $35,000 less the adjusted 
depreciable basis of $23,040). The gain of $11,960 is subject to section 
1245 to the extent of the depreciation allowed or allowable for the 
account (plus the expensed cost for assets in the account) less the 
amounts previously recognized as ordinary income ($36,960 + $0 - $10,000 
= $26,960). As a result, the entire gain of $11,960 is subject to 
section 1245.

    (iii) Disposition of an asset in a qualifying disposition--(A) 
Optional determination of the amount of gain, loss, or other deduction. 
In the case of a qualifying disposition of an asset (described in 
paragraph (e)(3)(iii)(B) of this section), a taxpayer may apply this 
paragraph (e)(3)(iii) (rather than having paragraph (e)(2) of this 
section apply). Under this paragraph (e)(3)(iii), general

[[Page 1056]]

asset account treatment for the asset terminates as of the first day of 
the taxable year in which the qualifying disposition occurs, and the 
amount of gain, loss, or other deduction for the asset is determined by 
taking into account the asset's adjusted basis. The adjusted basis of 
the asset at the time of the disposition equals the unadjusted 
depreciable basis of the asset less the depreciation allowed or 
allowable for the asset, computed by using the depreciation method, 
recovery period, and convention applicable to the general asset account 
in which the asset was included. The recognition and character of the 
gain, loss, or other deduction are determined under other applicable 
provisions of the Code, except that the amount of gain subject to 
section 1245 (or section 1250) is limited to the lesser of--
    (1) The depreciation allowed or allowable for the asset, including 
any expensed cost (or the additional depreciation allowed or allowable 
for the asset); or
    (2) The excess of--
    (i) The original unadjusted depreciable basis of the general asset 
account plus, in the case of section 1245 property originally included 
in the general asset account, any expensed cost; over
    (ii) The cumulative amounts of gain previously recognized as 
ordinary income under either paragraph (e)(2) of this section or section 
1245 (or section 1250).
    (B) Qualifying dispositions. A qualifying disposition is a 
disposition that does not involve all the assets, or the last asset, 
remaining in a general asset account and that is--
    (1) A direct result of a fire, storm, shipwreck, or other casualty, 
or from theft;
    (2) A charitable contribution for which a deduction is allowable 
under section 170;
    (3) A direct result of a cessation, termination, or disposition of a 
business, manufacturing or other income producing process, operation, 
facility, plant, or other unit (other than by transfer to a supplies, 
scrap, or similar account); or
    (4) [Reserved]. For further guidance, see Sec. 1.168(i)-
1T(e)(3)(iii)(B)(4).
    (C) Effect of a qualifying disposition on a general asset account. 
If the taxpayer applies this paragraph (e)(3)(iii) to a qualifying 
disposition of an asset, then--
    (1) The asset is removed from the general asset account as of the 
first day of the taxable year in which the qualifying disposition 
occurs;
    (2) The unadjusted depreciable basis of the general asset account is 
reduced by the unadjusted depreciable basis of the asset as of the first 
day of the taxable year in which the disposition occurs;
    (3) The depreciation reserve of the general asset account is reduced 
by the depreciation allowed or allowable for the asset as of the end of 
the taxable year immediately preceding the year of disposition, computed 
by using the depreciation method, recovery period, and convention 
applicable to the general asset account in which the asset was included; 
and
    (4) For purposes of determining the amount of gain realized on 
subsequent dispositions that is subject to ordinary income treatment 
under paragraph (e)(2)(ii) of this section, the amount of any expensed 
cost with respect to the asset is disregarded.
    (D) Example. The provisions of this paragraph (e)(3)(iii) are 
illustrated by the following example.

    Example. (i) Z, a calendar-year corporation, maintains one general 
asset account for 12 machines. Each machine costs $15,000 and was placed 
in service in 1995. Of the 12 machines, nine machines that cost a total 
of $135,000 are used in Z's Kentucky plant, and three machines that cost 
a total of $45,000 are used in Z's Ohio plant. Assume this general asset 
account has a depreciation method of 200 percent declining balance, a 
recovery period of 5 years, and a half-year convention. Z does not make 
a section 179 election for any of the machines. As of January 1, 1997, 
the depreciation reserve for the account is $93,600.
    (ii) On May 27, 1997, Z sells its entire manufacturing plant in Ohio 
to an unrelated party. The sales proceeds allocated to each of the three 
machines at the Ohio plant is $5,000. Because this transaction is a 
qualifying disposition under paragraph (e)(3)(iii)(B)(3) of this 
section, Z chooses to apply paragraph (e)(3)(iii) of this section.

[[Page 1057]]

    (iii) For Z's 1997 return, the depreciation allowance for the 
account is computed as follows. As of December 31, 1996, the 
depreciation allowed or allowable for the three machines at the Ohio 
plant is $23,400. Thus, as of January 1, 1997, the unadjusted 
depreciable basis of the account is reduced from $180,000 to $135,000 
($180,000 less the unadjusted depreciable basis of $45,000 for the three 
machines), and the depreciation reserve of the account is decreased from 
$93,600 to $70,200 ($93,600 less the depreciation allowed or allowable 
of $23,400 for the three machines as of December 31, 1996). 
Consequently, the depreciation allowance for the account in 1997 is 
$25,920 (($135,000 - $70,200) x 40%).
    (iv) For Z's 1997 return, gain or loss for each of the three 
machines at the Ohio plant is determined as follows. The depreciation 
allowed or allowable in 1997 for each machine is $1,440 [(($15,000 - 
$7,800) x 40%) / 2]. Thus, the adjusted basis of each machine under 
section 1011 is $5,760 (the adjusted depreciable basis of $7,200 removed 
from the account less the depreciation allowed or allowable of $1,440 in 
1997). As a result, the loss recognized in 1997 for each machine is $760 
($5,000 - $5,760), which is subject to section 1231.

    (iv) Transactions subject to section 168(i)(7). If an asset in a 
general asset account is transferred in a transaction described in 
section 168(i)(7)(B) (pertaining to treatment of transferees in certain 
nonrecognition transactions), the transferor must remove the transferred 
asset from the general asset account as of the first day of the taxable 
year in which the transaction occurs. In addition, the adjustments to 
the general asset account described in paragraph (e)(3)(iii)(C)(2) 
through (4) of this section must be made. The transferee is bound by the 
transferor's election under paragraph (k) of this section with respect 
to so much of the asset's basis in the hands of the transferee as does 
not exceed the asset's adjusted basis in the hands of the transferor. If 
all of the assets, or the last asset, in a general asset account are 
transferred, the transferee's basis in the assets or asset transferred 
is equal to the adjusted depreciable basis of the general asset account 
as of the beginning of the transferor's taxable year in which the 
transaction occurs, decreased by the amount of depreciation allocable to 
the transferor for the year of the transfer.
    (v) [Reserved]. For further guidance, see Sec. 1.168(i)-
1T(e)(3)(v).
    (vi) Anti-abuse rule [Reserved]. For further guidance, see Sec. 
1.168(i)-1T(e)(3)(vi).
    (f) Assets generating foreign source income--(1) In general. 
[Reserved]. For further guidance, see Sec. 1.168(i)-1T(f)(1).
    (2) Source of ordinary income, gain, or loss. (i) [Reserved]. For 
further guidance, see Sec. 1.168(i)-1T(f)(2)(i).
    (ii) Formula for determining foreign source income, gain, or loss. 
The amount of ordinary income, gain, or loss recognized on the 
disposition that shall be treated as foreign source income, gain, or 
loss must be determined under the formula in this paragraph (f)(2)(ii). 
For purposes of this formula, the allowed depreciation deductions are 
determined for the applicable time period provided in paragraph 
(f)(2)(i) of this section. The formula is:
[GRAPHIC] [TIFF OMITTED] TC05OC91.038

    (3) Section 904(d) separate categories. If the assets in the general 
asset account generate foreign source income in more than one separate 
category under section 904(d)(1) or another section of the Code (for 
example, income treated as foreign source income under section 
904(g)(10)), or under a United States income tax treaty that requires 
the foreign tax credit limitation to be determined separately for 
specified types of income, the amount of ``foreign source

[[Page 1058]]

income, gain, or loss from the disposition of an asset'' (as determined 
under the formula in paragraph (f)(2)(ii) of this section) must be 
allocated and apportioned to the applicable separate category or 
categories under the formula in this paragraph (f)(3). For purposes of 
this formula, the allowed depreciation deductions are determined for the 
applicable time period provided in paragraph (f)(2)(i) of this section. 
The formula is:
[GRAPHIC] [TIFF OMITTED] TC05OC91.039

    (g) Assets subject to recapture. If the basis of an asset in a 
general asset account is increased as a result of the recapture of any 
allowable credit or deduction (for example, the basis adjustment for the 
recapture amount under section 30(d)(2), 50(c)(2), 179(d)(10), or 
179A(e)(4)), general asset account treatment for the asset terminates as 
of the first day of the taxable year in which the recapture event 
occurs. Consequently, the taxpayer must remove the asset from the 
general asset account as of that day and must make the adjustments to 
the general asset account described in paragraph (e)(3)(iii)(C)(2) 
through (4) of this section.
    (h) Changes in use--(1) Conversion to personal use. An asset in a 
general asset account becomes ineligible for general asset account 
treatment if a taxpayer uses the asset in a personal activity during a 
taxable year. Upon a conversion to personal use, the taxpayer must 
remove the asset from the general asset account as of the first day of 
the taxable year in which the change in use occurs (the year of change) 
and must make the adjustments to the general asset account described in 
paragraph (e)(3)(iii)(C)(2) through (4) of this section.
    (2) Change in use results in a different recovery period and/or 
depreciation method--(i) No effect on general asset account election. A 
change in the use described in Sec. 1.168(i)-4(d) (change in use 
results in a different recovery period and/or depreciation method) of an 
asset in a general asset account shall not cause or permit the 
revocation of the election made under this section.
    (ii) Asset is removed from the general asset account. Upon a change 
in the use described in Sec. 1.168(i)-4(d), the taxpayer must remove 
the asset from the general asset account as of the first day of the year 
of change and must make the adjustments to the general asset account 
described in paragraphs (e)(3)(iii)(C)(2) through (4) of this section. 
If, however, the result of the change in use is described in Sec. 
1.168(i)-4(d)(3) (change in use results in a shorter recovery period 
and/or a more accelerated depreciation method) and the taxpayer elects 
to treat the asset as though the change in use had not occurred pursuant 
to Sec. 1.168(i)-4(d)(3)(ii), no adjustment is made to the general 
asset account upon the change in use.
    (iii) New general asset account is established--(A) Change in use 
results in a shorter recovery period and/or a more accelerated 
depreciation method. If the result of the change in use is described in 
Sec. 1.168(i)-4(d)(3) (change in use results in a shorter recovery 
period and/or a more accelerated depreciation method) and adjustments to 
the general asset account are made pursuant to paragraph (h)(2)(ii) of 
this section, the taxpayer must establish a new general asset account 
for the asset in the year of change in accordance with the rules in 
paragraph (c) of this section, except that the adjusted depreciable 
basis of the asset as of the first day of the year of change is included 
in the general

[[Page 1059]]

asset account. For purposes of paragraph (c)(2) of this section, the 
applicable depreciation method, recovery period, and convention are 
determined under Sec. 1.168(i)-4(d)(3)(i).
    (B) Change in use results in a longer recovery period and/or a 
slower depreciation method. If the result of the change in use is 
described in Sec. 1.168(i)-4(d)(4) (change in use results in a longer 
recovery period and/or a slower depreciation method), the taxpayer must 
establish a separate general asset account for the asset in the year of 
change in accordance with the rules in paragraph (c) of this section, 
except that the unadjusted depreciable basis of the asset, and the 
greater of the depreciation of the asset allowed or allowable in 
accordance with section 1016(a)(2), as of the first day of the year of 
change are included in the newly established general asset account. 
Consequently, this general asset account as of the first day of the year 
of change will have a beginning balance for both the unadjusted 
depreciable basis and the depreciation reserve of the general asset 
account. For purposes of paragraph (c)(2) of this section, the 
applicable depreciation method, recovery period, and convention are 
determined under Sec. 1.168(i)-4(d)(4)(ii).
    (i) Identification of disposed or converted asset. [Reserved]. For 
further guidance, see Sec. 1.168(i)-1T(i).
    (j) Effect of adjustments on prior dispositions. [Reserved]. For 
further guidance, see Sec. 1.168(i)-1T(j).
    (k) Election--(1) Irrevocable election. If a taxpayer makes an 
election under this paragraph (k), the taxpayer consents to, and agrees 
to apply, all of the provisions of this section to the assets included 
in a general asset account. Except as provided in paragraph 
(c)(1)(ii)(A), (e)(3), (g), or (h) of this section, an election made 
under this section is irrevocable and will be binding on the taxpayer 
for computing taxable income for the taxable year for which the election 
is made and for all subsequent taxable years. An election under this 
paragraph (k) is made separately by each person owning an asset to which 
this section applies (for example, by each member of a consolidated 
group, at the partnership level (and not by the partner separately), or 
at the S corporation level (and not by the shareholder separately)).
    (2) Time for making election. The election to apply this section 
shall be made on the taxpayer's timely filed (including extensions) 
income tax return for the taxable year in which the assets included in 
the general asset account are placed in service by the taxpayer.
    (3) Manner of making election. In the year of election, a taxpayer 
makes the election under this section by typing or legibly printing at 
the top of the Form 4562, ``GENERAL ASSET ACCOUNT ELECTION MADE UNDER 
SECTION 168(i)(4),'' or in the manner provided for on Form 4562 and its 
instructions. The taxpayer shall maintain records (for example, 
``General Asset Account 1 - all 1995 additions in asset class 
00.11 for Salt Lake City, Utah facility'') that identify the assets 
included in each general asset account, that establish the unadjusted 
depreciable basis and depreciation reserve of the general asset account, 
and that reflect the amount realized during the taxable year upon 
dispositions from each general asset account. (But see section 179(c) 
and Sec. 1.179-5 for the recordkeeping requirements for section 179 
property.) The taxpayer's recordkeeping practices should be consistently 
applied to the general asset accounts. If Form 4562 is revised or 
renumbered, any reference in this section to that form shall be treated 
as a reference to the revised or renumbered form.
    (l) Effective dates--(1) [Reserved] For further guidance, see Sec. 
1.168(i)-1T(l)(1).
    (2) Exceptions--(i) In general. (A) Paragraph (b)(1) of this section 
applies on or after June 17, 2004. For the applicability of Sec. 
1.168(i)-1(b)(1) before June 17, 2004, see Sec. 1.168(i)-1(b)(1) in 
effect prior to June 17, 2004 (Sec. 1.168(i)-1(b)(1) as contained in 26 
CFR part 1 edition revised as of April 1, 2004).
    (B) Paragraphs (c)(2)(ii)(E) and (h)(2) of this section apply to any 
change in the use of depreciable assets pursuant to Sec. 1.168(i)-4(d) 
in a taxable year ending on or after June 17, 2004. For any change in 
the use of depreciable assets as described in Sec. 1.168(i)-4(d) after 
December 31, 1986, in a taxable year ending before June 17, 2004, the 
Internal

[[Page 1060]]

Revenue Service will allow any reasonable method that is consistently 
applied to the taxpayer's general asset accounts or the taxpayer may 
choose, on an asset-by-asset basis, to apply paragraphs (c)(2)(ii)(E) 
and (h)(2) of this section.
    (ii) Change in method of accounting--(A) In general. If a taxpayer 
adopted a method of accounting for general asset account treatment due 
to a change in the use of depreciable assets pursuant to Sec. 1.168(i)-
4(d) in a taxable year ending on or after December 30, 2003, and the 
method adopted is not in accordance with the method of accounting 
provided in paragraphs (c)(2)(ii)(E) and (h)(2) of this section, a 
change to the method of accounting provided in paragraphs (c)(2)(ii)(E) 
and (h)(2) of this section is a change in method of accounting to which 
the provisions of section 446(e) and the regulations under section 
446(e) apply. However, if a taxpayer adopted a method of accounting for 
general asset account treatment due to a change in the use of 
depreciable assets pursuant to Sec. 1.168(i)-4(d) after December 31, 
1986, in a taxable year ending before December 30, 2003, and the method 
adopted is not in accordance with the method of accounting provided in 
paragraphs (c)(2)(ii)(E) and (h)(2) of this section, the taxpayer may 
treat the change to the method of accounting provided in paragraphs 
(c)(2)(ii)(E) and (h)(2) of this section as a change in method of 
accounting to which the provisions of section 446(e) and the regulations 
under section 446(e) apply.
    (B) Automatic consent to change method of accounting. A taxpayer 
changing its method of accounting in accordance with this paragraph 
(l)(2)(ii) must follow the applicable administrative procedures issued 
under Sec. 1.446-1(e)(3)(ii) for obtaining the Commissioner's automatic 
consent to a change in method of accounting (for further guidance, for 
example, see Rev. Proc. 2002-9 (2002-1 C.B. 327), as modified by Rev. 
Proc. 2004-11 (2004-3 I.R.B. 311) (see Sec. 601.601(d)(2)(ii)(b) of 
this chapter)). Because this change does not change the adjusted 
depreciable basis of the asset, the method change is made on a cut-off 
basis and, therefore, no adjustment under section 481(a) is required or 
allowed. For purposes of Form 3115, Application for Change in Accounting 
Method, the designated number for the automatic accounting method change 
authorized by this paragraph (l)(2)(ii) is ``87.'' If Form 3115 is 
revised or renumbered, any reference in this section to that form is 
treated as a reference to the revised or renumbered form.
    (3) [Reserved] For further guidance, see Sec. 1.168(i)-1T(l)(3).

[T.D. 8566, 59 FR 51371, Oct. 11, 1994; 59 FR 64849, Dec. 16, 1994, as 
amended by T.D. 9115, 69 FR 9534, Mar. 1, 2004; T.D. 9132, 69 FR 33842, 
June 17, 2004]



Sec. 1.168(i)-1T  General asset accounts (temporary).

    (a) through (c)(2)(ii)(D) [Reserved]. For further guidance, see 
Sec. 1.168(i)-1(a) through (c)(2)(ii)(D).
    (c)(2)(ii)(E) [Reserved] For further guidance, see Sec. 1.168(i)-
1(c)(2)(ii)(E).
    (d)(1) [Reserved]. For further guidance, see Sec. 1.168(i)-1(d)(1).
    (2) Special rule for passenger automobiles. For purposes of applying 
section 280F(a), the depreciation allowance for a general asset account 
established for passenger automobiles is limited for each taxable year 
to the amount prescribed in section 280F(a) multiplied by the excess of 
the number of automobiles originally included in the account over the 
number of automobiles disposed of during the taxable year or in any 
prior taxable year in a transaction described in paragraph (e)(3)(iii) 
(disposition of an asset in a qualifying disposition), (e)(3)(iv) 
(transactions subject to section 168(i)(7)), (e)(3)(v) (transactions 
subject to section 1031 or 1033), (e)(3)(vi) (anti-abuse rule), (g) 
(assets subject to recapture), or (h) (changes in use) of this section.
    (e)(1) through (e)(2) [Reserved]. For further guidance, see Sec. 
1.168(i)-1(e)(1) through (e)(2).
    (e)(3) Special rules--(i) In general. This paragraph (e)(3) provides 
the rules for terminating general asset account treatment upon certain 
dispositions. While the rules under paragraphs (e)(3)(ii) and (iii) of 
this section are optional rules, the rules under paragraphs (e)(3)(iv), 
(v), and (vi) of this section are mandatory rules. A taxpayer applies 
paragraph (e)(3)(ii) or (iii) of this section by reporting the gain,

[[Page 1061]]

loss, or other deduction on the taxpayer's timely filed Federal income 
tax return (including extensions) for the taxable year in which the 
disposition occurs. For purposes of applying paragraph (e)(3)(iii) 
through (vi) of this section, see paragraph (i) of this section for 
identifying the unadjusted depreciable basis of a disposed asset.
    (e)(3)(ii) through (e)(3)(iii)(B)(3) [Reserved]. For further 
guidance, see Sec. 1.168(i)-1(e)(3)(ii) through (e)(3)(iii)(B)(3).
    (e)(3)(iii)(B)(4) A transaction, other than a transaction described 
in paragraph (e)(3)(iv) of this section (pertaining to transactions 
subject to section 168(i)(7)) and (e)(3)(v) of this section (pertaining 
to transactions subject to section 1031 or 1033), to which a 
nonrecognition section of the Code applies (determined without regard to 
this section).
    (e)(3)(iii)(C) through (e)(3)(iv) [Reserved]. For further guidance, 
see Sec. 1.168(i)-1(e)(iii)(C) through (e)(3)(iv).
    (e)(3)(v) Transactions subject to section 1031 or section 1033--(A) 
Like-kind exchange or involuntary conversion of all assets remaining in 
a general asset account. If all the assets, or the last asset, in a 
general asset account are transferred by a taxpayer in a like-kind 
exchange (as defined under Sec. 1.168-6T(b)(11)) or in an involuntary 
conversion (as defined under Sec. 1.168-6T(b)(12)), the taxpayer must 
apply this paragraph (e)(3)(v)(A) (instead of applying paragraph (e)(2), 
(e)(3)(ii), or (e)(3)(iii) of this section). Under this paragraph 
(e)(3)(v)(A), the general asset account terminates as of the first day 
of the year of disposition (as defined in Sec. 1.168(i)-6T(b)(5)) and--
    (1) The amount of gain or loss for the general asset account is 
determined under section 1001(a) by taking into account the adjusted 
depreciable basis of the general asset account at the time of 
disposition (as defined in Sec. 1.168(i)-6T(b)(3)). The depreciation 
allowance for the general asset account in the year of disposition is 
determined in the same manner as the depreciation allowance for the 
relinquished MACRS property (as defined in Sec. 1.168(i)-6T(b)(2)) in 
the year of disposition is determined under Sec. 1.168(i)-6T. The 
recognition and character of gain or loss are determined in accordance 
with paragraph (e)(3)(ii)(A) of this section (notwithstanding that 
paragraph (e)(3)(ii) of this section is an optional rule); and
    (2) The adjusted depreciable basis of the general asset account at 
the time of disposition is treated as the adjusted depreciable basis of 
the relinquished MACRS property.
    (B) Like-kind exchange or involuntary conversion of less than all 
assets remaining in a general asset account. If an asset in a general 
asset account is transferred by a taxpayer in a like-kind exchange or in 
an involuntary conversion and if paragraph (e)(3)(v)(A) of this section 
does not apply to this asset, the taxpayer must apply this paragraph 
(e)(3)(v)(B) (instead of applying paragraph (e)(2), (e)(3)(ii), or 
(e)(3)(iii) of this section). Under this paragraph (e)(3)(v)(B), general 
asset account treatment for the asset terminates as of the first day of 
the year of disposition (as defined in Sec. 1.168(i)-6T(b)(5)), and--
    (1) The amount of gain or loss for the asset is determined by taking 
into account the asset's adjusted basis at the time of disposition (as 
defined in Sec. 1.168(i)-6T(b)(3)). The adjusted basis of the asset at 
the time of disposition equals the unadjusted depreciable basis of the 
asset less the depreciation allowed or allowable for the asset, computed 
by using the depreciation method, recovery period, and convention 
applicable to the general asset account in which the asset was included. 
The depreciation allowance for the asset in the year of disposition is 
determined in the same manner as the depreciation allowance for the 
relinquished MACRS property (as defined in Sec. 1.168(i)-6T(b)(2)) in 
the year of disposition is determined under Sec. 1.168(i)-6T. The 
recognition and character of the gain or loss are determined in 
accordance with paragraph (e)(3)(iii)(A) of this section 
(notwithstanding that paragraph (e)(3)(iii) of this section is an 
optional rule); and
    (2) As of the first day of the year of disposition, the taxpayer 
must remove the relinquished asset from the general

[[Page 1062]]

asset account and make the adjustments to the general asset account 
described in paragraph (e)(3)(iii)(C)(2) through (4) of this section.
    (e)(3)(vi) Anti-abuse rule--(A) In general. If an asset in a general 
asset account is disposed of by a taxpayer in a transaction described in 
paragraph (e)(3)(vi)(B) of this section, general asset account treatment 
for the asset terminates as of the first day of the taxable year in 
which the disposition occurs. Consequently, the taxpayer must determine 
the amount of gain, loss, or other deduction attributable to the 
disposition in the manner described in paragraph (e)(3)(iii)(A) of this 
section (notwithstanding that paragraph (e)(3)(iii)(A) of this section 
is an optional rule) and must make the adjustments to the general asset 
account described in paragraph (e)(3)(iii)(C)(1) through (4) of this 
section.
    (B) Abusive transactions. A transaction is described in this 
paragraph (e)(3)(vi)(B) if the transaction is not described in paragraph 
(e)(3)(iv) or (e)(3)(v) of this section and the transaction is entered 
into, or made, with a principal purpose of achieving a tax benefit or 
result that would not be available absent an election under this 
section. Examples of these types of transactions include--
    (1) A transaction entered into with a principal purpose of shifting 
income or deductions among taxpayers in a manner that would not be 
possible absent an election under this section in order to take 
advantage of differing effective tax rates among the taxpayers; or
    (2) An election made under this section with a principal purpose of 
disposing of an asset from a general asset account in order to utilize 
an expiring net operating loss or credit. The fact that a taxpayer with 
a net operating loss carryover or a credit carryover transfers an asset 
to a related person or transfers an asset pursuant to an arrangement 
where the asset continues to be used (or is available for use) by the 
taxpayer pursuant to a lease (or otherwise) indicates, absent strong 
evidence to the contrary, that the transaction is described in this 
paragraph (e)(3)(vi)(B).
    (f) Assets generating foreign source income--(1) In general. This 
paragraph (f) provides the rules for determining the source of any 
income, gain, or loss recognized, and the appropriate section 904(d) 
separate limitation category or categories for any foreign source 
income, gain, or loss recognized, on a disposition (within the meaning 
of paragraph (e)(1) of this section) of an asset in a general asset 
account that consists of assets generating both United States and 
foreign source income. These rules apply only to a disposition to which 
paragraph (e)(2) (general disposition rules), (e)(3)(ii) (disposition of 
all assets remaining in a general asset account), (e)(3)(iii) 
(disposition of an asset in a qualifying disposition), (e)(3)(v) 
(transactions subject to section 1031 or 1033), or (e)(3)(vi) (anti-
abuse rule) of this section applies.
    (2) Source of ordinary income, gain or loss--(i) Source determined 
by allocation and apportionment of depreciation allowed. The amount of 
any ordinary income, gain, or loss that is recognized on the disposition 
of an asset in a general asset account must be apportioned between 
United States and foreign sources based on the allocation and 
apportionment of the--
    (A) Depreciation allowed for the general asset account as of the end 
of the taxable year in which the disposition occurs if paragraph (e)(2) 
of this section applies to the disposition;
    (B) Depreciation allowed for the general asset account as of the 
time of disposition if the taxpayer applies paragraph (e)(3)(ii) of this 
section to the disposition of all assets, or the last asset, in the 
general asset account, or if all the assets, or the last asset, in the 
general asset account are disposed of in a transaction described in 
paragraph (e)(3)(v)(A) of this section; or
    (C) Depreciation allowed for the disposed asset for only the taxable 
year in which the disposition occurs if the taxpayer applies paragraph 
(e)(3)(iii) of this section to the disposition of the asset in a 
qualifying disposition, if the asset is disposed of in a transaction 
described in paragraph (e)(3)(v)(B) of this section (like-kind exchange 
or involuntary conversion), or if the asset is disposed in a transaction 
described in paragraph (e)(3)(vi) of this section (anti-abuse rule).

[[Page 1063]]

    (f)(2)(ii) through (h) [Reserved]. For further guidance, see Sec. 
1.168(i)-1(f)(2)(ii) through (h).
    (i) Identification of disposed or converted asset. A taxpayer may 
use any reasonable method that is consistently applied to the taxpayer's 
general asset accounts for purposes of determining the unadjusted 
depreciable basis of a disposed or converted asset in a transaction 
described in paragraph (e)(3)(iii) (disposition of an asset in a 
qualifying disposition), (e)(3)(iv) (transactions subject to section 
168(i)(7)), (e)(3)(v) (transactions subject to section 1031 or 1033), 
(e)(3)(vi) (anti-abuse rule), (g) (assets subject to recapture), or (h) 
(changes in use) of this section.
    (j) Effect of adjustments on prior dispositions. The adjustments to 
a general asset account under paragraph (e)(3)(iii), (e)(3)(iv), 
(e)(3)(v), (e)(3)(vi), (g), or (h) of this section have no effect on the 
recognition and character of prior dispositions subject to paragraph 
(e)(2) of this section.
    (k) [Reserved]. For further guidance, see Sec. 1.168(i)-1(k).
    (l) Effective date--(1) In general. Except as provided in paragraphs 
(l)(2) and (l)(3) of this section, this section applies to depreciable 
assets placed in service in taxable years ending on or after October 11, 
1994. For depreciable assets placed in service after December 31, 1986, 
in taxable years ending before October 11, 1994, the Internal Revenue 
Service will allow any reasonable method that is consistently applied to 
the taxpayer's general asset accounts.
    (2) [Reserved] For further guidance, see Sec. 1.168(i)-1(l)(2).
    (3) Like-kind exchanges and involuntary conversions. (i) This 
section applies for an asset transferred by a taxpayer in a like-kind 
exchange (as defined under Sec. 1.168-6T(b)(11)) or in an involuntary 
conversion (as defined under Sec. 1.168-6T(b)(12)) for which the time 
of disposition (as defined in Sec. 1.168(i)-6T(b)(3)) and the time of 
replacement (as defined in Sec. 1.168(i)-6T(b)(4)) both occur after 
February 27, 2004. For an asset transferred by a taxpayer in a like-kind 
exchange or in an involuntary conversion for which the time of 
disposition, the time of replacement, or both occur on or before 
February 27, 2004, see Sec. 1.168(i)-1 in effect prior to February 27, 
2004, (Sec. 1.168(i)-1 as contained in 26 CFR part 1 edition revised as 
of April 1, 2003).
    (ii) The applicability of this section expires on or before February 
26, 2007.

[T.D. 9115, 69 FR 9535, Mar. 1, 2004; 69 FR 17586, Apr. 5, 2004; T.D. 
9132, 69 FR 33843, June 17, 2004]



Sec. 1.168(i)-2  Lease term.

    (a) In general. For purposes of section 168, a lease term is 
determined under all the facts and circumstances. Paragraph (b) of this 
section and Sec. 1.168(j)-1T, Q&A 17, describe certain circumstances 
that will result in a period of time not included in the stated duration 
of an original lease (additional period) nevertheless being included in 
the lease term. These rules do not prevent the inclusion of an 
additional period in the lease term in other circumstances.
    (b) Lessee retains financial obligation--(1) In general. An 
additional period of time during which a lessee may not continue to be 
the lessee will nevertheless be included in the lease term if the lessee 
(or a related person)--
    (i) Has agreed that one or both of them will or could be obligated 
to make a payment of rent or a payment in the nature of rent with 
respect to such period; or
    (ii) Has assumed or retained any risk of loss with respect to the 
property for such period (including, for example, by holding a note 
secured by the property).
    (2) Payments in the nature of rent. For purposes of paragraph 
(b)(1)(i) of this section, a payment in the nature of rent includes a 
payment intended to substitute for rent or to fund or supplement the 
rental payments of another. For example, a payment in the nature of rent 
includes a payment of any kind (whether denominated as supplemental 
rent, as liquidated damages, or otherwise) that is required to be made 
in the event that--
    (i) The leased property is not leased for the additional period;
    (ii) The leased property is leased for the additional period under 
terms that do not satisfy specified terms and conditions;
    (iii) There is a failure to make a payment of rent with respect to 
such additional period; or

[[Page 1064]]

    (iv) Circumstances similar to those described in paragraph (b)(2) 
(i), (ii), or (iii) of this section occur.
    (3) De minimis rule. For the purposes of this paragraph (b), 
obligations to make de minimis payments will be disregarded.
    (c) Multiple leases or subleases. If property is subject to more 
than one lease (including any sublease) entered into as part of a single 
transaction (or a series of related transactions), the lease term 
includes all periods described in one or more of such leases. For 
example, if one taxable corporation leases property to another taxable 
corporation for a 20-year term and, as part of the same transaction, the 
lessee subleases the property to a tax-exempt entity for a 10-year term, 
then the lease term of the property for purposes of section 168 is 20 
years. During the period of tax-exempt use, the property must be 
depreciated under the alternative depreciation system using the straight 
line method over the greater of its class life or 25 years (125 percent 
of the 20-year lease term).
    (d) Related person. For purposes of paragraph (b) of this section, a 
person is related to the lessee if such person is described in section 
168(h)(4).
    (e) Changes in status. Section 168(i)(5) (changes in status) applies 
if an additional period is included in a lease term under this section 
and the leased property ceases to be tax-exempt use property for such 
additional period.
    (f) Example. The following example illustrates the principles of 
this section. The example does not address common law doctrines or other 
authorities that may apply to cause an additional period to be included 
in the lease term or to recharacterize a lease as a conditional sale or 
otherwise for federal income tax purposes. Unless otherwise indicated, 
parties to the transactions are not related to one another.

    Example Financial obligation with respect to an additional period--
(i) Facts.
    X, a taxable corporation, and Y, a foreign airline whose income is 
not subject to United States taxation, enter into a lease agreement 
under which X agrees to lease an aircraft to Y for a period of 10 years. 
The lease agreement provides that, at the end of the lease period, Y is 
obligated to find a subsequent lessee (replacement lessee) to enter into 
a subsequent lease (replacement lease) of the aircraft from X for an 
additional 10-year period. The provisions of the lease agreement require 
that any replacement lessee be unrelated to Y and that it not be a tax-
exempt entity as defined in section 168(h)(2). The provisions of the 
lease agreement also set forth the basic terms and conditions of the 
replacement lease, including its duration and the required rental 
payments. In the event Y fails to secure a replacement lease, the lease 
agreement requires Y to make a payment to X in an amount determined 
under the lease agreement.
    (ii) Application of this section. The lease agreement between X and 
Y obligates Y to make a payment in the event the aircraft is not leased 
for the period commencing after the initial 10-year lease period and 
ending on the date the replacement lease is scheduled to end. 
Accordingly, pursuant to paragraph (b) of this section, the term of the 
lease between X and Y includes such additional period, and the lease 
term is 20 years for purposes of section 168.
    (iii) Facts modified. Assume the same facts as in paragraph (i) of 
this Example, except that Y is required to guarantee the payment of 
rentals under the 10-year replacement lease and to make a payment to X 
equal to the present value of any excess of the replacement lease rental 
payments specified in the lease agreement between X and Y, over the 
rental payments actually agreed to be paid by the replacement lessee. 
Pursuant to paragraph (b) of this section, the term of the lease between 
X and Y includes the additional period, and the lease term is 20 years 
for purposes of section 168.
    (iv) Changes in status. If, upon the conclusion of the stated 
duration of the lease between X and Y, the aircraft either is returned 
to X or leased to a replacement lessee that is not a tax-exempt entity 
as defined in section 168(h)(2), the subsequent method of depreciation 
will be determined pursuant to section 168(i)(5).

    (g) Effective date--(1) In general. Except as provided in paragraph 
(g)(2) of this section, this section applies to leases entered into on 
or after April 20, 1995.
    (2) Special rules. Paragraphs (b)(1)(ii) and (c) of this section 
apply to leases entered into after April 26, 1996.

[T.D. 8667, 61 FR 18677, Apr. 29, 1996]



Sec. 1.168(i)-4  Changes in use.

    (a) Scope. This section provides the rules for determining the 
depreciation allowance for MACRS property (as defined in Sec. 1.168(b)-
1T(a)(2)) for which the use changes in the hands of the same

[[Page 1065]]

taxpayer (change in the use). The allowance for depreciation under this 
section constitutes the amount of depreciation allowable under section 
167(a) for the year of change and any subsequent taxable year. For 
purposes of this section, the year of change is the taxable year in 
which a change in the use occurs.
    (b) Conversion to business or income-producing use--(1) Depreciation 
deduction allowable. This paragraph (b) applies to property that is 
converted from personal use to use in a taxpayer's trade or business, or 
for the production of income, during a taxable year. This conversion 
includes property that was previously used by the taxpayer for personal 
purposes, including real property (other than land) that is acquired 
before 1987 and converted from personal use to business or income-
producing use after 1986, and depreciable property that was previously 
used by a tax-exempt entity before the entity changed to a taxable 
entity. Except as otherwise provided by the Internal Revenue Code or 
regulations under the Internal Revenue Code, upon a conversion to 
business or income-producing use, the depreciation allowance for the 
year of change and any subsequent taxable year is determined as though 
the property is placed in service by the taxpayer on the date on which 
the conversion occurs. Thus, except as otherwise provided by the 
Internal Revenue Code or regulations under the Internal Revenue Code, 
the taxpayer must use any applicable depreciation method, recovery 
period, and convention prescribed under section 168 for the property in 
the year of change, consistent with any election made under section 168 
by the taxpayer for that year (see, for example, section 168(b)(5)). See 
Sec. Sec. 1.168(k)-1T(f)(6)(iii) and 1.1400L(b)-1T(f)(6) for the 
additional first year depreciation deduction rules applicable to a 
conversion to business or income-producing use. The depreciable basis of 
the property for the year of change is the lesser of its fair market 
value or its adjusted depreciable basis (as defined in Sec. 1.168(b)-
1T(a)(4)), as applicable, at the time of the conversion to business or 
income-producing use.
    (2) Example. The application of this paragraph (b) is illustrated by 
the following example:

    Example. A, a calendar-year taxpayer, purchases a house in 1985 that 
she occupies as her principal residence. In February 2004, A ceases to 
occupy the house and converts it to residential rental property. At the 
time of the conversion to residential rental property, the house's fair 
market value (excluding land) is $130,000 and adjusted depreciable basis 
attributable to the house (excluding land) is $150,000. Pursuant to this 
paragraph (b), A is considered to have placed in service residential 
rental property in February 2004 with a depreciable basis of $130,000. A 
depreciates the residential rental property under the general 
depreciation system by using the straight-line method, a 27.5-year 
recovery period, and the mid-month convention. Pursuant to Sec. Sec. 
1.168(k)-1T(f)(6)(iii)(B) or 1.1400L(b)-1T(f)(6), this property is not 
eligible for the additional first year depreciation deduction provided 
by section 168(k) or section 1400L(b). Thus, the depreciation allowance 
for the house for 2004 is $4,137, after taking into account the mid-
month convention (($130,000 adjusted depreciable basis multiplied by the 
applicable depreciation rate of 3.636% (1/27.5)) multiplied by the mid-
month convention fraction of 10.5/12). The amount of depreciation 
computed under section 168, however, may be limited under other 
provisions of the Internal Revenue Code, such as, section 280A.

    (c) Conversion to personal use. The conversion of MACRS property 
from business or income-producing use to personal use during a taxable 
year is treated as a disposition of the property in that taxable year. 
The depreciation allowance for MACRS property for the year of change in 
which the property is treated as being disposed of is determined by 
first multiplying the adjusted depreciable basis of the property as of 
the first day of the year of change by the applicable depreciation rate 
for that taxable year (for further guidance, for example, see section 6 
of Rev. Proc. 87-57 (1987-2 C. B. 687, 692) (see Sec. 
601.601(d)(2)(ii)(b) of this chapter)). This amount is then multiplied 
by a fraction, the numerator of which is the number of months (including 
fractions of months) the property is deemed to be placed in service 
during the year of change (taking into account the applicable 
convention) and the denominator of which is 12. No depreciation 
deduction is allowable for MACRS property placed in service and disposed 
of in the

[[Page 1066]]

same taxable year. See Sec. Sec. 1.168(k)-1T(f)(6)(ii) and 1.1400L(b)-
1T(f)(6) for the additional first year depreciation deduction rules 
applicable to property placed in service and converted to personal use 
in the same taxable year. Upon the conversion to personal use, no gain, 
loss, or depreciation recapture under section 1245 or section 1250 is 
recognized. However, the provisions of section 1245 or section 1250 
apply to any disposition of the converted property by the taxpayer at a 
later date. For listed property (as defined in section 280F(d)(4)), see 
section 280F(b)(2) for the recapture of excess depreciation upon the 
conversion to personal use.
    (d) Change in the use results in a different recovery period and/or 
depreciation method--(1) In general. This paragraph (d) applies to a 
change in the use of MACRS property during a taxable year subsequent to 
the placed-in-service year, if the property continues to be MACRS 
property owned by the same taxpayer and, as a result of the change in 
the use, has a different recovery period, a different depreciation 
method, or both. For example, this paragraph (d) applies to MACRS 
property that--
    (i) Begins or ceases to be used predominantly outside the United 
States;
    (ii) Results in a reclassification of the property under section 
168(e) due to a change in the use of the property; or
    (iii) Begins or ceases to be tax-exempt use property (as defined in 
section 168(h)).
    (2) Determination of change in the use--(i) In general. Except as 
provided in paragraph (d)(2)(ii) of this section, a change in the use of 
MACRS property occurs when the primary use of the MACRS property in the 
taxable year is different from its primary use in the immediately 
preceding taxable year. The primary use of MACRS property may be 
determined in any reasonable manner that is consistently applied to the 
taxpayer's MACRS property.
    (ii) Alternative depreciation system property--(A) Property used 
within or outside the United States. A change in the use of MACRS 
property occurs when a taxpayer begins or ceases to use MACRS property 
predominantly outside the United States during the taxable year. The 
determination of whether MACRS property is used predominantly outside 
the United States is made in accordance with the test in Sec. 1.48-
1(g)(1)(i) for determining predominant use.
    (B) Tax-exempt bond financed property. A change in the use of MACRS 
property occurs when the property changes to tax-exempt bond financed 
property, as described in section 168(g)(1)(C) and (g)(5), during the 
taxable year. For purposes of this paragraph (d), MACRS property changes 
to tax-exempt bond financed property when a tax-exempt bond is first 
issued after the MACRS property is placed in service. MACRS property 
continues to be tax-exempt bond financed property in the hands of the 
taxpayer even if the tax-exempt bond (including any refunding issue) is 
no longer outstanding or is redeemed.
    (C) Other mandatory alternative depreciation system property. A 
change in the use of MACRS property occurs when the property changes to, 
or changes from, property described in section 168(g)(1)(B) (tax-exempt 
use property) or (D) (imported property covered by an Executive order) 
during the taxable year.
    (iii) Change in the use deemed to occur on first day of the year of 
change. If a change in the use of MACRS property occurs under this 
paragraph (d)(2), the depreciation allowance for that MACRS property for 
the year of change is determined as though the use of the MACRS property 
changed on the first day of the year of change.
    (3) Change in the use results in a shorter recovery period and/or a 
more accelerated depreciation method--(i) Treated as placed in service 
in the year of change--(A) In general. If a change in the use results in 
the MACRS property changing to a shorter recovery period and/or a 
depreciation method that is more accelerated than the method used for 
the MACRS property before the change in the use, the depreciation 
allowances beginning in the year of change are determined as though the 
MACRS property is placed in service by the taxpayer in the year of 
change.
    (B) Computation of depreciation allowance. The depreciation 
allowances for the MACRS property for any 12-month taxable year 
beginning with the year of change are determined by multiplying the 
adjusted depreciable basis of the

[[Page 1067]]

MACRS property as of the first day of each taxable year by the 
applicable depreciation rate for each taxable year. In determining the 
applicable depreciation rate for the year of change and subsequent 
taxable years, the taxpayer must use any applicable depreciation method 
and recovery period prescribed under section 168 for the MACRS property 
in the year of change, consistent with any election made under section 
168 by the taxpayer for that year (see, for example, section 168(b)(5)). 
If there is a change in the use of MACRS property, the applicable 
convention that applies to the MACRS property is the same as the 
convention that applied before the change in the use of the MACRS 
property. However, the depreciation allowance for the year of change for 
the MACRS property is determined without applying the applicable 
convention, unless the MACRS property is disposed of during the year of 
change. See paragraph (d)(5) of this section for the rules relating to 
the computation of the depreciation allowance under the optional 
depreciation tables. If the year of change or any subsequent taxable 
year is less than 12 months, the depreciation allowance determined under 
this paragraph (d)(3)(i) must be adjusted for a short taxable year (for 
further guidance, for example, see Rev. Proc. 89-15 (1989-1 C.B. 816) 
(see Sec. 601.601(d)(2)(ii)(b) of this chapter)).
    (C) Special rules. MACRS property affected by this paragraph 
(d)(3)(i) is not eligible in the year of change for the election 
provided under section 168(f)(1), 179, or 1400L(f), or for the 
additional first year depreciation deduction provided in section 168(k) 
or 1400L(b). See Sec. Sec. 1.168(k)-1T(f)(6)(iv) and 1.1400L(b)-
1T(f)(6) for other additional first year depreciation deduction rules 
applicable to a change in the use of MACRS property subsequent to its 
placed-in-service year. For purposes of determining whether the mid-
quarter convention applies to other MACRS property placed in service 
during the year of change, the unadjusted depreciable basis (as defined 
in Sec. 1.168(b)-1T(a)(3)) or the adjusted depreciable basis of MACRS 
property affected by this paragraph (d)(3)(i) is not taken into account.
    (ii) Option to disregard the change in the use. In lieu of applying 
paragraph (d)(3)(i) of this section, the taxpayer may elect to determine 
the depreciation allowance as though the change in the use had not 
occurred. The taxpayer elects this option by claiming on the taxpayer's 
timely filed (including extensions) Federal income tax return for the 
year of change the depreciation allowance for the property as though the 
change in the use had not occurred. See paragraph (g)(2) of this section 
for the manner for revoking this election.
    (4) Change in the use results in a longer recovery period and/or a 
slower depreciation method--(i) Treated as originally placed in service 
with longer recovery period and/or slower depreciation method. If a 
change in the use results in a longer recovery period and/or a 
depreciation method for the MACRS property that is less accelerated than 
the method used for the MACRS property before the change in the use, the 
depreciation allowances beginning with the year of change are determined 
as though the MACRS property had been originally placed in service by 
the taxpayer with the longer recovery period and/or the slower 
depreciation method. MACRS property affected by this paragraph (d)(4) is 
not eligible in the year of change for the election provided under 
section 168(f)(1), 179, or 1400L(f), or for the additional first year 
depreciation deduction provided in section 168(k) or 1400L(b). See 
Sec. Sec. 1.168(k)-1T(f)(6)(iv) and 1.1400L(b)-1T(f)(6) for other 
additional first year depreciation deduction rules applicable to a 
change in the use of MACRS property subsequent to its placed-in-service 
year.
    (ii) Computation of the depreciation allowance. The depreciation 
allowances for the MACRS property for any 12-month taxable year 
beginning with the year of change are determined by multiplying the 
adjusted depreciable basis of the MACRS property as of the first day of 
each taxable year by the applicable depreciation rate for each taxable 
year. If there is a change in the use of MACRS property, the applicable 
convention that applies to the MACRS property is the same as the 
convention that applied before the change in the use of the MACRS 
property. If the year of change or any subsequent taxable

[[Page 1068]]

year is less than 12 months, the depreciation allowance determined under 
this paragraph (d)(4)(ii) must be adjusted for a short taxable year (for 
further guidance, for example, see Rev. Proc. 89-15 (1989-1 C.B. 816) 
(see Sec. 601.601(d)(2)(ii)(b) of this chapter)). See paragraph (d)(5) 
of this section for the rules relating to the computation of the 
depreciation allowance under the optional depreciation tables. In 
determining the applicable depreciation rate for the year of change and 
any subsequent taxable year--
    (A) The applicable depreciation method is the depreciation method 
that would apply in the year of change and any subsequent taxable year 
for the MACRS property had the taxpayer used the longer recovery period 
and/or the slower depreciation method in the placed-in-service year of 
the property. If the 200-or 150-percent declining balance method would 
have applied in the placed-in-service year but the method would have 
switched to the straight line method in the year of change or any prior 
taxable year, the applicable depreciation method beginning with the year 
of change is the straight line method; and
    (B) The applicable recovery period is either--
    (1) The longer recovery period resulting from the change in the use 
if the applicable depreciation method is the 200-or 150-percent 
declining balance method (as determined under paragraph (d)(4)(ii)(A) of 
this section) unless the recovery period did not change as a result of 
the change in the use, in which case the applicable recovery period is 
the same recovery period that applied before the change in the use; or
    (2) The number of years remaining as of the beginning of each 
taxable year (taking into account the applicable convention) had the 
taxpayer used the longer recovery period in the placed-in-service year 
of the property if the applicable depreciation method is the straight 
line method (as determined under paragraph (d)(4)(ii)(A) of this 
section) unless the recovery period did not change as a result of the 
change in the use, in which case the applicable recovery period is the 
number of years remaining as of the beginning of each taxable year 
(taking into account the applicable convention) based on the recovery 
period that applied before the change in the use.
    (5) Using optional depreciation tables--(i) Taxpayer not bound by 
prior use of table. If a taxpayer used an optional depreciation table 
for the MACRS property before a change in the use, the taxpayer is not 
bound to use the appropriate new table for that MACRS property beginning 
in the year of change (for further guidance, for example, see section 8 
of Rev. Proc. 87-57 (1987-2 C.B. 687, 693) (see Sec. 
601.601(d)(2)(ii)(b) of this chapter)). If a taxpayer did not use an 
optional depreciation table for MACRS property before a change in the 
use and the change in the use results in a shorter recovery period and/
or a more accelerated depreciation method (as described in paragraph 
(d)(3)(i) of this section), the taxpayer may use the appropriate new 
table for that MACRS property beginning in the year of change. If a 
taxpayer chooses not to use the optional depreciation table, the 
depreciation allowances for the MACRS property beginning in the year of 
change are determined under paragraph (d)(3)(i) or (4) of this section, 
as applicable.
    (ii) Taxpayer chooses to use optional depreciation table after a 
change in the use. If a taxpayer chooses to use an optional depreciation 
table for the MACRS property after a change in the use, the depreciation 
allowances for the MACRS property for any 12-month taxable year 
beginning with the year of change are determined as follows:
    (A) Change in the use results in a shorter recovery period and/or a 
more accelerated depreciation method. If a change in the use results in 
a shorter recovery period and/or a more accelerated depreciation method 
(as described in paragraph (d)(3)(i) of this section), the depreciation 
allowances for the MACRS property for any 12-month taxable year 
beginning with the year of change are determined by multiplying the 
adjusted depreciable basis of the MACRS property as of the first day of 
the year of change by the annual depreciation rate for each recovery 
year (expressed as a decimal equivalent) specified in the appropriate 
optional depreciation table. The appropriate optional depreciation table 
for the MACRS property

[[Page 1069]]

is based on the depreciation system, depreciation method, recovery 
period, and convention applicable to the MACRS property in the year of 
change as determined under paragraph (d)(3)(i) of this section. The 
depreciation allowance for the year of change for the MACRS property is 
determined by taking into account the applicable convention (which is 
already factored into the optional depreciation tables). If the year of 
change or any subsequent taxable year is less than 12 months, the 
depreciation allowance determined under this paragraph (d)(5)(ii)(A) 
must be adjusted for a short taxable year (for further guidance, for 
example, see Rev. Proc. 89-15 (1989-1 C.B. 816) (see Sec. 
601.601(d)(2)(ii)(b) of this chapter)).
    (B) Change in the use results in a longer recovery period and/or a 
slower depreciation method--(1) Determination of the appropriate 
optional depreciation table. If a change in the use results in a longer 
recovery period and/or a slower depreciation method (as described in 
paragraph (d)(4)(i) of this section), the depreciation allowances for 
the MACRS property for any 12-month taxable year beginning with the year 
of change are determined by choosing the optional depreciation table 
that corresponds to the depreciation system, depreciation method, 
recovery period, and convention that would have applied to the MACRS 
property in the placed-in-service year had that property been originally 
placed in service by the taxpayer with the longer recovery period and/or 
the slower depreciation method. If there is a change in the use of MACRS 
property, the applicable convention that applies to the MACRS property 
is the same as the convention that applied before the change in the use 
of the MACRS property. If the year of change or any subsequent taxable 
year is less than 12 months, the depreciation allowance determined under 
this paragraph (d)(5)(ii)(B) must be adjusted for a short taxable year 
(for further guidance, for example, see Rev. Proc. 89-15 (1989-1 C.B. 
816) (see Sec. 601.601(d)(2)(ii)(b) of this chapter)).
    (2) Computation of the depreciation allowance. The depreciation 
allowances for the MACRS property for any 12-month taxable year 
beginning with the year of change are computed by first determining the 
appropriate recovery year in the table identified under paragraph 
(d)(5)(ii)(B)(1) of this section. The appropriate recovery year for the 
year of change is the year that corresponds to the year of change. For 
example, if the recovery year for the year of change would have been 
Year 4 in the table that applied before the change in the use of the 
MACRS property, then the recovery year for the year of change is Year 4 
in the table identified under paragraph (d)(5)(ii)(B)(1) of this 
section. Next, the annual depreciation rate (expressed as a decimal 
equivalent) for each recovery year is multiplied by a transaction 
coefficient. The transaction coefficient is the formula (1 / (1-x)) 
where x equals the sum of the annual depreciation rates from the table 
identified under paragraph (d)(5)(ii)(B)(1) of this section (expressed 
as a decimal equivalent) for the taxable years beginning with the 
placed-in-service year of the MACRS property through the taxable year 
immediately prior to the year of change. The product of the annual 
depreciation rate and the transaction coefficient is multiplied by the 
adjusted depreciable basis of the MACRS property as of the beginning of 
the year of change.
    (6) Examples. The application of this paragraph (d) is illustrated 
by the following examples:

    Example 1. Change in the use results in a shorter recovery period 
and/or a more accelerated depreciation method and optional depreciation 
table is not used. (i) X, a calendar-year corporation, places in service 
in 1999 equipment at a cost of $100,000 and uses this equipment from 
1999 through 2003 primarily in its A business. X depreciates the 
equipment for 1999 through 2003 under the general depreciation system as 
7-year property by using the 200-percent declining balance method (which 
switched to the straight-line method in 2003), a 7-year recovery period, 
and a half-year convention. Beginning in 2004, X primarily uses the 
equipment in its B business. As a result, the classification of the 
equipment under section 168(e) changes from 7-year property to 5-year 
property and the recovery period of the equipment under the general 
depreciation system changes from 7 years to 5 years. The depreciation 
method does not change. On January 1, 2004, the adjusted depreciable 
basis of the equipment is $22,311. X depreciates its 5-year recovery 
property placed in service in 2004 under the general depreciation system 
by using the 200-percent declining balance method and a 5-year recovery 
period.

[[Page 1070]]

X does not use the optional depreciation tables.
    (ii) Under paragraph (d)(3)(i) of this section, X's allowable 
depreciation deduction for the equipment for 2004 and subsequent taxable 
years is determined as though X placed the equipment in service in 2004 
for use primarily in its B business. The depreciable basis of the 
equipment as of January 1, 2004, is $22,311 (the adjusted depreciable 
basis at January 1, 2004). Because X does not use the optional 
depreciation tables, the depreciation allowance for 2004 (the deemed 
placed-in-service year) for this equipment only is computed without 
taking into account the half-year convention. Pursuant to paragraph 
(d)(3)(i)(C) of this section, this equipment is not eligible for the 
additional first year depreciation deduction provided by section 168(k) 
or section 1400L(b). Thus, X's allowable depreciation deduction for the 
equipment for 2004 is $8,924 ($22,311 adjusted depreciable basis at 
January 1, 2004, multiplied by the applicable depreciation rate of 40% 
(200/5)). X's allowable depreciation deduction for the equipment for 
2005 is $5,355 ($13,387 adjusted depreciable basis at January 1, 2005, 
multiplied by the applicable depreciation rate of 40% (200/5)).
    (iii) Alternatively, under paragraph (d)(3)(ii) of this section, X 
may elect to disregard the change in the use and, as a result, may 
continue to treat the equipment as though it is used primarily in its A 
business. If the election is made, X's allowable depreciation deduction 
for the equipment for 2004 is $8,924 ($22,311 adjusted depreciable basis 
at January 1, 2004, multiplied by the applicable depreciation rate of 
40% (1/2.5 years remaining at January 1, 2004)). X's allowable 
depreciation deduction for the equipment for 2005 is $8,925 ($13,387 
adjusted depreciable basis at January 1, 2005, multiplied by the 
applicable depreciation rate of 66.67% (1/1.5 years remaining at January 
1, 2005)).
    Example 2. Change in the use results in a shorter recovery period 
and/or a more accelerated depreciation method and optional depreciation 
table is used. (i) Same facts as in Example 1, except that X used the 
optional depreciation tables for computing depreciation for 1999 through 
2003. Pursuant to paragraph (d)(5) of this section, X chooses to 
continue to use the optional depreciation table for the equipment. X 
does not make the election provided in paragraph (d)(3)(ii) of this 
section to disregard the change in use.
    (ii) In accordance with paragraph (d)(5)(ii)(A) of this section, X 
must first identify the appropriate optional depreciation table for the 
equipment. This table is table 1 in Rev. Proc. 87-57 because the 
equipment will be depreciated in the year of change (2004) under the 
general depreciation system using the 200-percent declining balance 
method, a 5-year recovery period, and the half-year convention (which is 
the convention that applied to the equipment in 1999). Pursuant to 
paragraph (d)(3)(i)(C) of this section, this equipment is not eligible 
for the additional first year depreciation deduction provided by section 
168(k) or section 1400L(b). For 2004, X multiplies its adjusted 
depreciable basis in the equipment as of January 1, 2004, of $22,311, by 
the annual depreciation rate in table 1 for recovery year 1 for a 5-year 
recovery period (.20), to determine the depreciation allowance of 
$4,462. For 2005, X multiplies its adjusted depreciable basis in the 
equipment as of January 1, 2004, of $22,311, by the annual depreciation 
rate in table 1 for recovery year 2 for a 5-year recovery period (.32), 
to determine the depreciation allowance of $7,140.
    Example 3. Change in the use results in a longer recovery period 
and/or a slower depreciation method. (i) Y, a calendar-year corporation, 
places in service in January 2002, equipment at a cost of $100,000 and 
uses this equipment in 2002 and 2003 only within the United States. Y 
elects not to deduct the additional first year depreciation under 
section 168(k). Y depreciates the equipment for 2002 and 2003 under the 
general depreciation system by using the 200-percent declining balance 
method, a 5-year recovery period, and a half-year convention. Beginning 
in 2004, Y uses the equipment predominantly outside the United States. 
As a result of this change in the use, the equipment is subject to the 
alternative depreciation system beginning in 2004. Under the alternative 
depreciation system, the equipment is depreciated by using the straight 
line method and a 9-year recovery period. The adjusted depreciable basis 
of the equipment at January 1, 2004, is $48,000.
    (ii) Pursuant to paragraph (d)(4) of this section, Y's allowable 
depreciation deduction for 2004 and subsequent taxable years is 
determined as though the equipment had been placed in service in January 
2002, as property used predominantly outside the United States. Further, 
pursuant to paragraph (d)(4)(i) of this section, the equipment is not 
eligible in 2004 for the additional first year depreciation deduction 
provided by section 168(k) or section 1400L(b). In determining the 
applicable depreciation rate for 2004, the applicable depreciation 
method is the straight line method and the applicable recovery period is 
7.5 years, which is the number of years remaining at January 1, 2004, 
for property placed in service in 2002 with a 9-year recovery period 
(taking into account the half-year convention). Thus, the depreciation 
allowance for 2004 is $6,398 ($48,000 adjusted depreciable basis at 
January 1, 2004, multiplied by the applicable depreciation rate of 
13.33% (1/7.5 years)). The depreciation allowance for 2005 is $6,398 
($41,602 adjusted depreciable basis at January 1, 2005, multiplied by 
the applicable depreciation rate of 15.38% (1/6.5 years remaining at 
January 1, 2005)).

[[Page 1071]]

    Example 4. Change in the use results in a longer recovery period 
and/or a slower depreciation method and optional depreciation table is 
used--(i) Same facts as in Example 3, except that Y used the optional 
depreciation tables for computing depreciation in 2002 and 2003. 
Pursuant to paragraph (d)(5) of this section, Y chooses to continue to 
use the optional depreciation table for the equipment. Further, pursuant 
to paragraph (d)(4)(i) of this section, the equipment is not eligible in 
2004 for the additional first year depreciation deduction provided by 
section 168(k) or section 1400L(b).
    (ii) In accordance with paragraph (d)(5)(ii)(B) of this section, Y 
must first determine the appropriate optional depreciation table for the 
equipment pursuant to paragraph (d)(5)(ii)(B)(1) of this section. This 
table is table 8 in Rev. Proc. 87-57, which corresponds to the 
alternative depreciation system, the straight line method, a 9-year 
recovery period, and the half-year convention (because Y depreciated 5-
year property in 2002 using a half-year convention). Next, Y must 
determine the appropriate recovery year in table 8. Because the year of 
change is 2004, the depreciation allowance for the equipment for 2004 is 
determined using recovery year 3 of table 8. For 2004, Y multiplies its 
adjusted depreciable basis in the equipment as of January 1, 2004, of 
$48,000, by the product of the annual depreciation rate in table 8 for 
recovery year 3 for a 9-year recovery period (.1111) and the transaction 
coefficient of 1.200 [1/(1-(.0556 (table 8 for recovery year 1 for a 9-
year recovery period) + .1111 (table 8 for recovery year 2 for a 9-year 
recovery period)))], to determine the depreciation allowance of $6,399. 
For 2005, Y multiplies its adjusted depreciable basis in the equipment 
as of January 1, 2004, of $48,000, by the product of the annual 
depreciation rate in table 8 for recovery year 4 for a 9-year recovery 
period (.1111) and the transaction coefficient (1.200), to determine the 
depreciation allowance of $6,399.

    (e) Change in the use of MACRS property during the placed-in-service 
year--(1) In general. Except as provided in paragraph (e)(2) of this 
section, if a change in the use of MACRS property occurs during the 
placed-in-service year and the property continues to be MACRS property 
owned by the same taxpayer, the depreciation allowance for that property 
for the placed-in-service year is determined by its primary use during 
that year. The primary use of MACRS property may be determined in any 
reasonable manner that is consistently applied to the taxpayer's MACRS 
property. For purposes of this paragraph (e), the determination of 
whether the mid-quarter convention applies to any MACRS property placed 
in service during the year of change is made in accordance with Sec. 
1.168(d)-1.
    (2) Alternative depreciation system property--(i) Property used 
within and outside the United States. The depreciation allowance for the 
placed-in-service year for MACRS property that is used within and 
outside the United States is determined by its predominant use during 
that year. The determination of whether MACRS property is used 
predominantly outside the United States during the placed-in-service 
year shall be made in accordance with the test in Sec. 1.48-1(g)(1)(i) 
for determining predominant use.
    (ii) Tax-exempt bond financed property. The depreciation allowance 
for the placed-in-service year for MACRS property that changes to tax-
exempt bond financed property, as described in section 168(g)(1)(C) and 
(g)(5), during that taxable year is determined under the alternative 
depreciation system. For purposes of this paragraph (e), MACRS property 
changes to tax-exempt bond financed property when a tax-exempt bond is 
first issued after the MACRS property is placed in service. MACRS 
property continues to be tax-exempt bond financed property in the hands 
of the taxpayer even if the tax-exempt bond (including any refunding 
issue) is not outstanding at, or is redeemed by, the end of the placed-
in-service year.
    (iii) Other mandatory alternative depreciation system property. The 
depreciation allowance for the placed-in-service year for MACRS property 
that changes to, or changes from, property described in section 
168(g)(1)(B) (tax-exempt use property) or (D) (imported property covered 
by an Executive order) during that taxable year is determined under--
    (A) The alternative depreciation system if the MACRS property is 
described in section 168(g)(1)(B) or (D) at the end of the placed-in-
service year; or
    (B) The general depreciation system if the MACRS property is not 
described in section 168(g)(1)(B) or (D) at the end of the placed-in-
service year, unless

[[Page 1072]]

other provisions of the Internal Revenue Code or regulations under the 
Internal Revenue Code require the depreciation allowance for that MACRS 
property to be determined under the alternative depreciation system (for 
example, section 168(g)(7)).
    (3) Examples. The application of this paragraph (e) is illustrated 
by the following examples:

    Example 1. (i) Z, a utility and calendar-year corporation, acquires 
and places in service on January 1, 2004, equipment at a cost of 
$100,000. Z uses this equipment in its combustion turbine production 
plant for 4 months and then uses the equipment in its steam production 
plant for the remainder of 2004. Z's combustion turbine production plant 
assets are classified as 15-year property and are depreciated by Z under 
the general depreciation system using a 15-year recovery period and the 
150-percent declining balance method of depreciation. Z's steam 
production plant assets are classified as 20-year property and are 
depreciated by Z under the general depreciation system using a 20-year 
recovery period and the 150-percent declining balance method of 
depreciation. Z uses the optional depreciation tables. The equipment is 
50-percent bonus depreciation property for purposes of section 168(k).
    (ii) Pursuant to this paragraph (e), Z must determine depreciation 
based on the primary use of the equipment during the placed-in-service 
year. Z has consistently determined the primary use of all of its MACRS 
properties by comparing the number of full months in the taxable year 
during which a MACRS property is used in one manner with the number of 
full months in that taxable year during which that MACRS property is 
used in another manner. Applying this approach, Z determines the 
depreciation allowance for the equipment for 2004 is based on the 
equipment being classified as 20-year property because the equipment was 
used by Z in its steam production plant for 8 months in 2004. If the 
half-year convention applies in 2004, the appropriate optional 
depreciation table is table 1 in Rev. Proc. 87-57, which is the table 
for MACRS property subject to the general depreciation system, the 150-
percent declining balance method, a 20-year recovery period, and the 
half-year convention. Thus, the depreciation allowance for the equipment 
for 2004 is $51,875, which is the total of $50,000 for the 50-percent 
additional first year depreciation deduction allowable (the unadjusted 
depreciable basis of $100,000 multiplied by .50), plus $1,875 for the 
2004 depreciation allowance on the remaining adjusted depreciable basis 
of $50,000 [(the unadjusted depreciable basis of $100,000 less the 
additional first year depreciation deduction of $50,000) multiplied by 
the annual depreciation rate of .0375 in table 1 for recovery year 1 for 
a 20-year recovery period].
    Example 2. T, a calendar year corporation, places in service on 
January 1, 2004, several computers at a total cost of $100,000. T uses 
these computers within the United States for 3 months in 2004 and then 
moves and uses the computers outside the United States for the remainder 
of 2004. Pursuant to Sec. 1.48-1(g)(1)(i), the computers are considered 
as used predominantly outside the United States in 2004. As a result, 
for 2004, the computers are required to be depreciated under the 
alternative depreciation system of section 168(g) with a recovery period 
of 5 years pursuant to section 168(g)(3)(C). T uses the optional 
depreciation tables. If the half-year convention applies in 2004, the 
appropriate optional depreciation table is table 8 in Rev. Proc. 87-57, 
which is the table for MACRS property subject to the alternative 
depreciation system, the straight line method, a 5-year recovery period, 
and the half-year convention. Thus, the depreciation allowance for the 
computers for 2004 is $10,000, which is equal to the unadjusted 
depreciable basis of $100,000 multiplied by the annual depreciation rate 
of .10 in table 8 for recovery year 1 for a 5-year recovery period. 
Because the computers are required to be depreciated under the 
alternative depreciation system in their placed-in-service year, 
pursuant to section 168(k)(2)(C)(i) and Sec. 1.168(k)-1T(b)(2)(ii), the 
computers are not eligible for the additional first year depreciation 
deduction provided by section 168(k).

    (f) No change in accounting method. A change in computing the 
depreciation allowance in the year of change for property subject to 
this section is not a change in method of accounting under section 
446(e). See Sec. 1.446-1T(e)(2)(ii)(d)(3)(ii).
    (g) Effective dates--(1) In general. This section applies to any 
change in the use of MACRS property in a taxable year ending on or after 
June 17, 2004. For any change in the use of MACRS property after 
December 31, 1986, in a taxable year ending before June 17, 2004, the 
Internal Revenue Service will allow any reasonable method of 
depreciating the property under section 168 in the year of change and 
the subsequent taxable years that is consistently applied to any 
property for which the use changes in the hands of the same taxpayer or 
the taxpayer may choose, on a property-by-property basis, to apply the 
provisions of this section.
    (2) Change in method of accounting--(i) In general. If a taxpayer 
adopted a

[[Page 1073]]

method of accounting for depreciation due to a change in the use of 
MACRS property in a taxable year ending on or after December 30, 2003, 
and the method adopted is not in accordance with the method of 
accounting for depreciation provided in this section, a change to the 
method of accounting for depreciation provided in this section is a 
change in the method of accounting to which the provisions of sections 
446(e) and 481 and the regulations under sections 446(e) and 481 apply. 
Also, a revocation of the election provided in paragraph (d)(3)(ii) of 
this section to disregard a change in the use is a change in method of 
accounting to which the provisions of sections 446(e) and 481 and the 
regulations under sections 446(e) and 481 apply. However, if a taxpayer 
adopted a method of accounting for depreciation due to a change in the 
use of MACRS property after December 31, 1986, in a taxable year ending 
before December 30, 2003, and the method adopted is not in accordance 
with the method of accounting for depreciation provided in this section, 
the taxpayer may treat the change to the method of accounting for 
depreciation provided in this section as a change in method of 
accounting to which the provisions of sections 446(e) and 481 and the 
regulations under sections 446(e) and 481 apply.
    (ii) Automatic consent to change method of accounting. A taxpayer 
changing its method of accounting in accordance with this paragraph 
(g)(2) must follow the applicable administrative procedures issued under 
Sec. 1.446-1(e)(3)(ii) for obtaining the Commissioner's automatic 
consent to a change in method of accounting (for further guidance, for 
example, see Rev. Proc. 2002-9 (2002-1 C.B. 327), as modified by Rev. 
Proc. 2004-11 (2004-3 I.R.B. 311) (see Sec. 601.601(d)(2)(ii)(b) of 
this chapter)). Any change in method of accounting made under this 
paragraph (g)(2) must be made using an adjustment under section 481(a). 
For purposes of Form 3115, Application for Change in Accounting Method, 
the designated number for the automatic accounting method change 
authorized by this paragraph (g)(2) is ``88.'' If Form 3115 is revised 
or renumbered, any reference in this section to that form is treated as 
a reference to the revised or renumbered form.

[T.D. 9132, 69 FR 33843, June 17, 2004]



Sec. 1.168(i)-5T  Table of contents (temporary).

    This section lists the major paragraphs contained in Sec. 1.168(i)-
6T.

   Sec. 1.168(i)-6T Like-kind exchanges and involuntary conversions 
                              (temporary).

    (a) Scope.
    (b) Definitions.
    (1) Replacement MACRS property.
    (2) Relinquished MACRS property.
    (3) Time of disposition.
    (4) Time of replacement.
    (5) Year of disposition.
    (6) Year of replacement.
    (7) Exchanged basis.
    (8) Excess basis.
    (9) Depreciable exchanged basis.
    (10) Depreciable excess basis.
    (11) Like-kind exchange.
    (12) Involuntary conversion.
    (c) Determination of depreciation allowance.
    (1) Computation of the depreciation allowance for depreciable 
exchanged basis beginning in the year of replacement.
    (i) In general.
    (ii) Applicable recovery period, depreciation method, and 
convention.
    (2) Effect of depreciation treatment of the replacement MACRS 
property by previous owners of the acquired property.
    (3) Recovery period and/or depreciation method of the properties are 
the same, or both are not the same.
    (i) In general.
    (ii) Both the recovery period and the depreciation method are the 
same.
    (iii) Either the recovery period or the depreciation method is the 
same, or both are not the same.
    (4) Recovery period or depreciation method of the properties is not 
the same.
    (i) Longer recovery period.
    (ii) Shorter recovery period.
    (iii) Less accelerated depreciation method.
    (iv) More accelerated depreciation method.
    (v) Convention.
    (A) In general.
    (B) Mid-quarter convention.
    (5) Year of disposition and year of replacement.
    (i) Relinquished MACRS property.
    (ii) Replacement MACRS property.
    (A) Year of replacement is 12 months.
    (B) Year of replacement is less than 12 months.
    (iii) Deferred transactions.
    (A) In general.
    (B) Allowable depreciation for a qualified intermediary.

[[Page 1074]]

    (iv) Remaining recovery period.
    (6) Examples.
    (d) Special rules for determining depreciation allowances.
    (1) Excess basis.
    (i) In general.
    (ii) Example.
    (2) Depreciable and nondepreciable property.
    (3) Depreciation limitations for automobiles.
    (i) In general.
    (ii) Order in which limitations on depreciation under section 
280F(a) are applied.
    (iii) Depreciation allowance for depreciable excess basis.
    (iv) Examples.
    (4) Replacement MACRS property acquired and placed in service before 
disposition of relinquished MACRS property.
    (e) Use of optional depreciation tables.
    (1) Taxpayer not bound by prior use of table.
    (2) Determination of the depreciation deduction.
    (i) Relinquished MACRS property.
    (ii) Replacement MACRS property.
    (A) Determination of the appropriate optional depreciation table.
    (B) Calculating the depreciation deduction for the replacement MACRS 
property.
    (iii) Unrecovered basis.
    (3) Excess basis.
    (4) Examples.
    (f) Mid-quarter convention.
    (1) Exchanged basis.
    (2) Excess basis.
    (3) Depreciable property acquired for nondepreciable property.
    (g) Section 179 election.
    (h) Additional first year depreciation deduction.
    (i) Election not to apply this section.
    (j) Time and manner of making elections.
    (1) In general.
    (2) Time for making election.
    (3) Manner of making election.
    (4) Revocation.
    (k) Effective date.
    (1) In general.
    (2) Application to pre-effective date like-kind exchanges and 
involuntary conversions.

[T.D. 9115, 69 FR 9536, Mar. 1, 2004; 69 FR 17586, Apr. 5, 2004]



Sec. 1.168(i)-6T  Like-kind exchanges and involuntary conversions 
(temporary).

    (a) Scope. This section provides the rules for determining the 
depreciation allowance for MACRS property acquired in a like-kind 
exchange or an involuntary conversion, including a like-kind exchange or 
an involuntary conversion of MACRS property that is exchanged or 
replaced with other MACRS property in a transaction between members of 
the same affiliated group. The allowance for depreciation under this 
section constitutes the amount of depreciation allowable under section 
167(a) for the year of replacement and any subsequent taxable year for 
the replacement MACRS property and for the year of disposition of the 
relinquished MACRS property. The provisions of this section apply only 
to MACRS property to which Sec. 1.168(h)-1 (like-kind exchanges of tax-
exempt use property) does not apply. Additionally, paragraphs (c) 
through (f) of this section apply only to MACRS property for which an 
election has not been made under paragraph (i) of this section.
    (b) Definitions. For purposes of this section, the following 
definitions apply:
    (1) Replacement MACRS property is MACRS property (as defined in 
Sec. 1.168(b)-1T(a)(2)) in the hands of the acquiring taxpayer that is 
acquired for other MACRS property in a like-kind exchange or an 
involuntary conversion.
    (2) Relinquished MACRS property is MACRS property that is 
transferred by the taxpayer in a like-kind exchange, or in an 
involuntary conversion.
    (3) Time of disposition is when the disposition of the relinquished 
MACRS property takes place under the convention, as determined under 
Sec. 1.168(d)-1T, that applies to the relinquished MACRS property.
    (4) Time of replacement is the later of:
    (i) When the replacement MACRS property is placed in service under 
the convention, as determined under this section, that applies to the 
replacement MACRS property; or
    (ii) The time of disposition of the exchanged or involuntarily 
converted property.
    (5) Year of disposition is the taxable year that includes the time 
of disposition.
    (6) Year of replacement is the taxable year that includes the time 
of replacement.
    (7) Exchanged basis is determined after the depreciation deductions 
for the year of disposition are determined under paragraph (c)(5)(i) of 
this section and is the lesser of--

[[Page 1075]]

    (i) The basis in the replacement MACRS property, as determined under 
section 1031(d) and the regulations under section 1031(d) or section 
1033(b) and the regulations under section 1033(b); or
    (ii) The adjusted depreciable basis (as defined in Sec. 1.168(b)-
1T(a)(4)) of the relinquished MACRS property.
    (8) Excess basis is any excess of the basis in the replacement MACRS 
property, as determined under section 1031(d) and the regulations under 
section 1031(d) or section 1033(b) and the regulations under section 
1033(b), over the exchanged basis as determined under paragraph (b)(7) 
of this section.
    (9) Depreciable exchanged basis is the exchanged basis as determined 
under paragraph (b)(7) of this section reduced by--
    (i) The percentage of such basis attributable to the taxpayer's use 
of property for the taxable year other than in the taxpayer's trade or 
business (or for the production of income); and
    (ii) Any adjustments to basis provided by other provisions of the 
Internal Revenue Code and the regulations under the Code (including 
section 1016(a)(2) and (3), for example, depreciation deductions in the 
year of replacement allowable under section 168(k) or 1400L(b)).
    (10) Depreciable excess basis is the excess basis as determined 
under paragraph (b)(8) of this section reduced by--
    (i) The percentage of such basis attributable to the taxpayer's use 
of property for the taxable year other than in the taxpayer's trade or 
business (or for the production of income);
    (ii) Any portion of the basis the taxpayer properly elects to treat 
as an expense under section 179; and
    (iii) Any adjustments to basis provided by other provisions of the 
Internal Revenue Code and the regulations under the Code (including 
section 1016(a)(2) and (3), for example, depreciation deductions in the 
year of replacement allowable under section 168(k) or 1400L(b)).
    (11) Like-kind exchange is an exchange of property for other 
property (or money) in a transaction to which section 1031(a)(1), (b), 
or (c) applies.
    (12) Involuntary conversion is a transaction described in section 
1033(a)(1) or (2) that resulted in the nonrecognition of any part of the 
gain realized as the result of the conversion.
    (c) Determination of depreciation allowance--(1) Computation of the 
depreciation allowance for depreciable exchanged basis beginning in the 
year of replacement--(i) In general. This paragraph (c) provides rules 
for determining the applicable recovery period, the applicable 
depreciation method, and the applicable convention used to determine the 
depreciation allowances for the depreciable exchanged basis beginning in 
the year of replacement. See paragraph (c)(5) of this section for rules 
relating to the computation of the depreciation allowance for the year 
of disposition and for the year of replacement. See paragraph (d)(1) of 
this section for rules relating to the computation of the depreciation 
allowance for depreciable excess basis. See paragraph (d)(4) of this 
section if the replacement MACRS property is acquired before disposition 
of the relinquished MACRS property in a transaction to which section 
1033 applies. See paragraph (e) of this section for rules relating to 
the computation of the depreciation allowance using the optional 
depreciation tables.
    (ii) Applicable recovery period, depreciation method, and 
convention. The recovery period, depreciation method, and convention 
determined under this paragraph (c) are the only permissible methods of 
accounting for MACRS property within the scope of this section unless 
the taxpayer makes the election under paragraph (i) of this section not 
to apply this section.
    (2) Effect of depreciation treatment of the replacement MACRS 
property by previous owners of the acquired property. If replacement 
MACRS property is acquired by a taxpayer in a like-kind exchange or an 
involuntary conversion, the depreciation treatment of the replacement 
MACRS property by previous owners has no effect on the determination of 
depreciation allowances for the replacement MACRS property in the hands 
of the acquiring taxpayer. For example, a taxpayer exchanging, in a 
like-kind exchange, MACRS property for property that was depreciated 
under ACRS by the previous owner

[[Page 1076]]

must use this section because the replacement property will become MACRS 
property in the hands of the acquiring taxpayer. In addition, elections 
made by previous owners in determining depreciation allowances for the 
replacement MACRS property have no effect on the acquiring taxpayer. For 
example, a taxpayer exchanging, in a like-kind exchange, MACRS property 
that the taxpayer depreciates under the general depreciation system for 
other MACRS property that the previous owner elected to depreciate under 
the alternative depreciation system (ADS) pursuant to section 168(g)(7) 
does not have to continue using the ADS for the replacement MACRS 
property.
    (3) Recovery period and/or depreciation method of the properties are 
the same, or both are not the same--(i) In general. For purposes of 
paragraphs (c)(3) and (c)(4) of this section in determining whether the 
recovery period and the depreciation method prescribed under section 168 
for the replacement MACRS property are the same as the recovery period 
and the depreciation method prescribed under section 168 for the 
relinquished MACRS property, the recovery period and the depreciation 
method for the replacement MACRS property are considered to be the 
recovery period and the depreciation method that would have applied, 
taking into account any elections made by the acquiring taxpayer under 
section 168(b)(5) or 168(g)(7), had the replacement MACRS property been 
placed in service by the acquiring taxpayer at the same time as the 
relinquished MACRS property.
    (ii) Both the recovery period and the depreciation method are the 
same. If both the recovery period and the depreciation method prescribed 
under section 168 for the replacement MACRS property are the same as the 
recovery period and the depreciation method prescribed under section 168 
for the relinquished MACRS property, the depreciation allowances for the 
replacement MACRS property beginning in the year of replacement are 
determined by using the same recovery period and depreciation method 
that were used for the relinquished MACRS property. Thus, the 
replacement MACRS property is depreciated over the remaining recovery 
period (taking into account the applicable convention), and by using the 
depreciation method, of the relinquished MACRS property. Except as 
provided in paragraph (c)(5) of this section, the depreciation 
allowances for the depreciable exchanged basis for any 12-month taxable 
year beginning with the year of replacement are determined by 
multiplying the depreciable exchanged basis by the applicable 
depreciation rate for each taxable year (for further guidance, for 
example, see section 6 of Rev. Proc. 87-57 (1987-2 C.B. 687, 692) and 
Sec. 601.601(d)(2)(ii)(b) of this chapter).
    (iii) Either the recovery period or the depreciation method is the 
same, or both are not the same. If either the recovery period or the 
depreciation method prescribed under section 168 for the replacement 
MACRS property is the same as the recovery period or the depreciation 
method prescribed under section 168 for the relinquished MACRS property, 
the depreciation allowances for the depreciable exchanged basis 
beginning in the year of replacement are determined using the recovery 
period or the depreciation method that is the same as the relinquished 
MACRS property. See paragraph (c)(4) of this section to determine the 
depreciation allowances when the recovery period or the depreciation 
method of the replacement MACRS property is not the same as that of the 
relinquished MACRS property.
    (4) Recovery period or depreciation method of the properties is not 
the same. If the recovery period prescribed under section 168 for the 
replacement MACRS property (as determined under paragraph (c)(3)(i) of 
this section) is not the same as the recovery period prescribed under 
section 168 for the relinquished MACRS property, the depreciation 
allowances for the depreciable exchanged basis beginning in the year of 
replacement are determined under this paragraph (c)(4). Similarly, if 
the depreciation method prescribed under section 168 for the replacement 
MACRS property (as determined under paragraph (c)(3)(i) of this section) 
is not the same as the depreciation method prescribed under section 168 
for the relinquished MACRS property, the depreciation

[[Page 1077]]

method used to determine the depreciation allowances for the depreciable 
exchanged basis beginning in the year of replacement is determined under 
this paragraph (c)(4).
    (i) Longer recovery period. If the recovery period prescribed under 
section 168 for the replacement MACRS property (as determined under 
paragraph (c)(3)(i) of this section) is longer than that prescribed for 
the relinquished MACRS property, the depreciation allowances for the 
depreciable exchanged basis beginning in the year of replacement are 
determined as though the replacement MACRS property had originally been 
placed in service by the acquiring taxpayer in the same taxable year the 
relinquished MACRS property was placed in service by the acquiring 
taxpayer, but using the longer recovery period of the replacement MACRS 
property (as determined under paragraph (c)(3)(i) of this section) and 
the convention determined under paragraph (c)(4)(v) of this section. 
Thus, the depreciable exchanged basis is depreciated over the remaining 
recovery period (taking into account the applicable convention) of the 
replacement MACRS property.
    (ii) Shorter recovery period. If the recovery period prescribed 
under section 168 for the replacement MACRS property (as determined 
under paragraph (c)(3)(i) of this section) is shorter than that of the 
relinquished MACRS property, the depreciation allowances for the 
depreciable exchanged basis beginning in the year of replacement are 
determined using the same recovery period as that of the relinquished 
MACRS property. Thus, the depreciable exchanged basis is depreciated 
over the remaining recovery period (taking into account the applicable 
convention) of the relinquished MACRS property.
    (iii) Less accelerated depreciation method--(A) If the depreciation 
method prescribed under section 168 for the replacement MACRS property 
(as determined under paragraph (c)(3)(i) of this section) is less 
accelerated than that of the relinquished MACRS property at the time of 
disposition, the depreciation allowances for the depreciable exchanged 
basis beginning in the year of replacement are determined as though the 
replacement MACRS property had originally been placed in service by the 
acquiring taxpayer at the same time the relinquished MACRS property was 
placed in service by the acquiring taxpayer, but using the less 
accelerated depreciation method. Thus, the depreciable exchanged basis 
is depreciated using the less accelerated depreciation method.
    (B) Except as provided in paragraph (c)(5) of this section, the 
depreciation allowances for the depreciable exchanged basis for any 12-
month taxable year beginning in the year of replacement are determined 
by multiplying the adjusted depreciable basis by the applicable 
depreciation rate for each taxable year. If, for example, the 
depreciation method of the replacement MACRS property in the year of 
replacement is the 150-percent declining balance method and the 
depreciation method of the relinquished MACRS property in the year of 
replacement is the 200-percent declining balance method, and neither 
method had been switched to the straight line method in the year of 
replacement or any prior taxable year, the applicable depreciation rate 
for the year of replacement and subsequent taxable years is determined 
by using the depreciation rate of the replacement MACRS property as if 
the replacement MACRS property was placed in service by the acquiring 
taxpayer at the same time the relinquished MACRS property was placed in 
service by the acquiring taxpayer, until the 150-percent declining 
balance method has been switched to the straight line method. If, for 
example, the depreciation method of the replacement MACRS property is 
the straight line method, the applicable depreciation rate for the year 
of replacement is determined by using the remaining recovery period at 
the beginning of the year of disposition (as determined under this 
paragraph (c)(4) and taking into account the applicable convention).
    (iv) More accelerated depreciation method--(A) If the depreciation 
method prescribed under section 168 for the replacement MACRS property 
(as determined under paragraph (c)(3)(i) of this section) is more 
accelerated than that of the relinquished MACRS property at

[[Page 1078]]

the time of disposition, the depreciation allowances for the replacement 
MACRS property beginning in the year of replacement are determined using 
the same depreciation method as the relinquished MACRS property.
    (B) Except as provided in paragraph (c)(5) of this section, the 
depreciation allowances for the depreciable exchanged basis for any 12-
month taxable year beginning in the year of replacement are determined 
by multiplying the adjusted depreciable basis by the applicable 
depreciation rate for each taxable year. If, for example, the 
depreciation method of the relinquished MACRS property in the year of 
replacement is the 150-percent declining balance method and the 
depreciation method of the replacement MACRS property in the year of 
replacement is the 200-percent declining balance method, and neither 
method had been switched to the straight line method in the year of 
replacement or any prior taxable year, the applicable depreciation rate 
for the year of replacement and subsequent taxable years is the same 
depreciation rate that applied to the relinquished MACRS property in the 
year of replacement, until the 150-percent declining balance method has 
been switched to the straight line method. If, for example, the 
depreciation method is the straight line method, the applicable 
depreciation rate for the year of replacement is determined by using the 
remaining recovery period at the beginning of the year of disposition 
(as determined under this paragraph (c)(4) and taking into account the 
applicable convention).
    (v) Convention--(A) In general. The applicable convention for the 
exchanged basis is determined under this paragraph (c)(4)(v). The 
applicable convention for the exchanged basis is deemed to be the mid-
month convention for replacement MACRS property that is nonresidential 
real property, residential rental property, or any railroad grading or 
tunnel bore. Thus, if the relinquished MACRS property was depreciated 
using the mid-month convention, then the replacement MACRS property is 
deemed to have been placed in service by the acquiring taxpayer in the 
same month as the relinquished MACRS property and must continue to be 
depreciated using the mid-month convention. If nonresidential real 
property, residential rental property, or any railroad grading or tunnel 
bore is received as a result of an exchange or an involuntary conversion 
of MACRS property that was depreciated using the mid-quarter convention, 
the replacement MACRS property is deemed to have been placed in service 
by the acquiring taxpayer in the month that includes the mid-point of 
the quarter that the relinquished MACRS property was placed in service 
and must be depreciated using the mid-month convention. If 
nonresidential real property, residential rental property, or any 
railroad grading or tunnel bore is received as a result of an exchange 
or an involuntary conversion of MACRS property that was depreciated 
using the half-year convention, the replacement MACRS property is deemed 
to have been placed in service by the acquiring taxpayer in the month 
that includes the mid-point of the placed-in-service year and must be 
depreciated using the mid-month convention (for example, for a calendar-
year taxpayer with a full 12-month taxable year, the mid-point is the 
first day of the second half of the taxable year (the seventh month)). 
For all other replacement MACRS property, the applicable convention is 
the half-year convention, unless the applicable convention for the 
relinquished MACRS property is the mid-quarter convention, in which case 
the mid-quarter convention is applied to the replacement MACRS property.
    (B) Mid-quarter convention. See paragraph (f) of this section for 
purposes of applying the 40-percent test of section 168(d)(3) to any 
replacement MACRS property.
    (5) Year of disposition and year of replacement. No depreciation 
deduction is allowable for MACRS property disposed of by a taxpayer in a 
like-kind exchange or involuntary conversion in the same taxable year 
that such property was placed in service by the taxpayer. If replacement 
MACRS property is disposed of by a taxpayer during the same taxable year 
that the relinquished MACRS property is placed in service by the 
taxpayer, no depreciation deduction is allowable for either

[[Page 1079]]

MACRS property. Otherwise, the depreciation allowances for the year of 
disposition and for the year of replacement are determined as follows:
    (i) Relinquished MACRS property. Except as provided in paragraphs 
(e) and (i) of this section, the depreciation allowance in the year of 
disposition for the relinquished MACRS property is computed by 
multiplying the allowable depreciation deduction for the property for 
that year by a fraction, the numerator of which is the number of months 
(including fractions of months) the property is deemed to be placed in 
service during the year of disposition (taking into account the 
applicable convention of the relinquished MACRS property), and the 
denominator of which is 12. However, if the year of disposition is less 
than 12 months, the depreciation allowance determined under this 
paragraph (c)(5)(i) must be adjusted for a short taxable year (for 
further guidance, for example, see Rev. Proc. 89-15 (1989-1 C.B. 816) 
and Sec. 601.601(d)(2)(ii)(b) of this chapter). In the case of 
termination under Sec. 1.168(i)-1T(e)(3)(v) of general asset account 
treatment of an asset, or of all the assets remaining, in a general 
asset account, the allowable depreciation deduction in the year of 
disposition for the asset or assets for which general asset account 
treatment is terminated is determined using the depreciation method, 
recovery period, and convention of the general asset account. This 
allowable depreciation deduction is adjusted to account for the period 
the asset or assets is deemed to be in service in accordance with this 
paragraph (c)(5)(i).
    (ii) Replacement MACRS property--(A) Year of replacement is 12 
months. Except as provided in paragraphs (c)(5)(iii), (e), and (i) of 
this section, the depreciation allowance in the year of replacement for 
the depreciable exchanged basis is determined by--
    (1) Calculating the applicable depreciation rate for that taxable 
year by taking into account the recovery period and depreciation method 
prescribed for the replacement MACRS property under paragraph (c)(3) or 
(4) of this section;
    (2) Calculating the depreciable exchanged basis of the replacement 
MACRS property, and adding to that amount the amount determined under 
paragraph (c)(5)(i) of this section for the year of disposition; and
    (3) Multiplying the product of the amounts determined under Sec. 
1.168(i)-6T(c)(5)(ii)(A)(1) and (A)(2) by a fraction, the numerator of 
which is the number of months (including fractions of months) the 
property is deemed to be in service during the year of replacement (in 
the year of replacement the replacement MACRS property is deemed to be 
placed in service by the acquiring taxpayer at the time of replacement 
under the convention determined under paragraph (c)(4)(v) of this 
section), and the denominator of which is 12.
    (B) Year of replacement is less than 12 months. If the year of 
replacement is less than 12 months, the depreciation allowance 
determined under paragraph (c)(5)(ii)(A) of this section must be 
adjusted for a short taxable year (for further guidance, for example, 
see Rev. Proc. 89-15 (1989-1 C.B. 816) and Sec. 601.601(d)(2)(ii)(b) of 
this chapter).
    (iii) Deferred transactions--(A) In general. If the replacement 
MACRS property is not acquired until after the disposition of the 
relinquished MACRS property, taking into account the applicable 
convention of the relinquished MACRS property and replacement MACRS 
property, depreciation is not allowable during the period between the 
disposition of the relinquished MACRS property and the acquisition of 
the replacement MACRS property. The recovery period for the replacement 
MACRS property is suspended during this period. For purposes of 
paragraph (c)(5)(ii) of this section, only the depreciable exchanged 
basis of the replacement MACRS property is taken into account for 
calculating the amount in paragraph (c)(5)(ii)(A)(2) of this section if 
the year of replacement is a taxable year subsequent to the year of 
disposition.
    (B) Allowable depreciation for a qualified intermediary. [Reserved].
    (iv) Remaining recovery period. The remaining recovery period of the 
replacement MACRS property is determined as of the beginning of the year 
of disposition of the relinquished MACRS property. For purposes of 
determining

[[Page 1080]]

the remaining recovery period of the replacement MACRS property, the 
replacement MACRS property is deemed to have been originally placed in 
service under the convention determined under paragraph (c)(4)(v) of 
this section but at the time the relinquished MACRS property was deemed 
to be placed in service under the convention that applied to it when it 
was placed in service.
    (6) Examples. The application of this paragraph (c) is illustrated 
by the following examples:

    Example 1. A1, a calendar-year taxpayer, exchanges Building M, an 
office building, for Building N, a warehouse in a like-kind exchange. 
Building M is relinquished in July 2004 and Building N is acquired and 
placed in service in October 2004. A1 did not make any elections under 
section 168 for either Building M or Building N. The unadjusted 
depreciable basis of Building M was $4,680,000 when placed in service in 
July 1997. Since the recovery period and depreciation method prescribed 
under section 168 for Building N (39 years, straight line method) are 
the same as the recovery period and depreciation method prescribed under 
section 168 for Building M (39 years, straight line method), Building N 
is depreciated over the remaining recovery period of, and using the same 
depreciation method and convention as that of, Building M. Thus, 
Building N will be depreciated using the straight line method over a 
remaining recovery period of 32 years beginning in October 2004 (the 
remaining recovery period of 32 years and 6.5 months at the beginning of 
2004, less the 6.5 months of depreciation taken prior to the disposition 
of the exchanged MACRS property (Building M) in 2004). For 2004, the 
year in which the transaction takes place, the depreciation allowance 
for Building M is ($120,000)(6.5/12) which equals $65,000. The 
depreciation allowance for Building N for 2004 is ($120,000)(2.5/12) 
which equals $25,000. For 2005 and subsequent years, Building N is 
depreciated over the remaining recovery period of, and using the same 
depreciation method and convention as that of, Building M. Thus, the 
depreciation allowance for Building N is the same as Building M, namely 
$10,000 per month.
    Example 2. B, a calendar-year taxpayer, placed in service Bridge P 
in January 1998. Bridge P is depreciated using the half-year convention. 
In January 2004, B exchanges Bridge P for Building Q, an apartment 
building, in a like-kind exchange. B did not make any elections under 
section 168 for either Bridge P or Building Q. Since the recovery period 
prescribed under section 168 for Building Q (27.5 years) is longer than 
that of Bridge P (15 years), Building Q is depreciated as if it had 
originally been placed in service in July 1998 and disposed of in July 
2004 using a 27.5-year recovery period. Additionally, since the 
depreciation method prescribed under section 168 for Building Q 
(straight line method) is less accelerated than that of Bridge P (150-
percent declining balance method), then the depreciation allowance for 
Building Q is computed using the straight line method. Thus, when 
Building Q is acquired and placed in service in 2004, its basis is 
depreciated over the remaining 21.5-year recovery period using the 
straight line method of depreciation and the mid-month convention 
beginning in July 2004.
    Example 3. C, a calendar-year taxpayer, placed in service Building 
R, a restaurant, in January 1996. In January 2004, C exchanges Building 
R for Tower S, a radio transmitting tower, in a like-kind exchange. C 
did not make any elections under section 168 for either Building R or 
Tower S. Since the recovery period prescribed under section 168 for 
Tower S (15 years) is shorter than that of Building R (39 years), Tower 
S is depreciated over the remaining recovery period of Building R. 
Additionally, since the depreciation method prescribed under section 168 
for Tower S (150% declining balance method) is more accelerated than 
that of Building R (straight line method), then the depreciation 
allowance for Tower S is also computed using the same depreciation 
method as Building R. Thus, Tower S is depreciated over the remaining 
31-year recovery period of Building R using the straight line method of 
depreciation and the mid-month convention. Alternatively, C may elect 
under paragraph (i) of this section to treat Tower S as though it is 
placed in service in January 2004. In such case, C uses the applicable 
recovery period, depreciation method, and convention prescribed under 
section 168 for Tower S.
    Example 4. (i) In February 2001, D, a calendar-year taxpayer and 
manufacturer of rubber products, acquired for $60,000 and placed in 
service Asset T (a special tool) and depreciated Asset T using the 
straight line method election under section 168(b)(5) and the mid-
quarter convention over its 3-year recovery period. In June 2004, D 
exchanges Asset T for Asset U (not a special tool) in a like-kind 
exchange. D elected not to deduct the additional first year depreciation 
for 7-year property placed in service in 2004. Since the recovery period 
prescribed under section 168 for Asset U (7 years) is longer than that 
of Asset T (3 years), Asset U is depreciated as if it had originally 
been placed in service in February 2001 using a 7-year recovery period. 
Additionally, since the depreciation method prescribed under section 168 
for Asset U (200-percent declining balance method) is more accelerated 
than that of Asset T (straight line method) at the time of disposition, 
the depreciation allowance is computed using

[[Page 1081]]

the straight line method. Asset U is depreciated over its remaining 
recovery period of 3.75 years using the straight line method of 
depreciation and the mid-quarter convention.
    (ii) The 2004 depreciation allowance for Asset T is $938 ($2,500 
allowable depreciation deduction ($60,000 original basis minus $17,500 
depreciation deduction for 2001 minus $20,000 depreciation deduction for 
2002 minus $20,000 depreciation deduction for 2003) x 4.5 months / 12).
    (iii) The depreciation rate in 2004 for Asset U is 0.2424 (1 / 4.125 
years (the length of the applicable recovery period remaining as of the 
beginning of 2004)). Therefore, the depreciation allowance in 2004 is 
$379 (0.2424 x $2,500 (the sum of the $1,562 depreciable exchanged basis 
of Asset U ($2,500 basis at the beginning of 2004 for Asset T, less the 
$938 depreciation allowable for Asset T for 2004) and the $938 
depreciation allowable for Asset T for 2004) x 7.5 months / 12).
    Example 5. On January 1, 2004, E, a calendar-year taxpayer, acquired 
and placed in service Canopy V, a gas station canopy. The purchase price 
of Canopy V was $60,000. On August 1, 2004, Canopy V was destroyed in a 
hurricane and was therefore no longer usable in E's business. On October 
1, 2004, as part of the involuntary conversion, E acquired and placed in 
service Canopy W with the insurance proceeds E received due to the loss 
of Canopy V. E elected not to deduct the additional first year 
depreciation for 5-year property placed in service in 2004. E 
depreciates both canopies under the general depreciation system of 
section 168(a) by using the 200-percent declining balance method of 
depreciation, a 5-year recovery period, and the half-year convention. No 
depreciation deduction is allowable for Canopy V. The depreciation 
deduction allowable for Canopy W for 2004 is $12,000 ($60,000 x the 
annual depreciation rate of .40 x \1/2\ year).
    Example 6. Same facts as in Example 5, except that E did not make 
the election out of the additional first year depreciation for 5-year 
property placed in service in 2004. E depreciates both canopies under 
the general depreciation system of section 168(a) by using the 200-
percent declining balance method of depreciation, a 5-year recovery 
period, and the half-year convention. No depreciation deduction is 
allowable for Canopy V. For 2004, E is allowed a 50-percent additional 
first year depreciation deduction of $30,000 for Canopy W (the 
unadjusted depreciable basis of $60,000 multiplied by .50), and a 
regular MACRS depreciation deduction of $6,000 for Canopy W (the 
depreciable exchanged basis of $30,000 multiplied by the annual 
depreciation rate of .40 x \1/2\ year). For 2005, E is allowed a regular 
MACRS depreciation deduction of $9,600 for Canopy W (the depreciable 
exchanged basis of $24,000 ($30,000 minus regular 2003 depreciation of 
$6,000) multiplied by the annual depreciation rate of .40).

    (d) Special rules for determining depreciation allowances--(1) 
Excess basis--(i) In general. Any excess basis in the replacement MACRS 
property is treated as property that is placed in service by the 
acquiring taxpayer in the year of replacement. Thus, the depreciation 
allowances for the depreciable excess basis are determined by using the 
applicable recovery period, depreciation method, and convention 
prescribed under section 168 for the property at the time of 
replacement. However, if replacement MACRS property is disposed of 
during the same taxable year the relinquished MACRS property is placed 
in service by the acquiring taxpayer, no depreciation deduction is 
allowable for either MACRS property. See paragraph (g) of this section 
regarding the application of section 179. See paragraph (h) of this 
section regarding the application of section 168(k) or 1400L(b).
    (ii) Example. The application of this paragraph (d)(1) is 
illustrated by the following example:

    Example. In 1989, G placed in service a hospital. On January 16, 
2004, G exchanges this hospital plus $2,000,000 cash for an office 
building in a like-kind exchange. On January 16, 2004, the hospital has 
an adjusted depreciable basis of $1,500,000. After the exchange, the 
basis of the office building is $3,500,000. The depreciable exchanged 
basis of the office building is depreciated in accordance with paragraph 
(c) of this section. The depreciable excess basis of $2,000,000 is 
treated as being placed in service by G in 2004 and, as a result, is 
depreciated using the applicable depreciation method, recovery period, 
and convention prescribed for the office building under section 168 at 
the time of replacement.

    (2) Depreciable and nondepreciable property--(i) If land or other 
nondepreciable property is acquired in a like-kind exchange for, or as a 
result of an involuntary conversion of, depreciable property, the land 
or other nondepreciable property is not depreciated. If both MACRS and 
nondepreciable property are acquired in a like-kind exchange for, or as 
part of an involuntary conversion of, MACRS property, the basis 
allocated to the nondepreciable property (as determined under section 
1031(d) and the regulations under section 1031(d) or section 1033(b) and 
the

[[Page 1082]]

regulations under section 1033(b)) is not depreciated and the basis 
allocated to the replacement MACRS property (as determined under section 
1031(d) and the regulations under section 1031(d) or section 1033(b) and 
the regulations under section 1033(b)) is depreciated in accordance with 
this section.
    (ii) If MACRS property is acquired, or if both MACRS and 
nondepreciable property are acquired, in a like-kind exchange for, or as 
part of an involuntary conversion of, land or other nondepreciable 
property, the basis in the replacement MACRS property that is 
attributable to the relinquished nondepreciable property is treated as 
though the replacement MACRS property is placed in service by the 
acquiring taxpayer in the year of replacement. Thus, the depreciation 
allowances for the replacement MACRS property are determined by using 
the applicable recovery period, depreciation method, and convention 
prescribed under section 168 for the replacement MACRS property at the 
time of replacement. See paragraph (g) of this section regarding the 
application of section 179. See paragraph (h) of this section regarding 
the application of section 168(k) or 1400L(b).
    (3) Depreciation limitations for automobiles--(i) In general. 
Depreciation allowances under section 179 and section 167 (including 
allowances under sections 168 and 1400L(b)) for a passenger automobile, 
as defined in section 280F(d)(5), are subject to the limitations of 
section 280F(a). The depreciation allowances for a passenger automobile 
that is replacement MACRS property (replacement MACRS passenger 
automobile) generally are limited in any taxable year to the replacement 
automobile section 280F limit for the taxable year. The taxpayer's basis 
in the replacement MACRS passenger automobile is treated as being 
comprised of two separate components. The first component is the 
exchanged basis and the second component is the excess basis, if any. 
The depreciation allowances for a passenger automobile that is 
relinquished MACRS property (relinquished MACRS passenger automobile) 
for the taxable year generally are limited to the relinquished 
automobile section 280F limit for that taxable year. For purposes of 
this paragraph (d)(3), the following definitions apply:
    (A) Replacement automobile section 280F limit is the limit on 
depreciation deductions under section 280F(a) for the taxable year based 
on the time of replacement of the replacement MACRS passenger automobile 
(including the effect of any elections under section 168(k) or section 
1400L(b), as applicable).
    (B) Relinquished automobile section 280F limit is the limit on 
depreciation deductions under section 280F(a) for the taxable year based 
on when the relinquished MACRS passenger automobile was placed in 
service by the taxpayer.
    (ii) Order in which limitations on depreciation under section 
280F(a) are applied. Generally, depreciation deductions allowable under 
section 280F(a) reduce the basis in the relinquished MACRS passenger 
automobile and the exchanged basis of the replacement MACRS passenger 
automobile, before the excess basis of the replacement MACRS passenger 
automobile is reduced. The depreciation deductions for the relinquished 
MACRS passenger automobile in the year of disposition and the 
replacement MACRS passenger automobile in the year of replacement and 
each subsequent taxable year are allowable in the following order:
    (A) The depreciation deduction allowable for the relinquished MACRS 
passenger automobile as determined under paragraph (c)(5)(i) of this 
section for the year of disposition to the extent of the smaller of the 
replacement automobile section 280F limit and the relinquished 
automobile section 280F limit, if the year of disposition is the year of 
replacement. If the year of replacement is a taxable year subsequent to 
the year of disposition, the depreciation deduction allowable for the 
relinquished MACRS passenger automobile for the year of disposition is 
limited to the relinquished automobile section 280F limit.
    (B) The additional first year depreciation allowable on the 
remaining exchanged basis (remaining carryover basis as determined under 
Sec. 1.168(k)-1T(f)(5) or Sec. 1.1400L(b)-1T(f)(5), as applicable) of 
the replacement MACRS passenger automobile, as determined

[[Page 1083]]

under Sec. 1.168(k)-1T(f)(5) or Sec. 1.1400L(b)-1T(f)(5), as 
applicable, to the extent of the excess of the replacement automobile 
section 280F limit over the amount allowable under paragraph 
(d)(3)(ii)(A) of this section.
    (C) The depreciation deduction allowable for the taxable year on the 
depreciable exchanged basis of the replacement MACRS passenger 
automobile determined under paragraph (c) of this section to the extent 
of any excess over the sum of the amounts allowable under paragraphs 
(d)(3)(ii)(A) and (B) of this section of the smaller of the replacement 
automobile section 280F limit and the relinquished automobile section 
280F limit.
    (D) Any section 179 deduction allowable in the year of replacement 
on the excess basis of the replacement MACRS passenger automobile to the 
extent of the excess of the replacement automobile section 280F limit 
over the sum of the amounts allowable under paragraphs (d)(3)(ii)(A), 
(B), and (C) of this section.
    (E) The additional first year depreciation allowable on the 
remaining excess basis of the replacement MACRS passenger automobile, as 
determined under Sec. 1.168(k)-1T(f)(5) or Sec. 1.1400L(b)-1T(f)(5), 
as applicable, to the extent of the excess of the replacement automobile 
section 280F limit over the sum of the amounts allowable under 
paragraphs (d)(3)(ii)(A), (B), (C), and (D) of this section.
    (F) The depreciation deduction allowable under paragraph (d) of this 
section for the depreciable excess basis of the replacement MACRS 
passenger automobile to the extent of the excess of the replacement 
automobile section 280F limit over the sum of the amounts allowable 
under paragraphs (d)(3)(ii)(A), (B), (C), (D), and (E) of this section.
    (iii) Examples. The application of this paragraph (d)(3) is 
illustrated by the following examples:

    Example 1. H, a calendar-year taxpayer, acquired and placed in 
service Automobile X in January 2000 for $30,000 to be used solely for 
H's business. In December 2003, H exchanges, in a like-kind exchange, 
Automobile X plus $15,000 cash for new Automobile Y that will also be 
used solely in H's business. Automobile Y is 50-percent bonus 
depreciation property for purposes of section 168(k)(4). Both 
automobiles are depreciated using the double declining balance method, 
the half-year convention, and a five-year recovery period. The 
relinquished automobile section 280F limit for 2003 for Automobile X is 
$1,775. The replacement automobile section 280F limit for Automobile Y 
is $10,710. The exchanged basis for Automobile Y is $17,315 ($30,000 
less total depreciation allowable of $12,685 ($3,060 for 2000, $4,900 
for 2001, $2,950 for 2002, and $1,775 for 2003)). Without taking section 
280F into account, the additional first year depreciation deduction for 
the remaining exchanged basis is $8,658 ($17,315 x 0.5). Because this 
amount is less than $8,935 ($10,710 (the replacement automobile section 
280F limit for 2003 for Automobile Y) $1,775 (the depreciation allowable 
for Automobile X for 2003)) the additional first year depreciation 
deduction for the exchanged basis is $8,658. No depreciation deduction 
is allowable in 2003 for the depreciable exchanged basis because the 
depreciation deductions taken for Automobile X and the remaining 
exchanged basis exceed the exchanged automobile section 280F limit. An 
additional first year depreciation deduction of $277 is allowable for 
the excess basis of $15,000 in Automobile Y. Thus at the end of 2003 the 
adjusted depreciable basis in Automobile Y is $23,379 comprised of 
adjusted depreciable exchanged basis of $8,657 ($17,315 (exchanged 
basis) -$8,658 (additional first year depreciation for exchanged basis)) 
and of an adjusted depreciable excess basis of $14,723 ($15,000 (excess 
basis)-$277 (additional first year depreciation for 2003)).
    Example 2. Same facts as in Example 1, except that H placed in 
service Automobile X in January 2002, and H elected not to claim the 
additional first year depreciation deduction for 5-year property placed 
in service in 2002 and 2003. The relinquished automobile section 280F 
limit for Automobile X for 2003 is $4,900. Because the replacement 
automobile section 280F limit for 2003 for Automobile Y ($3,060) is less 
than the relinquished automobile section 280F limit for Automobile X for 
2003 and is less than $5,388 (($30,000 (cost)-$3,060 (depreciation 
allowable for 2002)) x 0.4 x 6/12), the depreciation that would be 
allowable for Automobile X (determined without regard to section 280F) 
in the year of disposition, the depreciation for Automobile X in the 
year of disposition is limited to $3,060. For 2003 no depreciation is 
allowable for the excess basis and the exchanged basis in Automobile Y.
    Example 3. AB, a calendar-year taxpayer, purchased and placed in 
service Automobile X1 in February 2000 for $10,000. X1 is a passenger 
automobile subject to section 280F(a) and is used solely for AB's 
business. AB depreciated X1 using a five-year recovery period, the 
double declining balance method and the half-year convention. As of 
January 1, 2003, the adjusted basis of X1 was $2,880

[[Page 1084]]

($10,000 original cost minus $2,000 depreciation deduction for 2000, 
minus $3,200 depreciation deduction for 2001, and $1,920 depreciation 
deduction for 2002). In November 2003, AB exchanges, in a like-kind 
exchange, Automobile X1 plus $14,000 cash for new Automobile Y1 that 
will be used solely in AB's business. Automobile Y1 is 50-percent bonus 
depreciation property for purposes of section 168(k)(4) and qualifies 
for the expensing election under section 179. Pursuant to paragraph 
Sec. 1.168(k)-1T(g)(3)(ii) and paragraph (k)(2)(i) of this section, AB 
decided to apply Sec. 1.168(i)-6T to the exchange of Automobile X1 for 
Automobile Y1, the replacement MACRS property. AB also makes the 
election under section 179 for the excess basis of Automobile Y1. AB 
depreciates Y1 using a five-year recovery period, the double declining 
balance method and the half-year convention. For 2003, the relinquished 
automobile section 280F limit for Automobile X1 is $1,775 and the 
replacement automobile section 280F limit for 2003 for Automobile Y1 is 
$10,710.
    (i) The 2003 depreciation deduction for Automobile X1 is $576. The 
depreciation deduction calculated for X1 is $576 (the adjusted 
depreciable basis of Automobile X1 at the beginning of 2003 of $2,880 x 
40% x \1/2\ year), which is less than the relinquished automobile 
section 280F limit and the replacement automobile section 280F limit.
    (ii) The additional first year depreciation deduction for the 
exchanged basis is $1,152. The additional first year depreciation 
deduction of $1,152 (remaining exchanged basis of $2,304 ($2,880 
adjusted basis of Automobile X1 at the beginning of 2003 minus $576) x 
0.5)) is less than the replacement automobile section 280F limit minus 
$576.
    (iii) AB's MACRS depreciation deduction allowable in 2003 for the 
remaining exchanged basis of $1,152 is $47 (the relinquished automobile 
section 280F limit of $1,775 less the depreciation deduction of $576 
taken for Automobile X1 less the additional first year depreciation 
deduction of $1,152 taken for the exchanged basis) which is less than 
the depreciation deduction calculated for the depreciable exchanged 
basis.
    (iv) For 2003, AB takes a $1,400 section 179 deduction for the 
excess basis of Automobile Y1. AB must reduce the excess basis of 
$14,000 by the section 179 deduction of $1,400 to determine the 
remaining excess basis of $12,600.
    (v) For 2003, AB is allowed a 50-percent additional first year 
depreciation deduction of $6,300 (the remaining excess basis of $12,600 
multiplied by .50).
    (vi) For 2003, AB's depreciation deduction for the depreciable 
excess basis is limited to $1,235. The depreciation deduction computed 
without regard to the replacement automobile section 280F limit is 
$1,260 ($6,300 depreciable excess basis x 0.4 x 6/12). However the 
depreciation deduction for the depreciable excess basis is limited to 
$1,235 ($10,710 (replacement automobile section 280F limit)-$576 
(depreciation deduction for Automobile X1)-$1,152 (additional first year 
depreciation deduction for the exchanged basis)-$47 (depreciation 
deduction for exchanged basis) -$1,400 (section 179 deduction) -$6,300 
(additional first year depreciation deduction for remaining excess 
basis)).

    (4) Replacement MACRS property acquired and placed-in-service before 
disposition of relinquished MACRS property. If, in an involuntary 
conversion, a taxpayer acquires and places in service the replacement 
MACRS property before the date of disposition of the relinquished MACRS 
property, the taxpayer depreciates the unadjusted depreciable basis of 
the replacement MACRS property under section 168 beginning in the 
taxable year when the replacement MACRS property is placed in service by 
the taxpayer and by using the applicable depreciation method, recovery 
period, and convention prescribed under section 168 for the replacement 
MACRS property at the placed-in-service date. However, at the time of 
disposition of the relinquished MACRS property, the taxpayer determines 
the exchanged basis and the excess basis of the replacement MACRS 
property and begins to depreciate the depreciable exchanged basis of the 
replacement MACRS property in accordance with paragraph (c) of this 
section. The depreciable excess basis of the replacement MACRS property 
continues to be depreciated by the taxpayer in accordance with the first 
sentence of this paragraph (d)(4). Further, in the year of disposition 
of the relinquished MACRS property, the taxpayer must include in taxable 
income the excess of the depreciation deductions allowable on the 
unadjusted depreciable basis of the replacement MACRS property over the 
depreciation deductions that would have been allowable to the taxpayer 
on the depreciable excess basis of the replacement MACRS property from 
the date the replacement MACRS property was placed in service by the 
taxpayer (taking into account the applicable convention) to the time of 
disposition of the relinquished MACRS property.
    (e) Use of optional depreciation tables--(1) Taxpayer not bound by 
prior use of

[[Page 1085]]

table. If a taxpayer used an optional depreciation table for the 
relinquished MACRS property, the taxpayer is not required to use an 
optional table for the depreciable exchanged basis of the replacement 
MACRS property. Conversely, if a taxpayer did not use an optional 
depreciation table for the relinquished MACRS property, the taxpayer may 
use the appropriate table for the depreciable exchanged basis of the 
replacement MACRS property. If a taxpayer decides not to use the table 
for the depreciable exchanged basis of the replacement MACRS property, 
the depreciation allowance for this property for the year of replacement 
and subsequent taxable years is determined under paragraph (c) of this 
section. If a taxpayer decides to use the optional depreciation tables, 
no depreciation deduction is allowable for MACRS property placed in 
service by the acquiring taxpayer and subsequently exchanged or 
involuntarily converted by such taxpayer in the same taxable year, and, 
if, during the same taxable year, MACRS property is placed in service by 
the acquiring taxpayer, exchanged or involuntarily converted by such 
taxpayer, and the replacement MACRS property is disposed of by such 
taxpayer, no depreciation deduction is allowable for either MACRS 
property.
    (2) Determination of the depreciation deduction--(i) Relinquished 
MACRS property. In the year of disposition, the depreciation allowance 
for the relinquished MACRS property is computed by multiplying the 
unadjusted depreciable basis (less the amount of the additional first 
year depreciation deduction allowed or allowable, whichever is greater, 
under section 168(k) or section 1400L(b), as applicable) of the 
relinquished MACRS property by the annual depreciation rate (expressed 
as a decimal equivalent) specified in the appropriate table for the 
recovery year corresponding to the year of disposition. This product is 
then multiplied by a fraction, the numerator of which is the number of 
months (including fractions of months) the property is deemed to be 
placed in service during the year of the exchange or involuntary 
conversion (taking into account the applicable convention) and the 
denominator of which is 12. However, if the year of disposition is less 
than 12 months, the depreciation allowance determined under this 
paragraph (e)(2)(i) must be adjusted for a short taxable year (for 
further guidance, for example, see Rev. Proc. 89-15 (1989-1 C.B. 816) 
and Sec. 601.601(d)(2)(ii)(b) of this chapter).
    (ii) Replacement MACRS property--(A) Determination of the 
appropriate optional depreciation table. If a taxpayer chooses to use 
the appropriate optional depreciation table for the depreciable 
exchanged basis, the depreciation allowances for the depreciable 
exchanged basis beginning in the year of replacement are determined by 
choosing the optional depreciation table that corresponds to the 
recovery period, depreciation method, and convention of the replacement 
MACRS property determined under paragraph (c) of this section.
    (B) Calculating the depreciation deduction for the replacement MACRS 
property--(1) The depreciation deduction for the taxable year is 
computed by first determining the appropriate recovery year in the table 
identified under paragraph (e)(2)(ii)(A) of this section. The 
appropriate recovery year for the year of replacement is the same as the 
recovery year for the year of disposition, regardless of the taxable 
year in which the replacement property is acquired. For example, if the 
recovery year for the year of disposition would have been Year 4 in the 
table that applied before the disposition of the relinquished MACRS 
property, then the recovery year for the year of replacement is Year 4 
in the table identified under paragraph (e)(2)(ii)(A) of this section.
    (2) Next, the annual depreciation rate (expressed as a decimal 
equivalent) for each recovery year is multiplied by a transaction 
coefficient. The transaction coefficient is the formula (1/(1-x)) where 
x equals the sum of the annual depreciation rates from the table 
identified under paragraph (e)(2)(ii)(A) of this section (expressed as a 
decimal equivalent) corresponding to the replacement MACRS property (as 
determined under paragraph (e)(2)(ii)(A) of this section) for the 
taxable years beginning with the placed-in-service year of the 
relinquished MACRS property through the taxable year immediately prior 
to the year of

[[Page 1086]]

disposition. The product of the annual depreciation rate and the 
transaction coefficient is multiplied by the depreciable exchanged basis 
(taking into account paragraph (e)(2)(i) of this section). In the year 
of replacement, this product is then multiplied by a fraction, the 
numerator of which is the number of months (including fractions of 
months) the property is deemed to be placed in service by the acquiring 
taxpayer during the year of replacement (taking into account the 
applicable convention) and the denominator of which is 12. However, if 
the year of replacement is the year the relinquished MACRS property is 
placed in service by the acquiring taxpayer, the preceding sentence does 
not apply. In addition, if the year of replacement is less than 12 
months, the depreciation allowance determined under paragraph (e)(2)(ii) 
of this section must be adjusted for a short taxable year (for further 
guidance, for example, see Rev. Proc. 89-15 (1989-1 C.B. 816) and Sec. 
601.601(d)(2)(ii)(b) of this chapter).
    (iii) Unrecovered basis. If the replacement MACRS property would 
have unrecovered depreciable basis after the final recovery year (for 
example, due to a deferred exchange), the unrecovered basis is an 
allowable depreciation deduction in the taxable year that corresponds to 
the final recovery year unless the unrecovered basis is subject to a 
depreciation limitation such as section 280F.
    (3) Excess basis. As provided in paragraph (d)(1) of this section, 
any excess basis in the replacement MACRS property is treated as 
property that is placed in service by the acquiring taxpayer at the time 
of replacement. Thus, if the taxpayer chooses to use the appropriate 
optional depreciation table for the depreciable excess basis in the 
replacement MACRS property, the depreciation allowances for the 
depreciable excess basis are determined by multiplying the depreciable 
excess basis by the annual depreciation rate (expressed as a decimal 
equivalent) specified in the appropriate table for each taxable year. 
The appropriate table for the depreciable excess basis is based on the 
depreciation method, recovery period, and convention applicable to the 
depreciable excess basis under section 168 at the time of replacement. 
However, if the year of replacement is less than 12 months, the 
depreciation allowance determined under this paragraph (e)(3) must be 
adjusted for a short taxable year (for further guidance, for example, 
see Rev. Proc. 89-15 (1989-1 C.B. 816) and Sec. 601.601(d)(2)(ii)(b) of 
this chapter).
    (4) Examples. The application of this paragraph (e) is illustrated 
by the following examples:

    Example 1. J, a calendar-year taxpayer, acquired 5-year property for 
$10,000 and placed it in service in January 2001. J uses the optional 
tables to depreciate the property. J uses the half-year convention and 
did not make any elections for the property. In December 2003, J 
exchanges the 5-year property for used 7-year property in a like-kind 
exchange. The depreciable exchanged basis of the 7-year property equals 
the adjusted depreciable basis of the 5-year property at the time of 
disposition of the relinquished MACRS property, namely $3,840 ($10,000 
less $2,000 depreciation in 2001, $3,200 depreciation in 2002, and $960 
depreciation in 2003). J must first determine the appropriate optional 
depreciation table pursuant to paragraph (c) of this section. Since the 
replacement MACRS property has a longer recovery period and the same 
depreciation method as the relinquished MACRS property, J uses the 
optional depreciation table corresponding to a 7-year recovery period, 
the 200% declining balance method, and the half-year convention (because 
the 5-year property was depreciated using a half-year convention). Had 
the replacement MACRS property been placed in service in the same 
taxable year as the placed-in-service year of the relinquished MACRS 
property, the depreciation allowance for the replacement MACRS property 
for the year of replacement would be determined using recovery year 3 of 
the optional table. The depreciation allowance equals the depreciable 
exchanged basis ($3,840) multiplied by the annual depreciation rate for 
the current taxable year (.1749 for recovery year 3) as modified by the 
transaction coefficient [1 / (1-(.1429 + .2449))] which equals 1.6335. 
Thus, J multiplies $3,840, its depreciable exchanged basis in the 
replacement MACRS property, by the product of .1749 and 1.6335, and then 
by one-half, to determine the depreciation allowance for 2003, $549. For 
2004, J multiplies its depreciable exchanged basis in the replacement 
MACRS property determined at the time of replacement of $3,840 by the 
product of the modified annual depreciation rate for the current taxable 
year (.1249 for recovery year 4) and the transaction coefficient 
(1.6335) to determine its depreciation allowance of $783.

[[Page 1087]]

    Example 2. K, a calendar-year taxpayer, acquired used Asset V for 
$100,000 and placed it in service in January 1999. K depreciated Asset V 
under the general depreciation system of section 168(a) by using a 5-
year recovery period, the 200-percent declining balance method of 
depreciation, and the half-year convention. In December 2003, as part of 
the involuntary conversion, Asset V is involuntarily converted due to an 
earthquake. In October 2005, K purchases used Asset W with the insurance 
proceeds from the destruction of Asset V and places Asset W in service 
to replace Asset V. If Asset W had been placed in service when Asset V 
was placed in service, it would have been depreciated using a 7-year 
recovery period, the 200-percent declining balance method, and the half-
year convention. K uses the optional depreciation tables to depreciate 
Asset V and Asset W. For 2003 (recovery year 5 on the optional table), 
the depreciation deduction for Asset V is $5,760 ((0.1152)($100,000)(1/
2)). Thus, the adjusted depreciable basis of Asset V at the time of 
replacement is $11,520 ($100,000 less $20,000 depreciation in 1999, 
$32,000 depreciation in 2000, $19,200 depreciation in 2001, $11,520 
depreciation in 2002, and $5,760 depreciation in 2003). Under the table 
that applied to Asset V, the year of disposition was recovery year 5 and 
the depreciation deduction was determined under the straight line 
method. The table that applies for Asset W is the table that applies the 
straight line depreciation method, the half-year convention, and a 7-
year recovery period. The appropriate recovery year under this table is 
recovery year 5. The depreciation deduction for Asset W for 2005 is 
$1,646 (($11,520)(0.1429)(1/(1-0.5))(1/2)). Thus, the depreciation 
deduction for Asset W in 2006 (recovery year 6) is $3,290 
($11,520)(0.1428)(1/(1-0.5)). The depreciation deduction for 2007 
(recovery year 7) is $3,292 (($11,520)(.1429)(1/(1-.5))). The 
depreciation deduction for 2008 (recovery year 8) is $3,292 ($11,520 
less allowable depreciation for Asset W for 2005 through 2007 ($1,646 + 
$3,290 + $3,292)).
    Example 3. L, a calendar-year taxpayer, placed in service used 
Computer X in January 2002 for $5,000. L depreciated Computer X under 
the general depreciation system of section 168(a) by using the 200-
percent declining balance method of depreciation, a 5-year recovery 
period, and the half-year convention. Computer X is destroyed in a fire 
in March 2004. For 2004, the depreciation deduction allowable for 
Computer X equals $480 ([($5,000)(.1920)] x (1/2)). Thus, the adjusted 
depreciable basis of Computer X was $1,920 when it was destroyed ($5,000 
unadjusted depreciable basis less $1,000 depreciation for 2002, $1,600 
depreciation for 2003, and $480 depreciation for 2004). In April 2004, 
as part of the involuntary conversion, L acquired and placed in service 
used Computer Y with insurance proceeds received due to the loss of 
Computer X. Computer Y will be depreciated using the same depreciation 
method, recovery period, and convention as Computer X. L elected to use 
the optional depreciation tables to compute the depreciation allowance 
for Computer X and Computer Y. The depreciation deduction allowable for 
2004 for Computer Y equals $384 ([$1,920 x (.1920)(1/(1-.52))] x (1/2)).

    (f) Mid-quarter convention. For purposes of applying the 40-percent 
test under section 168(d) and the regulations under section 168(d), the 
following rules apply:
    (1) Exchanged basis. If, in a taxable year, MACRS property is placed 
in service by the acquiring taxpayer (but not as a result of a like-kind 
exchange or involuntary conversion) and--
    (i) In the same taxable year, is disposed of by the acquiring 
taxpayer in a like-kind exchange or an involuntary conversion and 
replaced by the acquiring taxpayer with replacement MACRS property, the 
exchanged basis (determined without any adjustments for depreciation 
deductions during the taxable year) of the replacement MACRS property is 
taken into account in the year of replacement in the quarter the 
relinquished MACRS property was placed in service by the acquiring 
taxpayer; or
    (ii) In the same taxable year, is disposed of by the acquiring 
taxpayer in a like-kind exchange or an involuntary conversion, and in a 
subsequent taxable year is replaced by the acquiring taxpayer with 
replacement MACRS property, the exchanged basis (determined without any 
adjustments for depreciation deductions during the taxable year) of the 
replacement MACRS property is taken into account in the year of 
replacement in the quarter the replacement MACRS property was placed in 
service by the acquiring taxpayer; or
    (iii) In a subsequent taxable year, disposed of by the acquiring 
taxpayer in a like-kind exchange or involuntary conversion, the 
exchanged basis of the replacement MACRS property is not taken into 
account in the year of replacement.
    (2) Excess basis. Any excess basis is taken into account in the 
quarter the replacement MACRS property is placed in service by the 
acquiring taxpayer.

[[Page 1088]]

    (3) Depreciable property acquired for nondepreciable property. Both 
the exchanged basis and excess basis of the replacement MACRS property 
described in paragraph (d)(2)(ii) of this section (depreciable property 
acquired for nondepreciable property), are taken into account for 
determining whether the mid-quarter convention applies in the year of 
replacement.
    (g) Section 179 election. In applying the section 179 election, only 
the excess basis, if any, in the replacement MACRS property is taken 
into account. If the replacement MACRS property is described in 
paragraph (d)(2)(ii) of this section (depreciable property acquired for 
nondepreciable property), only the excess basis in the replacement MACRS 
property is taken into account.
    (h) Additional first year depreciation deduction. See Sec. 
1.168(k)-1T(f)(5) (for qualified property or 50-percent bonus 
depreciation property) and Sec. 1.1400L(b)-1T(f)(5) (for qualified New 
York Liberty Zone property).
    (i) Election not to apply this section. A taxpayer may elect not to 
apply this section for any MACRS property involved in a like-kind 
exchange or involuntary conversion. An election under this paragraph (i) 
applies only to the taxpayer making the election and the election 
applies to both the relinquished MACRS property and the replacement 
MACRS property. If an election is made under this paragraph (i), the 
depreciation allowances for the replacement MACRS property beginning in 
the year of replacement and for the relinquished MACRS property in the 
year of disposition are not determined under this section. Instead, for 
depreciation purposes, the exchanged basis and excess basis, if any, in 
the replacement MACRS property are treated as being placed in service by 
the taxpayer at the time of replacement and the adjusted depreciable 
basis of the relinquished MACRS property is treated as being disposed of 
by the taxpayer at the time of disposition. Paragraphs (c)(5)(i) 
(determination of depreciation for relinquished MACRS property in the 
year of disposition), (c)(5)(iii) (rules for deferred transactions), (g) 
(section 179 election), and (h) (additional first year depreciation 
deduction) of this section apply to property to which this paragraph (i) 
applies. See paragraph (j) of this section for the time and manner of 
making the election under this paragraph (i).
    (j) Time and manner of making elections--(1) In general. The 
election provided in paragraph (i) of this section is made separately by 
each person acquiring replacement MACRS property. The election is made 
for each member of a consolidated group by the common parent of the 
group, by the partnership (and not by the partners separately) in the 
case of a partnership, or by the S corporation (and not by the 
shareholders separately) in the case of an S corporation. A separate 
election under paragraph (i) of this section is required for each like-
kind exchange or involuntary conversion. The election provided in 
paragraph (i) of this section must be made within the time and manner 
provided in paragraph (j)(2) and (3) of this section and may not be made 
by the taxpayer in any other manner (for example, the election cannot be 
made through a request under section 446(e) to change the taxpayer's 
method of accounting), except as provided in paragraph (k)(2) of this 
section.
    (2) Time for making election. The election provided in paragraph (i) 
of this section is made by the due date (including extensions) of the 
taxpayer's Federal tax return for the year of replacement.
    (3) Manner of making election. The election provided in paragraph 
(i) of this section is made by typing or legibly printing at the top of 
Form 4562, Depreciation and Amortization, ``ELECTION MADE UNDER SECTION 
1.168(i)-6T(i),'' or in the manner provided for on Form 4562 and its 
instructions. If Form 4562 is revised or renumbered, any reference in 
this section to that form is treated as a reference to the revised or 
renumbered form.
    (4) Revocation. The election provided in paragraph (i) of this 
section, once made, may be revoked only with the consent of the 
Commissioner of Internal Revenue. Such consent will be granted only in 
extraordinary circumstances. Requests for consent are requests for a 
letter ruling and must be

[[Page 1089]]

filed with the Commissioner of Internal Revenue, Washington, DC 20224. 
Requests for consent may not be made in any other manner (for example, 
through a request under section 446(e) to change the taxpayer's method 
of accounting).
    (k) Effective date--(1) In general. (i) This section applies to a 
like-kind exchange or an involuntary conversion of MACRS property for 
which the time of disposition and the time of replacement both occur 
after February 27, 2004.
    (ii) The applicability of this section expires on or before February 
26, 2007.
    (2) Application to pre-effective date like-kind exchanges and 
involuntary conversions. For a like-kind exchange or an involuntary 
conversion of MACRS property for which the time of disposition, the time 
of replacement, or both occur on or before February 27, 2004, a taxpayer 
may:
    (i) Apply the provisions of this section. If a taxpayer's applicable 
federal income tax return has been filed on or before February 27, 2004, 
and the taxpayer has treated the replacement MACRS property as acquired, 
and the relinquished MACRS property as disposed of, in a like-kind 
exchange or an involuntary conversion, the taxpayer changes its method 
of accounting for depreciation of the replacement MACRS property and 
relinquished MACRS property in accordance with this paragraph (k)(2)(i) 
by following the applicable administrative procedures issued under Sec. 
1.446-1T(e)(3)(ii) for obtaining the Commissioner's automatic consent to 
a change in method of accounting (for further guidance, see Rev. Proc. 
2002-9 (2002-1 C.B. 327) and Sec. 601.601(d)(2)(ii)(b) of this 
chapter); or
    (ii) Rely on prior guidance issued by the Internal Revenue Service 
for determining the depreciation deductions of replacement MACRS 
property and relinquished MACRS property (for further guidance, for 
example, see Notice 2000-4 (2001-1 C.B. 313) and Sec. 
601.601(d)(2)(ii)(b) of this chapter). In relying on such guidance, a 
taxpayer may use any reasonable, consistent method of determining 
depreciation in the year of disposition and the year of replacement. If 
a taxpayer's applicable federal income tax return has been filed on or 
before February 27, 2004, and the taxpayer has treated the replacement 
MACRS property as acquired, and the relinquished MACRS property as 
disposed of, in a like-kind exchange or an involuntary conversion, the 
taxpayer changes its method of accounting for depreciation of the 
replacement MACRS property and relinquished MACRS property in accordance 
with this paragraph (k)(2)(ii) by following the applicable 
administrative procedures issued under Sec. 1.446-1T(e)(3)(ii) for 
obtaining the Commissioner's automatic consent to a change in method of 
accounting (for further guidance, see Rev. Proc. 2002-9 (2002-1 C.B. 
327) and Sec. 601.601(d)(2)(ii)(b) of this chapter).

[T.D. 9115, 69 FR 9537, Mar. 1, 2004; 69 FR 17586, Apr. 5, 2004]



Sec. 1.168(j)-1T  Questions and answers concerning tax-exempt entity 
leasing rules (temporary).

    The following questions and answers concern tax-exempt entity 
leasing under section 168(j) of the Internal Revenue Code of 1954, as 
enacted by section 31 of the Tax Reform Act of 1984 (``TRA'') (Pub. L. 
98-369):

                  Consequences of Tax-Exempt Use Status

    Q-1. If recovery property is subject to the tax-exempt entity 
leasing provisions of section 168(j), how must the taxpayer compute the 
property's recovery deductions?
    A-1. The taxpayer must compute the property's recovery deductions in 
accordance with section 168(j) (1) and (2); that is, the taxpayer must 
use the straight line method and the specified recovery period. For 
property other than 18-year real property, the applicable recovery 
percentages for the specified recovery period are to be determined with 
reference to the tables contained in Prop. Treas. Reg. Sec. 1.168-
2(g)(3)(iv)(A). For 18-year real property for which a 40-year recovery 
period is required, the applicable recovery percentages are to be 
determined under the following table:

[[Page 1090]]



                          40-Year Straight Line Method (Assuming Mid-Month Convention)
----------------------------------------------------------------------------------------------------------------
                                And the month in the first recovery year the property is placed in service is--
  If the recovery year is--  -----------------------------------------------------------------------------------
                                1      2      3      4      5      6      7      8      9      10     11     12
----------------------------------------------------------------------------------------------------------------
                                                    The applicable recovery percentage is--
                             -----------------------------------------------------------------------------------
 1..........................    2.4    2.2    2.0    1.8    1.6    1.4    1.1    0.9    0.7    0.5    0.3    0.1
 2..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
 3..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
 4..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
 5..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
 6..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
 7..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
 8..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
 9..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
10..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
11..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
12..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
13..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
14..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
15..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
16..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
17..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
18..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
19..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
20..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
21..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
22..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
23..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
24..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
25..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
26..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
27..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
28..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
29..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
30..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
31..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
32..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
33..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
34..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
35..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
36..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
37..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
38..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
39..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
40..........................    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5    2.5
41..........................    0.1    0.3    0.5    0.7    0.9    1.1    1.4    1.6    1.8    2.0    2.2    2.4
----------------------------------------------------------------------------------------------------------------

    Q-2. If recovery property that was placed in service after December 
31, 1980 by a taxable entity subsequently becomes tax-exempt use 
property, how are such property's cost recovery deductions under section 
168 affected?
    A-2. A change to tax-exempt use property, as defined in section 
168(j)(3), will cause the cost recovery deductions under the accelerated 
cost recovery system (ACRS) to be recomputed. The allowable recovery 
deduction for the taxable year in which the change occurs (and for 
subsequent taxable years) must be determined as if the property had 
originally been tax-exempt use property. Proper adjustment must be made 
under the principles of Prop. Treas. Reg. Sec. 1.168-2(j)(3)(i)(B) to 
account for the difference between the deductions allowable with respect 
to the property prior to the year of change and those which would have 
been allowable had the taxpayer used the recovery period and method for 
tax-exempt use property under section 168(j) (1) and (2). However, no 
adjustment is made pursuant to the provisions of this A-2 if section 
168(j)(2)(C) applies, that is, if the taxpayer had selected a longer 
recovery period in the year the property was placed in service than the 
recovery period prescribed for such property under section 168(j)(1).


[[Page 1091]]


    Example (1). On July 1, 1983, X, a calendar year taxpayer, places in 
service 5-year recovery property with an unadjusted basis of $100. For 
1983, X's allowable deduction is $15 (i.e., .15 x $100). In 1984, the 
property becomes tax-exempt use property. Under section 168(j), assume 
the prescribed recovery period is 12 years. For 1984 (and subsequent 
taxable years), X's allowable deduction is determined as if the property 
had been tax-exempt use property since 1983, that is, the year it was 
placed in service. Thus, taxable year 1984 is the property's second 
recovery year of its 12-year recovery period. Additionally, X must 
account for the excess allowable recovery deduction of $11 (i.e., the 
difference between the recovery allowance for 1983 ($15) and the 
allowance for that year had the property been tax-exempt use property 
($4)) in accordance with the principles of Prop. Treas. Reg. Sec. 
1.168-2(j)(3)(i)(B). Thus, the recovery allowances in 1984 and 1985 are 
$7.97, determined as follows:

Unadjusted basis multiplied by the applicable recovery             $9.00
 percentage for second recovery year ($100x.09................
Excess allowable recovery deduction multiplied by the              -1.03
 applicable recovery percentage for second recovery year
 divided by the sum of the remaining unused applicable
 percentages for tax-exempt use property existing as of the
 taxable year of change (1984) (($11x.09)/.96)................
                                                               ---------
Difference--allowable deduction for 1984......................     $7.97
                                                               =========
Unadjusted basis multiplied by the applicable recovery             $9.00
 percentage for third recovery year ($100x.09)................
Excess allowable recovery deduction multiplied by the              -1.03
 applicable recovery percentage for third recovery year
 divided by the sum of the remaining unused applicable
 percentages for tax-exempt use property existing as of the
 taxable year of change (1984) (($11x.09)/.96)................
                                                               ---------
Difference--allowable deduction for 1985......................     $7.97
                                                               =========
 


Additionally, X must make a similar adjustment for the taxable years 
1986 through 1995, that is, his fourth through thirteenth recovery 
years.
    Example (2). Assume the same facts as in Example (1) except that in 
1983, X elected under section 168 (b) (3) with respect to the 5-year 
property to use the optional recovery percentages over a 25-year 
recovery period. Based on these facts, the provisions of this A-2 do not 
apply.

                  Definition of Tax-Exempt Use Property

               Mixed Leases of Real and Personal Property

    Q-3. How is a mixed lease of real property and personal property 
(e.g., a building with furniture) to be treated for purposes of applying 
the rules of section 168(j)(3) defining which property constitutes tax-
exempt use property?
    A-3. The general rule is that 18-year real property and property 
other than 18-year real property are tested separately to determine 
whether each constitutes tax-exempt use property. However, if a lease of 
section 1245 class property is incidental to a lease of 18-year real 
property, and the 18-year real property is not tax-exempt use property, 
then the section 1245 class property also does not constitute tax-exempt 
use property. A lease of section 1245 class property will be considered 
incidental if the adjusted basis of all section 1245 class property 
leased in the same transaction is 1 percent or less of the adjusted 
basis of all 18-year real property leased in such transaction.

          Buildings Which Are Partially Tax-Exempt Use Property

    Q-4. If part of a building is leased to a tax-exempt entity in a 
disqualified lease and part of the building is leased other than to a 
tax-exempt entity in a disqualified lease, to what extent do the tax-
exempt entity leasing rules apply to such building?
    A-4. The taxpaper must determine the amount of the building's 
unadjusted basis that is properly allocable to the portion of the 
building that is tax-exempt use property; the section 168(j) rules apply 
to the allocated amount. Solely for purposes of determining what 
percentage of the building's basis is subject to the tax-exempt entity 
leasing rules, no part of the basis is allocated to common areas.

    Example. A constructs a 3-story building in 1984 at a cost of 
$900,000. Each floor consists of 30,000 square feet. The only common 
area (10,000 square feet) in the building is on the first floor. A 
leases the first floor (other than the common areas) to a firm that is 
not a tax-exempt entity. A leases the top two floors to a tax-exempt 
entity in a 25-year lease. The top two floors constitute tax-exempt use 
property. Assume that square footage is the appropriate method for 
allocating basis in this case. Thus, A must allocate $675,000 of the 
$900,000 basis to the tax-exempt use portion, determined as follows:

[[Page 1092]]

[GRAPHIC] [TIFF OMITTED] TC05OC91.040


A must compute his recovery deductions on this portion of the basis 
($675,000) in accordance with the rules of section 168(j) (1) and (2).

                         Requirement of a Lease

    Q-5. Can the use of property by a party other than a tax-exempt 
entity result in the property being treated as tax-exempt use property 
within the meaning of section 168(j)(3)?
    A-5. Yes, if based on all the facts and circumstances it is more 
appropriate to characterize the transaction as a lease to a tax-exempt 
entity. A transaction can be characterized as a lease to a tax-exempt 
entity under section 168(j)(6)(A), which provides that ``the term 
`lease' includes any grant of a right to use property''; or under the 
service contract rules of section 7701(e). See Q&A 18 for rules 
regarding service contracts.

    Example. A trust is executed on January 1, 1984, to create a pooled 
income fund (P) that meets the requirements of section 642(c)(5). A 
university (U) that is tax-exempt under section 501(c)(3) is the 
remainderman of the pooled income fund. P's purpose is to construct and 
operate an athletic center on land adjacent to U's campus. Construction 
of the athletic center, which has a 50-year useful life, was completed 
and the center was placed in service on February 1, 1985. The athletic 
center is managed for a fee by M, an unrelated taxable organization 
which operates athletic facilities open to the public. Office space at 
the facility is occupied rent-free by both the U athletic department and 
M. Scheduling of activities at the center is handled jointly by members 
of U's athletic department and M. General operating expenses of the 
athletic center are paid by P. Although the athletic center is open to 
the public for a membership fee, the majority of members are U's 
students who pay membership fees as part of their tuition. These fees 
are remitted by U to P. This arrangement is in substance a grant to U of 
a right to use the facility, and therefore a lease to U under section 
168(j)(6)(A). U, as remainderman, will have obtained title to the entire 
building when the last pooled income fund donor dies. This arrangement 
is a disqualified lease because either (1) U has the equivalent of a 
fixed price purchase option under section 168(j)(3)(B)(ii)(II) (if U 
receives title as remainderman before the end of the useful life of the 
building), or (2) the lease has a term in excess of 20 years under 
section 168(j)(3)(B)(ii)(III) (if U does not receive title as 
remainderman until 20 years have elapsed), or both. Therefore, the 
allowable recovery deductions (without regard to salvage value) must be 
computed in accordance with section 168(j) (1) and (2). In addition, 
because this arrangement is treated as a lease under section 168(j), the 
facility is used by U for purposes of section 48(a)(4), and thus no 
investment tax credit is permitted with respect to any portion of the 
facility. This arrangement also may be treated as a lease to U for all 
purposes of chapter 1 of the Internal Revenue Code under section 7701 
(e).

              ``More Than 35 Percent of the Property'' Test

    Q-6. How is the percentage of 18-year real property leased to a tax-
exempt entity in a disqualified lease to be determined for purposes of 
the ``more than 35 percent of the property'' test of section 
168(j)(3)(B)(iii)?
    A-6. The phrase ``more than 35 percent of the property'' means more 
than 35 percent of the net rentable floor space of the property. The net 
rentable floor space in a building does not include the common areas of 
the building, regardless of the terms of the lease. For purposes of the 
``more than 35 percent of the property'' rule, two or more buildings 
will be treated as separate properties unless they are part of the same 
project, in which case they will be treated as one property. Two or more 
buildings will be treated as part of the same project if the buildings 
are constructed, under a common plan, within a reasonable time of each 
other on the same site and will be used in an integrated manner.
    Q-7. Are disqualified leases to different tax-exempt entities 
(regardless of whether they are related) aggregated

[[Page 1093]]

in determining whether 18-year real property is tax-exempt use property?
    A-7. Yes.

    Example. A tax-exempt entity participates in industrial development 
bond financing for the acquisition of a new building by a taxable 
entity. The tax-exempt entity leases 60 percent of the net rentable 
floor space in the building for 5 years. Sixty percent of the building 
is tax-exempt use property. If the same tax-exempt entity leased only 19 
percent of the net rentable floor space in the building for 5 years, no 
portion of the building would be tax-exempt use property because not 
more than 35 percent of the property is leased to a tax-exempt entity 
pursuant to a disqualified lease. If such tax-exempt entity leased only 
19 percent of the net rentable floor space in the building for 5 years 
and another tax-exempt entity leased 20 percent of the net rentable 
floor space in the building for a term in excess of 20 years (or a 
related entity leased 20 percent of the building for 5 years), 39 
percent of the building would be tax-exempt use property. See A-4 
regarding the determination of the amount of the building's unadjusted 
basis that is properly allocable to the portion of the building that is 
tax-exempt use property.

                       ``Predominantly Used'' Test

    Q-8. What does the term ``predominantly used'' mean for purposes of 
the section 168(j)(3)(D) exception to the tax-exempt use property rules?
    A-8. ``Predominantly used'' means that for more than 50 percent of 
the time used, as determined for each taxable year, the real or personal 
property is used in an unrelated trade or business the income of which 
is subject to tax under section 511 (determined without regard to the 
debt-financed income rules of section 514). If only a portion of 
property is predominantly used in an unrelated trade or business, the 
remainder may nevertheless be tax-exempt use property.
    Q-9. How is the ``predominantly used'' test of section 168(j)(3)(D) 
to be applied to a building?
    A-9. The ``predominantly used'' test is to be applied to a building 
in the following manner:
    (i) Identify the discrete portions (excluding common areas) of the 
building which are leased to a tax-exempt entity in a disqualified lease 
under section 168(j)(3)(B)(ii). A discrete portion of a building is an 
area physically separated from other areas. An area is physically 
separated from other areas if separated by permanent walls or by 
partitions serving as room dividers if such partitions remain in place 
throughout the taxable year. A discrete portion can be the entire 
building, floors, wings, offices, rooms, or a combination thereof. For 
example, a building whose entire internal space consists of a single 
large room used as a gymnasium has only one discrete portion. On the 
other hand, if the building has 3 stories with 10 offices on each floor, 
each of the 30 offices is a discrete portion.
    (ii) Determine whether each discrete portion is predominantly used 
in an unrelated trade or business subject to tax under section 511. See 
A-8 for the rules regarding how to make this determination.
    (iii) Once the discrete portions of the building that constitute 
tax-exempt use property have been identified, an appropriate allocation 
of basis must be made to such discrete portions. See A-4 for rules 
regarding how to make such allocation.
    (iv) The application of these rules is illustrated by the following 
example:

    Example. A building, constructed in 1985, is leased in its entirety 
to a tax-exempt entity (E) pursuant to a 25-year lease. The building has 
25,000 square feet of net rentable floor space and consists of an 
auditorium (15,000 square feet), a retail shop (10,000 square feet), 
plus common area of 5,000 square feet. E uses the auditorium 80 percent 
of the time in its exempt activity and 20 percent of the time in an 
unrelated trade or business subject to tax under section 511. The retail 
shop is used 90 percent of the time in an unrelated trade or business 
subject to tax under section 511 and 10 percent of the time in an exempt 
activity. Thus, the auditorium is tax-exempt use property; the retail 
shop is not. An appropriate allocation of basis to the auditorium must 
be made. See A-4.

                     Definition of Tax-Exempt Entity

    Q-10. What elections must be made in order to avoid the ``5-year 
lookback'' rule of section 168(j)(4)(E)(i)?
    A-10. Only organizations which were exempt from tax under section 
501(a) as organizations described in section 501(c)(12) (and which are 
no longer tax-exempt) may avoid the 5-year lookback rule of section 
168(j)(4)(E)(i). In order to avoid the 5-year lookback rule with

[[Page 1094]]

respect to any property, two elections are required. First, the 
organization must elect not to be exempt from tax under section 501(a) 
during the tax-exempt use period (as defined in section 
168(j)(4)(E)(ii)(II)) with respect to the property. Second, the 
organization must elect to be taxed on the exempt arbitrage profits as 
provided in section 31(g)(16) of the Tax Reform Act of 1984. See Temp. 
Treas. Reg. Sec. 301.9100-6T(a) for the time and manner of making these 
elections. These elections, once made, are irrevocable.
    Q-11. Does the term ``tax-exempt entity'' include tax-exempt plans 
of deferred compensation and similar arrangements?
    A-11. Yes. For purposes of section 168 (j), the term ``tax-exempt 
entity'' includes trusts or other entities that are tax-qualified under 
section 401 (a), individual retirement accounts, simplified employee 
pensions, and other tax-exempt arrangements described in subchapter D of 
chapter 1 of the Internal Revenue Code.

               Special Rules for High Technology Equipment

    Q-12. What effect do the tax-exempt entity leasing provisions have 
on ``qualified technological equipment''?
    A-12. ``Qualified technological equipment'' which is leased to a 
tax-exempt entity for a term of 5 years or less shall not constitute 
tax-exempt use property. If ``qualified technological equipment'' which 
is leased to a tax-exempt entity for a term of more than 5 years 
constitutes tax-exempt use property (as defined in section 168(j)(3)) 
and is not used predominantly outside the United States, the rules of 
section 168(j) (1) and (2) apply except that the recovery period to be 
used for such equipment shall be 5 years regardless of the length of the 
lease term. For purposes of section 168(j)(5), ``qualified technological 
equipment'' means (1) any computer or peripheral equipment, (2) any high 
technology telephone station equipment installed on the customer's 
premises, and (3) any high technology medical equipment. For definitions 
of these terms, see A-13 through A-16.
    Q-13. What is a ``computer'' as that term is used in section 
168(j)(5)(C)(i)(I)?
    A-13. Computers are electronically activated devices that are 
programmable by the user and that are capable of accepting information, 
applying prescribed processes to it, and supplying the results of those 
processes with or without human intervention. Computers consist of a 
central processing unit containing extensive storage, logic, arithmetic, 
and control capabilities. A computer does not include any equipment 
which is an integral part of property that is not a user-programmable 
device, any video games or other devices used by the user primarily for 
amusement or entertainment purposes, or any typewriters, calculators, 
adding or accounting machines, copiers, duplicating equipment, or 
similar equipment. A computer does not include any equipment that is not 
tangible personal property.
    Q-14. What is ``peripheral equipment'' as that term is used in 
section 168(j)(5)(C)(i)(I)?
    A-14. Peripheral equipment means tangible personal property such as 
auxiliary machines, whether on-line or off-line, that are designed to be 
placed under the control of the central processing unit of the computer. 
Some examples of peripheral equipment are: card readers, card punches, 
magnetic tape feeds, high speed printers, optical character readers, 
tape cassettes, mass storage units, paper tape equipment, keypunches, 
data entry devices, teleprinters, terminals, tape drives, disc drives, 
disc files, disc packs, visual image projector tubes, card sorters, 
plotters, and collators. Peripheral equipment does not include equipment 
not included in Asset Depreciation Range (ADR) 00.12 listed in section 3 
of Rev. Proc. 83-35, 1983-1 C.B. 745, 746. Peripheral equipment also 
does not include any equipment that is an integral part of property that 
is not a user-programmable device, any video games or other devices used 
by the user primarily for amusement or entertainment purposes, or any 
typewriters, calculators, adding or accounting machines, copiers, 
duplicating equipment, or similar equipment.
    Q-15. What does ``high technology telephone station equipment'' mean 
as that term is used in section 168(j)(5)(C)(i)(II)?

[[Page 1095]]

    A-15. High technology telephone station equipment includes only 
tangible personal property described in asset depreciation range (ADR) 
class 48.13 listed in section 3 of Rev. Proc. 83-35, 1983-1 C.B. 745, 
758 that has a high technology content and which, because of such high 
technology content, can reasonably be expected to become obsolete before 
the expiration of its physical useful life. For example, telephone 
booths and telephones which include only a standard dialing feature are 
not high technology equipment. However, telephones with features such as 
an abbreviated dialing short program, an automatic callback, or 
conference call feature may qualify as high technology equipment. High 
technology telephone station equipment may include terminal equipment 
including such extra features but not terminal equipment used in 
conjunction with features offered through central office capacity. There 
are no current plans to utilize the regulatory authority provided in 
section 168(j)(5)(C)(iv).
    Q-16. What is ``high technology medical equipment'' as that term is 
used in section 168 (j)(5)(C)(i)(III)?
    A-16. High technology medical equipment is any electronic, 
electromechanical, or computer-based high technology equipment which is 
tangible personal property used in the screening, monitoring, 
observation, diagnosis, or treatment of human patients in a laboratory, 
medical, or hospital environment. High technology medical equipment 
includes only equipment that has a high technology content and which, 
because of such high technology content, can reasonably be expected to 
become obsolete before the expiration of its physical useful life. High 
technology medical equipment may include computer axial tomography 
(C.A.T.) scanners, nuclear magnetic resonance equipment, clinical 
chemistry analyzers, drug monitors, diagnostic ultrasound scanners, 
nuclear cameras, radiographic and fluoroscopic systems, Holter monitors, 
and bedside monitors. Incidental use of any such equipment for othe 
purposes, such as research, will not prevent it from qualifying as high 
technology medical equipment. There are no current plans to utilize the 
regulatory authority provided in section 168(j)(5)(C)(iv).

                               Lease Term

    Q-17. What is included in determining the length of a lease term?
    A-17. (i) The lease term starts when the property is first made 
available to the lessee under the lease. The lease term includes not 
only the stated duration, but also any additional period of time which 
is within the ``realistic contemplation of the parties at the time the 
property is first put into service. Hokanson v. Commissioner, 730 F.2d 
1245, 1248 (9th Cir. 1984). A subsequent period of time is included in 
the term of the original lease if the circumstances indicate that the 
parties, upon entering into the original lease, had informally agreed 
that there would be an extension of the original lease.
    (ii) With respect to personal property, the lease term includes all 
periods for which the tax-exempt lessee or a related party (as defined 
under section 168(j)(7)) has a legally enforceable option to renew the 
lease, or the lessor has a legally enforceable option to compel its 
renewal by the tax-exempt entity or a related party. This is true 
regardless of the renewal terms of the lease agreement or whether the 
lease is in fact renewed.
    (iii) With respect to real property, the lease term includes all 
periods for which the tax-exempt lessee or a related party (as defined 
under section 168(j)(7)) has a legally enforceable option to renew the 
lease, or the lessor has a legally enforceable option to compel its 
renewal by the tax-exempt entity or a related party, unless the option 
to renew is at fair market value, determined at the time of renewal. The 
Hokanson facts and circumstances test (see (i) above) may cause the term 
of a fair market value renewal option to be treated as part of the 
original lease term.
    (iv) Successive leases that are part of the same transaction or a 
series of related transactions concerning the same or substantially 
similar property shall be treated as one lease. This rule applies if at 
substantially the same time or as part of one arrangement the parties 
enter into multiple leases covering

[[Page 1096]]

the same or substantially similar property, each having a different 
term. If so, then the original lease term will be treated as running 
through the term of the lease that has the last expiration date of the 
multiple leases. The multiple lease rule will not apply merely because 
the parties enter into a new lease at fair market rental value at the 
end of the original lease term.
    (v) The application of the above rules is illustrated by the 
following examples:

    Example (1). On December 30, 1984, X, a taxable corporation, and Y, 
a tax-exempt entity, enter into a requirements contract for a period of 
3 years. The requirements contract sets the terms and conditions under 
which X and Y will do business on those occasions when X actually leases 
items of personal property to Y. The requirements contract imposes no 
obligation on either party to actually enter into a lease agreement. 
Pursuant to this requirements contract, on January 1, 1985, X and Y 
enter into three separate leases. Under the leases, Y obtained the use 
of three identical items of personal property, each for a term of six 
months beginning on January 1, 1985. On March 1, 1985, Y entered into a 
fourth lease for the use of a fourth item of personal property 
substantially similar to the other three items for a term of 20 months 
beginning on that date. The mere fact that all 4 leases were entered 
into pursuant to the same requirements contract and involved the same or 
substantially similar property does not require aggregation of the terms 
of such leases under section 168(j)(6)(B).
    Example (2). Assume the same facts as in example (1) except that, 
instead of the 4 leases entered into in example (1), on January 1, 1985, 
pursuant to the requirements contract, X and Y enter into a lease for an 
item of personal property for one year. On January 10, 1986, after the 
end of the one-year lease term, X and Y enter into a second lease with 
respect to the same or substantially similar equipment. Assuming that 
the requirements contract itself is not a lease and assuming that the 
parties did not have any informal or implicit understanding (other than 
the general expectation of doing some business in the future) to enter 
into the second lease when the first lease was entered into, these two 
leases are not aggregated. The mere fact that the parties entered into 
two leases under the requirements contract does not result in the 
application of the section 168(j)(6)(B) rules for successive leases.
    Example (3). The facts are the same as in example (2) except that 
the parties did have an understanding, informal or otherwise, at the 
time of the first lease that they would enter into a second lease of the 
same personal property. The terms of the leases are aggregated.
    Example (4). The facts are the same as in example (2) except that, 
instead of the leases entered into in example (2), on January 1, 1985, X 
and Y enter into two separate leases, each for a term of one year. One 
lease is for the period beginning on January 1, 1985 and ending on 
December 31, 1985. The other lease is for the period beginning on 
January 1, 1986 and ending on December 31, 1986. Both leases involve the 
same or substantially similar personal property. Under the successive 
lease rule, the terms of both leases are aggregated for purposes of 
determining the term of either lease under section 168(j)(6)(B). This 
result occurs because the two leases were entered into as part of the 
same transaction, and they relate to the same or substantially similar 
personal property.

                         Service Contract Issues

    Q-18. How is the treatment of service contracts affected by the 
service contract rules set forth in section 7701(e)?
    A-18. If a contract which purports to be a service contract is 
treated as a lease under section 7701(e), such contract is to be treated 
as a lease for all purposes of Chapter 1 of the Internal Revenue Code 
(including, for example, section 168(j) and section 48(a) (4) and (5)).
    Q-19. Does a contract to provide heating, maintenance, etc. services 
in low-income housing come within the low-income housing exception in 
section 7701(e)(5) to the service contract rules set forth in section 
7701(e)?
    A-19. No. Although certain low-income housing operated by or for an 
organization described in paragraphs (3) or (4) of section 501(c) is not 
subject to the service contract rules in section 7701(e), a contract, 
for instance, to provide heating services to low-income housing units, 
such as by installing and operating a furnace, does not constitute 
``low-income housing'' within the meaning of section 7701(e)(5). Thus, 
the rules of section 7701(e) apply to such contracts in determining 
whether they are properly treated as leases.

                           Partnership Issues

    Q-20. Do the provisions applicable to property leased to 
partnerships, set forth in section 168(j)(8), and the provisions 
applicable to property owned by

[[Page 1097]]

partnerships, set forth in section 168(j)(9), apply to pass-through 
entities other than partnerships?
    A-20. Yes. Rules similar to those provided in paragraphs (8), 
(9)(A), (9)(B), and (9)(C) of section 168(j) and those provided in Q & 
A's 21-26 apply to pass-through entities other than partnerships.
    Q-21. What rules apply to property owned by a partnership in which 
one or more partners is a tax-exempt entity?
    A-21. If property is owned by a partnership having both taxable and 
tax-exempt entities as partners, and any allocation to a tax-exempt 
entity partner is not a ``qualified allocation'' under section 
168(j)(9)(B), then such entity's proportionate share of the property is 
to be treated as tax-exempt use property for all purposes. However, the 
property will not be tax-exempt use property if it is predominantly used 
by the partnership in an activity which, with respect to the tax-exempt 
entity, is an unrelated trade or business. An activity is an unrelated 
trade or business with respect to a tax-exempt entity if such entity's 
distributive share of the partnership's gross income from the activity 
is includible in computing its unrelated business taxable income under 
section 512(c) (determined without regard to the debt-financed income 
rules of section 514). A tax-exempt entity partner's proportionate share 
of property of a partnership equals such partner's share of that item of 
the partnership's income or gain (excluding income or gain allocated 
under section 704(c)) in which the tax-exempt entity has the highest 
share. If the tax-exempt entity partner's share of any item of income or 
gain (excluding income or gain allocated under section 704(c)) may vary 
during the period it is a partner, the previous sentence shall be 
applied with reference to the highest share of any such item that it may 
receive at any time during such period. The application of these rules 
is illustrated by the following example:

    Example. A partnership (P) operates a factory, which consists of a 
building and various items of machinery. P has one tax-exempt entity (E) 
as a partner, and E's proportionate share is 10 percent (i.e., 10 
percent is the largest share of any item of income or gain that E may 
receive during the time E is a partner). Unless P's allocations to E are 
qualified under section 168(j)(9)(B), 10 percent of each item of 
partnership property (including the building) is tax-exempt use 
property, notwithstanding the 35 percent threshold test of section 
168(j)(3)(B)(iii) that is otherwise applicable to 18-year real property. 
However, the property will not be tax-exempt use property if it is 
predominantly used by the partnership in an activity which, with respect 
to E, is an unrelated trade or business (determined without regard to 
the debt-financed income rules of section 514).

    Q-22. What consititutes a ``qualified allocation'' under section 
168(j)(9)(B)?
    A-22. (i) A ``qualified allocation'' means any allocation to a tax-
exempt entity which is consistent with such entity's being allocated the 
same share (i.e., the identical percentage) of each and every item of 
partnership income, gain, loss, deduction, credit, and basis during the 
entire period such entity is a partner. Except as provided in A-23, an 
allocation is not qualified if it does not have substantial economic 
effect under section 704(b). However, for purposes of the two preceding 
sentences, items allocated under section 704(c) (relating to contributed 
property) are not taken into account. An allocation is not a ``qualified 
allocation'' under section 168(j)(9)(B) if the partnership agreement 
provides for, or the partners have otherwise formally or informally 
agreed to, any change (regardless of whether such change is contingent 
upon the happening of one or more events) in the tax-exempt entity's 
distributive share of income, gain, loss, deduction, credit, or basis at 
any time during the entire period the tax-exempt entity is a partner.
    (ii) A change in a tax-exempt entity's distributive share of income, 
gain, loss, deduction, credit, or basis which occurs as a result of a 
sale or redemption of a partnership interest (or portion thereof) or a 
contribution of cash or property to the partnership shall be disregarded 
in determining whether the partnership allocations are qualified, 
provided that such transaction is based on fair market value at the time 
of the transaction and that the allocations are qualified after the 
change. For this purpose, the consideration determined by the parties 
dealing at arm's length and with adverse interests normally will be 
deemed to satisfy the fair market value requirement. In addition, a

[[Page 1098]]

change in a tax-exempt entity's distributive share which occurs as a 
result of a partner's default (other than a prearranged default) under 
the terms of the partnership agreement will be disregarded, provided 
that the allocations are qualified after the change, and that the change 
does not have the effect of avoiding the restrictions of section 
168(j)(9). Any of the above-described transactions between existing 
partners (and parties related to them) will be closely scrutinized.

    Example (1). A, a taxable entity, and B, a tax-exempt entity, form a 
partnership in 1985. A contributes $800,000 to the partnership; B 
contributes $200,000. The partnership agreement allocates 95 percent of 
each item of income, gain, loss, deduction, credit, and basis to A; B's 
share of each of these items is 5 percent. Liquidation proceeds are, 
throughout the term of the partnership, to be distributed in accordance 
with the partner's capital account balances, and any partner with a 
deficit in his capital account following the distribution of liquidation 
proceeds is required to restore the amount of such deficit to the 
partnership. Assuming that these allocations have substantial economic 
effect within the meaning of section 704(b)(2), they are qualified 
because B's distributive share of each item of income, gain, loss, 
deduction, credit, and basis will remain the same during the entire 
period that B is a partner. The fact that the liquidation proceeds may 
be distributed in a ratio other than 95 percent/5 percent does not cause 
the allocations not to be qualified.
    Example (2). A, B, and E are members of a partnership formed on July 
1, 1984. On that date the partnership places in service a building and 
section 1245 class property. A and B are taxable entities; E is a tax-
exempt entity. The partnership agreement provides that during the first 
5 years of the partnership, A and B are each allocated 40 percent of 
each item of income, gain, loss, deduction, credit, and basis; E is 
allocated 20 percent. Thereafter, A, B, and E are each allocated 33\1/3\ 
percent of each item of income, gain, loss, deduction, credit, and 
basis. Assume that these allocations meet the substantial economic 
effect test of section 704(b)(2) and E's distributive share of the 
partnership's income is not unrelated trade or business income subject 
to tax under section 511. The allocations to E are not qualified 
allocations under section 168(j)(9)(B) because E's distributive share of 
partnership items does not remain the same during the entire period that 
E is a partner in the partnership. Thus, 33\1/3\ percent of the building 
and 33\1/3\ percent of the section 1245 class property are tax-exempt 
use property from the time each is placed in service by the partnership 
and are thus subject to the cost recovery rules of section 168(j) (1) 
and (2). In addition, no investment tax credit is allowed for 33\1/3\ 
percent of the section 1245 class property because of section 48(a)(4).

    Q-23. In determining whether allocations constitute qualified 
allocations, what rules are applied to test allocations that are not 
governed by the substantial economic effect rules?
    A-23. A-22 provides the general rules to be used in determining 
whether an allocation is a qualified allocation, including the rule that 
the allocation must have substantial economic effect. However, certain 
allocations are not governed by the substantial economic effect rules 
(e.g., an allocation of basis of an oil and gas property is generally 
governed by section 613A(c)(7)(D), rather than section 704(b)), and 
other allocations cannot satisfy the substantial economic effect rules 
(e.g., allocations of credits, allocations of deduction and loss 
attributable to nonrecourse debt, and allocations of percentage 
depletion in excess of basis). Since allocations in either of these 
categories cannot be tested under the substantial economic effect test, 
these allocations, in order to be qualified, must comply with the 
relevant Code or regulation section that governs the particular 
allocation (e.g., in the case of an allocation of basis of an oil and 
gas property, section 613A(c)(7)(D)).
    Q-24. Will the Internal Revenue Service issue letter rulings on the 
issue of whether an allocation is a ``qualified allocation'' for 
purposes of section 168(j)(9)?
    A-24. The Internal Revenue Service will accept requests for rulings 
on the question of whether an allocation is a ``qualified allocation'' 
for purposes of section 168(j)(9). Such requests should be submitted in 
accordance with the appropriate revenue procedure. One requirement of a 
qualified allocation is that such allocation must have substantial 
economic effect under section 704(b)(2). Currently, the Service will not 
rule on the question of whether an allocation has substantial economic 
effect under section 704(b)(2). Therefore, unless and until this policy 
is changed, a ruling request regarding a qualified

[[Page 1099]]

allocation must contain a representation that the subject allocation has 
substantial economic effect (or complies with A-23, if applicable).
    Q-25. Do priority cash distributions which constitute guaranteed 
payments under section 707(c) disqualify an otherwise qualified 
allocation?
    A-25. Priority cash distributions to partners which constitute 
guaranteed payments will not disqualify an otherwise qualified 
allocation if the priority cash distributions are reasonable in amount 
(e.g., equal to the Federal short-term rate described in section 
1274(d)) and are made in equal priorities to all partners in proportion 
to their capital in the partnership. Other guaranteed payments will be 
closely scrutinized and, in appropriate cases, will disqualify an 
otherwise qualified allocation.

    Example. A and B form Partnership AB to operate a manufacturing 
business. A is a tax-exempt entity; B is a taxable person. A contributes 
$500,000 to the partnership; B contributes $100,000. The partnership 
agreement provides that A and B are each entitled to cash distributions 
each year, in equal priority, in an amount equal to 8 percent of their 
capital contribution. Assume that these payments are reasonable in 
amount and constitute guaranteed payments under section 707(c). Without 
taking into consideration the guaranteed payments, all allocations 
constitute qualified allocations under section 168(j)(9)(B) and A-22. 
These guaranteed payments will not disqualify such allocations.

    Q-26. Can property be treated as tax-exempt use property under both 
the general rule of section 168(j)(3) and the partnership provisions of 
section 168(j)(9)?
    A-26. Yes. For example, a tax-exempt entity may be a partner in a 
partnership that owns a building 60 percent of which is tax-exempt use 
property because it is leased to an unrelated tax-exempt entity under a 
25-year lease. The status of the remaining 40 percent depends on whether 
or not allocations under the partnership agreement are qualified under 
section 168(j)(9). If the allocations are not qualified under section 
168(j)(9), the tax-exempt entity's proportionate share (as determined 
under section 168(j)(9)(C)) of the remaining 40 percent will be tax-
exempt use property. For example, if the tax-exempt entity's 
proportionate share is 30 percent, then 12 percent of the remaining 40 
percent (i.e., .30 times .40) is tax-exempt use property and a total of 
72 percent of the property (60 percent +12 percent) is tax-exempt use 
property.

                        Effective Date Questions

    Q-27. Does an amendment to a lease (or sublease) to a tax-exempt 
entity of property which, pursuant to the effective date provisions of 
section 31(g) of TRA, is not subject to section 168(j) cause such 
property to be subject to the provisions of section 168(j)?
    A-27. An amendment to such a lease (or sublease) does not cause such 
property to be subject to the provisions of section 168(j) unless the 
amendment increases the term of the lease (or sublease). However, if the 
amendment increases the amount of property subject to the lease, the 
additional property must be tested independently under the effective 
date provisions of section 31(g) of TRA. See A-31 for special rules 
regarding improvements to property.

    Example. On May 1, 1983, X, a taxable entity, and E, a tax-exempt 
entity, enter into a lease whereby X will lease to E the top 4 floors of 
a ten-story building for a lease term of 25 years. In 1985, the lease is 
amended to provide that E will lease an additional floor for the balance 
of the lease term. At that time the annual rent due under the lease is 
increased. Pursuant to the provisions of section 31(g)(2)(A) of TRA, 
section 168(j) does not apply to the lease to E of the top 4 floors of 
the building. Assuming that no other provision of section 31(g) of TRA 
provides otherwise, the floor added to the lease in 1985 is subject to 
the provisions of section 168(j).

    Q-28. If property which is not subject to section 168(j) by virtue 
of the effective date provisions of section 31(g) of TRA is sold, 
subject to the lease to the tax-exempt entity, what are the 
consequences?
    A-28. Property to which section 168(j) does not apply by virtue of 
the effective date provisions set forth in section 31(g) (2), (3), and 
(4) of TRA will not become subject to section 168(j) merely by reason of 
a transfer of the property subject to the lease by the lessor (or a 
transfer of the contract to acquire, construct, reconstruct, or 
rehabilitate the property), so long as the lessee (or party obligated to 
lease) does not

[[Page 1100]]

change. For purposes of the preceding sentence, the term ``transfer'' 
includes the sale-leaseback by a taxable lessor of its interest in the 
property, subject to the underlying lease to the tax-exempt entity. 
However, if property is transferred to a partnership or other pass-
through entity after the effective date of section 168(j)(9) (see 
section 31(g) of TRA), such property is subject to the provisions of 
section 168(j)(9).
    Q-29. Can property which was leased to a tax-exempt entity after May 
23, 1983 and acquired by a partnership before October 22, 1983 be tax-
exempt use property?
    A-29. Yes. Because the property was leased to a tax-exempt entity 
after May 23, 1983, it may be tax-exempt use property under section 
168(j)(3) and section 31(g)(1) of TRA. However, if the partnership 
included a tax-exempt entity as a partner, section 168(j)(9) would be 
inapplicable under section 31(g)(3)(B) of TRA because the partnership 
acquired the property before October 22, 1983.
    Q-30. What is a binding contract for purposes of the transitional 
rules in section 31(g) of TRA?
    A-30. (i) A contract is binding only if it is enforceable under 
State law against the taxpayer or a predecessor and does not limit 
damages to a specified amount, as for example, by a liquidated damages 
provision. A contract that limits damages to an amount equal to at least 
5 percent of the total contract price will not be treated as limiting 
damages for this purpose. In determining whether a contract limits 
damages, the fact that there may be little or no damages because the 
contract price does not significantly differ from fair market value will 
not be taken into account. For example, if a taxpayer entered into an 
irrevocable contract to purchase an asset for $100 and the contract 
contained no provision for liquidated damages, the contract is 
considered binding notwithstanding the fact that the property had a fair 
market value of $99 and under local law the seller would only recover 
the difference in the event the purchaser failed to perform. If the 
contract provided for a refund of the purchase price in lieu of any 
damages allowable by law in the event of breach or cancellation, the 
contract is not considered binding.
    (ii) A contract is binding even if subject to a condition, so long 
as the condition is not within the control of either party or a 
predecessor in interest. A contract will not be treated as ceasing to be 
binding merely because the parties make insubstantial changes in its 
terms or because any term is to be determined by a standard beyond the 
control of either party. A contract which imposes significant 
obligations on the taxpayer (or a predecessor) will be treated as 
binding notwithstanding the fact that insubstantial terms remain to be 
negotiated by the parties to the contract.
    (iii) A binding contract to acquire a component part of a larger 
piece of property will not be treated as a binding contract to acquire 
the larger piece of property. For example, if a tax-exempt entity 
entered into a binding contract on May 1, 1983 to acquire a new aircraft 
engine, there would be a binding contract to acquire only the engine, 
not the entire aircraft.
    Q-31. If an improvement is made to a property that is 
``grandfathered'' (i.e., property that is not subject to section 168(j) 
because of the effective date provisions of section 31(g) of TRA), to 
what extent will such improvement be grandfathered?
    A-31. Section 31(g)(20)(B) provides that a ``substantial 
improvement'' to property is treated as a separate property for purposes 
of the effective date provisions of section 31(g) of TRA. As a result, a 
``substantial improvement'' will not be grandfathered unless such 
``substantial improvement'' is grandfathered under a provision other 
than section 31(g)(20)(B). A property that is grandfathered will not 
become subject to section 168(j) merely because an improvement is made 
to such property, regardless of whether the improvement is a 
``substantial improvement''. If an improvement other than a 
``substantial improvement'' is made to property (other than land) that 
is grandfathered, that improvement also will be grandfathered. The 
determination of whether new construction constitutes an improvement to 
property or the creation of a new separate property will be based on all 
facts and circumstances.

[[Page 1101]]

Furthermore, any improvement to land will be treated as a separate 
property.

    Example. On January 3, 1983, T, a taxable entity, entered into a 
lease of a parking lot to E, a tax-exempt entity. On January 1, 1985, T 
begins construction of a building for use by E on the site of the 
parking lot. The building is completed and placed in service in November 
1985. The building is treated as a separate property, and is thus 
subject to the provisions of section 168(j), unless the building is 
grandfathered under a provision other than section 31(g)(20)(B) of TRA.

    Q-32. What is ``significant official governmental action'' for 
purposes of the section 31(g)(4) transitional rule of TRA?
    A-32. (i) ``Significant official governmental action'' involves 
three separate requirements. First, the action must be an official 
action. Second, the action must be specific action with respect to a 
particular project. Third, the action must be taken by a governmental 
entity having authority to commit the tax-exempt entity to the project, 
to provide funds for it, or to approve the project under State or local 
law.
    (ii) The first requirement of official action means that the 
governing body must adopt a resolution or ordinance, or take similar 
official action, on or before November 1, 1983. The action qualifies 
only if it conforms with Federal, State, and local law (as applicable) 
and is a proper exercise of the powers of the governing body. Moreover, 
the action must not have been withdrawn. There must be satisfactory 
written evidence of the action that was in existence on or before 
November 1, 1983. Satisfactory written evidence includes a formal 
resolution or ordinance, minutes of meetings, and binding contracts with 
third parties pursuant to which third parties are to render services in 
furtherance of the project.
    (iii) The second requirement of specific action is directed at the 
substance of the action taken. The action must be a specific action with 
respect to a particular project in which the governing body indicates an 
intent to have the project (or the design work for it) proceed. This 
requires that a specific project have been formulated and that the 
significant official action be a step toward consummation of the 
project. If the action does not relate to a specific project or merely 
directs that a proposal or recommendation be formulated, it will not 
qualify. The following set of actions with respect to a particular 
project constitute specific action: the hiring of bond counsel or bond 
underwriters necessary to assist in the issuance and sale of bonds to 
finance a particular project or the adoption of an inducement resolution 
relating to bonds to be issued for such a project; applying for an Urban 
Development Action Grant on behalf of the project described in the 
application, receiving such a grant concerning the project, or the 
recommendation of a city planning authority to proceed with a project; 
the enactment of a State law authorizing the sale, lease, or 
construction of the property; the appropriation of funds for the 
property or authorization of a feasibility study or a development 
services contract with respect to it; the approval of financing 
arrangements by a regulatory agency; the enactment of a State law 
designed to provide funding for a project; the certification of a 
building as a historic structure by a State agency and the Department of 
the Interior; or the endorsement of the application for a certification 
of need with respect to a medical facility by a regulatory agency other 
than the agency empowered to issue such a certificate.
    (iv) The third requirement for significant official governmental 
action is that the action must be taken by a Federal, State, or local 
governing body having authority to commit the tax-exempt entity to the 
project, to provide funds for it, or to approve the project under 
applicable law.

If the chief executive or another representative of a governing body has 
such authority, action by such representative would satisfy the 
requirement of this (iv). A governing body may have the authority to 
commit the tax-exempt entity to a project notwithstanding the fact that 
the project cannot be consummated without other governmental action 
being taken. For example, a city council will be treated as having 
authority to commit a city to do a sale-leaseback of its city hall 
notwithstanding the fact that State law needs to be amended to permit 
such a transaction. Similarly, if a local

[[Page 1102]]

project cannot be completed without Federal approval, either legislative 
or administrative, the obtaining of such approval satisfies the 
requirements of this (iv).
    (v) Routine governmental action at a local level will not qualify as 
significant official governmental action. Routine governmental action 
includes the granting of building permits or zoning changes and the 
issuance of environmental impact statements.
    (vi) In order to qualify under the transitional rule of TRA section 
31(g)(4), a sale and leaseback pursuant to a binding contract entered 
into before January 1, 1985 must be part of the project as to which 
there was significant official governmental action. Except as provided 
in the following sentence, where there has been significant official 
governmental action on or before November 1, 1983 with respect to the 
construction, reconstruction or rehabilitation of a property, the sale 
and leaseback of such property pursuant to a binding contract entered 
into before January 1, 1985 will be treated as part of the project which 
was the subject of the significant official governmental action. 
However, if the construction, reconstruction or rehabilitation was 
substantially completed prior to January 1, 1983, the sale and leaseback 
of such property will be treated as a separate project, unless the sale 
and leaseback was contemplated at the time of the significant official 
governmental action. Nevertheless, where the sale and leaseback is 
treated as a separate project, section 31(g)(4) may apply if there was 
significant official governmental action on or before November 1, 1983, 
with respect to such sale and leaseback. The application of this 
provision is illustrated by the following example:

    Example. In the summer of 1927, the Board of Aldermen of City C 
passed a resolution authorizing the design and contruction of a new city 
hall and appropriated the funds necessary for such project. Construction 
was completed in 1928. At the time of the significant official 
governmental action, City C had no plan to enter into a sale-leaseback 
arrangement with respect to the facility. On December 15, 1984, City C 
entered into a binding sale-leaseback arrangement concerning the city 
hall. This transaction will not qualify for exclusion from section 
168(j) under the section 31(g)(4) of TRA since construction of the 
facility in question was substantially completed before January 1, 1983. 
If, however, there had been significant official governmental action on 
or before November 1, 1983 with respect to the sale-leaseback project, 
then the transitional rule of section 31(g)(4) of TRA would apply.

[T.D. 8033, 50 FR 27224, July 2, 1985, as amended by T.D. 8435, 57 FR 
43896, Sept. 23, 1992]



Sec. 1.168(k)-0T  Table of contents (temporary).

    This section lists the headings that appear in Sec. 1.168(k)-1T.

Sec. 1.168(k)-1T Additional first year depreciation deduction 
(temporary).
    (a) Scope and definitions.
    (1) Scope.
    (2) Definitions.
    (b) Qualified property or 50-percent bonus depreciation property.
    (1) In general.
    (2) Description of qualified property or 50-percent bonus 
depreciation property.
    (i) In general.
    (ii) Property not eligible for additional first year depreciation 
deduction.
    (A) Property that is not qualified property.
    (B) Property that is not 50-percent bonus depreciation property.
    (3) Original use.
    (i) In general.
    (ii) Conversion to business or income-producing use.
    (iii) Sale-leaseback and syndication transactions.
    (A) Sale-leaseback transaction.
    (B) Syndication transaction.
    (C) Sale-leaseback transaction followed by a syndication 
transaction.
    (iv) Fractional interests in property.
    (v) Examples.
    (4) Acquisition of property.
    (i) In general.
    (A) Qualified property.
    (B) 50-percent bonus depreciation property.
    (ii) Definition of binding contract.
    (A) In general.
    (B) Conditions.
    (C) Options.
    (D) Supply agreements.
    (E) Components.
    (iii) Self-constructed property.
    (A) In general.
    (B) When does construction begin.
    (C) Components of self-constructed property.
    (1) Acquired components.
    (2) Self-constructed components.
    (iv) Disqualified transactions.
    (A) In general.
    (B) Related party defined.
    (v) Examples.
    (5) Placed-in-service date.

[[Page 1103]]

    (i) In general.
    (ii) Sale-leaseback and syndication transactions.
    (A) Sale-leaseback transaction.
    (B) Syndication transaction.
    (C) Sale-leaseback transaction followed by a syndication 
transaction.
    (iii) Technical termination of a partnership.
    (iv) Section 168(i)(7) transactions.
    (c) Qualified leasehold improvement property.
    (1) In general.
    (2) Certain improvements not included.
    (3) Definitions.
    (d) Computation of depreciation deduction for qualified property or 
50-percent bonus depreciation property.
    (1) Additional first year depreciation deduction.
    (i) In general.
    (ii) Property having a longer production period.
    (iii) Alternative minimum tax.
    (2) Otherwise allowable depreciation deduction.
    (i) In general.
    (ii) Alternative minimum tax.
    (3) Examples.
    (e) Election not to deduct additional first year depreciation.
    (1) In general.
    (i) Qualified property.
    (ii) 50-percent bonus depreciation property.
    (2) Definition of class of property.
    (3) Time and manner for making election.
    (i) Time for making election.
    (ii) Manner of making election.
    (4) Special rules for 2000 or 2001 returns.
    (5) Failure to make election.
    (f) Special rules.
    (1) Property placed in service and disposed of in the same taxable 
year.
    (i) In general.
    (ii) Technical termination of a partnership.
    (iii) Section 168(i)(7) transactions.
    (iv) Examples.
    (2) Redetermination of basis.
    (i) Increase in basis.
    (ii) Decrease in basis.
    (iii) Definition.
    (iv) Examples.
    (3) Section 1245 and 1250 depreciation recapture.
    (4) Coordination with section 169.
    (5) Like-kind exchanges and involuntary conversions.
    (i) Scope.
    (ii) Definitions.
    (iii) Computation.
    (A) In general.
    (B) Year of disposition and year of replacement.
    (iv) Sale-leasebacks.
    (v) Examples.
    (6) Change in use.
    (i) Change in use of depreciable property.
    (ii) Conversion to personal use.
    (iii) Conversion to business or income-producing use.
    (A) During the same taxable year.
    (B) Subsequent to the acquisition year.
    (iv) Depreciable property changes use subsequent to the placed-in-
service year.
    (v) Examples.
    (7) Earnings and profits.
    (8) Limitation of amount of depreciation for certain passenger 
automobiles.
    (9) Section 754 election.
    (g) Effective date.
    (1) In general.
    (2) Technical termination of a partnership or section 168(i)(7) 
transactions.
    (3) Like-kind exchanges and involuntary conversions.
    (4) Change in method of accounting.
    (i) Special rules for 2000 or 2001 returns.
    (ii) Like-kind exchanges and involuntary conversions.

[T.D. 9091, 68 FR 52991, Sept. 8, 2003]



Sec. 1.168(k)-1T  Additional first year depreciation deduction 
(temporary).

    (a) Scope and definitions--(1) Scope. This section provides the 
rules for determining the 30-percent additional first year depreciation 
deduction allowable under section 168(k)(1) for qualified property and 
the 50-percent additional first year depreciation deduction allowable 
under section 168(k)(4) for 50-percent bonus depreciation property.
    (2) Definitions. For purposes of section 168(k) and this section, 
the following definitions apply:
    (i) Depreciable property is property that is of a character subject 
to the allowance for depreciation as determined under section 167 and 
the regulations thereunder.
    (ii) MACRS property is tangible, depreciable property that is placed 
in service after December 31, 1986 (or after July 31, 1986, if the 
taxpayer made an election under section 203(a)(1)(B) of the Tax Reform 
Act of 1986; 100 Stat. 2143) and subject to section 168, except for 
property excluded from the application of section 168 as a result of 
section 168(f) or as a result of a transitional rule.
    (iii) Unadjusted depreciable basis is the basis of property for 
purposes of section 1011 without regard to any adjustments described in 
section 1016(a)(2) and (3). This basis reflects the reduction in basis 
for the percentage of the

[[Page 1104]]

taxpayer's use of property for the taxable year other than in the 
taxpayer's trade or business (or for the production of income), for any 
portion of the basis the taxpayer properly elects to treat as an expense 
under section 179, and for any adjustments to basis provided by other 
provisions of the Internal Revenue Code and the regulations thereunder 
(other than section 1016(a)(2) and (3)) (for example, a reduction in 
basis by the amount of the disabled access credit pursuant to section 
44(d)(7)). For property subject to a lease, see section 167(c)(2).
    (iv) Adjusted depreciable basis is the unadjusted depreciable basis 
of the property, as defined in Sec. 1.168(k)-1T(a)(2)(iii), less the 
adjustments described in section 1016(a)(2) and (3).
    (b) Qualified property or 50-percent bonus depreciation property--
(1) In general. Qualified property or 50-percent bonus depreciation 
property is depreciable property that--
    (i) Meets the requirements in Sec. 1.168(k)-1T(b)(2) (description 
of property);
    (ii) Meets the requirements in Sec. 1.168(k)-1T(b)(3) (original 
use);
    (iii) Meets the requirements in Sec. 1.168(k)-1T(b)(4) (acquisition 
of property); and
    (iv) Meets the requirements in Sec. 1.168(k)-1T(b)(5) (placed-in-
service date).
    (2) Description of qualified property or 50-percent bonus 
depreciation property--(i) In general. Depreciable property will meet 
the requirements of this paragraph (b)(2) if the property is--
    (A) MACRS property (as defined in Sec. 1.168(k)-1T(a)(2)(ii)) that 
has a recovery period of 20 years or less. For purposes of this 
paragraph (b)(2)(i)(A) and section 168(k)(2)(B)(i)(II) and 168(k)(4)(C), 
the recovery period is determined in accordance with section 168(c) 
regardless of any election made by the taxpayer under section 168(g)(7);
    (B) Computer software as defined in, and depreciated under, section 
167(f)(1) and the regulations thereunder;
    (C) Water utility property as defined in section 168(e)(5) and 
depreciated under section 168; or
    (D) Qualified leasehold improvement property as defined in paragraph 
(c) of this section and depreciated under section 168.
    (ii) Property not eligible for additional first year depreciation 
deduction--(A) Property that is not qualified property. For purposes of 
the 30-percent additional first year depreciation deduction, depreciable 
property will not meet the requirements of this paragraph (b)(2) if the 
property is--
    (1) Described in section 168(f);
    (2) Required to be depreciated under the alternative depreciation 
system of section 168(g) pursuant to section 168(g)(1)(A) through (D) or 
other provisions of the Internal Revenue Code (for example, property 
described in section 263A(e)(2)(A) or section 280F(b)(1));
    (3) Included in any class of property for which the taxpayer elects 
not to deduct the 30-percent additional first year depreciation (for 
further guidance, see paragraph (e) of this section); or
    (4) Qualified New York Liberty Zone leasehold improvement property 
as defined in section 1400L(c)(2).
    (B) Property that is not 50-percent bonus depreciation property. For 
purposes of the 50-percent additional first year depreciation deduction, 
depreciable property will not meet the requirements of this paragraph 
(b)(2) if the property is--
    (1) Described in paragraph (b)(2)(ii)(A)(1), (2), or (4) of this 
section; or
    (2) Included in any class of property for which the taxpayer elects 
the 30-percent, instead of the 50-percent, additional first year 
depreciation deduction or elects not to deduct any additional first year 
depreciation (for further guidance, see paragraph (e) of this section).
    (3) Original use--(i) In general. For purposes of the 30-percent 
additional first year depreciation deduction, depreciable property will 
meet the requirements of this paragraph (b)(3) if the original use of 
the property commences with the taxpayer after September 10, 2001. For 
purposes of the 50-percent additional first year depreciation deduction, 
depreciable property will meet the requirements of this paragraph (b)(3) 
if the original use of

[[Page 1105]]

the property commences with the taxpayer after May 5, 2003. Except as 
provided in paragraph (b)(3)(iii) and (iv) of this section, original use 
means the first use to which the property is put, whether or not that 
use corresponds to the use of the property by the taxpayer. Thus, 
additional capital expenditures incurred by a taxpayer to recondition or 
rebuild property acquired or owned by the taxpayer satisfies the 
original use requirement. However, the cost of reconditioned or rebuilt 
property acquired by the taxpayer does not satisfy the original use 
requirement. The question of whether property is reconditioned or 
rebuilt property is a question of fact. For purposes of this paragraph 
(b)(3)(i), property that contains used parts will not be treated as 
reconditioned or rebuilt if the cost of the used parts is not more than 
20 percent of the total cost of the property.
    (ii) Conversion to business or income-producing use. If a taxpayer 
initially acquires new property for personal use and subsequently uses 
the property in the taxpayer's trade or business or for the taxpayer's 
production of income, the taxpayer is considered as the original user of 
the property. If a person initially acquires new property for personal 
use and a taxpayer subsequently acquires the property from the person 
for use in the taxpayer's trade or business or for the taxpayer's 
production of income, the taxpayer is not considered the original user 
of the property.
    (iii) Sale-leaseback and syndication transactions--(A) Sale-
leaseback transaction. If new property is originally placed in service 
by a person after September 10, 2001 (for qualified property), or after 
May 5, 2003 (for 50-percent bonus depreciation property), and is sold to 
a taxpayer and leased back to the person by the taxpayer within three 
months after the date the property was originally placed in service by 
the person, the taxpayer-lessor is considered the original user of the 
property.
    (B) Syndication transaction. If new property is originally placed in 
service by a lessor (including by operation of paragraph (b)(5)(ii)(A) 
of this section) after September 10, 2001 (for qualified property), or 
after May 5, 2003 (for 50-percent bonus depreciation property), and is 
sold by the lessor or any subsequent purchaser within three months after 
the date the property was originally placed in service by the lessor, 
and the user of the property after the last sale during the three-month 
period remains the same as when the property was originally placed in 
service by the lessor, the purchaser of the property in the last sale 
during the three-month period is considered the original user of the 
property.
    (C) Sale-leaseback transaction followed by a syndication 
transaction. If a sale-leaseback transaction that satisfies the 
requirements in paragraph (b)(3)(iii)(A) of this section is followed by 
a syndication transaction that satisfies the requirements in paragraph 
(b)(3)(iii)(B) of this section, the original user of the property is 
determined in accordance with paragraph (b)(3)(iii)(B) of this section.
    (iv) Fractional interests in property. If, in the ordinary course of 
its business, a taxpayer sells fractional interests in property to 
unrelated third parties, each first fractional owner of the property is 
considered as the original user of its proportionate share of the 
property. Furthermore, if the taxpayer uses the property before all of 
the fractional interests of the property are sold but the property 
continues to be held primarily for sale by the taxpayer, the original 
use of any fractional interest sold to an unrelated third party 
subsequent to the taxpayer's use of the property begins with the first 
purchaser of that fractional interest. For purposes of this paragraph 
(b)(3)(iv), persons are not related if they do not have a relationship 
described in section 267(b) or 707(b) and the regulations thereunder.
    (v) Examples. The application of this paragraph (b)(3) is 
illustrated by the following examples:

    Example 1. On August 1, 2002, A buys from B for $20,000 a machine 
that has been previously used by B in B's trade or business. On March 1, 
2003, A makes a $5,000 capital expenditure to recondition the machine. 
The $20,000 purchase price does not qualify for the additional first 
year depreciation deduction because the original use requirement of this 
paragraph (b)(3) is not met. However, the $5,000 expenditure satisfies 
the original use requirement of this paragraph (b)(3) and, assuming all 
other requirements are met, qualifies for the 30-percent additional 
first

[[Page 1106]]

year depreciation deduction, regardless of whether the $5,000 is added 
to the basis of the machine or is capitalized as a separate asset.
    Example 2. C, an automobile dealer, uses some of its automobiles as 
demonstrators in order to show them to prospective customers. The 
automobiles that are used as demonstrators by C are held by C primarily 
for sale to customers in the ordinary course of its business. On 
September 1, 2002, D buys from C an automobile that was previously used 
as a demonstrator by C. D will use the automobile solely for business 
purposes. The use of the automobile by C as a demonstrator does not 
constitute a ``use'' for purposes of the original use requirement and, 
therefore, D will be considered the original user of the automobile for 
purposes of this paragraph (b)(3). Assuming all other requirements are 
met, D's purchase price of the automobile qualifies for the 30-percent 
additional first year depreciation deduction for D, subject to any 
limitation under section 280F.
    Example 3. On April 1, 2000, E acquires a horse to be used in E's 
thoroughbred racing business. On October 1, 2003, F buys the horse from 
E and will use the horse in F's horse breeding business. The use of the 
horse by E in its racing business prevents the original use of the horse 
from commencing with F. Thus, F's purchase price of the horse does not 
qualify for the additional first year depreciation deduction.
    Example 4. In the ordinary course of its business, G sells 
fractional interests in its aircraft to unrelated parties. G holds out 
for sale eight equal fractional interests in an aircraft. On January 1, 
2003, G sells five of the eight fractional interests in the aircraft to 
H, an unrelated party, and H begins to use its proportionate share of 
the aircraft immediately upon purchase. On June 1, 2003, G sells to I, 
an unrelated party to G and H, the remaining unsold 3/8 fractional 
interests in the aircraft. H is considered the original user as to its 
5/8 fractional interest in the aircraft and I is considered the original 
user as to its 3/8 fractional interest in the aircraft. Thus, assuming 
all other requirements are met, H's purchase price for its 5/8 
fractional interest in the aircraft qualifies for the 30-percent 
additional first year depreciation deduction and I's purchase price for 
its 3/8 fractional interest in the aircraft qualifies for the 50-percent 
additional first year depreciation deduction.

    (4) Acquisition of property--(i) In general--(A) Qualified property. 
For purposes of the 30-percent additional first year depreciation 
deduction, depreciable property will meet the requirements of this 
paragraph (b)(4) if the property is--
    (1) Acquired by the taxpayer after September 10, 2001, and before 
January 1, 2005, but only if no written binding contract for the 
acquisition of the property was in effect before September 11, 2001; or
    (2) Acquired by the taxpayer pursuant to a written binding contract 
that was entered into after September 10, 2001, and before January 1, 
2005.
    (B) 50-percent bonus depreciation property. For purposes of the 50-
percent additional first year depreciation deduction, depreciable 
property will meet the requirements of this paragraph (b)(4) if the 
property is acquired by the taxpayer after May 5, 2003, and before 
January 1, 2005, but only if no written binding contract for the 
acquisition of the property was in effect before May 6, 2003.
    (ii) Definition of binding contract--(A) In general. A contract is 
binding only if it is enforceable under State law against the taxpayer 
or a predecessor, and does not limit damages to a specified amount (for 
example, by use of a liquidated damages provision). For this purpose, a 
contractual provision that limits damages to an amount equal to at least 
5 percent of the total contract price will not be treated as limiting 
damages to a specified amount. In determining whether a contract limits 
damages, the fact that there may be little or no damages because the 
contract price does not significantly differ from fair market value will 
not be taken into account. For example, if a taxpayer entered into an 
irrevocable written contract to purchase an asset for $100 and the 
contract contained no provision for liquidated damages, the contract is 
considered binding notwithstanding the fact that the asset had a fair 
market value of $99 and under local law the seller would only recover 
the difference in the event the purchaser failed to perform. If the 
contract provided for a full refund of the purchase price in lieu of any 
damages allowable by law in the event of breach or cancellation by the 
seller, the contract is not considered binding.
    (B) Conditions. A contract is binding even if subject to a 
condition, as long as the condition is not within the control of either 
party or a predecessor. A contract will continue to be binding if

[[Page 1107]]

the parties make insubstantial changes in its terms and conditions or 
because any term is to be determined by a standard beyond the control of 
either party. A contract that imposes significant obligations on the 
taxpayer or a predecessor will be treated as binding notwithstanding the 
fact that insubstantial terms remain to be negotiated by the parties to 
the contract.
    (C) Options. An option to either acquire or sell property is not a 
binding contract.
    (D) Supply agreements. A binding contract does not include a supply 
or similar agreement if the amount and design specifications of the 
property to be purchased have not been specified. The contract will not 
be a binding contract for the property to be purchased until both the 
amount and the design specifications are specified. For example, if the 
provisions of a supply or similar agreement state the design 
specifications of, and the pricing for, the property to be purchased, a 
purchase order under the agreement for a specific number of assets is 
treated as a binding contract.
    (E) Components. A binding contract to acquire one or more components 
of a larger property will not be treated as a binding contract to 
acquire the larger property. If a binding contract to acquire the 
component does not satisfy the requirements of this paragraph (b)(4), 
the component does not qualify for the 30-percent or 50-percent 
additional first year depreciation deduction, as applicable.
    (iii) Self-constructed property--(A) In general. If a taxpayer 
manufactures, constructs, or produces property for use by the taxpayer 
in its trade or business (or for its production of income), the 
acquisition rules in paragraph (b)(4)(i) of this section are treated as 
met for qualified property if the taxpayer begins manufacturing, 
constructing, or producing the property after September 10, 2001, and 
before January 1, 2005, and for 50-percent bonus depreciation property 
if the taxpayer begins manufacturing, constructing, or producing the 
property after May 5, 2003, and before January 1, 2005. Property that is 
manufactured, constructed, or produced for the taxpayer by another 
person under a written binding contract (as defined in paragraph 
(b)(4)(ii) of this section) that is entered into prior to the 
manufacture, construction, or production of the property for use by the 
taxpayer in its trade or business (or for its production of income) is 
considered to be manufactured, constructed, or produced by the taxpayer.
    (B) When does construction begin. For purposes of paragraph 
(b)(4)(iii) of this section, construction of property begins when 
physical work of a significant nature begins. Physical work does not 
include preliminary activities such as planning or designing, securing 
financing, exploring, or researching. The determination of when physical 
work of a significant nature begins depends on the facts and 
circumstances. For purposes of this paragraph (b)(4)(iii)(B), physical 
work of a significant nature will not be considered to begin before the 
taxpayer incurs (in the case of an accrual basis taxpayer) or pays (in 
the case of a cash basis taxpayer) more than 10 percent of the total 
cost of the property (excluding the cost of any land and preliminary 
activities such as planning or designing, securing financing, exploring, 
or researching). For example, if a retail motor fuels outlet is to be 
constructed on-site, construction begins when physical work of a 
significant nature commences at the site; that is, when work begins on 
the excavation for footings, pouring the pads for the outlet, or the 
driving of foundation pilings into the ground. Preliminary work, such as 
clearing a site, test drilling to determine soil condition, or excation 
to change the contour of the land (as distinguished from excavation for 
footings) does not constitute the beginning of construction. However, if 
a retail motor fuels outlet is to be assembled on-site from modular 
units constructed off-site and delivered to the site where the outlet 
will be used, construction begings when physical work of a significant 
nature commences at the off-site location.
    (C) Components of self-constructed property--(1) Acquired 
components. If a binding contract (as defined in paragraph (b)(4)(ii) of 
this section) to acquire a component does not satisfy the requirements 
of paragraph (b)(4)(i) of this section, the component does not

[[Page 1108]]

qualify for the 30-percent or 50-percent additional first year 
depreciation deduction, as applicable. A binding contract (as defined in 
paragraph (b)(4)(ii) of this section) to acquire one or more components 
of a larger self-constructed property will not preclude the larger self-
constructed property from satisfying the acquisition rules in paragraph 
(b)(4)(iii)(A) of this section. Accordingly, the unadjusted depreciable 
basis of the larger self-constructed property that is eligible for the 
30-percent or 50-percent additional first year depreciation deduction, 
as applicable (assuming all other requirements are met), must not 
include the unadjusted depreciable basis of any component that does not 
satisfy the requirements of paragraph (b)(4)(i) of this section. If the 
manufacture, construction, or production of the larger self-constructed 
property begins before September 11, 2001, for qualified property, or 
before May 6, 2003, for 50-percent bonus depreciation property, the 
larger self-constructed property and any acquired components related to 
the larger self-constructed property do not qualify for the 30-percent 
or 50-percent additional first year depreciation deduction, as 
applicable. If a binding contract to acquire the component is entered 
into after September 10, 2001, for qualified property, or after May 5, 
2003, for 50-percent bonus depreciation property, and before January 1, 
2005, but the manufacture, construction, or production of the larger 
self-constructed property does not begin before January 1, 2005, the 
component qualifies for the additional first year depreciation deduction 
(assuming all other requirements are met) but the larger self-
constructed property does not.
    (2) Self-constructed components. If the manufacture, construction, 
or production of a component does not satisfy the requirements of 
paragraph (b)(4)(iii)(A) of this section, the component does not qualify 
for the 30-percent or 50-percent additional first year depreciation 
deduction, as applicable. However, if the manufacture, construction, or 
production of a component does not satisfy the requirements of paragraph 
(b)(4)(iii)(A) of this section, but the manufacture, construction, or 
production of the larger self-constructed property satisfies the 
requirements of paragraph (b)(4)(iii)(A) of this section, the larger 
self-constructed property qualifies for the 30-percent or 50-percent 
additional first year depreciation deduction, as applicable (assuming 
all other requirements are met) even though the component does not 
qualify for the 30-percent or 50-percent additional first year 
depreciation deduction. Accordingly, the unadjusted depreciable basis of 
the larger self-constructed property that is eligible for the 30-percent 
or 50-percent additional first year depreciation deduction, as 
applicable (assuming all other requirements are met), must not include 
the unadjusted depreciable basis of any component that does not qualify 
for the 30-percent or 50-percent additional first year depreciation 
deduction. If the manufacture, construction, or production of the larger 
self-constructed property began before September 11, 2001, for qualified 
property, or before May 6, 2003, for 50-percent bonus depreciation 
property, the larger self-constructed property and any self-constructed 
components related to the larger self-constructed property do not 
qualify for the 30-percent or 50-percent additional first year 
depreciation deduction, as applicable. If the manufacture, construction, 
or production of a component begins after September 10, 2001, for 
qualified property, or after May 5, 2003, for 50-percent bonus 
depreciation property, and before January 1, 2005, but the manufacture, 
construction, or production of the larger self-constructed property does 
not begin before January 1, 2005, the component qualifies for the 
additional first year depreciation deduction (assuming all other 
requirements are met) but the larger self-constructed property does not.
    (iv) Disqualified transactions--(A) In general. Property does not 
satisfy the requirements of this paragraph (b)(4) if the user of the 
property as of the date on which the property was originally placed in 
service (including by operation of paragraph (b)(5)(ii), (iii), and (iv) 
of this section), or a related party to the user, acquired, or had a 
written binding contract (as defined in paragraph (b)(4)(ii) of this 
section) in effect for the acquisition of, the property at any time 
before September 11, 2001 (for

[[Page 1109]]

qualified property), or before May 6, 2003 (for 50-percent bonus 
depreciation property). In addition, property manufactured, constructed, 
or produced for the taxpayer or a related party does not satisfy the 
requirements of this paragraph (b)(4) if the manufacture, construction, 
or production of the property for the taxpayer or a related party began 
at any time before September 11, 2001 (for qualified property), or 
before May 6, 2003 (for 50-percent bonus depreciation property).
    (B) Related party defined. For purposes of this paragraph 
(b)(4)(iv), persons are related if they have a relationship specified in 
section 267(b) or 707(b) and the regulations thereunder.
    (v) Examples. The application of this paragraph (b)(4) is 
illustrated by the following examples:

    Example 1. On September 1, 2001, J, a corporation, entered into a 
written agreement with K, a manufacturer, to purchase 20 new lamps for 
$100 each within the next two years. Although the agreement specifies 
the number of lamps to be purchased, the agreement does not specify the 
design of the lamps to be purchased. Accordingly, the agreement is not a 
binding contract pursuant to paragraph (b)(4)(ii)(D) of this section.
    Example 2. Same facts as Example 1. On December 1, 2001, J placed a 
purchase order with K to purchase 20 new model XPC5 lamps for $100 each 
for a total amount of $2,000. Because the agreement specifies the number 
of lamps to be purchased and the purchase order specifies the design of 
the lamps to be purchased, the purchase order placed by J with K on 
December 1, 2001, is a binding contract pursuant to paragraph 
(b)(4)(ii)(D) of this section. Accordingly, the cost of the 20 lamps 
qualifies for the 30-percent additional first year depreciation 
deduction.
    Example 3. Same facts as Example 1 except that the written agreement 
between J and K is to purchase 100 model XPC5 lamps for $100 each within 
the next two years. Because this agreement specifies the amount and 
design of the lamps to be purchased, the agreement is a binding contract 
pursuant to paragraph (b)(4)(ii)(D) of this section. Accordingly, 
because the agreement was entered into before September 11, 2001, any 
lamp acquired by J under this contract does not qualify for the 
additional first year depreciation deduction.
    Example 4. On September 1, 2001, L began constructing an electric 
generation power plant for its own use. On November 1, 2002, L ceases 
construction of the power plant prior to its completion. Between 
September 1, 2001, and November 1, 2002, L incurred $3,000,000 for the 
construction of the power plant. On May 6, 2003, L resumed construction 
of the power plant and completed its construction on August 31, 2003. 
Between May 6, 2003, and August 31, 2003, L incurred another $1,600,000 
to complete the construction of the power plant and, on September 1, 
2003, L placed the power plant in service. None of L's total 
expenditures of $4,600,000 qualify for the additional first year 
depreciation deduction because, pursuant to paragraph (b)(4)(iii)(A) of 
this section, L began constructing the power plant before September 11, 
2001.
    Example 5. Same facts as Example 4 except that L began constructing 
the electric generation power plant for its own use on October 1, 2001. 
L's total expenditures of $4,600,000 qualify for the additional first 
year depreciation deduction because, pursuant to paragraph 
(b)(4)(iii)(A) of this section, L began constructing the power plant 
after September 10, 2001, and placed the power plant in service before 
January 1, 2005. Accordingly, the additional first year depreciation 
deduction for the power plant will be $1,380,000, computed as $4,600,000 
multiplied by 30 percent.
    Example 6. On August 1, 2001, M entered into a written binding 
contract to acquire a new turbine. The new turbine is a component part 
of a new electric generation power plant that is being constructed on 
M's behalf. The construction of the new electric generation power plant 
commenced in November 2001, and the new electric generation power plant 
was completed in November 2002. Because M entered into a written binding 
contract to acquire a component part (the new turbine) prior to 
September 11, 2001, pursuant to paragraph (b)(4)(iii)(C) of this 
section, the component part does not qualify for the additional first 
year depreciation deduction. However, pursuant to paragraphs 
(b)(4)(iii)(A) and (C) of this section, the new plant constructed for M 
will qualify for the 30-percent additional first year depreciation 
deduction because construction of the new plant began after September 
10, 2001, and before May 6, 2003. Accordingly, the unadjusted 
depreciable basis of the new plant that is eligible for the 30-percent 
additional first year depreciation deduction must not include the 
unadjusted depreciable basis of the new turbine.
    Example 7. Same facts as Example 6 except that M entered into the 
written binding contract to acquire the new turbine on September 30, 
2002, and construction of the new plant commenced on August 1, 2001. 
Because M began construction of the new plant prior to September 11, 
2001, pursuant to paragraphs (b)(4)(iii)(A) and (C) of this section, 
neither the new plant constructed for M nor the turbine will qualify for 
the additional first year depreciation deduction because self-
construction of the new plant began prior to September 11, 2001.

[[Page 1110]]

    Example 8. On September 1, 2001, N began constructing property for 
its own use. On October 1, 2001, N sold its rights to the property to O, 
a related party under section 267(b). Pursuant to paragraph (b)(4)(iv) 
of this section, the property is not eligible for the additional first 
year depreciation deduction because N and O are related parties and 
construction of the property by N began prior to September 11, 2001.
    Example 9. On September 1, 2001, P entered into a written binding 
contract to acquire property. On October 1, 2001, P sold its rights to 
the property to Q, a related party under section 267(b). Pursuant to 
paragraph (b)(4)(iv) of this section, the property is not eligible for 
the additional first year depreciation deduction because P and Q are 
related parties and a written binding contract for the acquisition of 
the property was in effect prior to September 11, 2001.
    Example 10. Prior to September 11, 2001, R began constructing an 
electric generation power plant for its own use. On May 1, 2003, prior 
to the completion of the power plant, R transferred the rights to own 
and use this power plant to S, an unrelated party, for $6,000,000. 
Between May 6, 2003, and June 30, 2003, S, a calendar-year taxpayer, 
incurred another $1,200,000 to complete the construction of the power 
plant and, on August 1, 2003, S placed the power plant in service. 
Because R and S are not related parties, the transaction between R and S 
will not be a disqualified transaction pursuant to paragraph (b)(4)(iv) 
of this section. Accordingly, S's total expenditures of $7,200,000 for 
the power plant qualify for the additional first year depreciation 
deduction. S's additional first year depreciation deduction for the 
power plant will be $2,400,000, computed as $6,000,000 multiplied by 30 
percent, plus $1,200,000 multiplied by 50 percent. The $6,000,000 
portion of the total $7,200,000 unadjusted depreciable basis qualifies 
for the 30-percent additional first year depreciation deduction because 
that portion of the total unadjusted depreciable basis was acquired by S 
after September 10, 2001, and before May 6, 2003. However, because S 
began construction to complete the power plant after May 5, 2003, the 
$1,200,000 portion of the total $7,200,000 unadjusted depreciable basis 
qualifies for the 50-percent additional first year depreciation 
deduction.
    Example 11. On September 1, 2001, T acquired and placed in service 
equipment. On October 15, 2001, T sells the equipment to U, an unrelated 
party, and leases the property back from U in a sale-leaseback 
transaction. Pursuant to paragraph (b)(4)(iv) of this section, the 
equipment does not qualify for the additional first year depreciation 
deduction because T, the user of the equipment, acquired the equipment 
prior to September 11, 2001.

    (5) Placed-in-service date--(i) In general. Depreciable property 
will meet the requirements of this paragraph (b)(5) if the property is 
placed in service by the taxpayer before January 1, 2005, or, in the 
case of property described in section 168(k)(2)(B), is placed in service 
by the taxpayer before January 1, 2006.
    (ii) Sale-leaseback and syndication transactions--(A) Sale-leaseback 
transaction. If qualified property is originally placed in service after 
September 10, 2001, or 50-percent bonus depreciation property is 
originally placed in service after May 5, 2003, by a person and sold to 
a taxpayer and leased back to the person by the taxpayer within three 
months after the date the property was originally placed in service by 
the person, the property is treated as originally placed in service by 
the taxpayer-lessor not earlier than the date on which the property is 
used by the lessee under the leaseback.
    (B) Syndication transaction. If qualified property is originally 
placed in service after September 10, 2001, or 50-percent bonus 
depreciation property is originally placed in service after May 5, 2003, 
by a lessor (including by operation of paragraph (b)(5)(ii)(A) of this 
section) and is sold by the lessor or any subsequent purchaser within 
three months after the date the property was originally placed in 
service by the lessor, and the user of the property after the last sale 
during this three-month period remains the same as when the property was 
originally placed in service by the lessor, the property is treated as 
originally placed in service by the purchaser of the property in the 
last sale during the three-month period but not earlier than the date of 
the last sale.
    (C) Sale-leaseback transaction followed by a syndication 
transaction. If a sale-leaseback transaction that satisfies the 
requirements in paragraph (b)(5)(ii)(A) of this section is followed by a 
syndication transaction that satisfies the requirements in paragraph 
(b)(5)(ii)(B) of this section, the placed-in-service date of the 
property is determined in accordance with paragraph (b)(5)(ii)(B) of 
this section.
    (iii) Technical termination of a partnership. For purposes of this 
paragraph

[[Page 1111]]

(b)(5), in the case of a technical termination of a partnership under 
section 708(b)(1)(B), qualified property or 50-percent bonus 
depreciation property placed in service by the terminated partnership 
during the taxable year of termination is treated as originally placed 
in service by the new partnership on the date the qualified property or 
the 50-percent bonus depreciation property is contributed by the 
terminated partnership to the new partnership.
    (iv) Section 168(i)(7) transactions. For purposes of this paragraph 
(b)(5), if qualified property or 50-percent bonus depreciation property 
is transferred in a transaction described in section 168(i)(7) in the 
same taxable year that the qualified property or the 50-percent bonus 
depreciation property is placed in service by the transferor, the 
transferred property is treated as originally placed in service on the 
date the transferor placed in service the qualified property or the 50-
percent bonus depreciation property, as applicable. In the case of 
multiple transfers of qualified property or 50-percent bonus 
depreciation property in multiple transactions described in section 
168(i)(7) in the same taxable year, the placed in service date of the 
transferred property is deemed to be the date on which the first 
transferor placed in service the qualified property or the 50-percent 
bonus depreciation property, as applicable.
    (c) Qualified leasehold improvement property--(1) In general. For 
purposes of section 168(k), qualified leasehold improvement property 
means any improvement, which is section 1250 property, to an interior 
portion of a building that is nonresidential real property if--
    (i) The improvement is made under or pursuant to a lease by the 
lessee (or any sublessee) of the interior portion, or by the lessor of 
that interior portion;
    (ii) The interior portion of the building is to be occupied 
exclusively by the lessee (or any sublessee) of that interior portion; 
and
    (iii) The improvement is placed in service more than 3 years after 
the date the building was first placed in service by any person.
    (2) Certain improvements not included. Qualified leasehold 
improvement property does not include any improvement for which the 
expenditure is attributable to:
    (i) The enlargement of the building;
    (ii) Any elevator or escalator;
    (iii) Any structural component benefiting a common area; or
    (iv) The internal structural framework of the building.
    (3) Definitions. For purposes of this paragraph (c), the following 
definitions apply:
    (i) Building has the same meaning as that term is defined in Sec. 
1.48-1(e)(1).
    (ii) Common area means any portion of a building that is equally 
available to all users of the building on the same basis for uses that 
are incidental to the primary use of the building. For example, 
stairways, hallways, lobbies, common seating areas, interior and 
exterior pedestrian walkways and pedestrian bridges, loading docks and 
areas, and rest rooms generally are treated as common areas if they are 
used by different lessees of a building.
    (iii) Elevator and escalator have the same meanings as those terms 
are defined in Sec. 1.48-1(m)(2).
    (iv) Enlargement has the same meaning as that term is defined in 
Sec. 1.48-12(c)(10).
    (v) Internal structural framework has the same meaning as that term 
is defined in Sec. 1.48-12(b)(3)(i)(D)(iii).
    (vi) Lease has the same meaning as that term is defined in section 
168(h)(7). In addition, a commitment to enter into a lease is treated as 
a lease, and the parties to the commitment are treated as lessor and 
lessee. However, a lease between related persons is not considered a 
lease. For purposes of the preceding sentence, related persons are--
    (A) Members of an affiliated group (as defined in section 1504 and 
the regulations thereunder); and
    (B) Persons having a relationship described in section 267(b) and 
the regulations thereunder. For purposes of applying section 267(b), the 
language ``80 percent or more'' is used instead of ``more than 50 
percent.''
    (vii) Nonresidential real property has the same meaning as that term 
is defined in section 168(e)(2)(B).

[[Page 1112]]

    (viii) Structural component has the same meaning as that term is 
defined in Sec. 1.48-1(e)(2).
    (d) Computation of depreciation deduction for qualified property or 
50-percent bonus depreciation property--(1) Additional first year 
depreciation deduction--(i) In general. Except as provided in paragraph 
(f)(5) of this section, the allowable additional first year depreciation 
deduction for qualified property is determined by multiplying the 
unadjusted depreciable basis (as defined in Sec. 1.168(k)-
1T(a)(2)(iii)) of the qualified property by 30 percent. Except as 
provided in paragraph (f)(5) of this section, the allowable additional 
first year depreciation deduction for 50-percent bonus depreciation 
property is determined by multiplying the unadjusted depreciable basis 
(as defined in Sec. 1.168(k)-1T(a)(2)(iii)) of the 50-percent bonus 
depreciation property by 50 percent. Except as provided in paragraph 
(f)(1) of this section, the 30-percent or 50-percent additional first 
year depreciation deduction is not affected by a taxable year of less 
than 12 months. See paragraph (f)(1) of this section for qualified 
property or 50-percent bonus depreciation property placed in service and 
disposed of in the same taxable year. See paragraph (f)(5) of this 
section for qualified property or 50-percent bonus depreciation property 
acquired in a like-kind exchange or as a result of an involuntary 
conversion.
    (ii) Property having a longer production period. For purposes of 
paragraph (d)(1)(i) of this section, the unadjusted depreciable basis 
(as defined in Sec. 1.168(k)-1T(a)(2)(iii)) of qualified property or 
50-percent bonus depreciation property described in section 168(k)(2)(B) 
is limited to the property's unadjusted depreciable basis attributable 
to the property's manufacture, construction, or production after 
September 10, 2001 (for qualified property), or May 5, 2003 (for 50-
percent bonus depreciation property), and before January 1, 2005.
    (iii) Alternative minimum tax. The 30-percent or 50-percent 
additional first year depreciation deduction is allowed for alternative 
minimum tax purposes for the taxable year in which the qualified 
property or the 50-percent bonus depreciation property is placed in 
service by the taxpayer. The 30-percent or 50-percent additional first 
year depreciation deduction for alternative minimum tax purposes is 
based on the unadjusted depreciable basis of the property for 
alternative minimum tax purposes.
    (2) Otherwise allowable depreciation deduction. (i) In general. 
Before determining the amount otherwise allowable as a depreciation 
deduction for the qualified property or the 50-percent bonus 
depreciation property for the placed-in-service year and any subsequent 
taxable year, the taxpayer must determine the remaining adjusted 
depreciable basis of the qualified property or the 50-percent bonus 
depreciation property. This remaining adjusted depreciable basis is 
equal to the unadjusted depreciable basis of the qualified property or 
the 50-percent bonus depreciation property reduced by the amount of the 
additional first year depreciation allowed or allowable, whichever is 
greater. The remaining adjusted depreciable basis of the qualified 
property or the 50-percent bonus depreciation property is then 
depreciated using the applicable depreciation provisions under the 
Internal Revenue Code for the qualified property or the 50-percent bonus 
depreciation property. The remaining adjusted depreciable basis of the 
qualified property or the 50-percent bonus depreciation property that is 
MACRS property is also the basis to which the annual depreciation rates 
in the optional depreciation tables apply (for further guidance, see 
section 8 of Rev. Proc. 87-57 (1987-2 C.B. 687) and Sec. 
601.601(d)(2)(ii)(b) of this chapter). The depreciation deduction 
allowable for the remaining adjusted depreciable basis of the qualified 
property or the 50-percent bonus depreciation property is affected by a 
taxable year of less than 12 months.
    (ii) Alternative minimum tax. For alternative minimum tax purposes, 
the depreciation deduction allowable for the remaining adjusted 
depreciable basis of the qualified property or the 50-percent bonus 
depreciation property is based on the remaining adjusted depreciable 
basis for alternative minimum tax purposes. The remaining adjusted 
depreciable basis of the qualified

[[Page 1113]]

property or the 50-percent bonus depreciable property for alternative 
minimum tax purposes is depreciated using the same depreciation method, 
recovery period (or useful life in the case of computer software), and 
convention that apply to the qualified property or the 50-percent bonus 
depreciation property for regular tax purposes.
    (3) Examples. This paragraph (d) is illustrated by the following 
examples:


    Example 1. On March 1, 2003, V, a calendar-year taxpayer, purchased 
and placed in service qualified property that costs $1 million and is 5-
year property under section 168(e). V depreciates its 5-year property 
placed in service in 2003 using the optional depreciation table that 
corresponds with the general depreciation system, the 200-percent 
declining balance method, a 5-year recovery period, and the half-year 
convention. For 2003, V is allowed a 30-percent additional first year 
depreciation deduction of $300,000 (the unadjusted depreciable basis of 
$1 million multiplied by .30). Next, V must reduce the unadjusted 
depreciable basis of $1 million by the additional first year 
depreciation deduction of $300,000 to determine the remaining adjusted 
depreciable basis of $700,000. Then, V's depreciation deduction 
allowable in 2003 for the remaining adjusted depreciable basis of 
$700,000 is $140,000 (the remaining adjusted depreciable basis of 
$700,000 multiplied by the annual depreciation rate of .20 for recovery 
year 1).

    Example 2. On June 1, 2003, W, a calendar-year taxpayer, purchased 
and placed in service 50-percent bonus depreciation property that costs 
$126,000. The property qualifies for the expensing election under 
section 179 and is 5-year property under section 168(e). W did not 
purchase any other section 179 property in 2003. W makes the election 
under section 179 for the property and depreciates its 5-year property 
placed in service in 2003 using the optional depreciation table that 
corresponds with the general depreciation system, the 200-percent 
declining balance method, a 5-year recovery period, and the half-year 
convention. For 2003, W is first allowed a $100,000 deduction under 
section 179. Next, W must reduce the cost of $126,000 by the section 179 
deduction of $100,000 to determine the unadjusted depreciable basis of 
$26,000. Then, for 2003, W is allowed a 50-percent additional first year 
depreciation deduction of $13,000 (the unadjusted depreciable basis of 
$26,000 multiplied by .50). Next, W must reduce the unadjusted 
depreciable basis of $26,000 by the additional first year depreciation 
deduction of $13,000 to determine the remaining adjusted depreciable 
basis of $13,000. Then, W's depreciation deduction allowable in 2003 for 
the remaining adjusted depreciable basis of $13,000 is $2,600 (the 
remaining adjusted depreciable basis of $13,000 multiplied by the annual 
depreciation rate of .20 for recovery year 1).

    (e) Election not to deduct additional first year depreciation--(1) 
In general. If a taxpayer makes an election under this paragraph (e), 
the election applies to all qualified property or 50-percent bonus 
depreciation property, as applicable, that is in the same class of 
property and placed in service in the same taxable year. The rules of 
this paragraph (e) apply to the following elections provided under 
section 168(k):
    (i) Qualified property. A taxpayer may make an election not to 
deduct the 30-percent additional first year depreciation for any class 
of property that is qualified property placed in service during the 
taxable year. If this election is made, no additional first year 
depreciation deduction is allowable for the property placed in service 
during the taxable year in the class of property.
    (ii) 50-percent bonus depreciation property. For any class of 
property that is 50-percent bonus depreciation property placed in 
service during the taxable year, a taxpayer may make an election--
    (A) To deduct the 30-percent, instead of the 50-percent, additional 
first year depreciation. If this election is made, the allowable 
additional first year depreciation deduction is determined as though the 
class of property is qualified property under section 168(k)(2); or
    (B) Not to deduct any additional first year depreciation. If this 
election is made, no additional first year depreciation deduction is 
allowable for the class of property.
    (2) Definition of class of property. For purposes of this paragraph 
(e), the term class of property means:
    (i) Except for the property described in paragraphs (e)(2)(ii) and 
(iv) of this section, each class of property described in section 168(e) 
(for example, 5-year property);
    (ii) Water utility property as defined in section 168(e)(5) and 
depreciated under section 168;
    (iii) Computer software as defined in, and depreciated under, 
section 167(f)(1) and the regulations thereunder; or

[[Page 1114]]

    (iv) Qualified leasehold improvement property as defined in 
paragraph (c) of this section and depreciated under section 168.
    (3) Time and manner for making election--(i) Time for making 
election. Except as provided in paragraph (e)(4) of this section, any 
election specified in paragraph (e)(1) of this section must be made by 
the due date (including extensions) of the Federal tax return for the 
taxable year in which the qualified property or the 50-percent bonus 
depreciation property, as applicable, is placed in service by the 
taxpayer.
    (ii) Manner of making election. Except as provided in paragraph 
(e)(4) of this section, any election specified in paragraph (e)(1) of 
this section must be made in the manner prescribed on Form 4562, 
``Depreciation and Amortization,'' and its instructions. The election is 
made separately by each person owning qualified property or 50-percent 
bonus depreciation property (for example, for each member of a 
consolidated group by the common parent of the group, by the 
partnership, or by the S corporation). If Form 4562 is revised or 
renumbered, any reference in this section to that form shall be treated 
as a reference to the revised or renumbered form.
    (4) Special rules for 2000 or 2001 returns. For the election 
specified in paragraph (e)(1)(i) of this section for qualified property 
placed in service by the taxpayer during the taxable year that included 
September 11, 2001, the taxpayer should refer to the guidance provided 
by the Internal Revenue Service for the time and manner of making this 
election on the 2000 or 2001 Federal tax return for the taxable year 
that included September 11, 2001 (for further guidance, see sections 
3.03(3) and 4 of Rev. Proc. 2002-33 (2002-1 C.B. 963), Rev. Proc. 2003-
50 (2003-29 I.R.B. 119), and Sec. 601.601(d)(2)(ii)(b) of this 
chapter).
    (5) Failure to make election. If a taxpayer does not make the 
applicable election specified in paragraph (e)(1) of this section within 
the time and in the manner prescribed in paragraph (e)(3) or (4) of this 
section, the amount of depreciation allowable for that property under 
section 167(f)(1) or under section 168, as applicable, must be 
determined for the placed-in-service year and for all subsequent taxable 
years by taking into account the additional first year depreciation 
deduction. Thus, any election specified in paragraph (e)(1) of this 
section shall not be made by the taxpayer in any other manner (for 
example, the election cannot be made through a request under section 
446(e) to change the taxpayer's method of accounting).
    (f) Special rules--(1) Property placed in service and disposed of in 
the same taxable year--(i) In general. Except as provided in paragraphs 
(f)(1)(ii) and (iii) of this section, the additional first year 
depreciation deduction is not allowed for qualified property or 50-
percent bonus depreciation property placed in service and disposed of 
during the same taxable year.
    (ii) Technical termination of a partnership. In the case of a 
technical termination of a partnership under section 708(b)(1)(B), the 
additional first year depreciation deduction is allowable for any 
qualified property or 50-percent bonus depreciation property placed in 
service by the terminated partnership during the taxable year of 
termination and contributed by the terminated partnership to the new 
partnership. The allowable additional first year depreciation deduction 
for the qualified property or the 50-percent bonus depreciation property 
shall not be claimed by the terminated partnership but instead shall be 
claimed by the new partnership for the new partnership's taxable year in 
which the qualified property or the 50-percent bonus depreciation 
property was contributed by the terminated partnership to the new 
partnership. However, if qualified property or 50-percent bonus 
depreciation property is both placed in service and contributed to a new 
partnership in a transaction described in section 708(b)(1)(B) by the 
terminated partnership during the taxable year of termination, and if 
such property is disposed of by the new partnership in the same taxable 
year the new partnership received such property from the terminated 
partnership, then no additional first year depreciation deduction is 
allowable to either partnership.
    (iii) Section 168(i)(7) transactions. If any qualified property or 
50-percent

[[Page 1115]]

bonus depreciation property is transferred in a transaction described in 
section 168(i)(7) in the same taxable year that the qualified property 
or the 50-percent bonus depreciation property is placed in service by 
the transferor, the additional first year depreciation deduction is 
allowable for the qualified property or the 50-percent bonus 
depreciation property. The allowable additional first year depreciation 
deduction for the qualified property or the 50-percent bonus 
depreciation property for the transferor's taxable year in which the 
property is placed in service is allocated between the transferor and 
the transferee on a monthly basis. This allocation shall be made in 
accordance with the rules in Sec. 1.168(d)-1(b)(7)(ii) for allocating 
the depreciation deduction between the transferor and the transferee. 
However, if qualified property or 50-percent bonus depreciation property 
is both placed in service and transferred in a transaction described in 
section 168(i)(7) by the transferor during the same taxable year, and if 
such property is disposed of by the transferee (other than by a 
transaction described in section 168(i)(7)) during the same taxable year 
the transferee received such property from the transferor, then no 
additional first year depreciation deduction is allowable to either 
party.
    (iv) Examples. The application of this paragraph (f)(1) is 
illustrated by the following examples:

    Example 1. X and Y are equal partners in Partnership XY, a general 
partnership. On February 1, 2002, Partnership XY purchased and placed in 
service new equipment at a cost of $30,000. On March 1, 2002, X sells 
its entire 50 percent interest to Z in a transfer that terminates the 
partnership under section 708(b)(1)(B). As a result, terminated 
Partnership XY is deemed to have contributed the equipment to new 
Partnership XY. Pursuant to paragraph (f)(1)(ii) of this section, new 
Partnership XY, not terminated Partnership XY, is eligible to claim the 
30-percent additional first year depreciation deduction allowable for 
the equipment for the taxable year 2002 (assuming all other requirements 
are met).
    Example 2. On January 5, 2002, BB purchased and placed in service 
new office desks for a total amount of $8,000. On August 20, 2002, BB 
transferred the office desks to Partnership BC in a transaction 
described in section 721. BB and Partnership BC are calendar-year 
taxpayers. Because the transaction between BB and Partnership BC is a 
transaction described in section 168(i)(7), pursuant to paragraph 
(f)(1)(iii) of this section the 30-percent additional first year 
depreciation deduction allowable for the desks is allocated between BB 
and Partnership BC in accordance with the rules in Sec. 1.168(d)-
1(b)(7)(ii) for allocating the depreciation deduction between the 
transferor and the transferee. Accordingly, the 30-percent additional 
first year depreciation deduction allowable for the desks for 2002 of 
$2,400 (the unadjusted depreciable basis of $8,000 multiplied by .30) is 
allocated between BB and Partnership BC based on the number of months 
that BB and Partnership BC held the desks in service. Thus, because the 
desks were held in service by BB for 7 of 12 months, which includes the 
month in which BB placed the desks in service but does not include the 
month in which the desks were transferred, BB is allocated $1,400 (\7/
12\ x $2,400 additional first year depreciation deduction). Partnership 
BC is allocated $1,000, the remaining \5/12\ of the $2,400 additional 
first year depreciation deduction allowable for the desks.

    (2) Redetermination of basis. If the unadjusted depreciable basis 
(as defined in Sec. 1.168(k)-1T(a)(2)(iii)) of qualified property or 
50-percent bonus depreciation property is redetermined (for example, due 
to contingent purchase price or discharge of indebtedness) by January 1, 
2005 (or January 1, 2006, for property described in section 
168(k)(2)(B)), the additional first year depreciation deduction 
allowable for the qualified property or the 50-percent bonus 
depreciation property is redetermined as follows:
    (i) Increase in basis. For the taxable year in which an increase in 
basis of qualified property or 50-percent bonus depreciation property 
occurs, the taxpayer shall claim an additional first year depreciation 
deduction for qualified property by multiplying the amount of the 
increase in basis for this property by 30 percent or, for 50-percent 
bonus depreciation property, by multiplying the amount of the increase 
in basis for this property by 50 percent. For purposes of this paragraph 
(f)(2)(i), the 30-percent additional first year depreciation deduction 
applies to the increase in basis if the underlying property is qualified 
property and the 50-percent additional first year depreciation deduction 
applies to the increase in basis if the underlying property is 50-
percent bonus depreciation property.

[[Page 1116]]

To determine the amount otherwise allowable as a depreciation deduction 
for the increase in basis of qualified property or 50-percent bonus 
depreciation property, the amount of the increase in basis of the 
qualified property or the 50-percent bonus depreciation property must be 
reduced by the additional first year depreciation deduction allowed or 
allowable, whichever is greater, for the increase in basis and the 
remaining increase in basis of--
    (A) Qualified property or 50-percent bonus depreciation property 
(except for computer software described in paragraph (b)(2)(i)(B) of 
this section) is depreciated over the recovery period of the qualified 
property or the 50-percent bonus depreciation property, as applicable, 
remaining as of the beginning of the taxable year in which the increase 
in basis occurs, and using the same depreciation method and convention 
applicable to the qualified property or 50-percent bonus depreciation 
property, as applicable, that applies for the taxable year in which the 
increase in basis occurs; and
    (B) Computer software (as defined in paragraph (b)(2)(i)(B) of this 
section) that is qualified property or 50-percent bonus depreciation 
property is depreciated ratably over the remainder of the 36-month 
period (the useful life under section 167(f)(1)) as of the beginning of 
the first day of the month in which the increase in basis occurs.
    (ii) Decrease in basis. For the taxable year in which a decrease in 
basis of qualified property or 50-percent bonus depreciation property 
occurs, the taxpayer shall include in the taxpayer's income the excess 
additional first year depreciation deduction previously claimed for the 
qualified property or the 50-percent bonus depreciation property. This 
excess additional first year depreciation deduction for qualified 
property is determined by multiplying the amount of the decrease in 
basis for this property by 30 percent. The excess additional first year 
depreciation deduction for 50-percent bonus depreciation property is 
determined by multiplying the amount of the decrease in basis for this 
property by 50 percent. For purposes of this paragraph (f)(2)(ii), the 
30-percent additional first year depreciation deduction applies to the 
decrease in basis if the underlying property is qualified property and 
the 50-percent additional first year depreciation deduction applies to 
the decrease in basis if the underlying property is 50-percent bonus 
depreciation property. Also, if the taxpayer establishes by adequate 
records or other sufficient evidence that the taxpayer claimed less than 
the additional first year depreciation deduction allowable for the 
qualified property or the 50-percent bonus depreciation property before 
the decrease in basis or if the taxpayer claimed more than the 
additional first year depreciation deduction allowable for the qualified 
property or the 50-percent bonus depreciation property before the 
decrease in basis, the excess additional first year depreciation 
deduction is determined by multiplying the amount of the decrease in 
basis by the additional first year depreciation deduction percentage 
actually claimed by the taxpayer for the qualified property or the 50-
percent bonus depreciation property, as applicable, before the decrease 
in basis. To determine the amount includible in the taxpayer's income 
for the excess depreciation previously claimed (other than the 
additional first year depreciation deduction) resulting from the 
decrease in basis of the qualified property or the 50-percent bonus 
depreciation property, the amount of the decrease in basis of the 
qualified property or the 50-percent bonus depreciation property must be 
adjusted by the excess additional first year depreciation deduction 
includible in the taxpayer's income (as determined under this paragraph) 
and the remaining decrease in basis of--
    (A) Qualified property or 50-percent bonus depreciation property 
(except for computer software described in paragraph (b)(2)(i)(B) of 
this section) is included in the taxpayer's income over the recovery 
period of the qualified property or the 50-percent bonus depreciation 
property, as applicable, remaining as of the beginning of the taxable 
year in which the decrease in basis occurs, and using the same 
depreciation method and convention of the qualified property or 50-
percent bonus depreciation property, as applicable, that applies in the 
taxable year in which the decrease in basis occurs; and

[[Page 1117]]

    (B) Computer software (as defined in paragraph (b)(2)(i)(B) of this 
section) that is qualified property or 50-percent bonus depreciation 
property is included in the taxpayer's income ratably over the remainder 
of the 36-month period (the useful life under section 167(f)(1)) as of 
the beginning of the first day of the month in which the decrease in 
basis occurs.
    (iii) Definition. For purposes of this paragraph (f)(2)--
    (A) An increase in basis occurs in the taxable year an amount is 
taken into account under section 461; and
    (B) A decrease in basis occurs in the taxable year an amount would 
be taken into account under section 451.
    (iv) Examples. The application of this paragraph (f)(2) is 
illustrated by the following examples:

    Example 1. (i) On May 15, 2002, CC, a cash-basis taxpayer, purchased 
and placed in service qualified property that is 5-year property at a 
cost of $200,000. In addition to the $200,000, CC agrees to pay the 
seller 25 percent of the gross profits from the operation of the 
property in 2002. On May 15, 2003, CC paid to the seller an additional 
$10,000. CC depreciates the 5-year property placed in service in 2002 
using the optional depreciation table that corresponds with the general 
depreciation system, the 200-percent declining balance method, a 5-year 
recovery period, and the half-year convention.
    (ii) For 2002, CC is allowed a 30-percent additional first year 
depreciation deduction of $60,000 (the unadjusted depreciable basis of 
$200,000 multiplied by .30). In addition, CC's depreciation deduction 
for 2002 for the remaining adjusted depreciable basis of $140,000 (the 
unadjusted depreciable basis of $200,000 reduced by the additional first 
year depreciation deduction of $60,000) is $28,000 (the remaining 
adjusted depreciable basis of $140,000 multiplied by the annual 
depreciation rate of .20 for recovery year 1).
    (iii) For 2003, CC's depreciation deduction for the remaining 
adjusted depreciable basis of $140,000 is $44,800 (the remaining 
adjusted depreciable basis of $140,000 multiplied by the annual 
depreciation rate of .32 for recovery year 2). In addition, pursuant to 
paragraph (f)(2)(i) of this section, CC is allowed an additional first 
year depreciation deduction for 2003 for the $10,000 increase in basis 
of the qualified property. Consequently, CC is allowed an additional 
first year depreciation deduction of $3,000 (the increase in basis of 
$10,000 multiplied by .30). Also, CC is allowed a depreciation deduction 
for 2003 attributable to the remaining increase in basis of $7,000 (the 
increase in basis of $10,000 reduced by the additional first year 
depreciation deduction of $3,000). The depreciation deduction allowable 
for 2003 attributable to the remaining increase in basis of $7,000 is 
$3,111 (the remaining increase in basis of $7,000 multiplied by .4444, 
which is equal to 1/remaining recovery period of 4.5 years at January 1, 
2003, multiplied by 2). Accordingly, for 2003, CC's total depreciation 
deduction allowable for the qualified property is $50,911.
    Example 2. (i) On May 15, 2002, CC purchased and placed in service 
qualified property that is 5-year property at a cost of $400,000. To 
purchase the property, DD borrowed $250,000 from Bank2. On May 15, 2003, 
Bank2 forgives $50,000 of the indebtedness. DD makes the election 
provided in section 108(b)(5) to apply any portion of the reduction 
under section 1017 to the basis of the depreciable property of the 
taxpayer. DD depreciates the 5-year property placed in service in 2002 
using the optional depreciation table that corresponds with the general 
depreciation system, the 200-percent declining balance method, a 5-year 
recovery period, and the half-year convention.
    (ii) For 2002, DD is allowed a 30-percent additional first year 
depreciation deduction of $120,000 (the unadjusted depreciable basis of 
$400,000 multiplied by .30). In addition, DD's depreciation deduction 
allowable for 2002 for the remaining adjusted depreciable basis of 
$280,000 (the unadjusted depreciable basis of $400,000 reduced by the 
additional first year depreciation deduction of $120,000) is $56,000 
(the remaining adjusted depreciable basis of $280,000 multiplied by the 
annual depreciation rate of .20 for recovery year 1).
    (iii) For 2003, DD's deduction for the remaining adjusted 
depreciable basis of $280,000 is $89,600 (the remaining adjusted 
depreciable basis of $280,000 multiplied by the annual depreciation rate 
of .32 for recovery year 2). However, pursuant to paragraph (f)(2)(ii) 
of this section, DD must include in its taxable income for 2003 the 
excess depreciation previously claimed for the $50,000 decrease in basis 
of the qualified property. Consequently, DD must include in its taxable 
income for 2003 the excess additional first year depreciation of $4,500 
(the decrease in basis of $50,000 multiplied by .30). Also, DD must 
include in its taxable income for 2003 the excess depreciation 
attributable to the remaining decrease in basis of $45,500 (the decrease 
in basis of $50,000 reduced by the excess additional first year 
depreciation of $4,500). The amount includible in taxable income for 
2003 for the remaining decrease in basis of $45,500 is $20,222 (the 
remaining decrease in basis of $45,500 multiplied by .4444, which is 
equal to 1/remaining recovery period of 4.5 years at January 1, 2003, 
multiplied by 2). Accordingly, for 2003, DD's total depreciation 
deduction allowable for the qualified property is $64,878 ($89,600 minus 
$4,500 minus $20,222).


[[Page 1118]]


    (3) Section 1245 and 1250 depreciation recapture. For purposes of 
section 1245 and the regulations thereunder, the additional first year 
depreciation deduction is an amount allowed or allowable for 
depreciation. Further, for purposes of section 1250(b) and the 
regulations thereunder, the additional first year depreciation deduction 
is not a straight line method.
    (4) Coordination with section 169. The additional first year 
depreciation deduction is allowable in the placed-in-service year of a 
certified pollution control facility (as defined in Sec. 1.169-2(a)) 
that is qualified property or 50-percent bonus depreciation property, 
even if the taxpayer makes the election to amortize the certified 
pollution control facility under section 169 and the regulations 
thereunder in the certified pollution control facility's placed-in-
service year.
    (5) Like-kind exchanges and involuntary conversions--(i) Scope. The 
rules of this paragraph (f)(5) apply to acquired MACRS property or 
acquired computer software that is eligible for the additional first 
year depreciation deduction under section 168(k) at the time of 
replacement provided the time of replacement is after September 10, 
2001, and before January 1, 2005, or, in the case of acquired MACRS 
property or acquired computer software that is qualified property, or 
50-percent bonus depreciation property, described in section 
168(k)(2)(B), the time of replacement is after September 10, 2001, and 
before January 1, 2006.
    (ii) Definitions. For purposes of this paragraph (f)(5), the 
following definitions apply:
    (A) Acquired MACRS property is MACRS property in the hands of the 
acquiring taxpayer that is acquired in a transaction described in 
section 1031(a), (b), or (c) for other MACRS property or that is 
acquired in connection with an involuntary conversion of other MACRS 
property in a transaction to which section 1033 applies.
    (B) Exchanged or involuntarily converted MACRS property is MACRS 
property that is transferred by the taxpayer in a transaction described 
in section 1031(a), (b), or (c), or that is converted as a result of an 
involuntary conversion to which section 1033 applies.
    (C) Acquired computer software is computer software (as defined in 
paragraph (b)(2)(i)(B) of this section) in the hands of the acquiring 
taxpayer that is acquired in a like-kind exchange under section 1031 or 
as a result of an involuntary conversion under section 1033.
    (D) Exchanged or involuntarily converted computer software is 
computer software (as defined in paragraph (b)(2)(i)(B) of this section) 
that is transferred by the taxpayer in a like-kind exchange under 
section 1031 or that is converted as a result of an involuntary 
conversion under section 1033.
    (E) Time of disposition is when the disposition of the exchanged or 
involuntarily converted MACRS property or the exchanged or involuntarily 
converted computer software, as applicable, takes place.
    (F) Time of replacement is the later of:
    (1) When the property received in the exchange or involuntary 
conversion is placed in service; or
    (2) The time of disposition of the exchanged or involuntarily 
converted property.
    (G) Carryover basis is the lesser of:
    (1) The basis in the acquired MACRS property or acquired computer 
software, as applicable and as determined under section 1031(d) or 
1033(b) and the regulations thereunder; or
    (2) The adjusted depreciable basis of the exchanged or involuntarily 
converted MACRS property or the exchanged or involuntarily converted 
computer software, as applicable.
    (H) Excess basis is any excess of the basis in the acquired MACRS 
property or acquired computer software, as applicable and as determined 
under section 1031(d) or 1033(b) and the regulations thereunder, over 
the carryover basis as determined under paragraph (f)(5)(ii)(G) of this 
section.
    (I) Remaining carryover basis is the carryover basis as determined 
under paragraph (f)(5)(ii)(G) of this section reduced by--
    (1) The percentage of the taxpayer's use of property for the taxable 
year other than in the taxpayer's trade or business (or for the 
production of income); and

[[Page 1119]]

    (2) Any adjustments to basis provided by other provisions of the 
Code and the regulations thereunder (including section 1016(a)(2) and 
(3)) for periods prior to the disposition of the exchanged or 
involuntarily converted property.
    (J) Remaining excess basis is the excess basis as determined under 
paragraph (f)(5)(ii)(H) of this section reduced by--
    (1) The percentage of the taxpayer's use of property for the taxable 
year other than in the taxpayer's trade or business (or for the 
production of income);
    (2) Any portion of the basis the taxpayer properly elects to treat 
as an expense under section 179; and
    (3) Any adjustments to basis provided by other provisions of the 
Code and the regulations thereunder.
    (iii) Computation--(A) In general. Assuming all other requirements 
are met, the remaining carryover basis for the year of replacement and 
the remaining excess basis, if any, for the year of replacement for the 
acquired MACRS property or the acquired computer software, as 
applicable, are eligible for the additional first year depreciation 
deduction. The 30-percent additional first year depreciation deduction 
applies to the remaining carryover basis and the remaining excess basis, 
if any, of the acquired MACRS property or the acquired computer software 
if the time of replacement is after September 10, 2001, and before May 
6, 2003, or if the taxpayer made the election provided in paragraph 
(e)(1)(ii)(A) of this section. The 50-percent additional first year 
depreciation deduction applies to the remaining carryover basis and the 
remaining excess basis, if any, of the acquired MACRS property or the 
acquired computer software if the time of replacement is after May 5, 
2003, and before January 1, 2005, or before January 1, 2006, for 50-
percent bonus depreciation property described in section 168(k)(2)(B). 
The additional first year depreciation deduction is computed separately 
for the remaining carryover basis and the remaining excess basis. Rules 
similar to the rules provided in paragraph (d) of this section apply to 
property described in section 168(k)(2)(B) and for alternative minimum 
tax purposes (for example, use the remaining carryover basis as 
determined for alternative minimum tax purposes).
    (B) Year of disposition and year of replacement. The additional 
first year depreciation deduction is allowable for the acquired MACRS 
property or acquired computer software in the year of replacement. 
However, the additional first year depreciation deduction is not 
allowable for the exchanged or involuntarily converted MACRS property or 
the exchanged or involuntarily converted computer software if the MACRS 
property or computer software, as applicable, is placed in service and 
disposed of in an exchange or involuntary conversion in the same taxable 
year.
    (iv) Sale-leaseback transaction. For purposes of this paragraph 
(f)(5), if MACRS property or computer software is sold to a taxpayer and 
leased back to a person by the taxpayer within three months after the 
time of disposition of the MACRS property or computer software, as 
applicable, the time of replacement for this MACRS property or computer 
software, as applicable, shall not be earlier than the date on which the 
MACRS property or computer software, as applicable, is used by the 
lessee under the leaseback.
    (v) Examples. The application of this paragraph (f)(5) is 
illustrated by the following examples:
    Example 1. (i) In December 2002, EE, a calendar-year corporation, 
acquired for $200,000 and placed in service Canopy V1, a gas station 
canopy. Canopy V1 is qualified property under section 168(k)(1) and is 
5-year property under section 168(e). EE depreciated Canopy V1 under the 
general depreciation system of section 168(a) by using the 200-percent 
declining balance method of depreciation, a 5-year recovery period, and 
the half-year convention. EE elected to use the optional depreciation 
tables to compute the depreciation allowance for Canopy V1. On January 
1, 2003, Canopy V1 was destroyed in a fire and was no longer usable in 
EE's business. On June 1, 2003, in an involuntary conversion, EE 
acquired and placed in service Canopy W1 with all of the $160,000 of 
insurance proceeds EE received due to the loss of Canopy V1. Canopy W1 
is 50-percent bonus depreciation property under section 168(k)(4) and is 
5-year property under section 168(e). Pursuant to paragraph (g)(3)(ii) 
of this section and Sec. 1.168(i)-6T(k)(2)(i), EE decided to apply 
Sec. 1.168(i)-6T to the involuntary conversion of

[[Page 1120]]

Canopy V1 with the replacement of Canopy W1, the acquired MACRS 
property.
    (ii) For 2002, EE is allowed a 30-percent additional first year 
depreciation deduction of $60,000 for Canopy V1 (the unadjusted 
depreciable basis of $200,000 multiplied by .30), and a regular MACRS 
depreciation deduction of $28,000 for Canopy V1 (the remaining adjusted 
depreciable basis of $140,000 multiplied by the annual depreciation rate 
of .20 for recovery year 1).
    (iii) For 2003, EE is allowed a regular MACRS depreciation deduction 
of $22,400 for Canopy V1 (the remaining adjusted depreciable basis of 
$140,000 multiplied by the annual depreciation rate of .32 for recovery 
year 2 x \1/2\ year).
    (iv) Pursuant to paragraph (f)(5)(iii)(A) of this section, the 
additional first year depreciation deduction allowable for Canopy W1 
equals $44,800 (.50 of Canopy W1's remaining carryover basis at the time 
of replacement of $89,600 (Canopy V1's remaining adjusted depreciable 
basis of $140,000 minus 2002 regular MACRS depreciation deduction of 
$28,000 minus 2003 regular MACRS depreciation deduction of $22,400)).
    Example 2. (i) Same facts as in Example 1, except EE elected not to 
deduct the additional first year depreciation for 5-year property placed 
in service in 2002. EE deducted the additional first year depreciation 
for 5-year property placed in service in 2003.
    (ii) For 2002, EE is allowed a regular MACRS depreciation deduction 
of $40,000 for Canopy V1 (the unadjusted depreciable basis of $200,000 
multiplied by the annual depreciation rate of .20 for recovery year 1).
    (iii) For 2003, EE is allowed a regular MACRS depreciation deduction 
of $32,000 for Canopy V1 (the unadjusted depreciable basis of $200,000 
multiplied by the annual depreciation rate of .32 for recovery year 2 x 
\1/2\ year).
    (iv) Pursuant to paragraph (f)(5)(iii)(A) of this section, the 
additional first year depreciation deduction allowable for Canopy W1 
equals $64,000 (.50 of Canopy W1's remaining carryover basis at the time 
of replacement of $128,000 (Canopy V1's unadjusted depreciable basis of 
$200,000 minus 2002 regular MACRS depreciation deduction of $40,000 
minus 2003 regular MACRS depreciation deduction of $32,000)).
    Example 3. (i) In December 2001, FF, a calendar-year corporation, 
acquired for $10,000 and placed in service Computer X2. Computer X2 is 
qualified property under section 168(k)(1) and is 5-year property under 
section 168(e). FF depreciated Computer X2 under the general 
depreciation system of section 168(a) by using the 200-percent declining 
balance method of depreciation, a 5-year recovery period, and the half-
year convention. FF elected to use the optional depreciation tables to 
compute the depreciation allowance for Computer X2. On January 1, 2002, 
FF acquired Computer Y2 by exchanging Computer X2 and $1,000 cash in a 
like-kind exchange. Computer Y2 is qualified property under section 
168(k)(1) and is 5-year property under section 168(e). Pursuant to 
paragraph (g)(3)(ii) of this section and Sec. 1.168(i)-6T(k)(2)(i), FF 
decided to apply Sec. 1.168(i)-6T to the exchange of Computer X2 for 
Computer Y2, the acquired MACRS property.
    (ii) For 2001, FF is allowed a 30-percent additional first year 
depreciation deduction of $3,000 for Computer X2 (unadjusted basis of 
$10,000 multiplied by .30), and a regular MACRS depreciation deduction 
of $1,400 for Computer X2 (the remaining adjusted depreciable basis of 
$7,000 multiplied by the annual depreciation rate of .20 for recovery 
year 1).
    (iii) For 2002, FF is allowed a regular MACRS depreciation deduction 
of $1,120 for Computer X2 (the remaining adjusted depreciable basis of 
$7,000 multiplied by the annual depreciation rate of .32 for recovery 
year 2 x \1/2\ year).
    (iv) Pursuant to paragraph (f)(5)(iii)(A) of this section, the 30-
percent additional first year depreciation deduction for Computer Y2 is 
allowable for the remaining carryover basis at the time of replacement 
of $4,480 (Computer X2's unadjusted depreciable basis of $10,000 minus 
additional first year depreciation deduction allowable of $3,000 minus 
2001 regular MACRS depreciation deduction of $1,400 minus 2002 regular 
MACRS depreciation deduction of $1,120) and for the remaining excess 
basis at the time of replacement of $1,000 (cash paid for Computer Y2). 
Thus, the 30-percent additional first year depreciation deduction for 
the remaining carryover basis at the time of replacement equals $1,344 
($4,480 multiplied by .30) and for the remaining excess basis at the 
time of replacement equals $300 ($1,000 multiplied by .30), which totals 
$1,644.
    Example 4. (i) In September 2002, GG, a June 30 year-end 
corporation, acquired for $20,000 and placed in service Equipment X3. 
Equipment X3 is qualified property under section 168(k)(1) and is 5-year 
property under section 168(e). GG depreciated Equipment X3 under the 
general depreciation system of section 168(a) by using the 200-percent 
declining balance method of depreciation, a 5-year recovery period, and 
the half-year convention. GG elected to use the optional depreciation 
tables to compute the depreciation allowance for Equipment X3. In 
December 2002, GG acquired Equipment Y3 by exchanging Equipment X3 and 
$5,000 cash in a like-kind exchange. Equipment Y3 is qualified property 
under section 168(k)(1) and is 5-year property under section 168(e). 
Pursuant to paragraph (g)(3)(ii) of this section and Sec. 1.168(i)-
6T(k)(2)(i), GG decided to apply Sec. 1.168(i)-6T to the exchange of 
Equipment X3 for Equipment Y3, the acquired MACRS property.

[[Page 1121]]

    (ii) Pursuant to paragraph (f)(5)(iii)(B) of this section, no 
additional first year depreciation deduction is allowable for Equipment 
X3 and, pursuant to Sec. 1.168(d)-1T(b)(3)(ii), no regular depreciation 
deduction is allowable for Equipment X3, for the taxable year ended June 
30, 2003.
    (iii) Pursuant to paragraph (f)(5)(iii)(A) of this section, the 30-
percent additional first year depreciation deduction for Equipment Y3 is 
allowable for the remaining carryover basis at the time of replacement 
of $20,000 (Equipment X3's unadjusted depreciable basis of $20,000) and 
for the remaining excess basis at the time of replacement of $5,000 
(cash paid for Equipment Y3). Thus, the 30-percent additional first year 
depreciation deduction for the remaining carryover basis at the time of 
replacement equals $6,000 ($20,000 multiplied by .30) and for the 
remaining excess basis at the time of replacement equals $1,500 ($5,000 
multiplied by .30), which totals $7,500.
    Example 5. (i) Same facts as in Example 4. GG depreciated Equipment 
Y3 under the general depreciation system of section 168(a) by using the 
200-percent declining balance method of depreciation, a 5-year recovery 
period, and the half-year convention. GG elected to use the optional 
depreciation tables to compute the depreciation allowance for Equipment 
Y3. On July 1, 2003, GG acquired Equipment Z1 by exchanging Equipment Y3 
in a like-kind exchange. Equipment Z1 is 50-percent bonus depreciation 
property under section 168(k)(4) and is 5-year property under section 
168(e). Pursuant to paragraph (g)(3)(ii) of this section and Sec. 
1.168(i)-6T(k)(2)(i), GG decided to apply Sec. 1.168(i)-6T to the 
exchange of Equipment Y3 for Equipment Z1, the acquired MACRS property.
    (ii) For the taxable year ending June 30, 2003, the regular MACRS 
depreciation deduction allowable for the remaining carryover basis at 
the time of replacement (after taking into account the additional first 
year depreciation deduction) of Equipment Y3 is $2,800 (the remaining 
carryover basis at the time of replacement of $20,000 minus the 
additional first year depreciation deduction of $6,000, multiplied by 
the annual depreciation rate of .20 for recovery year 1) and for the 
remaining excess basis at the time of replacement (after taking into 
account the additional first year depreciation deduction) of Equipment 
Y3 is $700 (the remaining excess basis at the time of replacement of 
$5,000 minus the additional first year depreciation deduction of $1,500, 
multiplied by the annual depreciation rate of .20 for recovery year 1), 
which totals $3,500.
    (iii) For the taxable year ending June 30, 2004, the regular MACRS 
depreciation deduction allowable for the remaining carryover basis 
(after taking into account the additional first year depreciation 
deduction) of Equipment Y3 is $2,240 (the remaining carryover basis at 
the time of replacement of $20,000 minus the additional first year 
depreciation deduction of $6,000, multiplied by the annual depreciation 
rate of .32 for recovery year 2 x \1/2\ year) and for the remaining 
excess basis (after taking into account the additional first year 
depreciation deduction) of Equipment Y3 is $560 (the remaining excess 
basis at the time of replacement of $5,000 minus the additional first 
year depreciation deduction of $1,500, multiplied by the annual 
depreciation rate of .32 for recovery year 2 x \1/2\ year), which totals 
$2,800.
    (iv) For the taxable year ending June 30, 2004, pursuant to 
paragraph (f)(5)(iii)(A) of this section, the 50-percent additional 
first year depreciation deduction for Equipment Z1 is allowable for the 
remaining carryover basis at the time of replacement of $11,200 
(Equipment Y3's unadjusted depreciable basis of $25,000 minus the total 
additional first year depreciation deduction of $7,500 minus the total 
2003 regular MACRS depreciation deduction of $3,500 minus the total 2004 
regular depreciation deduction (taking into account the half-year 
convention) of $2,800). Thus, the 50-percent additional first year 
depreciation deduction for the remaining carryover basis at the time of 
replacement equals $5,600 ($11,200 multiplied by .50).

    (6) Change in use--(i) Change in use of depreciable property. The 
determination of whether the use of depreciable property changes is made 
in accordance with section 168(i)(5) and regulations thereunder.
    (ii) Conversion to personal use. If qualified property or 50-percent 
bonus depreciation property is converted from business or income-
producing use to personal use in the same taxable year in which the 
property is placed in service by a taxpayer, the additional first year 
depreciation deduction is not allowable for the property.
    (iii) Conversion to business or income-producing use--(A) During the 
same taxable year. If, during the same taxable year, property is 
acquired by a taxpayer for personal use and is converted by the taxpayer 
from personal use to business or income-producing use, the additional 
first year depreciation deduction is allowable for the property in the 
taxable year the property is converted to business or income-producing 
use (assuming all of the requirements in paragraph (b) of this section 
are met). See paragraph (b)(3)(ii) of this section relating to the 
original use rules for a conversion of property to business or income-
producing use.

[[Page 1122]]

    (B) Subsequent to the acquisition year. If property is acquired by a 
taxpayer for personal use and, during a subsequent taxable year, is 
converted by the taxpayer from personal use to business or income-
producing use, the additional first year depreciation deduction is 
allowable for the property in the taxable year the property is converted 
to business or income-producing use (assuming all of the requirements in 
paragraph (b) of this section are met). For purposes of paragraphs 
(b)(4) and (5) of this section, the property must be acquired by the 
taxpayer for personal use after September 10, 2001 (for qualified 
property), or after May 5, 2003 (for 50-percent bonus depreciation 
property), and converted by the taxpayer from personal use to business 
or income-producing use by January 1, 2005. See paragraph (b)(3)(ii) of 
this section relating to the original use rules for a conversion of 
property to business or income-producing use.
    (iv) Depreciable property changes use subsequent to the placed-in-
service year--(A) If the use of qualified property or 50-percent bonus 
depreciation property changes in the hands of the same taxpayer 
subsequent to the taxable year the qualified property or the 50-percent 
bonus depreciation property, as applicable, is placed in service and, as 
a result of the change in use, the property is no longer qualified 
property or 50-percent bonus depreciation property, as applicable, the 
additional first year depreciation deduction allowable for the qualified 
property or the 50-percent bonus depreciation property, as applicable, 
is not redetermined.
    (B) If depreciable property is not qualified property or 50-percent 
bonus depreciation property in the taxable year the property is placed 
in service by the taxpayer, the additional first year depreciation 
deduction is not allowable for the property even if a change in the use 
of the property subsequent to the taxable year the property is placed in 
service results in the property being qualified property or 50-percent 
bonus depreciation property in the taxable year of the change in use.
    (v) Examples. The application of this paragraph (f)(6) is 
illustrated by the following examples:
    Example 1. (i) On January 1, 2002, HH, a calendar year corporation, 
purchased and placed in service several new computers at a total cost of 
$100,000. HH used these computers within the United States for 3 months 
in 2002 and then moved and used the computers outside the United States 
for the remainder of 2002. On January 1, 2003, HH permanently returns 
the computers to the United States for use in its business.
    (ii) For 2002, the computers are considered as used predominantly 
outside the United States in 2002 pursuant to Sec. 1.48-1(g)(1)(i). As 
a result, the computers are required to be depreciated under the 
alternative depreciation system of section 168(g). Pursuant to paragraph 
(b)(2)(ii)(A)2) of this section, the computers are not qualified 
property in 2002, the placed-in-service year. Thus, pursuant to 
(f)(6)(iv)(B) of this section, no additional first year depreciation 
deduction is allowed for these computers, regardless of the fact that 
the computers are permanently returned to the United States in 2003.
    Example 2. (i) On February 8, 2002, II, a calendar year corporation, 
purchased and placed in service new equipment at a cost of $1,000,000 
for use in its California plant. The equipment is 5-year property under 
section 168(e) and is qualified property under section 168(k). II 
depreciates its 5-year property placed in service in 2002 using the 
optional depreciation table that corresponds with the general 
depreciation system, the 200-percent declining balance method, a 5-year 
recovery period, and the half-year convention. On June 4, 2003, due to 
changes in II's business circumstances, II permanently moves the 
equipment to its plant in Mexico.
    (ii) For 2002, II is allowed a 30-percent additional first year 
depreciation deduction of $300,000 (the adjusted depreciable basis of 
$1,000,000 multiplied by .30). In addition, II's depreciation deduction 
allowable in 2002 for the remaining adjusted depreciable basis of 
$700,000 (the unadjusted depreciable basis of $1,000,000 reduced by the 
additional first year depreciation deduction of $300,000) is $140,000 
(the remaining adjusted depreciable basis of $700,000 multiplied by the 
annual depreciation rate of .20 for recovery year 1).
    (iii) For 2003, the equipment is considered as used predominantly 
outside the United States pursuant to Sec. 1.48-1(g)(1)(i). As a result 
of this change in use, the adjusted depreciable basis of $560,000 for 
the equipment is required to be depreciated under the alternative 
depreciation system of section 168(g) beginning in 2003. However, the 
additional first year depreciation deduction of $300,000 allowed for the 
equipment in 2002 is not redetermined.

    (7) Earnings and profits. The additional first year depreciation 
deduction is not allowable for purposes of computing earnings and 
profits.

[[Page 1123]]

    (8) Limitation of amount of depreciation for certain passenger 
automobiles. For a passenger automobile as defined in section 
280F(d)(5), the limitation under section 280F(a)(1)(A)(i) is increased 
by--
    (i) $4,600 for qualified property acquired by a taxpayer after 
September 10, 2001, and before May 6, 2003; and
    (ii) $7,650 for qualified property or 50-percent bonus depreciation 
property acquired by a taxpayer after May 5, 2003.
    (9) Section 754 election. In general, for purposes of section 168(k) 
any increase in basis of qualified property or 50-percent bonus 
depreciation property due to a section 754 election is not eligible for 
the additional first year depreciation deduction. However, if qualified 
property or 50-percent bonus depreciation property is placed in service 
by a partnership in the taxable year the partnership terminates under 
section 708(b)(1)(B), any increase in basis of the qualified property or 
the 50-percent bonus depreciation property due to a section 754 election 
is eligible for the additional first year depreciation deduction.
    (g) Effective date--(1)(i) In general. Except as provided in 
paragraphs (g)(2) and (3) of this section, this section applies to 
qualified property under section 168(k)(2) acquired by a taxpayer after 
September 10, 2001, and to 50-percent bonus depreciation property under 
section 168(k)(4) acquired by a taxpayer after May 5, 2003.
    (ii) Except as provided in paragraph (g)(3)(ii) of this section, the 
applicability of this section expires on or before September 4, 2006.
    (2) Technical termination of a partnership or section 168(i)(7) 
transactions. If qualified property or 50 percent bonus depreciation 
property is transferred in a technical termination of a partnership 
under section 708(b)(1)(B) or in a transaction described in section 
168(i)(7) for a taxable year ending on or before September 8, 2003, and 
the additional first year depreciation deduction allowable for the 
property was not determined in accordance with paragraph (f)(1)(ii) or 
(iii) of this section, as applicable, the Internal Revenue Service will 
allow any reasonable method of determining the additional first year 
depreciation deduction allowable for the property in the year of the 
transaction that is consistently applied to the property by all parties 
to the transaction.
    (3)(i) Like-kind exchanges and involuntary conversions. If a 
taxpayer did not claim on a federal tax return for a taxable year ending 
on or before September 8, 2003, the additional first year depreciation 
deduction for the remaining carryover basis of qualified property or 50-
percent bonus depreciation property acquired in a transaction described 
in section 1031(a), (b), or (c), or in a transaction to which section 
1033 applies and the taxpayer did not make an election not to deduct the 
additional first year depreciation deduction for the class of property 
applicable to the remaining carryover basis, the Internal Revenue 
Service will treat the taxpayer's method of not claiming the additional 
first year depreciation deduction for the remaining carryover basis as a 
permissible method of accounting and will treat the amount of the 
additional first year depreciation deduction allowable for the remaining 
carryover basis as being equal to zero, provided the taxpayer does not 
claim the additional first year depreciation deduction for the remaining 
carryover basis in accordance with paragraph (g)(4)(ii) of this section.
    (ii) Paragraph (f)(5)(ii)(F)(2) of this section and paragraph 
(f)(5)(v) of this section apply to a like-kind exchange or an 
involuntary conversion of MACRS property and computer software for which 
the time of disposition and the time of replacement both occur after 
February 27, 2004. For a like-kind exchange or an involuntary conversion 
of MACRS property for which the time of disposition, the time of 
replacement, or both occur on or before February 27, 2004, see Sec. 
1.168(i)-6T(k)(2)(ii). For a like-kind exchange or involuntary 
conversion of computer software for which the time of disposition, the 
time of replacement, or both occur on or before February 27, 2004, a 
taxpayer may rely on prior guidance issued by the Internal Revenue 
Service for determining the depreciation deductions of the acquired 
computer software and the exchanged or involuntarily converted

[[Page 1124]]

computer software (for further guidance, see Sec. 1.168(k)-1T(f)(5) 
published in the Federal Register on September 8, 2003 (68 FR 53000)). 
In relying on such guidance, a taxpayer may use any reasonable, 
consistent method of determining depreciation in the year of disposition 
and the year of replacement. The applicability of paragraph (f)(5) of 
this section expires on or before February 26, 2007.
    (4) Change in method of accounting--(i) Special rules for 2000 or 
2001 returns. If a taxpayer did not claim on the Federal tax return for 
the taxable year that included September 11, 2001, any additional first 
year depreciation deduction for a class of property that is qualified 
property and did not make an election not to deduct the additional first 
year depreciation deduction for that class of property, the taxpayer 
should refer to the guidance provided by the Internal Revenue Service 
for the time and manner of claiming the additional first year 
depreciation deduction for the class of property (for further guidance, 
see section 4 of Rev. Proc. 2002-33 (2002-1 C.B. 963), Rev. Proc. 2003-
50 (2003-29 I.R.B. 119), and Sec. 601.601(d)(2)(ii)(b) of this 
chapter).
    (ii) Like-kind exchanges and involuntary conversions. If a taxpayer 
did not claim on a federal tax return for any taxable year ending on or 
before September 8, 2003, the additional first year depreciation 
deduction allowable for the remaining carryover basis of qualified 
property or 50-percent bonus depreciation property acquired in a 
transaction described in section 1031(a), (b), or (c), or in a 
transaction to which section 1033 applies and the taxpayer did not make 
an election not to deduct the additional first year depreciation 
deduction for the class of property applicable to the remaining 
carryover basis, the taxpayer may claim the additional first year 
depreciation deduction allowable for the remaining carryover basis in 
accordance with paragraph (f)(5) of this section either:
    (A) By filing an amended return (or a qualified amended return, if 
applicable (for further guidance, see Rev. Proc. 94-69 (1994-2 C.B. 804) 
and Sec. 601.601(d)(2)(ii)(b) of this chapter)) on or before December 
31, 2003, for the year of replacement and any affected subsequent 
taxable year; or,
    (B) By following the applicable administrative procedures issued 
under Sec. 1.446-1(e)(3)(ii) for obtaining the Commissioner's automatic 
consent to a change in method of accounting (for further guidance, see 
Rev. Proc. 2002-9 (2002-1 C.B. 327) and Sec. 601.601(d)(2)(ii)(b) of 
this chapter).

[T.D. 9091, 68 FR 52992, Sept. 8, 2003; 68 FR 63734, Nov. 10, 2003, as 
amended by T.D. 9115, 69 FR 9546, Mar. 1, 2004; 69 FR 17586, 17587, Apr. 
5, 2004]



Sec. 1.168A-1  Amortization of emergency facilities; general rule.

    (a) A person (including an estate or trust (see section 642(f) and 
Sec. 1.642(f)-1) and a partnership (see section 703 and Sec. 1.703-1)) 
is entitled, by election, to a deduction with respect to the 
amortization of the adjusted basis (for determining gain) of an 
emergency facility, such amortization to be based on a period of 60 
months. As to the adjusted basis of an emergency facility, see Sec. 
1.168A-5. The taxpayer may elect to begin the 60-month amortization 
period with (1) the month following the month in which such facility was 
completed or acquired, or (2) the taxable year succeeding that in which 
such facility was completed or acquired (see Sec. 1.168A-2). The date 
on which, or the month within which, an emergency facility is completed 
or acquired is to be determined upon the facts in the particular case. 
Ordinarily, the taxpayer is in possession of all the facts and, 
therefore, in a position to ascertain such date. A statement of the date 
ascertained by the taxpayer, together with a statement of the pertinent 
facts relied upon, should be filed with the taxpayer's election to take 
amortization deductions with respect to such facility.
    (b) Generally, an amortization deduction will not be allowed with 
respect to an emergency facility for any taxable year unless such 
facility has been certified before the date of filing of the taxpayer's 
income tax return for such taxable year. However, this limitation does 
not apply in the case of a certificate made after August 22, 1957, for 
an emergency facility to provide primary processing for uranium ore or 
uranium concentrate under a program of the

[[Page 1125]]

Atomic Energy Commission for the development of any sources of uranium 
ore or uranium concentrate, if application for such certificate was 
filed either (1) before September 2, 1958, and before the expiration of 
six months after the beginning of construction, reconstruction, 
erection, or installation or the date of acquisition of the facility, or 
(2) after September 1, 1958, and on or before December 2, 1958.
    (c) In general, with respect to each month of the 60-month period 
which falls within the taxable year, the amortization deduction is an 
amount equal to the adjusted basis of the facility at the end of each 
month divided by the number of months (including the particular month 
for which the deduction is computed) remaining in the 60-month period. 
The adjusted basis at the end of any month shall be computed without 
regard to the amortization deduction for such month. The total 
amortization deduction with respect to an emergency facility for a 
particular taxable year is the sum of the amortization deductions 
allowable for each month of the 60-month period which falls within such 
taxable year. The amortization deduction taken for any month is in lieu 
of the deduction for depreciation which would otherwise be allowable 
under section 167. See, however, Sec. 1.168A-6, relating to 
depreciation with respect to any portion of the emergency facility not 
subject to amortization.
    (d) This section may be illustrated by the following examples:

    Example (1). On July 1, 1954, the X Corporation, which makes its 
income tax returns on the calendar year basis, begins the construction 
of an emergency facility which is completed on September 30, 1954, at a 
cost of $240,000. The certificate covers the entire construction. The X 
Corporation elects to take amortization deductions with respect to the 
facility and to begin the 60-month amortization period with October, the 
month following its completion. The adjusted basis of the facility at 
the end of October is $240,000. The allowable amortization deduction 
with respect to such facility for the taxable year 1954 is $12,000, 
computed as follows:

Monthly amortization deductions:
  October: $240,000 divided by 60.............................    $4,000
  November: $236,000 ($240,000 minus $4,000) divided by 59....     4,000
  December: $232,000 ($236,000 minus $4,000) divided by 58....     4,000
                                                               ---------
    Total amortization deduction for 1954.....................    12,000
 

    Example (2). The Y Corporation, which makes its income tax returns 
on the basis of a fiscal year ending November 30, purchases an emergency 
facility (No. 1) on July 29, 1955. On June 15, 1955, it begins the 
construction of an emergency facility (No. 2) which is completed on 
August 2, 1955. The entire acquisition and construction of such 
facilities are covered by the certificate. The Y Corporation elects to 
take amortization deductions with respect to both facilities and to 
begin the 60-month amortization period in each case with the month 
following the month of acquisition or completion. At the end of the 
first month of the amortization period the adjusted basis of facility 
No. 1 is $300,000 and the adjusted basis of facility No. 2 is $54,000. 
In September 1955, facility No. 1 is damaged by fire, as a result of 
which its adjusted basis is properly reduced by $25,370. The allowable 
amortization deduction with respect to such facilities for the taxable 
year ending November 30, 1955, is $21,410, computed as follows:

                             Facility No. 1
Monthly amortization deductions:
  August: $300,000 divided by 60..............................    $5,000
  September: $269,630 ($300,000 minus $5,000 and $25,370)          4,570
   divided by 59..............................................
  October: $265,060 ($269,630 minus $4,570) divided by 58.....     4,570
  November: $260,490 ($265,060 minus $4,570) divided by 57....     4,570
                                                               ---------
      Amortization deduction for 1955.........................    18,710
 
                             Facility No. 2
 
Monthly amortization deductions:
  September: $54,000 divided by 60............................      $900
  October: $53,100 divided by 59..............................       900
  November: $52,200 divided by 58.............................       900
                                                               ---------
    Amortization deduction for 1955...........................     2,700
                                                               =========
    Total amortization deduction for 1955.....................    21,410
 

    Example (3). On June 15, 1954, the Z Corporation, which makes its 
income tax returns on the calendar year basis, completes the 
construction of an emergency facility at a cost of $110,000. In its 
income tax return for 1954, filed on March 15, 1955, the Z Corporation 
elects to take amortization deductions with respect to such facility and 
to begin the 60-month amortization period with July 1954, the month 
following its completion. No certificate with respect to such facility 
is made until April 10, 1955, and therefore no amortization deduction 
with respect to such facility is allowable for any month in the taxable 
year 1954. The Z Corporation is entitled, however, to take a deduction 
for depreciation of such facility for the taxable year 1954, such 
deduction being assumed, for the purposes of this example, to be $2,000. 
Accordingly, the adjusted basis of such facility at the end of January 
1955 (without regard to the amortization deduction for such month)

[[Page 1126]]

is $108,000 ($110,000 minus $2,000). For the taxable year 1955, the Z 
Corporation is, with respect to such facility, entitled to an 
amortization deduction of $24,000, computed as follows:

Monthly amortization deductions:
  January: $108,000 divided by 54.............................    $2,000
  February: $106,000 ($108,000 minus $2,000) divided by 53....     2,000
  March: $104,000 ($106,000 minus $2,000) divided by 52.......     2,000
  For the remaining nine months (similarly computed)..........    18,000
                                                               ---------
    Total amortization deduction for 1955.....................    24,000
 


Since the Z Corporation elected in its return for 1954 to take 
amortization deductions with respect to such facility and to begin the 
60-month amortization period with July 1954, it must compute its 
amortization deductions for the 12 months in the taxable year 1955 on 
the basis of the remaining months of the established 60-month 
amortization period, as indicated in the above computation.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960. 
Redesignated and amended by T.D. 8116, 51 FR 46618, Dec. 24, 1986]



Sec. 1.168A-2  Election of amortization.

    (a) General rule. An election by the taxpayer to take amortization 
deductions with respect to an emergency facility and to begin the 60-
month amortization period either with the month following the month in 
which such facility was completed or acquired, or with the taxable year 
succeeding the taxable year in which such facility was completed or 
acquired, shall be made by a statement to that effect in its return for 
the taxable year in which falls the first month of the 60-month 
amortization period so elected. However, if the facility is described in 
section 168(e)(2)(C) and an application for a certificate is filed 
within the period prescribed by section 9(c) of the Technical Amendments 
Act of 1958 (72 Stat. 1609) and paragraph (b) of Sec. 1.168A-1, the 
election may be made by a statement in an amended income tax return for 
the taxable year in which falls the first month of the 60-month 
amortization period so elected. The statement and amended return in such 
case must be filed not later than 90 days after the date the certificate 
is made or not later than April 4, 1960, whichever is later. Amended 
income tax returns or claims for credit or refund should also be filed 
for other taxable years which are within such amortization period and 
which precede the taxable year in which the election is made. Nothing in 
this paragraph should be construed as extending the time specified in 
section 6511 within which a claim for credit or refund may be filed.
    (b) Election not made, in prescribed manner. If the statement of 
election is not made by the taxpayer as prescribed in paragraph (a) of 
this section, it may, in the discretion of the Commissioner and for good 
cause shown, be made in such manner and form and within such time as may 
be approved by the Commissioner.
    (c) Other requirements and considerations. No method of making such 
election other than those prescribed in this section and corresponding 
sections of prior regulations is permitted. Any statement of election 
should contain a description clearly identifying each emergency facility 
for which an amortization deduction is claimed. A taxpayer which does 
not elect, in the manner prescribed in this section or corresponding 
sections of prior regulations, to take amortization deductions with 
respect to an emergency facility shall not be entitled to such 
deductions.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960. 
Redesignated and amended by T.D. 8116, 51 FR 46618, Dec. 24, 1986]



Sec. 1.168A-3  Election to discontinue amortization.

    (a) If a taxpayer has elected to take amortization deductions with 
respect to an emergency facility, it may, after such election and prior 
to the expiration of the 60-month amortization period, discontinue the 
amortization deductions for the remainder of the 60-month period. An 
election to discontinue the amortization deductions shall be made by a 
notice in writing filed with the district director for the internal 
revenue district in which the return of the taxpayer is required to be 
filed, specifying the month as of the beginning of which the taxpayer 
elects to discontinue such deductions. Such notice shall be filed before 
the beginning of the month specified therein, and shall contain a 
description clearly identifying the emergency facility with respect to 
which the taxpayer elects to

[[Page 1127]]

discontinue the amortization deductions. If the taxpayer so elects to 
discontinue the amortization deductions, it shall not be entitled to any 
further amortization deductions with respect to such facility.
    (b) A taxpayer which thus elects to discontinue amortization 
deductions with respect to an emergency facility is entitled, if such 
facility is depreciable property under section 167 and the regulations 
thereunder, to a deduction for depreciation with respect to such 
facility. The deduction for depreciation shall begin with the first 
month as to which the amortization deduction is not applicable, and 
shall be computed on the adjusted basis of the property as of the 
beginning of such month (see section 1011 and the regulations 
thereunder).
    (c) This section may be illustrated by the following example:

    Example. On July 1, 1954, the X Corporation, which makes its income 
tax returns on the calendar year basis, purchases an emergency facility, 
consisting of land with a building thereon, at a cost of $306,000 of 
which $60,000 is allocable to the land and $246,000 to the building. The 
certificate covers the entire acquisition. The corporation elects to 
take amortization deductions with respect to the facility and to begin 
the 60-month amortization period with the taxable year 1955. 
Depreciation of the building in the amount of $6,000 is deducted and 
allowed for the taxable year 1954. On March 25, 1956, the corporation 
files notice with the district director of its election to discontinue 
the amortization deductions beginning with the month of April 1956. The 
adjusted basis of the facility on January 31, 1955, is $300,000, or the 
cost of the facility ($306,000) less the depreciation allowed for 1954 
($6,000). The amortization deductions for the taxable year 1955 and the 
months of January, February, and March 1956, amount to $75,000, or 
$5,000 per month for 15 months. Since, at the beginning of the 
amortization period (January 1, 1955), the adjusted basis of the land 
($60,000) is one-fifth of the adjusted basis of the entire facility 
($300,000) and since there are no adjustments to basis other than on 
account of amortization during the period, the adjusted basis of the 
land should be reduced by $15,000, or one-fifth of the entire 
amortization deduction, and the adjusted basis of the building should be 
reduced by $60,000, or four-fifths of the entire amortization deduction. 
Accordingly, the adjusted basis of the facility as of April 1, 1956, is 
$225,000, of which $180,000 is allocable to the building for the purpose 
of depreciation deductions under section 167, and $45,000 is allocable 
to the land.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960. 
Redesignated by T.D. 8116, 51 FR 46619, Dec. 24, 1986]



Sec. 1.168A-4  Definitions.

    As used in the regulations under section 168, the term--
    (a) ``Certifying authority'' means the certifying authority 
designated by the President by Executive order.
    (b) ``Emergency facility'' means any facility, land, building, 
machinery, or equipment, or any part thereof, the acquisition of which 
occurred after December 31, 1949, or the construction, reconstruction, 
erection, or installation of which was completed after such date, and 
with respect to which a certificate under section 168(e) has been made. 
In the case of an application for a certificate under section 168(e) 
which is filed after March 23, 1951, only the part of any such facility 
which is constructed, reconstructed, erected, or installed by any person 
not earlier than six months prior to the filing of such application, and 
which is certified in accordance with section 168(e), shall be deemed to 
be an emergency facility, notwithstanding that the other part of such 
facility was constructed, reconstructed, erected, or installed earlier 
than six months prior to the filing of such application. However, if the 
facility is one described in section 168(e)(2)(C) and the application 
was filed after September 1, 1958, and on or before December 2, 1958, 
the preceding sentence shall not apply. The term ``emergency facility,'' 
as so defined, may include, among other things, improvements of land, 
such as the construction of roads, bridges, and airstrips, and the 
dredging of channels.
    (c) ``Emergency period'' means the period beginning on January 1, 
1950, and ending on the date on which the President proclaims that the 
utilization of a substantial portion of the certified emergency 
facilities is no longer required in the interest of national defense.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960. 
Redesignated by T.D. 8116, 51 FR 46619, Dec. 24, 1986]

[[Page 1128]]



Sec. 1.168A-5  Adjusted basis of emergency facility.

    (a) In general. (1) The adjusted basis of an emergency facility for 
the purpose of computing the amortization deduction may differ from what 
would otherwise constitute the adjusted basis of such emergency facility 
in that it shall be the adjusted basis for determining gain (see Part II 
(section 1011 and following), Subchapter 0, Chapter 1 of the Code) and 
in that it may be only a portion of what would otherwise constitute the 
adjusted basis. It will be only a portion of such other adjusted basis 
if only a portion of the basis (unadjusted) is attributable to certified 
construction, reconstruction, erection, installation, or acquisition 
taking place after December 31, 1949. Also, it will be only a portion of 
what would otherwise constitute the adjusted basis of the emergency 
facility if only a portion of the basis (unadjusted) is certified as 
attributable to defense purposes or, in the case of a certification 
after August 22, 1957, if only a portion of the basis (unadjusted) is 
certified as attributable to the national defense program. It is 
therefore necessary first to determine the unadjusted basis of the 
emergency facility from which the adjusted basis for amortization 
purposes is derived.
    (2) The unadjusted basis for amortization purposes is the same as 
the unadjusted basis otherwise determined only when the entire 
construction, reconstruction, erection, installation, or acquisition 
takes place after December 31, 1949, and is certified in its entirety by 
the certifying authority.
    (3) In cases in which only a portion of the construction, 
reconstruction, erection, installation, or acquisition takes place after 
December 31, 1949, and that portion is certified in its entirety by the 
certifying authority, the unadjusted basis for the purpose of 
amortization is so much of the entire unadjusted basis as is 
attributable to the certified construction, reconstruction, erection, 
installation, or acquisition which takes place after December 31, 1949. 
For example, the X Corporation begins the construction of a facility on 
November 15, 1949, and such facility is completed on April 1, 1952, at a 
cost of $5,000,000, of which $4,600,000 is attributable to construction 
after December 31, 1949. The entire construction after December 31, 
1949, is certified by the certifying authority. The unadjusted basis of 
the emergency facility for amortization purposes is therefore 
$4,600,000. For depreciation of the remaining portion ($400,000) of the 
cost see Sec. 1.168A-6.
    (4) If the certifying authority certifies only a portion of the 
construction, reconstruction, erection, installation, or acquisition of 
property which takes place after December 31, 1949, the unadjusted basis 
for amortization purposes is limited to such portion so certified. 
Assuming the same facts as in the example in subparagraph (3) of this 
paragraph, except that only 50 percent of the construction, 
reconstruction, erection, installation, or acquisition after December 
31, 1949, is certified, the unadjusted basis for amortization purposes 
is 50 percent of $4,600,000, or $2,300,000.
    (5) The adjusted basis of an emergency facility for amortization 
purposes is the unadjusted basis for amortization purposes less the 
adjustments properly applicable thereto. Such adjustments are those 
specified in sections 1016 and 1017, except that no adjustments are to 
be taken into account which increase the adjusted basis. (See paragraph 
(b) of this section.) If the taxpayer constructs, reconstructs, erects, 
installs, or acquires an emergency facility pursuant to a cost 
reimbursement contract with an obligation for reimbursement by the 
United States of all or a part of the cost of such facility, the 
unadjusted basis of such facility for amortization purposes shall not 
include that part of the cost for which the taxpayer is entitled to 
reimbursement, and the amount received as reimbursement shall be treated 
as a capital receipt. However, amounts received by a taxpayer which 
represent in fact compensation by reason of termination of a government 
contract or payment for articles under such a contract, though 
denominated reimbursements for all or a part of the cost of an emergency 
facility, are not to be treated as capital receipts but are to be taken 
into account in computing

[[Page 1129]]

income, and are therefore not to be applied in reduction of the basis of 
such facility.
    (6) The following examples will illustrate the computation of the 
adjusted basis of an emergency facility for amortization purposes:

    Example (1). The X Corporation completes an emergency facility on 
July 1, 1954, the entire unadjusted basis of which is $500,000, and the 
unadjusted basis of which for the purpose of amortization is $300,000. 
The X Corporation elects to begin amortization as of January 1, 1955. 
The only adjustment to basis for the period July 1, 1954, to January 31, 
1955, other than depreciation or amortization for January 1955, is 
$5,000 for depreciation for the last six months of 1954. The adjusted 
basis for the purpose of amortization is therefore $300,000 less $3,000 
(300,000/500,000x$5,000), or $297,000.
    Example (2). On July 31, 1956, the Y Corporation has an emergency 
facility (a building) which was completed on July 1, 1952, the entire 
basis of which is $500,000 and the unadjusted basis of which for the 
purpose of amortization is $300,000. The corporation elected to begin 
amortization as of January 1, 1953, at which time it was entitled to 
$5,000 depreciation for the last six months of 1952. On July 1, 1956, 
the facility was damaged by fire, as the result of which its adjusted 
basis is properly reduced by $200,000. The adjusted basis of the 
emergency facility as of July 1956 for the purpose of amortization and 
depreciation, and the adjusted basis for other purposes, are $23,849.18, 
$49,250.82, and $73,100.00, respectively, computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                                        For             For          For other
                                                                   amortization    depreciation      purposes
----------------------------------------------------------------------------------------------------------------
Unadjusted basis................................................     $300,000.00     $200,000.00        $500,000
Less depreciation to Jan. 1, 1953...............................        3,000.00        2,000.00           5,000
                                                                 -----------------------------------------------
  Adjusted basis January 1953...................................      297,000.00      198,000.00         495,000
Less amortization for 42 months.................................      207,900.00  ..............         207,900
Less depreciation for 42 months.................................  ..............       14,000.00          14,000
                                                                 -----------------------------------------------
  Adjusted basis at time of fire................................       89,100.00      184,000.00         273,100
Less fire loss (apportioned as explained below).................       65,250.82      134,749.18         200,000
                                                                 -----------------------------------------------
  Adjusted basis after fire loss................................       23,849.18       49,250.82          73,100
----------------------------------------------------------------------------------------------------------------


The $200,000 fire loss is applied against the adjusted basis for the 
purpose of amortization and the adjusted basis for the purpose of 
depreciation in the proportion that each such adjusted basis at the time 
of the fire bears to their sum, i.e., 89,100/273,100x$200,000 or 
$65,250.82, against the amortization basis, and 184,000/
273,100x$200,000, or $134,749.18 against the depreciation basis.

    (b) Capital additions. (1) If, after the completion or acquisition 
of an emergency facility which has been certified by the certifying 
authority, further expenditures are made for construction, 
reconstruction, erection, installation, or acquisition attributable to 
such facility but not covered by such certification, such expenditures 
shall not be added to the adjusted basis of the emergency facility for 
amortization purposes under such certification. If such further 
expenditures are separately certified in accordance with the provisions 
of section 168(e) (1) or (2) and this section, they are treated as 
certified expenditures in connection with a new and separate emergency 
facility and, if proper election is made, will be taken into account in 
computing the adjusted basis of such new and separate emergency facility 
for the purpose of amortization.
    (2) The application of subparagraph (1) of this paragraph may be 
illustrated by the following example:

    Example. On March 1, 1954, the certifying authority certifies as an 
emergency facility a heating plant proposed to be constructed by the Z 
Corporation. Such facility is completed on July 1, 1954. The Z 
Corporation, on August 1, 1954, begins the installation in the plant of 
an additional boiler, which is not included in the certification for the 
plant but is certified as a new and separate emergency facility. For 
amortization purposes, the adjusted basis of the heating plant is 
determined without including the cost of the additional boiler. Such 
cost is taken into account in computing the adjusted basis of the new 
and separate emergency facility (the boiler), as to which the taxpayer 
has a separate election for amortization purposes and a separate 
amortization period.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960. 
Redesignated and amended by T.D. 8116, 51 FR 46619, Dec. 24, 1986]

[[Page 1130]]



Sec. 1.168A-6  Depreciation of portion of emergency facility not 
subject to amortization.

    (a) The rule that an amortization deduction with respect to an 
emergency facility is in lieu of any deduction for depreciation which 
would otherwise be allowable under section 167 is subject to the 
exception provided in section 168(f). Under this exception, if the 
property constituting such facility is depreciable property under 
section 167 and the regulations thereunder and if the adjusted basis of 
such facility as computed under section 1011 for purposes other than the 
amortization deductions is in excess of the adjusted basis computed for 
the purpose of the amortization deductions, then the excess shall be 
charged off over the useful life of the facility and recovered through 
depreciation deductions. Thus, if the construction of an emergency 
facility is begun on or before December 31, 1949, and completed after 
such date, no amortization deductions are allowable with respect to the 
amount attributable to such construction on or before such date (see 
Sec. 1.168A-5). However, if the property constituting such facility is 
depreciable property under section 167 and the regulations thereunder, 
then the depreciation deduction provided by such section and regulations 
is allowable with respect to the amount attributable to such 
construction on or before December 31, 1949.
    (b) Similarly, if only a portion of the construction, 
reconstruction, erection, installation, or acquisition after December 
31, 1949, of an emergency facility has been certified by the certifying 
authority, and if such facility is depreciable property under section 
167 and the regulations thereunder, then the depreciation deduction 
provided by such section and regulations is allowable with respect to 
the portion which has not been so certified.
    (c) For illustration of the treatment of a depreciable portion of an 
emergency facility, see example (2) in paragraph (a)(6) of Sec. 1.168A-
5.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960. 
Redesignated and amended by T.D. 8116, 51 FR 46619, Dec. 24, 1986]



Sec. 1.168A-7  Payment by United States of unamortized cost of facility.

    (a) Section 168(g) contemplates that certain payments may be made by 
the United States to a taxpayer as compensation for the unamortized cost 
of an emergency facility. If any such payment is properly includible in 
gross income and has been certified, as provided in section 168(g), as 
having been paid under the circumstances described therein, a taxpayer 
which is recovering the adjusted basis of an emergency facility through 
amortization rather than depreciation may elect to take an amount equal 
to such payment as an amortization deduction with respect to such 
facility for the month in which such payment is so includible. Such 
amortization deduction shall be in lieu of the amortization deduction 
otherwise allowable with respect to such facility for such month, but it 
shall not in any case exceed the adjusted basis of such facility (see 
Sec. 1.168A-5) as of the end of such month (computed without regard to 
any amortization deduction for such month). The election referred to in 
this paragraph shall be made in the return for the taxable year in which 
the amount of such payment is includible in gross income.
    (b) If a taxpayer is recovering the adjusted basis of an emergency 
facility through depreciation rather than amortization, the depreciation 
deduction allowable under section 167 for the month in which the amount 
of any such payment is includible in gross income shall, at the 
taxpayer's election, be increased by such amount; but the total 
deduction with respect to the certified portion of such facility shall 
not in any case exceed the adjusted basis of such facility (computed as 
provided in section 168(e) and Sec. 1.168A-5 for amortization purposes) 
as of the end of such month (computed without regard to any amount 
allowable for such month under section 167 or 168(g)(2)). The election 
referred to in this paragraph shall be made in the return for the 
taxable year in which the amount of such payment is includible in gross 
income.
    (c) This section may be illustrated by the following examples:

    Example (1). On January 31, 1954, the X Corporation purchases an 
emergency facility at a cost of $600,000. The certificate covers the

[[Page 1131]]

entire acquisition. The X Corporation elects to take amortization 
deductions with respect to such facility and to begin the 60-month 
amortization period with February 1954, the month following the month of 
acquisition. On July 15, 1955, as a result of the cancellation of 
certain contracts with the X Corporation, the United States makes a 
payment of $300,000 to the corporation as compensation for the 
unamortized cost of such facility. The $300,000 payment is includible in 
the X Corporation's gross income for July 1955. The adjusted basis of 
such facility for amortization purposes as of the end of July 1955, 
computed without regard to any amortization deduction for such month, is 
$430,000. Accordingly, the corporation is entitled to take an 
amortization deduction of $300,000 for such month, in lieu of the 
$10,000 amortization deduction which is otherwise allowable.
    Example (2). On November 30, 1954, the Y Corporation purchases an 
emergency facility, consisting of land with a building thereon, at a 
cost of $500,000, of which $200,000 is allocable to the land and 
$300,000 to the building. The certificate covers the entire acquisition. 
The Y Corporation does not elect to take amortization deductions with 
respect to such facility, but is entitled to a depreciation deduction 
with respect to the building at the rate of 3 percent per annum, or $750 
per month. On August 12, 1956, as a result of cancellation of certain 
contracts, the United States makes a payment of $400,000 to the 
corporation as compensation for the unrecovered cost of such facility. 
The $400,000 is includible in the Y Corporation's gross income for 
August 1956. The adjusted basis of the facility as of the end of August 
1956, computed without regard to depreciation for such month, is 
$485,000, of which amount $200,000 is allocable to the land and $285,000 
to the building. Accordingly, the corporation is entitled to increase 
the $750 depreciation deduction for August 1956 by the full amount of 
the $400,000 payment.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960. 
Redesignated and amended by T.D. 8116, 51 FR 46619, Dec. 24, 1986]



Sec. 1.169-1  Amortization of pollution control facilities.

    (a) Allowance of deduction--(1) In general. Under section 169(a), 
every person, at his election, shall be entitled to a deduction with 
respect to the amortization of the amortizable basis (as defined in 
Sec. 1.169-3) of any certified pollution control facility (as defined 
in Sec. 1.169-2), based on a period of 60 months. Under section 169(b) 
and paragraph (a) of Sec. 1.169-4, the taxpayer may further elect to 
begin such 60-month period either with the month following the month in 
which the facility is completed or acquired or with the first month of 
the taxable year succeeding the taxable year in which such facility is 
completed or acquired. Under section 169(c), a taxpayer who has elected 
under section 169(b) to take the amortization deduction provided by 
section 169(a) may, at any time after making such election and prior to 
the expiration of the 60-month amortization period, elect to discontinue 
the amortization deduction for the remainder of the 60-month period in 
the manner prescribed in paragraph (b)(1) of Sec. 1.169-4. In addition, 
if on or before May 18, 1971, an election under section 169(a) has been 
made, consent is hereby given to revoke such election without the 
consent of the Commissioner in the manner prescribed in (b)(2) of Sec. 
1.169-4.
    (2) Amount of deduction. With respect to each month of such 60-month 
period which falls within the taxable year, the amortization deduction 
shall be an amount equal to the amortizable basis of the certified 
pollution control facility at the end of such month divided by the 
number of months (including the month for which the deduction is 
computed) remaining in such 60-month period. The amortizable basis at 
the end of any month shall be computed without regard to the 
amortization deduction for such month. The total amortization deduction 
with respect to a certified pollution control facility for a taxable 
year is the sum of the amortization deductions allowable for each month 
of the 60-month period which falls within such taxable year. If a 
certified pollution control facility is sold or exchanged or otherwise 
disposed of during 1 month, the amortization deduction (if any) 
allowable to the original holder in respect of such month shall be that 
portion of the amount to which such person would be entitled for a full 
month which the number of days in such month during which the facility 
was held by such person bears to the total number of days in such month.
    (3) Effect on other deductions. (i) The amortization deduction 
provided by section 169 with respect to any month

[[Page 1132]]

shall be in lieu of the depreciation deduction which would otherwise be 
allowable under section 167 or a deduction in lieu of depreciation which 
would otherwise be allowable under paragraph (b) of Sec. 1.162-11 for 
such month.
    (ii) If the adjusted basis of such facility as computed under 
section 1011 for purposes other than the amortization deduction provided 
by section 169 is in excess of the amortizable basis, as computed under 
Sec. 1.169-3, such excess shall be recovered through depreciation 
deductions under the rules of section 167. See section 169(g).
    (iii) See section 179 and paragraph (e)(1)(ii) of Sec. 1.179-1 and 
paragraph (b)(2) of Sec. 1.169-3 for additional first-year depreciation 
in respect of a certified pollution control facility.
    (4) [Reserved]
    (5) Special rules. (i) In the case of a certified pollution control 
facility held by one person for life with the remainder to another 
person, the amortization deduction under section 169(a) shall be 
computed as if the life tenant were the absolute owner of the property 
and shall be allowable to the life tenant during his life.
    (ii) If the assets of a corporation which has elected to take the 
amortization deduction under section 169(a) are acquired by another 
corporation in a transaction to which section 381 (relating to 
carryovers in certain corporate acquisitions) applies, the acquiring 
corporation is to be treated as if it were the distributor or transferor 
corporation for purposes of this section.
    (iii) For the right of estates and trusts to amortize pollution 
control facilities see section 642(f) and Sec. 1.642 (f)-1. For the 
allowance of the amortization deduction in the case of pollution control 
facilities of partnerships, see section 703 and Sec. 1.703-1.
    (6) Depreciation subsequent to discontinuance or in the case of 
revocation of amortization. A taxpayer which elects in the manner 
prescribed under paragraph (b) (1) of Sec. 1.169-4 to discontinue 
amortization deductions or under paragraph (b) (2) of Sec. 1.169-4 to 
revoke an election under section 169(a) with respect to a certified 
pollution control facility is entitled, if such facility is of a 
character subject to the allowance for depreciation provided in section 
167, to a deduction for depreciation (to the extent allowable) with 
respect to such facility. In the case of an election to discontinue an 
amortization deduction, the deduction for depreciation shall begin with 
the first month as to which such amortization deduction is not 
applicable and shall be computed on the adjusted basis of the property 
as of the beginning of such month (see section 1011 and the regulations 
thereunder). Such depreciation deduction shall be based upon the 
remaining portion of the period authorized under section 167 for the 
facility as determined, as of the first day of the first month as of 
which the amortization deduction is not applicable. If the taxpayer so 
elects to discontinue the amortization deduction under section 169(a), 
such taxpayer shall not be entitled to any further amortization 
deduction under this section and section 169(a) with respect to such 
pollution control facility. In the case of a revocation of an election 
under section 169(a), the deduction for depreciation shall begin as of 
the time such depreciation deduction would have been taken but for the 
election under section 169(a). See paragraph (b)(2) of Sec. 1.169-4 for 
rules as to filing amended returns for years for which amortization 
deductions have been taken.
    (7) Definitions. Except as otherwise provided in Sec. 1.169-2, all 
terms used in section 169 and the regulations thereunder shall have the 
meaning provided by this section and Sec. Sec. 1.169-2 through 1.169-4.
    (b) Examples. This section may be illustrated by the following 
examples:

    Example (1). On September 30, 1970, the X Corporation, which uses 
the calendar year as its taxable year, completes the installation of a 
facility all of which qualifies as a certified pollution control 
facility within the meaning of paragraph (a) of Sec. 1.169-2. The cost 
of the facility is $120,000 and the period referred to in paragraph 
(a)(6) of Sec. 1.169-2 is 10 years in accordance with the rules set 
forth in paragraph (a) of Sec. 1.169-4, on its income tax return filed 
for 1970, X elects to take amortization deductions under section 169(a) 
with respect to the facility and to begin the 60-month amortization 
period with October 1970, the month following the month in which it was 
completed. The amortizable basis at the end of October 1970 (determined

[[Page 1133]]

without regard to the amortization deduction under section 169(a) for 
that month) is $120,000. The allowable amortization deduction with 
respect to such facility for the taxable year 1970 is $6,000, computed 
as follows:

Monthly amortization deductions:
  October: $120,000 divided by 60.............................    $2,000
  November: $118,000 (that is, $120,000 minus $2,000) divided      2,000
   by 59......................................................
  December: $116,000 (that is, $118,000 minus $2,000) divided      2,000
   by 58......................................................
                                                               ---------
      Total amortization deduction for 1970...................     6,000
 

    Example (2). Assume the same facts as in example (1). Assume further 
that on May 20, 1972, X properly files notice of its election to 
discontinue the amortization deductions with the month of June 1972. The 
adjusted basis of the facility as of June 1, 1972, is $80,000, computed 
as follows:

Yearly amortization deductions:
  1970 (as computed in example (1))...........................    $6,000
  1971 (computed in accordance with example (1))..............    24,000
  1972 (for the first 5 months of 1972 computed in accordance     10,000
   with example (1))..........................................
                                                               ---------
    Total amortization deductions for 20 months...............    40,000
                                                               ---------
Adjusted basis as beginning of amortization period............   120,000
Less: Amortization deductions.................................    40,000
                                                               ---------
Adjusted basis as of June 1, 1972.............................    80,000
                                                               ---------
 


Beginning as of June 1, 1972, the deduction for depreciation under 
section 167 is allowable with respect to the property on its adjusted 
basis of $80,000.

[T.D. 7116, 36 FR 9012, May 18, 1971; 36 FR 9770, May 28, 1971, as 
amended by T.D. 7203, 37 FR 17133, Aug. 25, 1972]



Sec. 1.169-2  Definitions.

    (a) Certified pollution control facility--(1) In general. Under 
section 169 (d), the term ``certified pollution control facility'' means 
a facility which--
    (i) The Federal certifying authority certifies, in accordance with 
the rules prescribed in paragraph (c) of this section, is a ``treatment 
facility'' described in subparagraph (2) of this paragraph, and
    (ii) Is ``a new identifiable facility'' (as defined in paragraph (b) 
of this section).

For profitmaking abatement works limitation, see paragraph (d) of this 
section.
    (2) Treatment facility. For purposes of subparagraph (1)(i) of this 
paragraph, a ``treatment facility'' is a facility which (i) is used to 
abate or control water or atmospheric pollution or contamination by 
removing, altering, disposing, or storing of pollutants, contaminants, 
wastes, or heat and (ii) is used in connection with a plant or other 
property in operation before January 1, 1969. Determinations under 
subdivision (i) of this subparagraph shall be made solely by the Federal 
certifying authority. See subparagraph (3) of this paragraph. For 
meaning of the phrases ``plant or other property'' and ``in operation 
before January 1, 1969,'' see subparagraphs (4) and (5), respectively, 
of this paragraph.
    (3) Facilities performing multiple functions or used in connection 
with several plants, etc. (i) If a facility is designed to perform or 
does perform a function in addition to abating or controlling water or 
atmospheric pollution or contamination by removing, altering, disposing 
or storing pollutants, contaminants, wastes, or heat, such facility 
shall be a treatment facility only with respect to that part of the cost 
thereof which is certified by the Federal certifying authority as 
attributable to abating of controlling water or atmospheric pollution or 
contamination. For example, if a machine which performs a function in 
addition to abating water pollution is installed at a cost of $100,000 
in, and is used only in connection with, a plant which was in operation 
before January 1, 1969, and if the Federal certifying authority 
certifies that $30,000 of the cost of such machine is allocable to its 
function of abating water pollution, such $30,000 will be deemed to be 
the adjusted basis for purposes of determining gain for purposes of 
paragraph (a) of Sec. 1.169-3.
    (ii) If a facility is used in connection with more than one plant or 
other property, and at least one such plant or other property was not in 
operation before January 1, 1969, such facility shall be a treatment 
facility only to the extent of that part of the cost thereof certified 
by the Federal certifying authority as attributable to abating or 
controlling water or atmospheric pollution in connection with plants or 
other property in operation before January 1, 1969. For example, if a 
machine is constructed after December 31, 1968, at a cost of $100,000 
and is used in connection with a number of plants only some

[[Page 1134]]

of which were in operation before January 1, 1969, and if the Federal 
certifying authority certifies that $20,000 of the cost of such machine 
is allocable to its function of abating or controlling water pollution 
in connection with the plants or other property in operation before 
January 1, 1969, such $20,000 will be deemed to be the adjusted basis 
for purposes of determining gain for purposes of paragraph (a) of Sec. 
1.169-3. In a case in which the Federal certifying authority certifies 
the percentage of a facility which is used in connection with plants or 
other property in operation before January 1, 1969, the adjusted basis 
for the purposes of determining gain for purposes of paragraph (a) of 
Sec. 1.169-3 of the portion of the facility so used shall be the 
adjusted basis for determining gain of the entire facility multiplied by 
such percentage.
    (4) Plant or other property. As used in subparagraph (2) of this 
paragraph, the phrase ``plant or other property'' means any tangible 
property whether or not such property is used in the trade or business 
or held for the production of income. Such term includes, for example, a 
papermill, a motor vehicle, or a furnace in an apartment house.
    (5) In operation before January 1, 1969. (i) For purposes of 
subparagraph (2) of this paragraph and section 169 (d), a plant or other 
property will be considered to be in operation before January 1, 1969, 
if prior to that date such plant or other property was actually 
performing the function for which it was constructed or acquired. For 
example, a papermill which is completed in July 1968, but which is not 
actually used to produce paper until 1969 would not be considered to be 
in operation before January 1, 1969. The fact that such plant or other 
property was only operating at partial capacity prior to January 1, 
1969, or was being used as a standby facility prior to such date, shall 
not prevent its being considered to be in operation before such date.
    (ii)(a) A piece of machinery which replaces one which was in 
operation prior to January 1, 1969, and which was a part of the 
manufacturing operation carried on by the plant but which does not 
substantially increase the capacity of the plant will be considered to 
be in operation prior to January 1, 1969. However, an additional machine 
that is added to a plant which was in operation before January 1, 1969, 
and which represents a substantial increase in the plant's capacity will 
not be considered to have been in operation before such date. There 
shall be deemed to be a substantial increase in the capacity of a plant 
or other property as of the time its capacity exceeds by more than 20 
percent its capacity on December 31, 1968.
    (b) In addition, if the total replacements of equipment in any 
single taxable year beginning after December 31, 1968, represents the 
replacement of a substantial portion of a manufacturing plant which had 
been in operation before such date, such replacement shall be considered 
to result in a new plant which was not in operation before such date. 
Thus, if a substantial portion of a plant which was in existence before 
January 1, 1969, is subsequently destroyed by fire and such substantial 
portion is replaced in a taxable year beginning after that date, such 
replacement property shall not be considered to have been in operation 
before January 1, 1969. The replacement of a substantial portion of a 
plant or other property shall be deemed to have occurred if, during a 
single taxable year, the taxpayer replaces manufacturing or production 
facilities or equipment which comprises such plant or other property and 
which has an adjusted basis (determined without regard to the 
adjustments provided in section 1016(a) (2) and (3)) in excess of 20 
percent of the adjusted basis (so determined) of such plant or other 
property determined as of the first day of such taxable year.
    (6) Useful life. For purposes of section 169 and the regulations 
thereunder, the terms ``useful life'' and ``actual useful life'' shall 
mean the shortest period authorized under section 167 and the 
regulations thereunder if an election were not made under section 169.
    (b) New identifiable facility--(1) In general. For purposes of 
paragraph (a)(1)(ii) of this section, the term ``new identifiable 
facility'' includes only tangible property (not including a building and 
its structural components referred to

[[Page 1135]]

in subparagraph (2)(i) of this paragraph, other than a building and its 
structural components which under subparagraph (2)(ii) of this paragraph 
is exclusively a treatment facility) which--
    (i) Is of a character subject to the allowance for depreciation 
provided in section 167,
    (ii)(a) Is property the construction, reconstruction, or erection 
(as defined in subparagraph (2)(iii) of this paragraph) of which is 
completed by the taxpayer after December 31, 1968, or
    (b) Is property acquired by the taxpayer after December 31, 1968, if 
the original use of the property commences with the taxpayer and 
commences after such date (see subparagraph (2)(iii) of this paragraph), 
and
    (iii) Is placed in service (as defined in subparagraph (2)(v) of 
this paragraph) prior to January 1, 1975.
    (2) Meaning of terms. (i) For purposes of subparagraph (1) of this 
paragraph, the terms ``building'' and ``structural component'' shall be 
construed in a manner consistent with the principles set forth in 
paragraph (e) of Sec. 1.48-1. Thus, for example, the following rules 
are applicable:
    (a) The term ``building'' generally means any structure or edifice 
enclosing a space within its walls, and usually covered by a roof, the 
purpose of which is, for example, to provide shelter or housing, or to 
provide working, office, parking, display, or sales space. The term 
includes, for example, structures such as apartment houses, factory and 
office buildings, warehouses, barns, garages, railway or bus stations, 
and stores. Such term includes any such structure constructed by, or 
for, a lessee even if such structure must be removed, or ownership of 
such structure reverts to the lessor, at the termination of the lease. 
Such term does not include (1) a structure which is essentially an item 
of machinery or equipment, or (2) an enclosure which is so closely 
combined with the machinery or equipment which it supports, houses, or 
serves that it must be replaced, retired, or abandoned contemporaneously 
with such machinery or equipment, and which is depreciated over the life 
of such machinery or equipment. Thus, the term ``building'' does not 
include such structures as oil and gas storage tanks, grain storage 
bins, silos, fractioning towers, blast furnaces, coke ovens, brick 
kilns, and coal tipples.
    (b) The term ``structural components'' includes, for example, 
chimneys, and other components relating to the operating or maintenance 
of a building. However, the term ``structural components'' does not 
include machinery or a device which serves no function other than the 
abatement or control of water or atmospheric pollution.
    (ii) For purposes of subparagraph (1) of this paragraph, a building 
and its structural components will be considered to be exclusively a 
treatment facility if its only function is the abatement or control of 
air or water pollution. However, the incidental recovery of profits from 
wastes or otherwise shall not be deemed to be a function other than the 
abatement or control of air or water pollution. A building and its 
structural components which serve no function other than the treatment 
of wastes will be considered to be exclusively a treatment facility even 
if it contains areas for employees to operate the treatment facility, 
rest rooms for such workers, and an office for the management of such 
treatment facility. However, for example, if a portion of a building is 
used for the treatment of sewage and another portion of the building is 
used for the manufacture of machinery, the building is not exclusively a 
treatment facility. The Federal certifying authority will not certify as 
to what is a building and its structural components within the meaning 
of subdivision (i) of this subparagraph.
    (iii) For purposes of subparagraph (1)(ii) (a) and (b) of this 
paragraph (relating to construction, reconstruction, or erection after 
December 31, 1968, and original use after December 31, 1968) and 
paragraph (b)(1) of Sec. 1.169-3 (relating to definition of amortizable 
basis), the principles set forth in paragraph (a) (1) and (2) of Sec. 
1.167(c)-1 and in paragraphs (b) and (c) of Sec. 1.48-2 shall be 
applied. Thus, for example, the following rules are applicable:
    (a) Property is considered as constructed, reconstructed, or erected 
by

[[Page 1136]]

the taxpayer if the work is done for him in accordance with his 
specifications.
    (b) The portion of the basis of property attributable to 
construction, reconstruction, or erection after December 31, 1968, 
consists of all costs of construction, reconstruction, or erection 
allocable to the period after December 31, 1968, including the cost or 
other basis of materials entering into such work (but not including, in 
the case of reconstruction of property, the adjusted basis of the 
property as of the time such reconstruction is commenced).
    (c) It is not necessary that materials entering into construction, 
reconstruction or erection be acquired after December 31, 1968, or that 
they be new in use.
    (d) If construction or erection by the taxpayer began after December 
31, 1968, the entire cost or other basis of such construction or 
erection may be taken into account for purposes of determining the 
amortizable basis under section 169.
    (e) Construction, reconstruction, or erection by the taxpayer begins 
when physical work is started on such construction, reconstruction, or 
erection.
    (f) Property shall be deemed to be acquired when reduced to physical 
possession or control.
    (g) The term ``original use'' means the first use to which the 
property is put, whether or not such use corresponds to the use of such 
property by the taxpayer. For example, a reconditioned or rebuilt 
machine acquired by the taxpayer after December 31, 1968, for pollution 
control purposes will not be treated as being put to original use by the 
taxpayer regardless of whether it was used for purposes other than 
pollution control by its previous owner. Whether property is 
reconditioned or rebuilt property is a question of fact. Property will 
not be treated as reconditioned or rebuilt merely because it contains 
some used parts.
    (iv) For purposes of subparagraph (1)(iii) of this paragraph 
(relating to property placed in service prior to January 1, 1975), the 
principles set forth in paragraph (d) of Sec. 1.46-3 are applicable. 
Thus, property shall be considered placed in service in the earlier of 
the following taxable years:
    (a) The taxable year in which, under the taxpayer's depreciation 
practice, the period for depreciation with respect to such property 
begins or would have begun; or
    (b) The taxable year in which the property is placed in a condition 
or state of readiness and availability for the abatement or control of 
water or atmospheric pollution.

Thus, if property meets the conditions of (b) of this subdivision in a 
taxable year, it shall be considered placed in service in such year 
notwithstanding that the period for depreciation with respect to such 
property begins or would have begun in a succeeding taxable year 
because, for example, under the taxpayer's depreciation practice such 
property is or would have been accounted for in a multiple asset account 
and depreciation is or would have been computed under an ``averaging 
convention'' (Sec. 1.167(a)-10), or depreciation with respect to such 
property would have been computed under the completed contract method, 
the unit of production method, or the retirement method. In the case of 
property acquired by a taxpayer for use in his trade or business (or in 
the production of income), property shall be considered in a condition 
or state of readiness and availability for the abatement or control of 
water or atmospheric pollution if, for example, equipment is acquired 
for the abatement or control of water or atmospheric pollution and is 
operational but is undergoing testing to eliminate any defects. However, 
materials and parts acquired to be used in the construction of an item 
of equipment shall not be considered in a condition or state of 
readiness and availability for the abatement or control of water or 
atmospheric pollution.
    (c) Certification--(1) In general. For purposes of paragraph (a)(1) 
of this section, a facility is certified in accordance with the rules 
prescribed in this paragraph if--
    (i) The State certifying authority (as defined in subparagraph (2) 
of this paragraph) having jurisdiction with respect to such facility has 
certified to

[[Page 1137]]

the Federal certifying authority (as defined in subparagraph (3) of this 
paragraph) that the facility was constructed, reconstructed, erected, or 
acquired in conformity with the State program or requirements for the 
abatement or control of water or atmospheric pollution or contamination 
applicable at the time of such certification, and
    (ii) The Federal certifying authority has certified such facility to 
the Secretary or his delegate as (a) being in compliance with the 
applicable regulations of Federal agencies (such as, for example, the 
Atomic Energy Commission's regulations pertaining to radiological 
discharge (10 CFR Part 20)) and (b) being in furtherance of the general 
policy of the United States for cooperation with the States in the 
prevention and abatement of water pollution under the Federal Water 
Pollution Control Act, as amended (33 U.S.C. 1151-1175) or in the 
prevention and abatement of atmospheric pollution and contamination 
under the Clean Air Act, as amended (42 U.S.C. 1857 et seq.).
    (2) State certifying authority. The term ``state certifying 
authority'' means--
    (i) In the case of water pollution, the State water pollution 
control agency as defined in section 23(a) of the Federal Water 
Pollution Control Act, as amended (33 U.S.C. 1173(a)),
    (ii) In the case of air pollution, the air pollution control agency 
designated pursuant to section 302(b)(1) of the Clean Air Act, as 
amended (42 U.S.C. 1857h(b)), and
    (iii) Any interstate agency authorized to act in place of a 
certifying authority of a State. See section 23(a) of the Federal Water 
Pollution Control Act, as amended (33 U.S.C. 1173(b)) and section 302(c) 
of the Clean Air Act, as amended (42 U.S.C. 1857h(c)).
    (3) Federal certifying authority. The term ``Federal certifying 
authority'' means the Administrator of the Environmental Protection 
Agency (see Reorganization Plan No. 3 of 1970, 35 FR 15623).
    (d) Profitmaking abatement works, etc.--(1) In general. Section 
169(e) provides that the Federal certifying authority shall not certify 
any property to the extent it appears that by reason of estimated 
profits to be derived through the recovery of wastes or otherwise in the 
operation of such property its costs will be recovered over the period 
referred to in paragraph (a) (6) of this section for such property. The 
Federal certifying authority need not certify the amount of estimated 
profits to be derived from such recovery of wastes or otherwise with 
respect to such facility. Such estimated profits shall be determined 
pursuant to subparagraph (2) of this paragraph. However, the Federal 
certifying authority shall certify--
    (i) Whether, in connection with any treatment facility so certified, 
there is potential cost recovery through the recovery of wastes or 
otherwise, and
    (ii) A specific description of the wastes which will be recovered, 
or the nature of such cost recovery if otherwise than through the 
recovery of wastes.

For effect on computation of amortizable basis, see paragraph (c) of 
Sec. 1.169-3.
    (2) Estimated profits. For purpose of this paragraph, the term 
``estimated profits'' means the estimated gross receipts from the sale 
of recovered wastes reduced by the sum of the (i) estimated average 
annual maintenance and operating expenses, including utilities and 
labor, allocable to that portion of the facility which is certified as a 
treatment facility pursuant to paragraph (a)(1)(i) of this section which 
produces the recovered waste from which the gross receipts are derived, 
and (ii) estimated selling expenses. However, in determining expenses to 
be subtracted neither depreciation nor amortization of the facility is 
to be taken into account. Estimated profits shall not include any 
estimated savings to the taxpayer by reason of the taxpayer's reuse or 
recycling of wastes or other items recovered in connection with the 
operation of the plant or other property served by the treatment 
facility.
    (3) Special rules. The estimates of cost recovery required by 
subparagraph (2) of this paragraph shall be based on the period referred 
to in paragraph (a)(6) of this section. Such estimates shall be made at 
the time the election provided for by section 169 is made and shall also 
be set out in the application for

[[Page 1138]]

certification made to the Federal certifying authority. There shall be 
no redetermination of estimated profits due to unanticipated 
fluctuations in the market price for wastes or other items, to an 
unanticipated increase or decrease in the costs of extracting them from 
the gas or liquid released, or to other unanticipated factors or events 
occurring after certification.

[T.D. 7116, 36 FR 9013, May 18, 1971; 36 FR 9770, May 28, 1971]



Sec. 1.169-3  Amortizable basis.

    (a) [Reserved]. For further guidance, see Sec. 1.169-3T(a).
    (b) Limitation to post-1968 construction, reconstruction, or 
erection. (1) If the construction, reconstruction, or erection was begun 
before January 1, 1969, there shall be included in the amortizable basis 
only so much of the adjusted basis of such facility for purposes of 
determining gain (referred to in paragraph (a) of this section) as is 
properly attributable under the rules set forth in paragraph (b)(2)(iii) 
of Sec. 1.169-2 to construction, reconstruction, or erection after 
December 31, 1968. See section 169 (d)(4). For example, assume a 
certified pollution control facility for which the shortest period 
authorized under section 167 is 10 years has a cost of $500,000, of 
which $450,000 is attributable to construction after December 31, 1968. 
Further, assume such facility does not perform a function in addition to 
pollution control and is used only in connection with a plant in 
operation before January 1, 1969. The facility would have an amortizable 
basis of $450,000 (computed without regard to paragraphs (c) and (d) of 
this section). For depreciation of the remaining portion ($50,000) of 
the cost, see section 169(g) and paragraph (a)(3)(ii) of Sec. 1.169-1. 
For the definition of the term ``certified pollution control facility'' 
see paragraph (a) of Sec. 1.169-2.
    (2) [Reserved]. For further guidance, see Sec. 1.169-3T(b)(2).
    (c) Modification for profitmaking abatement works, etc. If it 
appears that by reason of estimated profits to be derived through the 
recovery of wastes or otherwise (as determined by applying the rules 
prescribed in paragraph (d) of Sec. 1.169-2) a portion or all of the 
total costs of the certified pollution control facility will be 
recovered over the period referred to in paragraph (a)(b) of Sec. 
1.169-2, its amortizable basis (computed without regard to this 
paragraph and paragraph (d) of this section) shall be reduced by an 
amount equal to (1) its amortizable basis (so computed) multiplied by 
(2) a fraction the numerator of which is such estimated profits and the 
denominator of which is its adjusted basis for purposes of determining 
gain. See section 169(e).
    (d) Cases in which the period referred to in paragraph (a)(6) of 
Sec. 1.169-2 exceeds 15 years. If as to a certified pollution control 
facility the period referred to in paragraph (a)(6) of Sec. 1.169-2 
exceeds 15 years (determined as of the first day of the first month for 
which a deduction is allowable under the election made under the section 
169(b) and paragraph (a) of Sec. 1.169-4), the amortizable basis of 
such facility shall be an amount equal to (1) its amortizable basis 
(computed without regard to this paragraph) multiplied by (2) a fraction 
the numerator of which is 15 years and the denominator of which is the 
number of years of such period. See section 169(f) (2)(A).
    (e) Examples. This section may be illustrated by the following 
example:

    Example (1). The X Corporation, which uses the calendar year as its 
taxable year, began the installation of a facility on November 1, 1968, 
and completed the installation on June 30, 1970, at a cost of $400,000. 
All of the facility qualifies as a certified pollution control facility 
within the meaning of paragraph (a) of Sec. 1.169-2. $40,000 of such 
cost is attributable to construction prior to January 1, 1969. The X 
Corporation elects to take amortization deductions under section 169(a) 
with respect to the facility and to begin the 60-month amortization 
period with January 1, 1971. The corporation takes a depreciation 
deduction under sections 167 and 179 of $10,000 (the amount allowable, 
of which $2,000 is for additional first year depreciation under section 
179) for the last 6 months of 1970. It is estimated that over the period 
referred to in paragraph (a) (6) of Sec. 1.169-2 (20 years) as to such 
facility, $80,000 in profits will be realized from the sale of wastes 
recovered in its operation. The amortizable basis of the facility for 
purposes of computing the amortization deduction as of January 1, 1971, 
is $210,600, computed as follows:

(1) Portion of $400,000 cost attributable to post-1968          $360,000
 construction, reconstruction, or erection...................

[[Page 1139]]

 
(2) Reduction for portion of depreciation
 deduction taken for the taxable year in which the
 facility was completed:
  (a) $10,000 depreciation deduction taken for        $10,000
   last 6 months of 1970 including $2,000 for
   additional first year depreciation under
   section 179....................................
  (b) Multiplied by the amount in line (1) and            0.9     $9,000
   divided by the total cost of the facility
   ($360,000/ $400,000)...........................
                                                   ---------------------
(3) Subtotal.................................................   $351,000
(4) Modification for profitmaking abatement works:
 Multiply line (3) by estimated profits through
 waste recovery ($80,000) and divide by the
 adjusted basis for determining gain of the
 facility ($400,000).
(5) Reduction................................................    $70,200
                                                   ------------
(6) Subtotal.................................................   $280,800
(7) Modification for period referred to in paragraph (a)(6)         0.75
 of Sec.  1.169-2 exceeding 15 years: Multiply by 15 years
 and divide by such period (determined in accordance with
 paragraph (d) of this section) (20 years)...................
                                                   ------------
(8) Amortizable basis........................................   $210,600
 

    Example (2). Assume the same facts as in example (1) except that the 
facility is used in connection with a number of separate plants some of 
which were in operation before January 1, 1969, that the Federal 
certifying authority certifies that 80 percent of the capacity of the 
facility is allocable to the plants which were in operation before such 
date, and that all of the waste recovery is allocable to the portion of 
the facility used in connection with the plants in operation before 
January 1, 1969. The amortizable basis of such facility, for purposes of 
computing the amortization deduction as of January 1, 1971, is $157,950 
computed as follows:

(1) Adjusted basis for purposes of determining gain: Multiply   $320,000
 percent certified as allocable to plants in operation before
 January 1, 1969 (80 percent) by cost of entire facility
 ($400,000)..................................................
                                                   ============
(2) Portion of adjusted basis for determining gain              $288,000
 attributable to post-1968 construction, reconstruction, or
 rection: Multiply line (1) by portion of total cost of
 facility attributable to post-1968 construction,
 reconstruction, or erection ($360,000) and divide by the
 total cost of the facility ($400,000).......................
(3) Reduction for portion of depreciation deduction taken for
 the taxable year in which the facility was completed:
  (a) $10,000 depreciation deduction taken for        $10,000
   last 6 months of 1970 including $2,000 for
   additional first year depreciation under
   section 170....................................
  (b) Multiplied by the amount in line (2) and           0.72     $7,200
   divided by the total cost of the facility
   ($288,000/$400,000)............................
                                                   ---------------------
(4) Subtotal.................................................   $280,800
(5) Modification for profitmaking abatement works; Multiply
 line (4) by estimated profits through waste recovery
 ($80,000) and divide by the amount in line (1) ($320,000).
(6) Reduction................................................    $70,200
                                                   ------------
(7) Subtotal.................................................   $210,600
(8) Modification for period referred to in paragraph (a)(6)         0.75
 of Sec.  1.169-2 exceeding 15 years: Multiply by 15 years
 and divide by such period (determined in accordance with
 paragraph (d) of this section) (20 years)...................
                                                   ------------
(9) Amortizable basis........................................   $157,950
 

    (f) Additions or improvements. (1) If after the completion or 
acquisition of a certified pollution control facility further 
expenditures are made for additional construction, reconstruction, or 
improvements, the cost of such additions or improvements made prior to 
the beginning of the amortization period shall increase the amortizable 
basis of such facility, but the cost of additions or improvements made 
after the amortization period has begun, shall not increase the 
amortizable basis. See section 169(f)(2)(B).
    (2) If expenditures for such additional construction, 
reconstruction, or improvements result in a facility which is new and is 
separately certified as a certified pollution control facility as 
defined in section 169(d)(1) and paragraph (a) of Sec. 1.169-2, and, if 
proper election is made, such expenditures shall be taken into account 
in computing under paragraph (a) of this section the amortizable basis 
of such new and separately certified pollution control facility.
    (g) Effective date for qualified property, 50-percent bonus 
depreciation property, and qualified New York Liberty Zone property. 
[Reserved]. For further guidance, see Sec. 1.169-3T(g).

[T.D. 7116, 36 FR 9015, May 18, 1971; 36 FR 9770, May 28, 1971, as 
amended by T.D. 9091, 68 FR 53004, Sept. 8, 2003]



Sec. 1.169-3T  Amortizable basis (temporary).

    (a) In general. The amortizable basis of a certified pollution 
control facility for the purpose of computing the amortization deduction 
under section 169 is the adjusted basis of the facility for purposes of 
determining gain (see part II (section 1011 and following), subchapter 
O, chapter 1 of the Internal Revenue Code), in conjuction with 
paragraphs (b), (c), and (d) of this section. The adjusted basis for 
purposes of

[[Page 1140]]

determining gain (computed without regard to paragraphs (b), (c), and 
(d) of this section) of a facility that performs a function in addition 
to pollution control, or that is used in connection with more than one 
plant or other property, or both, is determined under Sec. 1.169-
2(a)(3). For rules as to additions and improvements to such a facility, 
see paragraph (f) of this section. Before computing the amortization 
deduction allowable under section 169, the adjusted basis for purposes 
of determining gain for a facility that is placed in service by a 
taxpayer after September 10, 2001, and that is qualified property under 
section 168(k)(2) or Sec. 1.168(k)-1T, 50-percent bonus depreciation 
property under section 168(k)(4) or Sec. 1.168(k)-1T, or qualified New 
York Liberty Zone property under section 1400L(b) or Sec. 1.1400L(b)-1T 
must be reduced by the amount of the additional first year depreciation 
deduction allowed or allowable, whichever is greater, under section 
168(k) or section 1400L(b), as applicable, for the facility.
    (b) Limitation on post-1968 construction, reconstruction, or 
erection. (1) For further guidance, see Sec. 1.169-3(b)(1).
    (2) If the taxpayer elects to begin the 60-month amortization period 
with the first month of the taxable year succeeding the taxable year in 
which the facility is completed or acquired and a depreciation deduction 
is allowable under section 167 (including an additional first-year 
depreciation allowance under former section 179; for a facility that is 
acquired by the taxpayer after September 10, 2001, and that is qualified 
property under section 168(k)(2) or Sec. 1.168(k)-1T or qualified New 
York Liberty Zone property under section 1400L(b) or Sec. 1.1400L(b)-
1T, the additional first year depreciation deduction under section 
168(k)(1) or 1400L(b), as applicable; and for a facility that is 
acquired by the taxpayer after May 5, 2003, and that is 50-percent bonus 
depreciation property under section 168(k)(4) or Sec. 1.168(k)-1T, the 
additional first year depreciation deduction under section 168(k)(4)) 
with respect to the facility for the taxable year in which it is 
completed or acquired, the amount determined under paragraph (b)(1) of 
this section shall be reduced by an amount equal to the amount of the 
depreciation deduction allowed or allowable, whichever is greater, 
multiplied by a fraction the numerator of which is the amount determined 
under paragraph (b)(1) of this section, and the denominator of which is 
the facility's total cost. The additional first-year allowance for 
depreciation under former section 179 will be allowable only for the 
taxable year in which the facility is completed or acquired and only if 
the taxpayer elects to begin the amortization deduction under section 
169 with the taxable year succeeding the taxable year in which such 
facility is completed or acquired. For a facility that is acquired by a 
taxpayer after September 10, 2001, and that is qualified property under 
section 168(k)(2) or Sec. 1.168(k)-1T or qualified New York Liberty 
Zone property under section 1400L(b) or Sec. 1.1400L(b)-1T, see Sec. 
1.168(k)-1T(f)(4) or Sec. 1.1400L(b)-1T(f)(4), as applicable, with 
respect to when the additional first year depreciation deduction under 
section 168(k)(1) or 1400L(b) is allowable. For a facility that is 
acquired by a taxpayer after May 5, 2003, and that is 50-percent bonus 
depreciation property under section 168(k)(4) or Sec. 1.168(k)-1T, see 
Sec. 1.168(k)-1T(f)(4) with respect to when the additional first year 
depreciation deduction under section 168(k)(4) is allowable.
    (c) through (f) For further guidance, see Sec. 1.169-3(c) through 
(f).
    (g) Effective date for qualified property, 50-percent bonus 
depreciation property, and qualified New York Liberty Zone property. 
This section applies to a certified pollution control facility. This 
section also applies to a certified pollution control facility that is 
qualified property under section 168(k)(2) or qualified New York Liberty 
Zone property under section 1400L(b) acquired by a taxpayer after 
September 10, 2001, and to a certified pollution control facility that 
is 50-percent bonus depreciation property under section 168(k)(4) 
acquired by a taxpayer after May 5, 2003. This section expires on 
September 4, 2003.

[T.D. 9091, 68 FR 53004, Sept. 8, 2003; 68 FR 63734, Nov. 10, 2003]

[[Page 1141]]



Sec. 1.169-4  Time and manner of making elections.

    (a) Election of amortization--(1) In general. Under section 169(b), 
an election by the taxpayer to take an amortization deduction with 
respect to a certified pollution control facility and to begin the 60-
month amortization period (either with the month following the month in 
which the facility is completed or acquired, or with the first month of 
the taxable year succeeding the taxable year in which such facility is 
completed or acquired) shall be made by a statement to that effect 
attached to its return for the taxable year in which falls the first 
month of the 60-month amortization period so elected. Such statement 
shall include the following information (if not otherwise included in 
the documents referred to in subdivision (ix) of this subparagraph):
    (i) A description clearly identifying each certified pollution 
control facility for which an amortization deduction is claimed;
    (ii) The date on which such facility was completed or acquired (see 
paragraph (b)(2)(iii) of Sec. 1.169-2);
    (iii) The period referred to in paragraph (a)(6) of Sec. 1.169-2 
for the facility as of the date the property is placed in service;
    (iv) The date as of which the amortization period is to begin;
    (v) The date the plant or other property to which the facility is 
connected began operating (see paragraph (a)(5) of Sec. 1.169-2);
    (vi) The total costs and expenditures paid or incurred in the 
acquisition, construction, and installation of such facility;
    (vii) A description of any wastes which the facility will recover 
during the course of its operation, and a reasonable estimate of the 
profits which will be realized by the sale of such wastes whether 
pollutants or otherwise, over the period referred to in paragraph (a)(6) 
of Sec. 1.169-2 as to the facility. Such estimate shall include a 
schedule setting forth a detailed computation illustrating how the 
estimate was arrived at including every element prescribed in the 
definition of estimated profits in paragraph (d)(2) of Sec. 1.169-2;
    (viii) A computation showing the amortizable basis (as defined in 
Sec. 1.169-3) of the facility as of the first month for which the 
amortization deduction provided for by section 169(a) is elected; and
    (ix)(a) A statement that the facility has been certified by the 
Federal certifying authority, together with a copy of such 
certification, and a copy of the application for certification which was 
filed with and approved by the Federal certifying authority or (b), if 
the facility has not been certified by the Federal certifying authority, 
a statement that application has been made to the proper State 
certifying authority (see paragraph (c)(2) of Sec. 1.169-2) together 
with a copy of such application and (except in the case of an election 
to which subparagraph (4) of this paragraph applies) a copy of the 
application filed or to be filed with the Federal certifying authority.

If subdivision (ix)(b) of this subparagraph applies, within 90 days 
after receipt by the taxpayer, the certification from the Federal 
certifying authority shall be filed by the taxpayer with the district 
director, or with the director of the internal revenue service center, 
with whom the return referred to in this subparagraph was filed.
    (2) Special rule. If the return for the taxable year in which falls 
the first month of the 60-month amortization period to be elected is 
filed before November 16, 1971, without making the election for such 
year, then on or before December 31, 1971 (or if there is no State 
certifying authority in existence on November 16, 1971, on or before the 
90th day after such authority is established), the election may be made 
by a statement attached to an amended income tax return for the taxable 
year in which falls the first month of the 60-month amortization period 
so elected. Amended income tax returns or claims for credit or refund 
must also be filed at this time for other taxable years which are within 
the amortization period and which are subsequent to the taxable year for 
which the election is made. Nothing in this paragraph should be 
construed as extending the time specified in section 6511 within which a 
claim for credit or refund may be filed.

[[Page 1142]]

    (3) Other requirements and considerations. No method of making the 
election provided for in section 169(a) other than that prescribed in 
this section shall be permitted on or after May 18, 1971. A taxpayer 
which does not elect in the manner prescribed in this section to take 
amortization deductions with respect to a certified pollution control 
facility shall not be entitled to such deductions. In the case of a 
taxpayer which elects prior to May 18, 1971, the statement required by 
subparagraph (1) of this paragraph shall be attached to its income tax 
return for either its taxable year in which December 31, 1971, occurs or 
its taxable year preceding such year.
    (4) Elections filed before February 29, 1972. If a statement of 
election required by subparagraph (1) of this paragraph is attached to a 
return (including an amended return referred to in subparagraph (2) of 
this paragraph) filed before February 29, 1972, such statement of 
election need not include a copy of the Federal application to be filed 
with the Federal certifying authority but a copy of such application 
must be filed no later than February 29, 1972, by the taxpayer with the 
district director, or with the director of the internal revenue service 
center, with whom the return or amended return referred to in this 
subparagraph was filed.
    (b) Election to discontinue or revoke amortization--(1) Election to 
discontinue. An election to discontinue the amortization deduction 
provided by section 169(c) and paragraph (a)(1) of Sec. 1.169-1 shall 
be made by a statement in writing filed with the district director, or 
with the director of the internal revenue service center, with whom the 
return of the taxpayer is required to be filed for its taxable year in 
which falls the first month for which the election terminates. Such 
statement shall specify the month as of the beginning of which the 
taxpayer elects to discontinue such deductions. Unless the election to 
discontinue amortization is one to which subparagraph (2) of this 
paragraph applies, such statement shall be filed before the beginning of 
the month specified therein. In addition, such statement shall contain a 
description clearly identifying the certified pollution control facility 
with respect to which the taxpayer elects to discontinue the 
amortization deduction, and, if a certification has previously been 
issued, a copy of the certification by the Federal certifying authority. 
If at the time of such election a certification has not been issued (or 
if one has been issued it has not been filed as provided in paragraph 
(a)(1) of this section), the taxpayer shall file, with respect to any 
taxable year or years for which a deduction under section 169 has been 
taken, a copy of such certification within 90 days after receipt 
thereof. For purposes of this paragraph, notification to the Secretary 
or his delegate from the Federal certifying authority that the facility 
no longer meets the requirements under which certification was 
originally granted by the State or Federal certifying authority shall 
have the same effect as a notice from the taxpayer electing to terminate 
amortization as of the month following the month such facility ceased 
functioning in accordance with such requirements.
    (2) Revocation of elections made prior to May 18, 1971. If on or 
before May 18, 1971, an election under section 169(a) has been made, 
such election may be revoked (see paragraph (a)(1) of Sec. 1.169-1) by 
filing on or before August 16, 1971, a statement of revocation of an 
election under section 169(a) in accordance with the requirements in 
subparagraph (1) of this paragraph for filing a notice to discontinue an 
election. If such election to revoke is for a period which falls within 
one or more taxable years for which an income tax return has been filed, 
amended income tax returns shall be filed for any such taxable years in 
which deductions were taken under section 169 on or before August 16, 
1971.

[T.D. 7116, 36 FR 9016, May 18, 1971, as amended by T.D. 7135, 36 FR 
14183, July 31, 1971; 36 FR 24995, Dec. 28, 1971]

[[Page 1143]]



                              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 1145]]



                    Table of CFR Titles and Chapters




                      (Revised as of April 1, 2006)

                      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--Grants and Agreements

            Subtitle A--Office of Management and Budget Guidance 
                for Grants and Agreements
         I  Office of Management and Budget Governmentwide 
                Guidance for Grants and Agreements (Parts 100-199)
        II  Office of Management and Budget Circulars and Guidance 
                (200-299)
            Subtitle B--Federal Agency Regulations for Grants and 
                Agreements [Reserved]


                        Title 3--The President

         I  Executive Office of the President (Parts 100--199)

                           Title 4--Accounts

         I  Government Accountability Office (Parts 1--99)

                   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)
         V  The International Organizations Employees Loyalty 
                Board (Parts 1500--1599)
        VI  Federal Retirement Thrift Investment Board (Parts 
                1600--1699)
      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)

[[Page 1146]]

        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)
      XXIV  Federal Energy Regulatory Commission (Part 3401)
       XXV  Department of the Interior (Part 3501)
      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)
        LV  National Endowment for the Arts (Part 6501)
       LVI  National Endowment for the Humanities (Part 6601)
      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)
     LXVII  Institute of Museum and Library Services (Part 7701)
      LXIX  Tennessee Valley Authority (Part 7901)
      LXXI  Consumer Product Safety Commission (Part 8101)
    LXXIII  Department of Agriculture (Part 8301)
     LXXIV  Federal Mine Safety and Health Review Commission (Part 
                8401)
     LXXVI  Federal Retirement Thrift Investment Board (Part 8601)

[[Page 1147]]

    LXXVII  Office of Management and Budget (Part 8701)
     XCVII  Department of Homeland Security Human Resources 
                Management System (Department of Homeland 
                Security--Office of Personnel Management) (Part 
                9701)
      XCIX  Department of Defense Human Resources Management and 
                Labor Relations Systems (Department of Defense--
                Office of Personnel Management) (Part 9901)

                      Title 6--Homeland Security

         I  Department of Homeland Security, Office of the 
                Secretary (Parts 0--99)

                         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 Nutrition Service, Department of Agriculture 
                (Parts 210--299)
       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)

[[Page 1148]]

     XVIII  Rural Housing Service, Rural Business-Cooperative 
                Service, Rural Utilities Service, and Farm Service 
                Agency, Department of Agriculture (Parts 1800--
                2099)
        XX  Local Television Loan Guarantee Board (Parts 2200--
                2299)
      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 Policy and New Uses, Department of 
                Agriculture (Parts 2900--2999)
       XXX  Office of the Chief Financial Officer, Department of 
                Agriculture (Parts 3000--3099)
      XXXI  Office of Environmental Quality, Department of 
                Agriculture (Parts 3100--3199)
     XXXII  Office of Procurement and Property Management, 
                Department of Agriculture (Parts 3200--3299)
    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)
     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  Department of Homeland Security (Immigration and 
                Naturalization) (Parts 1--499)
         V  Executive Office for Immigration Review, Department of 
                Justice (Parts 1000--1399)

                 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, Department of 
                Agriculture (Parts 300--599)

[[Page 1149]]

                           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)
      XIII  Nuclear Waste Technical Review Board (Parts 1303--
                1399)
      XVII  Defense Nuclear Facilities Safety Board (Parts 1700--
                1799)
     XVIII  Northeast Interstate Low-Level Radioactive Waste 
                Commission (Part 1800)

                      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)
       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  Department of the Treasury (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)
        IV  Emergency Steel Guarantee Loan Board, Department of 
                Commerce (Parts 400--499)
         V  Emergency Oil and Gas Guaranteed Loan Board, 
                Department of Commerce (Parts 500--599)

[[Page 1150]]

                    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)
        VI  Air Transportation System Stabilization (Parts 1300--
                1399)

                 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 Industry and Security, 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)
       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)

[[Page 1151]]

             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  Bureau of Customs and Border Protection, Department of 
                Homeland Security; Department of the Treasury 
                (Parts 0--199)
        II  United States International Trade Commission (Parts 
                200--299)
       III  International Trade Administration, Department of 
                Commerce (Parts 300--399)
        IV  Bureau of Immigration and Customs Enforcement, 
                Department of Homeland Security (Parts 400--599)

                     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)
      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)

[[Page 1152]]

                      Title 22--Foreign Relations

         I  Department of State (Parts 1--199)
        II  Agency for International Development (Parts 200--299)
       III  Peace Corps (Parts 300--399)
        IV  International Joint Commission, United States and 
                Canada (Parts 400--499)
         V  Broadcasting Board of Governors (Parts 500--599)
       VII  Overseas Private Investment Corporation (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)
       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)

                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)
        IV  Office of Housing and Office of Multifamily Housing 
                Assistance Restructuring, Department of Housing 
                and Urban Development (Parts 400--499)
         V  Office of Assistant Secretary for Community Planning 
                and Development, Department of Housing and Urban 
                Development (Parts 500--599)

[[Page 1153]]

        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, Section 202 Direct Loan Program, Section 
                202 Supportive Housing for the Elderly Program and 
                Section 811 Supportive Housing for Persons With 
                Disabilities Program) (Parts 800--899)
        IX  Office of Assistant Secretary for Public and Indian 
                Housing, Department of Housing and Urban 
                Development (Parts 900--1699)
         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 (Parts 1000--1199)
       VII  Office of the Special Trustee for American Indians, 
                Department of the Interior (Part 1200)

                      Title 26--Internal Revenue

         I  Internal Revenue Service, Department of the Treasury 
                (Parts 1--899)

           Title 27--Alcohol, Tobacco Products and Firearms

         I  Alcohol and Tobacco Tax and Trade Bureau, Department 
                of the Treasury (Parts 1--399)

[[Page 1154]]

        II  Bureau of Alcohol, Tobacco, Firearms, and Explosives, 
                Department of Justice (Parts 400--699)

                   Title 28--Judicial Administration

         I  Department of Justice (Parts 0--299)
       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)
      VIII  Court Services and Offender Supervision Agency for the 
                District of Columbia (Parts 800--899)
        IX  National Crime Prevention and Privacy Compact Council 
                (Parts 900--999)
        XI  Department of Justice and Department of State (Parts 
                1100--1199)

                            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  Employee Benefits Security 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 1155]]

                      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)
       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)
        IX  Federal Claims Collection Standards (Department of the 
                Treasury--Department of Justice) (Parts 900--999)

                      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)
     XVIII  National Counterintelligence Center (Parts 1800--1899)
       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)

[[Page 1156]]

    XXVIII  Office of the Vice President of the United States 
                (Parts 2800--2899)

               Title 33--Navigation and Navigable Waters

         I  Coast Guard, Department of Homeland Security (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)
        XI  National Institute for Literacy (Parts 1100--1199)
            Subtitle C--Regulations Relating to Education
       XII  National Council on Disability (Parts 1200--1299)

                          Title 35 [Reserved]

             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)
         X  Presidio Trust (Parts 1000--1099)
        XI  Architectural and Transportation Barriers Compliance 
                Board (Parts 1100--1199)
       XII  National Archives and Records Administration (Parts 
                1200--1299)
        XV  Oklahoma City National Memorial Trust (Part 1501)

[[Page 1157]]

       XVI  Morris K. Udall Scholarship and Excellence in National 
                Environmental Policy Foundation (Parts 1600--1699)

             Title 37--Patents, Trademarks, and Copyrights

         I  United States Patent and Trademark Office, Department 
                of Commerce (Parts 1--199)
        II  Copyright Office, Library of Congress (Parts 200--299)
       III  Copyright Royalty Board, Library of Congress (Parts 
                301--399)
        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--1099)
        IV  Environmental Protection Agency and Department of 
                Justice (Parts 1400--1499)
         V  Council on Environmental Quality (Parts 1500--1599)
        VI  Chemical Safety and Hazard Investigation Board (Parts 
                1600--1699)
       VII  Environmental Protection Agency and Department of 
                Defense; Uniform National Discharge Standards for 
                Vessels of the Armed Forces (Parts 1700--1799)

          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 Service, 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)
       102  Federal Management Regulation (Parts 102-1--102-299)

[[Page 1158]]

       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
       300  General (Parts 300-1--300-99)
       301  Temporary Duty (TDY) Travel Allowances (Parts 301-1--
                301-99)
       302  Relocation Allowances (Parts 302-1--302-99)
       303  Payment of Expenses Connected with the Death of 
                Certain Employees (Part 303-1--303-99)
       304  Payment of Travel Expenses from a Non-Federal Source 
                (Parts 304-1--304-99)

                        Title 42--Public Health

         I  Public Health Service, Department of Health and Human 
                Services (Parts 1--199)
        IV  Centers for Medicare & Medicaid Services, 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--10010)

             Title 44--Emergency Management and Assistance

         I  Federal Emergency Management Agency, Department of 
                Homeland Security (Parts 0--399)
        IV  Department of Commerce and Department of 
                Transportation (Parts 400--499)

[[Page 1159]]

                       Title 45--Public Welfare

            Subtitle A--Department of Health and Human Services 
                (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)
         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  Corporation for National and Community Service (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)
     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 Homeland Security (Parts 
                1--199)
        II  Maritime Administration, Department of Transportation 
                (Parts 200--399)
       III  Coast Guard (Great Lakes Pilotage), Department of 
                Homeland Security (Parts 400--499)
        IV  Federal Maritime Commission (Parts 500--599)

                      Title 47--Telecommunication

         I  Federal Communications Commission (Parts 0--199)

[[Page 1160]]

        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  Defense Acquisition Regulations System, 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  United States 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)
        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  Broadcasting Board of Governors (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)
        30  Department of Homeland Security, Homeland Security 
                Acquisition Regulation (HSAR) (Parts 3000--3099)
        34  Department of Education Acquisition Regulation (Parts 
                3400--3499)
        35  [Reserved]
        44  Federal Emergency Management Agency (Parts 4400--4499)
        51  Department of the Army Acquisition Regulations (Parts 
                5100--5199)

[[Page 1161]]

        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 (Parts 
                5400--5499)
        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  Pipeline and Hazardous Materials Safety 
                Administration, Department of Transportation 
                (Parts 100--199)
        II  Federal Railroad Administration, Department of 
                Transportation (Parts 200--299)
       III  Federal Motor Carrier Safety Administration, 
                Department of Transportation (Parts 300--399)
        IV  Coast Guard, Department of Homeland Security (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)
        XI  Research and Innovative Technology Administration, 
                Department of Transportation (Parts 1400--1499)
       XII  Transportation Security Administration, Department of 
                Homeland Security (Parts 1500--1699)

                   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)

[[Page 1162]]

        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
            List of CFR Titles, Chapters, Subchapters, and Parts
            Alphabetical List of Agencies Appearing in the CFR

[[Page 1163]]





           Alphabetical List of Agencies Appearing in the CFR




                      (Revised as of April 1, 2006)

                                                  CFR Title, Subtitle or 
                     Agency                               Chapter

Administrative Committee of the Federal Register  1, I
Advanced Research Projects Agency                 32, I
Advisory Council on Historic Preservation         36, VIII
African Development Foundation                    22, XV
  Federal Acquisition Regulation                  48, 57
Agency for International Development, United      22, II
     States
  Federal Acquisition Regulation                  48, 7
Agricultural Marketing Service                    7, I, IX, X, XI
Agricultural Research Service                     7, V
Agriculture Department                            5, LXXIII
  Agricultural Marketing Service                  7, I, IX, X, XI
  Agricultural Research Service                   7, V
  Animal and Plant Health Inspection Service      7, III; 9, I
  Chief Financial Officer, Office of              7, XXX
  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
  Food and Nutrition 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
  Procurement and Property Management, Office of  7, XXXII
  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
Air Transportation Stabilization Board            14, VI
Alcohol and Tobacco Tax and Trade Bureau          27, I
Alcohol, Tobacco, Firearms, and Explosives,       27, II
     Bureau of
AMTRAK                                            49, VII
American Battle Monuments Commission              36, IV
American Indians, Office of the Special Trustee   25, VII
Animal and Plant Health Inspection Service        7, III; 9, I
Appalachian Regional Commission                   5, IX

[[Page 1164]]

Architectural and Transportation Barriers         36, XI
     Compliance Board
Arctic Research Commission                        45, XXIII
Armed Forces Retirement Home                      5, XI
Army Department                                   32, V
  Engineers, Corps of                             33, II; 36, III
  Federal Acquisition Regulation                  48, 51
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
Broadcasting Board of Governors                   22, V
  Federal Acquisition Regulation                  48, 19
Census Bureau                                     15, I
Centers for Medicare & Medicaid Services          42, IV
Central Intelligence Agency                       32, XIX
Chief Financial Officer, Office of                7, XXX
Child Support Enforcement, Office of              45, III
Children and Families, Administration for         45, II, III, IV, X
Civil Rights, Commission on                       45, VII
Civil Rights, Office for                          34, I
Coast Guard                                       33, I; 46, I; 49, IV
Coast Guard (Great Lakes Pilotage)                46, III
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
  Federal Acquisition Regulation                  48, 13
  Fishery Conservation and Management             50, VI
  Foreign-Trade Zones Board                       15, IV
  Industry and Security, Bureau of                15, VII
  International Trade Administration              15, III; 19, III
  National Institute of Standards and Technology  15, II
  National Marine Fisheries Service               50, II, IV, VI
  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, United States      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
Copyright Royalty Board                           37, III
Corporation for National and Community Service    45, XII, XXV
Cost Accounting Standards Board                   48, 99
Council on Environmental Quality                  40, V
Court Services and Offender Supervision Agency    28, VIII
     for the District of Columbia
Customs and Border Protection Bureau              19, I
Defense Contract Audit Agency                     32, I
Defense Department                                5, XXVI; 32, Subtitle A; 
                                                  40, VII

[[Page 1165]]

  Advanced Research Projects Agency               32, I
  Air Force Department                            32, VII
  Army Department                                 32, V; 33, II; 36, III, 
                                                  48, 51
  Defense Acquisition Regulations System          48, II
  Defense Intelligence Agency                     32, I
  Defense Logistics Agency                        32, I, XII; 48, 54
  Engineers, Corps of                             33, II; 36, III
  National Imagery and Mapping Agency             32, I
  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 Nuclear Facilities Safety Board           10, XVII
Delaware River Basin Commission                   18, III
District of Columbia, Court Services and          28, VIII
     Offender Supervision Agency for the
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
Emergency Oil and Gas Guaranteed Loan Board       13, V
Emergency Steel Guarantee Loan Board              13, IV
Employee Benefits Security Administration         29, XXV
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
Environmental Protection Agency                   5, LIV; 40, I, IV, VII
  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                5, III, LXXVII; 14, VI; 
                                                  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

[[Page 1166]]

  Trade Representative, Office of the United      15, XX
       States
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
Federal Claims Collection Standards               31, IX
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
Federal Home Loan Mortgage Corporation            1, IV
Federal Housing Enterprise Oversight Office       12, XVII
Federal Housing Finance Board                     12, IX
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 Management Regulation                     41, 102
Federal Maritime Commission                       46, IV
Federal Mediation and Conciliation Service        29, XII
Federal Mine Safety and Health Review Commission  5, LXXIV; 29, XXVII
Federal Motor Carrier Safety Administration       49, III
Federal Prison Industries, Inc.                   28, III
Federal Procurement Policy Office                 48, 99
Federal Property Management Regulations           41, 101
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
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 Nutrition 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 Services Administration                   5, LVII; 41, 105
  Contract Appeals, Board of                      48, 61
  Federal Acquisition Regulation                  48, 5
  Federal Management Regulation                   41, 102

[[Page 1167]]

  Federal Property Management Regulations         41, 101
  Federal Travel Regulation System                41, Subtitle F
  General                                         41, 300
  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
  Temporary Duty (TDY) Travel Allowances          41, 301
Geological Survey                                 30, IV
Government Accountability Office                  4, I
Government Ethics, Office of                      5, XVI
Government National Mortgage Association          24, III
Grain Inspection, Packers and Stockyards          7, VIII; 9, II
     Administration
Harry S. Truman Scholarship Foundation            45, XVIII
Health and Human Services, Department of          5, XLV; 45, Subtitle A
  Centers for Medicare & Medicaid Services        42, IV
  Child Support Enforcement, Office of            45, III
  Children and Families, Administration for       45, II, III, IV, X
  Community Services, Office of                   45, X
  Defense Acquisition Regulations System          48, 2
  Family Assistance, Office of                    45, II
  Federal Acquisition Regulation                  48, 3
  Food and Drug Administration                    21, I
  Human Development Services, Office of           45, XIII
  Indian Health Service                           25, V; 42, I
  Inspector General (Health Care), Office of      42, V
  Public Health Service                           42, I
  Refugee Resettlement, Office of                 45, IV
Homeland Security, Department of                  6, I
  Coast Guard                                     33, I; 46, I; 49, IV
  Coast Guard (Great Lakes Pilotage)              46, III
  Customs and Border Protection Bureau            19, I
  Federal Emergency Management Agency             44, I
  Immigration and Customs Enforcement Bureau      19, IV
  Immigration and Naturalization                  8, I
  Transportation Security Administration          49, XII
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
  Housing, Office of, and Multifamily Housing     24, IV
       Assistance Restructuring, Office of
  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
Housing, Office of, and Multifamily Housing       24, IV
     Assistance Restructuring, Office of
Human Development Services, Office of             45, XIII
Immigration and Customs Enforcement Bureau        19, IV
Immigration and Naturalization                    8, I
Immigration Review, Executive Office for          8, V
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; 42, I
Industry and Security, Bureau of                  15, VII
Information Resources Management, Office of       7, XXVII
Information Security Oversight Office, National   32, XX
   Archives and Records Administration
[[Page 1168]]

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
Interior Department
  American Indians, Office of the Special         25, VII
       Trustee
  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
  National Indian Gaming Commission               25, III
  National Park Service                           36, I
  Reclamation, Bureau of                          43, I
  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, United States Agency   22, II
     for
  Federal Acquisition Regulation                  48, 7
International Development Cooperation Agency,     22, XII
     United States
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, XI; 40, 
                                                  IV
  Alcohol, Tobacco, Firearms, and Explosives,     27, II
       Bureau of
  Drug Enforcement Administration                 21, II
  Federal Acquisition Regulation                  48, 28
  Federal Claims Collection Standards             31, IX
  Federal Prison Industries, Inc.                 28, III
  Foreign Claims Settlement Commission of the     45, V
       United States
  Immigration Review, Executive Office for        8, V
  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
  Employee Benefits Security Administration       29, XXV
  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 Standards, Office of           29, II, IV
  Mine Safety and Health Administration           30, I
  Occupational Safety and Health Administration   29, XVII
  Public Contracts                                41, 50

[[Page 1169]]

  Secretary of Labor, Office of                   29, Subtitle A
  Veterans' Employment and Training Service,      41, 61; 20, IX
       Office of the Assistant Secretary for
  Wage and Hour Division                          29, V
  Workers' Compensation Programs, Office of       20, I
Labor-Management Standards, Office of             29, II, IV
Land Management, Bureau of                        43, II
Legal Services Corporation                        45, XVI
Library of Congress                               36, VII
  Copyright Office                                37, II
  Copyright Royalty Board                         37, III
Local Television Loan Guarantee Board             7, XX
Management and Budget, Office of                  5, III, LXXVII; 14, VI; 
                                                  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
Minority Business Development Agency              15, XIV
Miscellaneous Agencies                            1, IV
Monetary Offices                                  31, I
Morris K. Udall Scholarship and Excellence in     36, XVI
     National Environmental Policy Foundation
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 and Community Service, Corporation for   45, XII, XXV
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 Council on Disability                    34, XII
National Counterintelligence Center               32, XVIII
National Credit Union Administration              12, VII
National Crime Prevention and Privacy Compact     28, IX
     Council
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 Imagery and Mapping Agency               32, I
National Indian Gaming Commission                 25, III
National Institute for Literacy                   34, XI
National Institute of Standards and Technology    15, II
National Labor Relations Board                    5, LXI; 29, I
National Marine Fisheries Service                 50, II, IV, VI
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

[[Page 1170]]

Neighborhood Reinvestment Corporation             24, XXV
Northeast Interstate Low-Level Radioactive Waste  10, XVIII
     Commission
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
Oklahoma City National Memorial Trust             36, XV
Operations Office                                 7, XXVIII
Overseas Private Investment Corporation           5, XXXIII; 22, VII
Patent and Trademark Office, United States        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 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
Pipeline and Hazardous Materials Safety           49, I
     Administration
Postal Rate Commission                            5, XLVI; 39, III
Postal Service, United States                     5, LX; 39, I
Postsecondary Education, Office of                34, VI
President's Commission on White House             1, IV
     Fellowships
Presidential Documents                            3
Presidio Trust                                    36, X
Prisons, Bureau of                                28, V
Procurement and Property Management, Office of    7, XXXII
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 Innovative Technology                49, XI
     Administration
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
State Department                                  22, I; 28, XI
  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

[[Page 1171]]

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 Supervision Office, Department of the      12, V
     Treasury
Trade Representative, United States, Office of    15, XX
Transportation, Department of                     5, L
  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
  Federal Motor Carrier Safety Administration     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
  Pipeline and Hazardous Materials Safety         49, I
       Administration
  Saint Lawrence Seaway Development Corporation   33, IV
  Secretary of Transportation, Office of          14, II; 49, Subtitle A
  Surface Transportation Board                    49, X
  Transportation Statistics Bureau                49, XI
Transportation, Office of                         7, XXXIII
Transportation Security Administration            49, XII
Transportation Statistics Bureau                  49, XI
Travel Allowances, Temporary Duty (TDY)           41, 301
Treasury Department                               5, XXI; 12, XV; 17, IV; 
                                                  31, IX
  Alcohol and Tobacco Tax and Trade Bureau        27, I
  Community Development Financial Institutions    12, XVIII
       Fund
  Comptroller of the Currency                     12, I
  Customs and Border Protection Bureau            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
Utah Reclamation Mitigation and Conservation      43, III
     Commission
Veterans Affairs Department                       38, I
  Federal Acquisition Regulation                  48, 8
Veterans' Employment and Training Service,        41, 61; 20, IX
     Office of the 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 1173]]







                      Table of OMB Control Numbers



The OMB control numbers for chapter I of title 26 were consolidated into 
Sec. Sec.  601.9000 and 602.101 at 50 FR 10221, Mar. 14, 1985. At 61 FR 
58008, Nov. 12, 1996, Sec.  601.9000 was removed. Section 602.101 is 
reprinted below for the convenience of the user.

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 comply with the requirements of Sec. Sec.  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) Display.

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described      control No.
------------------------------------------------------------------------
1.1(h)-1(e)................................................    1545-1654
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
1.25A-1....................................................    1545-1630
1.28-1.....................................................    1545-0619
1.31-2.....................................................    1545-0074
1.32-2.....................................................    1545-0074
1.32-3.....................................................    1545-1575
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(b)..................................................    1545-1625
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.....................................................    1545-1357
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
1.42-17....................................................    1545-1357
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
1.45D-1....................................................    1545-1765
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
1.48-12....................................................    1545-0155
                                                               1545-1783
1.50A-1....................................................    1545-0895
1.50A-2....................................................    1545-0895
1.50A-3....................................................    1545-0895
1.50A-4....................................................    1545-0895
1.50A-5....................................................    1545-0895
1.50A-6....................................................    1545-0895
1.50A-7....................................................    1545-0895
1.50B-1....................................................    1545-0895
1.50B-2....................................................    1545-0895
1.50B-3....................................................    1545-0895
1.50B-4....................................................    1545-0895
1.50B-5....................................................    1545-0895
1.51-1.....................................................    1545-0219
                                                               1545-0241
                                                               1545-0244
                                                               1545-0797
1.52-2.....................................................    1545-0219

[[Page 1174]]

 
1.52-3.....................................................    1545-0219
1.56-1.....................................................    1545-0123
1.56(g)-1..................................................    1545-1233
1.56A-1....................................................    1545-0227
1.56A-2....................................................    1545-0227
1.56A-3....................................................    1545-0227
1.56A-4....................................................    1545-0227
1.56A-5....................................................    1545-0227
1.57-5.....................................................    1545-0227
1.58-1.....................................................    1545-0175
1.58-9(c)(5)(iii)(B).......................................    1545-1093
1.58-9(e)(3)...............................................    1545-1093
1.59-1.....................................................    1545-1903
1.61-2.....................................................    1545-0771
1.61-2T....................................................    1545-0771
1.61-4.....................................................    1545-0187
1.61-15....................................................    1545-0074
1.62-2.....................................................    1545-1148
1.63-1.....................................................    1545-0074
1.66-4.....................................................    1545-1770
1.67-2T....................................................    1545-0110
1.67-3.....................................................    1545-1018
1.67-3T....................................................    1545-0118
1.71-1T....................................................    1545-0074
1.72-4.....................................................    1545-0074
1.72-6.....................................................    1545-0074
1.72-9.....................................................    1545-0074
1.72-17....................................................    1545-0074
1.72-17A...................................................    1545-0074
1.72-18....................................................    1545-0074
1.74-1.....................................................    1545-1100
1.79-2.....................................................    1545-0074
1.79-3.....................................................    1545-0074
1.83-2.....................................................    1545-0074
1.83-5.....................................................    1545-0074
1.83-6.....................................................    1545-1448
1.103-10...................................................    1545-0123
                                                               1545-0940
1.103-15AT.................................................    1545-0720
1.103-18...................................................    1545-1226
1.103(n)-2T................................................    1545-0874
1.103(n)-4T................................................    1545-0874
1.103A-2...................................................    1545-0720
1.105-4....................................................    1545-0074
1.105-5....................................................    1545-0074
1.105-6....................................................    1545-0074
1.108-4....................................................    1545-1539
1.108-5....................................................    1545-1421
1.110-1....................................................    1545-1661
1.117-5....................................................    1545-0869
1.118-2....................................................    1545-1639
1.119-1....................................................    1545-0067
1.120-3....................................................    1545-0057
1.121-1....................................................    1545-0072
1.121-2....................................................    1545-0072
1.121-3....................................................    1545-0072
1.121-4....................................................    1545-0072
                                                               1545-0091
1.121-5....................................................    1545-0072
1.127-2....................................................    1545-0768
1.132-1T...................................................    1545-0771
1.132-2....................................................    1545-0771
1.132-2T...................................................    1545-0771
1.132-5....................................................    1545-0771
1.132-5T...................................................    1545-0771
                                                               1545-1098
1.132-9(b).................................................    1545-1676
1.141-1....................................................    1545-1451
1.141-12...................................................    1545-1451
1.142-2....................................................    1545-1451
1.142(f)(4)-1..............................................    1545-1730
1.148-0....................................................    1545-1098
1.148-1....................................................    1545-1098
1.148-2....................................................    1545-1098
                                                               1545-1347
1.148-3....................................................    1545-1098
                                                               1545-1347
1.148-4....................................................    1545-1098
                                                               1545-1347
1.148-5....................................................    1545-1098
                                                               1545-1490
1.148-6....................................................    1545-1098
                                                               1545-1451
1.148-7....................................................    1545-1098
                                                               1545-1347
1.148-8....................................................    1545-1098
1.148-11...................................................    1545-1098
                                                               1545-1347
1.149(e)-1.................................................    1545-0720
1.150-1....................................................    1545-1347
1.151-1....................................................    1545-0074
1.152-3....................................................    1545-0071
                                                               1545-1783
1.152-4....................................................    1545-0074
1.152-4T...................................................    1545-0074
1.162-1....................................................    1545-0139
1.162-2....................................................    1545-0139
1.162-3....................................................    1545-0139
1.162-4....................................................    1545-0139
1.162-5....................................................    1545-0139
1.162-6....................................................    1545-0139
1.162-7....................................................    1545-0139
1.162-8....................................................    1545-0139
1.162-9....................................................    1545-0139
1.162-10...................................................    1545-0139
1.162-11...................................................    1545-0139
1.162-12...................................................    1545-0139
1.162-13...................................................    1545-0139
1.162-14...................................................    1545-0139
1.162-15...................................................    1545-0139
1.162-16...................................................    1545-0139
1.162-17...................................................    1545-0139
1.162-18...................................................    1545-0139
1.162-19...................................................    1545-0139
1.162-20...................................................    1545-0139
1.162-27...................................................    1545-1466
1.163-5....................................................    1545-0786
                                                               1545-1132
1.163-8T...................................................    1545-0995
1.163-10T..................................................    1545-0074
1.163-13...................................................    1545-1491
1.163(d)-1.................................................    1545-1421
1.165-1....................................................    1545-0177
1.165-2....................................................    1545-0177
1.165-3....................................................    1545-0177
1.165-4....................................................    1545-0177
1.165-5....................................................    1545-0177
1.165-6....................................................    1545-0177
1.165-7....................................................    1545-0177
1.165-8....................................................    1545-0177
1.165-9....................................................    1545-0177
1.165-10...................................................    1545-0177
1.165-11...................................................    1545-0074
                                                               1545-0177
                                                               1545-0786
1.165-12...................................................    1545-0786
1.166-1....................................................    1545-0123
1.166-2....................................................    1545-1254
1.166-4....................................................    1545-0123
1.166-10...................................................    1545-0123
1.167(a)-5T................................................    1545-1021
1.167(a)-7.................................................    1545-0172
1.167(a)-11................................................    1545-0152
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[[Page 1175]]

 
1.167(a)-12................................................    1545-0172
1.167(d)-1.................................................    1545-0172
1.167(e)-1.................................................    1545-0172
1.167(f)-11................................................    1545-0172
1.167(l)-1.................................................    1545-0172
1.168(d)-1.................................................    1545-1146
1.168(f)(8)-1T.............................................    1545-0923
1.168(i)-1.................................................    1545-1331
1.168-5....................................................    1545-0172
1.169-4....................................................    1545-0172
1.170-1....................................................    1545-0074
1.170-2....................................................    1545-0074
1.170-3....................................................    1545-0123
1.170A-1...................................................    1545-0074
1.170A-2...................................................    1545-0074
1.170A-4(A)(b).............................................    1545-0123
1.170A-8...................................................    1545-0074
1.170A-9...................................................    1545-0052
                                                               1545-0074
1.170A-11..................................................    1545-0123
                                                               1545-0074
1.170A-11T.................................................    1545-1868
1.170A-12..................................................    1545-0020
                                                               1545-0074
1.170A-13..................................................    1545-0074
                                                               1545-0754
                                                               1545-0908
                                                               1545-1431
1.170A-13(f)...............................................    1545-1464
1.170A-14..................................................    1545-0763
1.171-4....................................................    1545-1491
1.171-5....................................................    1545-1491
1.172-1....................................................    1545-0172
1.172-13...................................................    1545-0863
1.173-1....................................................    1545-0172
1.174-3....................................................    1545-0152
1.174-4....................................................    1545-0152
1.175-3....................................................    1545-0187
1.175-6....................................................    1545-0152
1.177-1....................................................    1545-0172
1.179-2....................................................    1545-1201
1.179-3....................................................    1545-1201
1.179-5....................................................    1545-0172
                                                               1545-1201
1.180-2....................................................    1545-0074
1.182-6....................................................    1545-0074
1.183-1....................................................    1545-0195
1.183-2....................................................    1545-0195
1.183-3....................................................    1545-0195
1.183-4....................................................    1545-0195
1.190-3....................................................    1545-0074
1.194-2....................................................    1545-0735
1.194-4....................................................    1545-0735
1.195-1....................................................    1545-1582
1.197-1T...................................................    1545-1425
1.197-2....................................................    1545-1671
1.213-1....................................................    1545-0074
1.215-1T...................................................    1545-0074
1.217-2....................................................    1545-0182
1.243-3....................................................    1545-0123
1.243-4....................................................    1545-0123
1.243-5....................................................    1545-0123
1.248-1....................................................    1545-0172
1.261-1....................................................    1545-1041
1.263(a)-5.................................................    1545-1870
1.263(e)-1.................................................    1545-0123
1.263A-1...................................................    1545-0987
1.263A-1T..................................................    1545-0187
1.263A-2...................................................    1545-0987
1.263A-3...................................................    1545-0987
                                                               1545-0987
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
1.265-2....................................................    1545-0123
1.266-1....................................................    1545-0123
1.267(f)-1.................................................    1545-0885
1.268-1....................................................    1545-0184
1.274-1....................................................    1545-0139
1.274-2....................................................    1545-0139
1.274-3....................................................    1545-0139
1.274-4....................................................    1545-0139
1.274-5....................................................    1545-0771
1.274-5A...................................................    1545-0139
                                                               1545-0771
1.274-5T...................................................    1545-0074
                                                               1545-0172
                                                               1545-0771
1.274-6....................................................    1545-0139
                                                               1545-0771
1.274-6T...................................................    1545-0074
                                                               1545-0771
1.274-7....................................................    1545-0139
1.274-8....................................................    1545-0139
1.279-6....................................................    1545-0123
1.280C-4...................................................    1545-1155
1.280F-3T..................................................    1545-0074
1.280G-1...................................................    1545-1851
1.281-4....................................................    1545-0123
1.302-4....................................................    1545-0074
1.305-3....................................................    1545-0123
1.305-5....................................................    1545-1438
1.307-2....................................................    1545-0074
1.312-15...................................................    1545-0172
1.316-1....................................................    1545-0123
1.331-1....................................................    1545-0074
1.332-4....................................................    1545-0123
1.332-6....................................................    1545-0123
1.337(d)-1.................................................    1545-1160
1.337(d)-2.................................................    1545-1160
1.337(d)-2.................................................    1545-1774
1.337(d)-4.................................................    1545-1633
1.337(d)-5.................................................    1545-1672
1.337(d)-6.................................................    1545-1672
1.337(d)-7.................................................    1545-1672
1.338-2....................................................    1545-1658
1.338-5....................................................    1545-1658
1.338-10...................................................    1545-1658
1.338(h)(10)-1.............................................    1545-1658
1.341-7....................................................    1545-0123
1.351-3....................................................    1545-0074
1.355-5....................................................    1545-0123
1.362-2....................................................    1545-0123
1.367(a)-1T................................................    1545-0026
1.367(a)-2T................................................    1545-0026
1.367(a)-3.................................................    1545-0026
                                                               1545-1478
1.367(a)-6T................................................    1545-0026
1.367(a)-8.................................................    1545-1271
1.367(b)-1.................................................    1545-1271
1.367(b)-3T................................................    1545-1666
1.367(d)-1T................................................    1545-0026
1.367(e)-1.................................................    1545-1487
1.367(e)-2.................................................    1545-1487
1.368-1....................................................    1545-1691
1.368-3....................................................    1545-0123
1.371-1....................................................    1545-0123
1.371-2....................................................    1545-0123
1.374-3....................................................    1545-0123
1.381(b)-1.................................................    1545-0123

[[Page 1176]]

 
1.381(c)(4)-1..............................................    1545-0123
                                                               1545-0152
                                                               1545-0879
1.381(c)(5)-1..............................................    1545-0123
                                                               1545-0152
1.381(c)(6)-1..............................................    1545-0123
                                                               1545-0152
1.381(c)(8)-1..............................................    1545-0123
1.381(c)(10)-1.............................................    1545-0123
1.381(c)(11)-1(k)..........................................    1545-0123
1.381(c)(13)-1.............................................    1545-0123
1.381(c)(17)-1.............................................    1545-0045
1.381(c)(25)-1.............................................    1545-0045
1.382-1T...................................................    1545-0123
1.382-2....................................................    1545-0123
1.382-2T...................................................    1545-0123
1.382-3....................................................    1545-1281
                                                               1545-1345
1.382-4....................................................    1545-1120
1.382-6....................................................    1545-1381
1.382-8....................................................    1545-1434
1.382-9....................................................    1545-1260
                                                               1545-1120
                                                               1545-1275
                                                               1545-1324
1.382-91...................................................    1545-1260
                                                               1545-1324
1.383-1....................................................    1545-0074
                                                               1545-1120
1.401-1....................................................    1545-0020
                                                               1545-0197
                                                               1545-0200
                                                               1545-0534
                                                               1545-0710
1.401(a)-11................................................    1545-0710
1.401(a)-20................................................    1545-0928
1.401(a)-31................................................    1545-1341
1.401(a)-50................................................    1545-0710
1.401(a)(31)-1.............................................    1545-1341
1.401(b)-1.................................................    1545-0197
1.401(f)-1.................................................    1545-0710
1.401(k)-1.................................................    1545-1039
                                                               1545-1069
                                                               1545-1669
                                                               1545-1930
1.401(k)-2.................................................    1545-1669
1.401(k)-3.................................................    1545-1669
1.401(k)-4.................................................    1545-1669
1.401(m)-3.................................................    1545-1699
1.401(a)(9)-1..............................................    1545-1573
1.401(a)(9)-3..............................................    1545-1466
1.401(a)(9)-4..............................................    1545-1573
1.401-12(n)................................................    1545-0806
1.401-14...................................................    1545-0710
1.402(c)-2.................................................    1545-1341
1.402(f)-1.................................................    1545-1341
                                                               1545-1632
1.403(b)-1.................................................    1545-0710
1.403(b)-2.................................................    1545-1341
1.403(b)-3.................................................    1545-0996
1.404(a)-4.................................................    1545-0710
1.404(a)-12................................................    1545-0710
1.404A-2...................................................    1545-0123
1.404A-6...................................................    1545-0123
1.408-2....................................................    1545-0390
1.408-5....................................................    1545-0747
1.408-6....................................................    1545-0203
                                                               1545-0390
1.408-7....................................................    1545-0119
1.408(q)-1.................................................    1545-1841
1.408A-2...................................................    1545-1616
1.408A-4...................................................    1545-1616
1.408A-5...................................................    1545-1616
1.408A-7...................................................    1545-1616
1.410(a)-2.................................................    1545-0710
1.410(d)-1.................................................    1545-0710
1.411(a)-11................................................    1545-1471
                                                               1545-1632
1.411(d)-4.................................................    1545-1545
1.411(d)-6.................................................    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
1.415-2....................................................    1545-0710
1.415-6....................................................    1545-0710
1.417(a)(3)-1..............................................    1545-0928
1.417(e)-1.................................................    1545-1471
                                                               1545-1724
1.417(e)-1T................................................    1545-1471
1.419A(f)(6)-1.............................................    1545-1795
1.422-1....................................................    1545-0820
1.441-2....................................................    1545-1748
1.442-1....................................................    1545-0074
                                                               1545-0123
                                                               1545-0134
                                                               1545-0152
                                                               1545-0820
                                                               1545-1748
1.443-1....................................................    1545-0123
1.444-3T...................................................    1545-1036
1.444-4....................................................    1545-1591
1.446-1....................................................    1545-0074
                                                               1545-0152
1.446-4(d).................................................    1545-1412
1.448-1(g).................................................    1545-0152
1.448-1(h).................................................    1545-0152
1.448-1(i).................................................    1545-0152
1.448-2T...................................................    1545-0152
                                                               1545-1855
1.451-1....................................................    1545-0091
1.451-4....................................................    1545-0123
1.451-5....................................................    1545-0074
1.451-6....................................................    1545-0074
1.451-7....................................................    1545-0074
1.453-1....................................................    1545-0152
1.453-2....................................................    1545-0152
1.453-8....................................................    1545-0152
                                                               1545-0228
1.453-10...................................................    1545-0152
1.453A-1...................................................    1545-0152
                                                               1545-1134
1.453A-2...................................................    1545-0152
                                                               1545-1134
1.453A-3...................................................    1545-0963
1.454-1....................................................    1545-0074
1.455-2....................................................    1545-0152
1.455-6....................................................    1545-0123
1.456-2....................................................    1545-0123
1.456-6....................................................    1545-0123
1.456-7....................................................    1545-0123
1.457-8....................................................    1545-1580
1.458-1....................................................    1545-0879
1.458-2....................................................    1545-0152
1.460-1....................................................    1545-1650
1.460-6....................................................    1545-1031
                                                               1545-1572
                                                               1545-1732
1.461-1....................................................    1545-0074
1.461-2....................................................    1545-0096
1.461-4....................................................    1545-0917
1.461-5....................................................    1545-0917

[[Page 1177]]

 
1.463-1T...................................................    1545-0916
1.465-1T...................................................    1545-0712
1.466-1T...................................................    1545-0152
1.466-4....................................................    1545-0152
1.468A-3...................................................    1545-1269
                                                               1545-1378
                                                               1545-1511
1.468A-4...................................................    1545-0954
1.468A-7...................................................    1545-0954
1.468A-8...................................................    1545-1269
1.468B-1...................................................    1545-1631
1.468B-9...................................................    1545-1631
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
1.469-2T...................................................    1545-0712
                                                               1545-1091
1.469-4T...................................................    1545-0985
                                                               1545-1037
1.469-7....................................................    1545-1244
1.471-2....................................................    1545-0123
1.471-5....................................................    1545-0123
1.471-6....................................................    1545-0123
1.471-8....................................................    1545-0123
1.471-11...................................................    1545-0123
                                                               1545-0152
1.472-1....................................................    1545-0042
                                                               1545-0152
1.472-2....................................................    1545-0152
1.472-3....................................................    1545-0042
1.472-5....................................................    1545-0152
1.472-8....................................................    1545-0028
                                                               1545-0042
                                                               1545-1767
1.475(b)-4.................................................    1545-1496
1.481-4....................................................    1545-0152
1.481-5....................................................    1545-0152
1.482-1....................................................    1545-1364
1.482-4....................................................    1545-1364
1.482-7....................................................    1545-1364
                                                               1545-1794
1.501(a)-1.................................................    1545-0056
                                                               1545-0057
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
                                                               1545-0052
1.505(c)-1T................................................    1545-0916
1.507-1....................................................    1545-0052
1.507-2....................................................    1545-0052
1.508-1....................................................    1545-0052
                                                               1545-0056
1.509(a)-3.................................................    1545-0047
1.509(a)-5.................................................    1545-0047
1.509(c)-1.................................................    1545-0052
1.512(a)-1.................................................    1545-0687
1.512(a)-4.................................................    1545-0047
                                                               1545-0687
1.521-1....................................................    1545-0051
                                                               1545-0058
1.527-2....................................................    1545-0129
1.527-5....................................................    1545-0129
1.527-6....................................................    1545-0129
1.527-9....................................................    1545-0129
1.528-8....................................................    1545-0127
1.533-2....................................................    1545-0123
1.534-2....................................................    1545-0123
1.542-3....................................................    1545-0123
1.545-2....................................................    1545-0123
1.545-3....................................................    1545-0123
1.547-2....................................................    1545-0045
                                                               1545-0123
1.547-3....................................................    1545-0123
1.551-4....................................................    1545-0074
1.552-3....................................................    1545-0099
1.552-4....................................................    1545-0099
1.552-5....................................................    1545-0099
1.556-2....................................................    1545-0704
1.561-1....................................................    1545-0044
1.561-2....................................................    1545-0123
1.562-3....................................................    1545-0123
1.563-2....................................................    1545-0123
1.564-1....................................................    1545-0123
1.565-1....................................................    1545-0043
                                                               1545-0123
1.565-2....................................................    1545-0043
1.565-3....................................................    1545-0043
1.565-5....................................................    1545-0043
1.565-6....................................................    1545-0043
1.585-1....................................................    1545-0123
1.585-3....................................................    1545-0123
1.585-8....................................................    1545-1290
1.586-2....................................................    1545-0123
1.593-1....................................................    1545-0123
1.593-6....................................................    1545-0123
1.593-6A...................................................    1545-0123
1.593-7....................................................    1545-0123
1.595-1....................................................    1545-0123
1.597-2....................................................    1545-1300
1.597-4....................................................    1545-1300
1.597-6....................................................    1545-1300
1.597-7....................................................    1545-1300
1.611-2....................................................    1545-0099
1.611-3....................................................    1545-0007
                                                               1545-0099
                                                               1545-1784
1.612-4....................................................    1545-0074
1.612-5....................................................    1545-0099
1.613-3....................................................    1545-0099
1.613-4....................................................    1545-0099
1.613-6....................................................    1545-0099
1.613-7....................................................    1545-0099
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
1.645-1....................................................    1545-1578
1.663(b)-2.................................................    1545-0092

[[Page 1178]]

 
1.664-1....................................................    1545-0196
1.664-1(a)(7)..............................................    1545-1536
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
1.671-5....................................................    1545-1540
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
                                                               1545-1588
1.736-1....................................................    1545-0074
1.743-1....................................................    1545-0074
                                                               1545-1588
1.751-1....................................................    1545-0074
                                                               1545-0099
                                                               1545-0941
1.752-5....................................................    1545-1090
1.752-7....................................................    1545-1843
1.754-1....................................................    1545-0099
1.755-1....................................................    1545-0099
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
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1.6031(a)-1................................................    1545-1583
1.6031(b)-1T...............................................    1545-0099
1.6031(c)-1T...............................................    1545-0099
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...................................................    1545-1617
1.6038-3...................................................    1545-1617
1.6038A-2..................................................    1545-1191
1.6038A-3..................................................    1545-1191
                                                               1545-1440
1.6038B-1..................................................    1545-1617
1.6038B-1T.................................................    1545-0026
1.6038B-2..................................................    1545-1617
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
                                                               1545-1705
1.6041-2...................................................    1545-0008
                                                               1545-0119
                                                               1545-0350
                                                               1545-0441
                                                               1545-1729
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
                                                               1545-1705
1.6045-2...................................................    1545-0115
1.6045-4...................................................    1545-1085
1.6046-1...................................................    1545-0704
                                                               1545-0794
                                                               1545-1317
1.6046-2...................................................    1545-0704
1.6046-3...................................................    1545-0704
1.6046A....................................................    1545-1646
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
1.6050L-2T.................................................    1545-1932
1.6050S-1..................................................    1545-1678
1.6050S-2..................................................    1545-1729
1.6050S-3..................................................    1545-1678
1.6050S-4..................................................    1545-1729
1.6052-1...................................................    1545-0008
1.6052-2...................................................    1545-0008
1.6060-1...................................................    1545-0074
1.6061-1...................................................    1545-0123

[[Page 1183]]

 
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
1.6081-6...................................................    1545-0148
                                                               1545-1054
1.6081-7...................................................    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
1.6153-1...................................................    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
1.6662-3(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
1.6695-2...................................................    1545-1570
1.6696-1...................................................    1545-0074
                                                               1545-0240
1.6851-1...................................................    1545-0086
                                                               1545-0138
1.6851-2...................................................    1545-0086
                                                               1545-0138
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
1.7701(l)-3................................................    1545-1642
1.7872-15..................................................    1545-1792
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
7.465-1....................................................    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

[[Page 1184]]

 
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
                                                               1545-1612
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
                                                               1545-1707
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
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
25.2702-5..................................................    1545-1485
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
                                                               1545-1892
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
31.3121(v)(2)-1............................................    1545-1643
31.3302(a)-2...............................................    1545-0028

[[Page 1185]]

 
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)..............................................    1545-1484
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
                                                               1545-1819
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
                                                               1545-0074
                                                               1545-0718
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31.6011(a)-2...............................................    1545-0001
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31.6011(a)-3...............................................    1545-0028
31.6011(a)-3A..............................................    1545-0955
31.6011(a)-4...............................................    1545-0034
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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
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31.6065(a)-1...............................................    1545-0029
31.6071(a)-1...............................................    1545-0001
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31.6071(a)-1A..............................................    1545-0955
31.6081(a)-1...............................................    1545-0008
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31.6091-1..................................................    1545-0028
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31.6205-1..................................................    1545-0029
31.6301(c)-1AT.............................................    1545-0035
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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
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31.6413(c)-1...............................................    1545-0029
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31.6414-1..................................................    1545-0029
32.1.......................................................    1545-0029
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32.2.......................................................    1545-0029
35a.3406-2.................................................    1545-0112
35a.9999-5.................................................    1545-0029
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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
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40.6302(c)-3(b)(2)(ii).....................................    1545-1296
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40.6302(c)-3(e)............................................    1545-1296
40.6302(c)-3(f)(2)(ii).....................................    1545-1296
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48.4061(a)-1...............................................    1545-0023
48.4061(a)-2...............................................    1545-0023
48.4061(b)-3...............................................    1545-0023
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48.4081-3T.................................................    1545-1897
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
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48.6416(b)(1)-3............................................    1545-0723
48.6416(b)(1)-4............................................    1545-0723
48.6416(b)(2)-1............................................    1545-0723
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48.6416(b)(5)-1............................................    1545-0723
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48.6416(e)-1...............................................    1545-0023
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48.6416(f)-1...............................................    1545-0023
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49.4251-2..................................................    1545-1075
49.4251-4(d)(2)............................................    1545-1628
49.4253-3..................................................    1545-0023
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49.4264(b)-1...............................................    1545-0023
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49.4271-1(d)...............................................    1545-0685
52.4682-1(b)(2)(iii).......................................    1545-1153
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52.4682-2(d)...............................................    1545-1153
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52.4682-3(c)(2)............................................    1545-1153
52.4682-3(g)...............................................    1545-1153
52.4682-4(f)...............................................    1545-1153
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52.4682-5(d)...............................................    1545-1361
52.4682-5(f)...............................................    1545-1361
53.4940-1..................................................    1545-0052
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53.6011-1..................................................    1545-0049
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53.6161-1..................................................    1545-0575
54.4972-1..................................................    1545-0197
54.4975-7..................................................    1545-0575
54.4977-1T.................................................    1545-0771
54.4980B-6.................................................    1545-1581
54.4980B-7.................................................    1545-1581
54.4980B-8.................................................    1545-1581
54.4980F-1.................................................    1545-1780
54.4981A-1T................................................    1545-0203
54.6011-1..................................................    1545-0575
54.6011-1T.................................................    1545-0575
54.9801-3..................................................    1545-1537
54.9801-4..................................................    1545-1537
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157.6001-1.................................................    1545-1824
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301.6047-1.................................................    1545-0367
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301.6057-1.................................................    1545-0710
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301.6059-1.................................................    1545-0710
301.6103(c)-1..............................................    1545-1816
301.6103(n)-1..............................................    1545-1841
301.6103(p)(2)(B)-1........................................    1545-1757
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301.6104(a)-5..............................................    1545-0056
301.6104(a)-6..............................................    1545-0056
301.6104(b)-1..............................................    1545-0094
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301.6104(d)-1..............................................    1545-1655
301.6104(d)-2..............................................    1545-1655
301.6104(d)-3..............................................    1545-1655
301.6109-1.................................................    1545-0003
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301.6109-3.................................................    1545-1564
301.6110-3.................................................    1545-0074
301.6110-5.................................................    1545-0074
301.6111-1T................................................    1545-0865
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301.6111-2.................................................    1545-0865
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301.6112-1.................................................    1545-0865
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301.6112-1T................................................    1545-0865
                                                               1545-1686
301.6114-1.................................................    1545-1126
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301.6222(a)-2..............................................    1545-0790
301.6222(b)-1..............................................    1545-0790
301.6222(b)-2..............................................    1545-0790
301.6222(b)-3..............................................    1545-0790
301.6223(b)-1..............................................    1545-0790
301.6223(c)-1..............................................    1545-0790
301.6223(e)-2..............................................    1545-0790
301.6223(g)-1..............................................    1545-0790
301.6223(h)-1..............................................    1545-0790
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301.6224(c)-1..............................................    1545-0790
301.6224(c)-3..............................................    1545-0790
301.6227(c)-1..............................................    1545-0790
301.6227(d)-1..............................................    1545-0790
301.6229(b)-2..............................................    1545-0790
301.6230(b)-1..............................................    1545-0790
301.6230(e)-1..............................................    1545-0790
301.6231(a)(1)-1...........................................    1545-0790
301.6231(a)(7)-1...........................................    1545-0790
301.6231(c)-1..............................................    1545-0790
301.6231(c)-2..............................................    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
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301.6361-2.................................................    1545-0024
301.6361-3.................................................    1545-0074
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301.6402-5.................................................    1545-0928
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301.6404-2T................................................    1545-0024
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301.6405-1.................................................    1545-0024
301.6501(c)-1..............................................    1545-1241
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301.6501(d)-1..............................................    1545-0074
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301.6501(o)-2..............................................    1545-0728
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301.6689-1T................................................    1545-1056
301.6707-1T................................................    1545-0865
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301.6708-1T................................................    1545-0865
301.6712-1.................................................    1545-1126
301.6723-1A(d).............................................    1545-0909
301.6903-1.................................................    1545-0013
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301.7216-2(o)..............................................    1545-1209
301.7425-3.................................................    1545-0854
301.7430-2(c)..............................................    1545-1356
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301.9100-4T................................................    1545-0016
                                                               1545-0042
                                                               1545-0074
                                                               1545-0129
                                                               1545-0172
                                                               1545-0619
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
301.9100-14T...............................................    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 509...................................................    1545-0846
Part 513...................................................    1545-0834
Part 514...................................................    1545-0845
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, which appears in the 
Findings Aids section of the printed volume and on GPO Access.

[[Page 1191]]



List of CFR Sections Affected



All changes to sections of Part 1 (Sec. Sec.  1.61 to 1.169) of Title 26 
of the Code of Federal Regulations that were made by documents published 
in the Federal Register since January 1, 2001, 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, 2001, see the ``List of CFR Sections 
Affected, 1949-1963, 1964-1972, 1973-1985, and 1986-2000,'' published in 
11 separate volumes.

                                  2001

26 CFR
                                                                   66 FR
                                                                    Page
Chapter I
1.118-2 Added.......................................................2254
1.125-3 Added......................................................52677
    Corrected......................................................63920
1.125-4 (g) amended................................................52680
1.132-9 (b) corrected..............................................18190
1.141-3 (c)(3), (d)(3)(i)(A), (ii)(A), (f) Examples 10, 12, 13, 15 
        and 16 amended.............................................58062
1.141-15 (b) existing text designated as (b)(1); new (b)(1) 
        heading and (2) added......................................58062

                                  2002

26 CFR
                                                                   67 FR
                                                                    Page
Chapter I
1.72(p)-1 amended..................................................71824
1.121-1 Revised....................................................78361
1.121-2 Revised....................................................78361
1.121-3 Revised....................................................78361
1.121-3T Added.....................................................78369
1.121-4 Revised....................................................78361
1.121-5 Removed....................................................78367
1.141-0 Amended....................................................59759
1.141-2 (d)(e)(ii)(B) amended......................................59759
1.141-7 Added......................................................59759
    Corrected......................................................70845
1.141-7T Removed...................................................59763
1.141-8 Added......................................................59763
1.141-8T Removed...................................................59765
1.141-15 (a) revised; (f) through (i) added........................59765
1.141-15T Removed..................................................59765
1.152-3 (c) removed................................................20031
1.152-3T Added.....................................................20031

                                  2003

26 CFR
                                                                   68 FR
                                                                    Page
Chapter I
1.61-2 (d)(2)(ii)(a) and (b) redesignated as (A) and (B); new 
        (d)(2)(ii)(A) amended......................................54344
1.61-22 Added......................................................54344
    (d)(3)(i), (4)(ii)(A), (5)(ii) and (h) Example 1 and Example 4 
corrected..........................................................63735
1.62-2 (e)(2) amended..............................................39011
1.66-1 Added.......................................................41070
1.66-2 Added.......................................................41070
1.66-3 Added.......................................................41070
1.66-4 Added.......................................................41070
1.66-5 Added.......................................................41070
1.72(p)-1 Corrected...........................................9532, 9533
1.83-1 (a)(2) amended..............................................54351
1.83-3 (a)(1) and (e) amended......................................54351
1.83-6 (a)(5) redesignated as (a)(6); new (a)(5) added.............54352
1.83-7 (d) added...................................................39454
1.83-7T Added......................................................39454
1.108-7T Added.....................................................42592
    (a)(2) and (d) Examples 3 and 4 corrected...............50711, 56556
1.121-4 (e) correctly amended.......................................6350
1.141-0 Amended....................................................45775
1.141-5 (c)(2)(ii) revised; (c)(2)(iii) and (iv) added.............45775
1.141-15 (b)(3) added..............................................45775
    Technical correction...........................................52975
1.148-0 (c) amended.........................................45775, 69022

[[Page 1192]]

1.148-1 (e)(1) and (2) revised.....................................45775
1.148-5 (e)(2)(iii) revised; (e)(2)(iv) removed....................69022
1.148-11 (j) added.................................................45777
    (i) revised....................................................69023
1.152-3 (a)(4) and (b) revised; (c) added...........................4920
1.152-3T Removed....................................................4921
1.163-9T (b)(2)(i)(A) amended......................................13226
1.167(a)-14 (b)(1), (e) heading and (2) revised; (e)(3) added......52990
1.167(a)-14T Added.................................................52991
    (e)(3) corrected...............................................63734
1.168(d)-1 (d) heading and (b)(3)(ii) revised; (d) redesignated as 
        (d)(1); (d)(2) added.......................................52991
1.168(d)-1T Added..................................................52991
    (d)(2) corrected...............................................63734
1.168(k)-0T Added..................................................52991
1.168(k)-1T Added..................................................52992
    (f)(5)(iii)(A) and (g)(1) corrected............................63734
1.169-3 (a) and (b)(2) revised; (g) added..........................53004
1.169-3T Added.....................................................53004
    (g) corrected..................................................63734

                                  2004

26 CFR
                                                                   69 FR
                                                                    Page
Chapter I
1.61-8 (b) amended.................................................41192
1.72(p)-1 Amended..................................................78153
1.83-7 (a) amended; (a)(1) and (2) added; (d) revised..............48392
1.83-7T Removed....................................................48393
1.108-7 Redesignated from 1.108-7T; heading amended; (c) and (e) 
        revised....................................................26039
1.108-7T Redesignated as 1.108-7...................................26039
1.121-3 (b) through (f) added; (h) through (k) removed; (l) 
        redesignated as (h) and revised............................50304
1.121-3T Removed...................................................50306
1.121-5 Added......................................................50306
1.141-0 Amended....................................................50066
1.141-16 (c) revised; (d) added....................................50066
1.142-0 Amended....................................................50066
1.142-2 (e) revised................................................50067
1.163(d)-1 Revised.................................................47364
1.163(d)-1T Added..................................................47364
1.167(a)-3 Existing text designated as (a); new (a) heading and 
        (b) added....................................................444
1.167(e)-1 (a) revised; (e) added......................................7
1.167(e)-1T Added......................................................7
    (e) corrected...................................................5273
1.168(a)-1T Added...................................................9533
    (c) corrected..................................................17586
1.168(b)-1T Added...................................................9533
    (b)(2) corrected...............................................17586
1.168(d)-1 (b)(3) revised; (d)(3) added.............................9533
1.168(d)-1T (a) through (b)(3)(ii) revised; (d)(3) added............9533
    (d)(3)(ii) corrected...........................................17586
1.168(i)-0 Amended...........................................9534, 33842
1.168(i)-0T Added...................................................9534
1.168(i)-1 (e)(3)(v) redesignated as (e)(3)(vi); (c)(2)(ii)(E) and 
        new (e)(3)(v) added; (d)(2), (e)(3)(i), (iii)(B)(4), new 
        (vi), (f)(1), (2)(i), (i), (j) and (l) revised..............9534
    (b)(1), (c)(2)(ii)(E), (h)(2) and (l) revised; (c)(2)(ii)(C), 
(D), (h)(1) and (k)(1) amended.....................................33842
1.168(i)-1T Added...................................................9535
    (l)(3)(ii) corrected...........................................17586
    (c)(2)(ii)(E) and (l)(2) revised; (d)(2), (i) and (j) amended 
                                                                   33843
1.168(i)-4 Added...................................................33843
    Technical correction...........................................44597
1.168(i)-5T Added...................................................9536
    (k)(2) corrected...............................................17586
1.168(i)-6T Added...................................................9537
    (c)(4)(v)(A), (5)(iii)(A), (d)(3)(ii)(C), (iii) Examples 1, 2, 
(e)(4) Example 3, (k)(1)(ii) corrected.............................17586
1.168(k)-1T (f)(5)(ii)(F)(2) and (v) revised; (g)(1) and (3) 
        redesignated as (g)(1)(i) and (3)(i); new (g)(1)(i) 
        amended and redesignated in part as (g)(1)(ii); (g)(3)(ii) 
        added.......................................................9546
    (f)(5)(v) Example 5 corrected..................................17586
    (g)(3)(ii).....................................................17587

                                  2005

26 CFR
                                                                   70 FR
                                                                    Page
Chapter I
1.79-1 (d)(3) revised..............................................50971
1.83-3 (e) amended.................................................50971
1.141-0 Amended....................................................75031
1.141-1 (b) amended................................................75032
1.141-13 Added.....................................................75032
1.141-15 (b)(1), (c), (d) and (h) revised; (j) added...............75035
1.143(g)-1 Added...................................................29449
1.145-0 Amended....................................................75035

[[Page 1193]]

1.145-2 (d) added..................................................75035
1.149(d)-1 (g) revised; (h) added..................................75035
1.150-1 (a)(3) and (c)(3)(ii) revised..............................75036
1.163(d)-1 Revised.................................................13100

                                  2006

   (Regulations published from January 1, 2006 through April 1, 2006)

26 CFR
                                                                   71 FR
                                                                    Page
Chapter I
1.118-2 Reinstated; CFR correction.................................11306
1.141-15 (j) corrected..............................................1971

                                  2006

                  (Correction published April 12, 2006)

26 CFR
                                                                   71 FR
                                                                    Page
Chapter I
1.163(d)-1T Removed................................................18623


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